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Frank Albert Fetter.

Source book in economics, selected and ed. for the use of college classes online

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concerning the clianges which affect the values of securities.
From their familiarity with the technique of dealings on the



140 THE NEW YORK EXCHANGES

Exchange, and ability to act in concert with others, and thus
manipulate values, they are supposed to have special advan-
tages over other traders.

(4) Outside operators having capital, experience, and
knowledge of the general conditions of business. Testimony
is clear as to the result which, in the long run, attends their
operations; commissions and interest charges constitute a
factor always working against them. Since good luck and bad
luck alternate in time, the gains only stimulate these men to
larger ventures, and they persist in them till a serious or
ruinous loss forces them out of the "Street."

(5) Inexperienced persons, who act on interested advice,
"tips," advertisements in newspapers, or circulars sent by
mail, or "take flyers" in absolute ignorance, and with blind
confidence in their luck. Almost without exception they
eventually lose.

Marginal trading. It is unquestionable that only a small
part of the transactions upon the Exchange is of an invest-
ment character; a substantial part may be characterized as
virtually gambling. . . . Two practices are prolific of losses,
namely, buying active securities on small margins and buying
unsound securities, paying for them in full. The losses in
the former case are due to the quick turns in the market, to
which active stocks are subject ; these exhaust the margins and
call for more money than the purchasers can supply. The
losses in the latter case are largely due to misrepresentations
of interested parties and unscrupulous manipulations. . . .
"Pyramiding," . . . is the use of paper profits in stock trans-
actions as a margin for further commitments. . . . The prac-
tice tends to produce more extreme fluctuations and more
rapid wiping out of margins. . . .

Short-selling. Contracts and agreements to sell, and de-
liver in the future, property which one does not possess at
the time of the contract, are common in all kinds of business.
The man who has "sold short" must some day buy in order to
return the stock which he has borrowed to make the short sale.



THE NEW YORK EXCHANGES 141

Short-sellers endeavor to select times when prices seem low
in order to buy, their action in both cases serving to lessen
advances and diminish declines of price. In other words,
short-selling tends to produce steadiness in prices, which is
an advantage to the community. No other means of restrain-
ing unwarranted marking up and down of prices has been sug-
gested to us. . . .

Manipulation of prices. A subject to which we have de-
voted much time and thought is that of the manipulation of
prices by large interests. This falls into two general classes:

(1) That which is resorted to for the purpose of making a
market for issues of new securities.

(2) That which is designed to serve merely speculative
purposes in the endeavor to make a profit as the result of
fluctuations which have been planned in advance.

The first kind of manipulation has certain advantages,
and when not accompanied by "matched orders" is unobjec-
tionable per se. It is essential to the organization and carry-
ing through of important enterprises, such as large corpora-
tions, that the organizers should be able to raise the money
necessary to complete them. This can be done only by the
sale of securities. Large blocks of securities, such as are
frequently issued by railroad and other companies, cannot
be sold over the counter or directly to the ultimate investor,
whose confidence in them can, as a rule, be only gradually
established. They must therefore, if sold at all, be disposed
of to some syndicate who will in turn pass them on to middle-
men or speculators, until, in the course of time, they find their
way into the boxes of investors. But prudent investors are
not likely to be induced to buy securities which are not reg-
ularly quoted on some exchange, and which they cannot sell,
or on which they cannot borrow money at their pleasure. If
the securities are really good and bids and offers l)ona fide,
open to all sellers and buyers, the operation is harmless. It
is merely a method of bringing new investments into public
notice.



142 THE NEW YORK EXCHANGES

The second kind of manipulation mentioned is undoubtedly
open to serious criticism. It has for its object either the
creation of high prices for particular stocks, in order to
draw in the public as buyers and to unload upon them the hold-
ings of the operators, or to depress the prices and induce the
public to sell. There have been instances of gross and un-
justifiable manipulation. of securities, as in the case of Amer-
ican Ice stock. . . .

"Wash sales" and "matched orders." In the foregoing
discussion we have confined ourselves to bona fide sales.
. . . Fictitious or so-called "wash sales," . . . are forbid-
den by the rules of all the regular exchanges, and
are not enforceable at law. They are less frequent than
many persons suppose. A transaction must take place upon
the floor of the Exchange to be reported, and if not reported
does not serve the purpose of those who engage in it. If
it takes place on the floor of the Exchange, but is purely a
pretense, the brokers involved run the risk of detection and
expulsion, which is to them a sentence of financial death.
There is, however, another class of transactions called
' ' matched orders, ' ' which differ materially from those already
mentioned, in that they are actual and enforceable contracts.
We refer to that class of transactions, engineered by some
manipulator, who sends a number of orders simultaneously to
different brokers, some to buy and some to sell. These brokers,
without knowing that other brokers have countervailing or-
ders from the same principal, execute their orders upon the
floor of the Exchange, and the transactions become binding
contracts; they cause an appearance of activity in a certain
security which is unreal. . . .

Listing requirements. Before securities can be bought and
sold on the Exchange, they must be examined. The com-
mittee on stock list is one of the most important parts of the
organization, since public confidence depends upon the hon-
esty, impartiality, and thoroughness of its work. While the



THE NEW YORK EXCHANGES 143

Exchange does not guarantee the character of any securities,
or aflRrm that the statemonts filed by the promoters are true,
it certifies that due diligence and caution have been used
by experienced men in examining them. Admission to the
list, therefore, establishes a presumption in favor of the sound-
ness of the security so admitted. Any securities authorized
to be bought and sold on the Exchange, which have not been
subjected to such scrutiny, are said to be in the unlisted de-
partment, and traders who deal in them do so at their own
risk. . . .

Wall Street as a factor. There is a tendency on the part
of the public to consider Wall Street and the New York Stock
Exchange as one and the same thing. This is an error arising
from their location. We have taken pains to ascertain what
proportion of the business transactions on the Exchange is
furnished by New York City. The only reliable sources of
information are the books of the commission houses. An in-
vestigation was made of the transactions on the Exchange for
a given day, when the sales were 1,500,000 shares. The re-
turns showed that on that day 52 per cent, of the total trans-
actions on the Exchange apparently originated in New York
City, and 48 per cent, in other localities.

The Consolidated Stock Exchange. The Consolidated Ex-
change was organized as a mining stock exchange in 1875,
altering its name and business in 1886. Although of far less
importance than the Stock Exchange, it is nevertheless a
secondary market of no mean proportions ; by far the greater
part of the trading is in securities listed upon the main ex-
change, and the prices are based upon the quotations made
there. The sales average about 45,000,000 shares per annum.
The fact that its members make a speciality of ''broken lots,"
i.e., transactions in shares less than the 100 unit, is used as
a ground for the claim that it is a serviceable institution for
investors of relatively small means. But it is obvious that
its utility as a provider of capital for enterprises is exceed-



144 THE NEW YORK EXCHANGES

ingly limited; and that it affords facilities for the most in-
jurious form of speculation вАФ ^that which attracts persons of
small means.

It also permits dealing in shares not listed in the main
exchange, and in certain mining shares, generally excluded
from the other. In these cases it prescribes a form of list-
ing requirements, but the original listing of securities is very
rarely availed of. The rules also provide for dealing in grain,
petroleum, and other products. Wheat is, however, at present
the only commodity actively dealt in, and this is due solely
to the permission to trade in smaller lots than the Produce
Exchange unit of 5,000 bushels.

There are 1225 members, about 450 active, and the member-
ships have sold in recent years at from $650 to $2000. In gen-
eral the methods of conducting business are similar to those
of the larger exchange, and subject to the same abuses.

Very strained relations have existed between the two se-
curity exchanges since the lesser one undertook in 1886 to
deal in stocks. The tension has been increased by the methods
by which the Consolidated obtains the quotations of the other,
through the use of the "tickers" conveying them. It is prob-
able that without the use of these instruments the business
of the Consolidated Exchange would be paralyzed; yet the
right to use them rests solely upon a technical point in a
judicial decision which enjoins their removal. . . .

The Curb Market. There is an unorganized stock market
held in the open air during exchange hours. It occupies a
section of Broad Street. An enclosure in the center of the
roadway is made by means of a rope, within which the traders
are supposed to confine themselves, leaving space on either
side for the passage of street traffic; but during days of
active trading the crowd often extends from curb to curb.

There are about 200 subscribers, of whom probably 150
appear on the curb each day, and the machinery of the opera-
tions requires the presence of as many messenger boys and
clerks. Such obstruction of a public thoroughfare is obviously



THE NEW YORK EXCHANGES 145

illegal, but no attempt has been made by the city authori-
ties to disperse the crowd that habitually assembles there.

This open-air market, we understand, is dependent for the
great bulk of its business upon members of the Stock Ex-
change, approximatel}^ 85 per cent, of the orders executed on
the curb coming from Stock Exchange houses. The Exchange
itself keeps the curb market in the street, since it forbids
its own members engaging in any transaction in any other
securit}'' exchange in New York. If the curb were put under
a roof and organized, this trading could not be maintained.

Its utility. The curb market has existed for upwards of
tliirty years, but only since the great development of trad-
ing in securities began, about the year 1897, has it become
really important. It affords a public market-place where all
persons can buy and sell securities which are not listed on
any organized exchange. Such rules and regulations as exist
are agreed to by common consent, and the expenses of main-
tenance are paid by voluntary subscription. An agency has
been established by common consent through which the rules
and regulations are prescribed.

This agency consists solely of an individual who, through
his long association with the curb, is tacitly accepted as
arbiter. From this source we learn that sales recorded during
the year 1908 were roughly as follows :

Bonds $66,000,000

Stocks, industrials, sliares 4,770,000

Stocks, mining, sliares 41,825,000

Official quotations are issued daily by the agency and
appear in the public press. Corporations desiring their se-
curities to be thus quoted are required to afford the agency
certain information, which is, however, superficial and in-
complete. There is nothing on the curb which corresponds
to the listing process of the Stock Exchange. The latter,
while not guaranteeing the soundness of the securities, gives
a prima facie character to those on the list, since the stock-
list committee takes some pains to learn the truth. The de-

10



146 THE NEW YORK EXCHANGES

eisions of the agent of the curb are based on insufficient data,
and since much of the work relates to mining schemes in dis-
tant States and Territories, and foreign countries, the mere
fact that a security is quoted on the curb should create no
presumption in its favor; quotations frequently represent
''wash sales," thus facilitating swindling enterprises.

Evils of unorganized status. Bitter complaints have
reached us of frauds perpetrated upon confiding persons, who
have been induced to purchase mining shares because they are
quoted on the curb; these are frequently advertised in news-
papers and circulars sent through the mails as so quoted.
Some of these swindles have been traced to their fountain
heads by the Post-office Department, to which complaint has
been made ; but usually the swindler, when cornered, has
settled privately with the individual complainant, and then
the prosecution has failed for want of testimony. Mean-
while the same operations may continue in many other places,
till the swindle becomes too notorious to be profitable.

Notwithstanding the lack of proper supervision and con-
trol over the admission of securities to the privilege of quo-
tation, some of them are meritorious, and in this particu-
lar the curb performs a useful function. The existence of the
cited abuses does not, in our judgment, demand the abolition
of the curb market. Regulation is, however, imperative. To
require an elaborate organization similar to that existing
in the Exchanges would result in the formation of another
curb free from such restraint.

As has been stated, about 85 per cent, of the business of
the curb comes through the offices of members of the New York
Stock Exchange, but a provision of the constitution of that
exchange prohibits its members from becoming members of, or
dealing on, any other organized stock exchange in New York.
Accordingly, operators on the curb market have not attempted
to form an organization. The attitude of the Stock Exchange
is therefore largely responsible for the existence of such
abuses as result from the want of organization of the curb



THE NEW YOUK EXCHANGES 147

market. The brokers dealing on the latter do not wish to
lose their best customers, and hence they submit to these
irreu'ularities and inconveniences.

Responsibility of the Exchange. Some of the members of
the Exchange dealing on the curb have apparently been satis-
tied with the prevailing conditions, and in their own selfish
interests have maintained an attitude of indifference toward
abuses. We are informed that some of the most flagrant cases
of discreditable enterprises finding dealings on the curb
were promoted by members of the New York Stock Exchange.
The present apparent attitude of the Exchange toward the
curb seems to us clearly inconsistent with its moral obliga-
tions to the community at large. Its governors have fre-
quently avowed before the committee a purpose to cooperate
to the greatest extent for the remedy of any evils found to
exist in stock speculation. The curb market as at present con-
stituted affords ample opportunity for the exercise of such
helpfulness. . . .

Bucket shops. Bucket shops are ostensibly brokerage of-
fices, where, however, commodities and securities are neither
bought nor sold in pursuance of customer's orders, the transac-
tions being closed by the payment of gains or losses, as deter-
mined by price quotations. In other words, they are merely
places for the registration of bets or wagers; their machinery
is generally controlled by the keepers, who can delay or manip-
ulate the quotations at will.

The law of this State, w^hich took effect September 1, 1908,
makes the keeping of a bucket shop a felony, punishable by fine
and imprisonment, and in the case of corporations, on second
offenses by dissolution or expulsion from the State. In
the case of individuals the penalty for the second offense is the
same as for the first. These penalties are imposed upon the
theory that the practice is gambling; but in order to estab-
lish the fact of gambling it is necessary, under the New York
law, to show that both parties to the trade intended that it
should be settled by the payment of differences, and not by



148 THE NEW YORK EXCHANGES

delivery of property. Under the law of Massachusetts it is
necessary to show only that the bucket-shop keeper so intended.
The Massachusetts law provides heavier penalties for the
second offense than for the first, and makes it a second offense
if a bucket shop is kept open after the first conviction. . . .
There has been a sensible diminution in the number of bucket
shops in New York since the act of 1908 took effect, but there
is still much room for improvement.

Continuous quotations of prices from an exchange are in-
dispensable to a bucket shop, and when such quotations are
cut off this gambling ends; therefore every means should be
employed to cut them off. . . .

The major commodity exchanges. Of the seven commodity
exchanges of New York, three dealing with produce, cotton,
and coffee are classed as of major importance; two organized
by dealers in fruit and hay, are classed as minor; and two
others, the Mercantile (concerned with dairy and poultry prod-
ucts) and the Metal (concerned with mining products) are
somewhat difficult of classification, as will appear hereafter.
The business transacted on the three major exchanges is
mainly speculative, consisting of purchases and sales for future
delivery either by those who wish to eliminate risks or by
those who seek to profit by fluctuations in the value of prod-
ucts. "Cash" or "spot" transactions are insignificant in
volume.

The objects, as set forth in the charters, are to provide
places for trading, establish equitable trade principles and
usages, obtain and disseminate useful information, adjust con-
troversies, and fix by-laws and rules for these purposes.

Trading in differences of price and "wash sales" are
strictly prohibited under penalty of expulsion. All con-
tracts of sale call for delivery, and unless balanced and can-
celled by equivalent contracts of purchase, must be finally
settled by a delivery of the merchandise against cash payment
of its value as specified in the terms of the contract; but
the actual delivery may be waived by the consent of both



TIIK NEW YOUK EXCHANGES 149

parties. Possession is For the most part transferred from
the seller to the purchaser by warehouse receipts entitling the
holder to the ownership of the goods described.

Dealing in "futures." The selling of agricultural prod-
ucts for future delivery has been the subject of much con-
troversy in recent years, A measure to prohibit such selling,
known as the Hatch Anti-Option Bill, was debated at great
length in Congress during the years 1892, 1893 and 1894.
Although it passed both House and Senate in different forms,
it was finally abandoned by common consent. Similar
legislation in Germany has proved injurious; and when at-
tempted by our States it has eith.er resulted detrimentally or
been inoperative. The subject was exhaustively considered
by the Industrial Commission of Congress which in 1901 made
an elaborate report (volume VI), showing that selling for
future delivery, based upon a forecast of future conditions
of supply and demand, is an indispensable part of the world's
commercial machinery, by which prices are, as far as pos-
sible, equalized throughout the year to the advantage of both
producer and consumer. The subject is also treated with
clearness and impartiality in the Cyclopedia of American
Agriculture, in an article on "Speculation and Farm
Prices"; where it is shown that since the yearly supply of
wheat, for example, matures within a comparatively short
period of time somebody must handle and store the great
Ijulk of it during the interval between production and con-
sumption. Otherwise the price will be unduly depressed at
the end of one harvest and correspondingly advanced before
the beginning of another.

Buying for future delivery causes advances in prices; sell-
ing short tends to restrain inordinate advances. In each
case there must be a buyer and a seller and the interaction
of their trading steadies prices. Speculation thus brings
into the market a distinct class of people possessing capital
and s{)eeial training who assume the risks of holding and
distributing the proceeds of the crops from one season to



150 THE NEW YORK EXCHANGES

another with the minimum of cost to producer and con-
sumer.

Hedging. A considerable part of the business done by
these exchanges consists of "hedging." This term is applied
to the act of a miller, for example, who is under contract
to supply a given quantity of flour monthly throughout the
year. In order to insure himself against loss he makes a
contract with anybody whom he considers financially re-
sponsible to supply him wheat at times and in the quantities
needed. He "hedges" against a possible scarcity and eon-
sequent rise in the price of wheat. If the miller were re-
stricted in his purchases to. persons in the actual possession
of wheat at the time of making the contract he would be
exposed to monopoly prices. If the wheat producer were
limited in his possibilities of sale to consumers only, he would
be subjected to the depressing effects of a glut in the market
in June and September, at times of harvest.

To the trader, manufacturer, or exporter, the act of trans-
ferring the risk of price fluctuations to other persons who
are willing to assume it, has the effect of an insurance. It
enables him to use all of his time and capital in management
of his own business instead of devoting some part of them
to contingencies arising from unforeseen crop conditions.

Alternative contracts, margins, settlements. In order to
eliminate the risk of a shortage of specific grades of the mer-
chandise thus traded in, contracts generally permit the delivery
of alternative grades, within certain limits, at differential
prices; and if the grade to be delivered be not suitable for
the ultimate needs of the purchaser, it can under ordinary cir-
cumstances be exchanged for the grade needed, by the pay-
ment of the differential. It is true that in this exchange of
grades there is sometimes a loss or a profit, owing to some
unexpected diminution or excess of supply of the particular
grade wanted, due to the weather or other natural causes.

Deposits of cash margins may be required mutually by
members at the time of making contracts, and subsequent



THE NEW YOKK EXCHANGES 151

additional ones if market fluctuations justify. Dealings for
outsiders are usually upon a 10 per cent, margin; obviously
if this margin were increased generally, say to 20 per cent.,
a considerable part of the criticism due to losses in specula-
tion, particularly as to the Cotton Exchange, would be elim-
inated.

The major part of the transactions are adjusted by clear-
ing systems, the method most prevalent being "ring settle-
ments," by which groups of members having buying and
selling contracts for identical quantities offset them against
each other, canceling them upon the payment of the differences
in prices.

The Produce Exchange. The New York Produce Exchange
was chartered by the Legislature in 1862, under the style of
the "New York Commercial Association." The charter has
been amended several times; in 1907 dealing in securities,
as well as in produce, was authorized. There are over 2000
members, but a large number are inactive. Some members
are also connected with the Stock and Cotton Exchanges. The
business includes dealing in all grains, cottonseed oil, and
a dozen or more other products; wheat is, however, the chief
subject of trading, and part thereof consists of hedging by
and for millers, exporters, and importers, both here and
abroad. The quantity of wheat received in New York in the
five years 1904-1908 averaged 21,000,000 bushels annually.
No record of "cash" sales is kept. The reported sales of



Online LibraryFrank Albert FetterSource book in economics, selected and ed. for the use of college classes → online text (page 12 of 30)