BANKER AND BROKER
The business of the investment banker must not be confused with that of the bond and stock broker. The two are often combined; but the functions are essentially different.
The broker performs a very limited service. He has properly nothing to do with the original issue of securities, nor with their introduction into the market. He merely negotiates a purchase or sale as agent for another under specific orders.
He exercises no discretion, except in the method of bringing buyer and seller together, or of executing orders. For his humble service he receives a moderate compensation, a commission, usually one-eighth of one per cent. (12 ½ cents for each $100) on the par value of the security sold. The investment banker also is a mere middleman. But he is a principal, not an agent.
He is also a merchant in bonds and stocks. The compensation received for his part in the transaction is in many cases more accurately described as profit than as commission. So far as concerns new issues of government, state and municipal bonds, especially, he acts as merchant, buying and selling securities on his own behalf; buying commonly at wholesale from the maker and selling at retail to the investors; taking the merchant's risk and the merchant’s profits.
On purchases of corporate securities the profits are often very large; but even a large profit may be entirely proper; for when the banker's services are needed and are properly performed, they are of great value. On purchases of government, state and municipal securities the profit is usually smaller; but even a very small profit cannot be justified, if unnecessary.
HOW THE BANKER CAN SERVE
The banker's services include three distinct functions, and only three:
First: Specifically as expert. The investment banker has the responsibility of the ordinary retailer to sell only that merchandise which is good of its kind. But his responsibility in this respect is unusually heavy, because he deals in an article on which a great majority of his customers are unable, themselves, to pass intelligent judgment without aid. The purchase by the investor of most corporate securities is little better than a gamble, where he fails to get the advice of some one who has investigated the security thoroughly as the banker should. For few investors have the time, the facilities, or the ability to investigate properly the value of corporate securities.
Second: Specifically as distributor. The banker performs an all-important service in providing an outlet for securities. His connections enable him to reach possible buyers quickly. And good-will—that is, possession of the confidence of regular customers—enables him to effect sales where the maker of the security might utterly fail to find a market.
Third: Specifically as jobber or retailer. The investment banker, like other merchants, carries his stock in trade until it can be marketed. In this he performs a service which is often of great value to the maker. Needed cash is obtained immediately, because the whole issue of securities can thus be disposed of by a single transaction. And even where there is not immediate payment, the knowledge that the money will be provided when needed is often of paramount importance. By carrying securities in stock, the banker performs a service also to investors, who are thereby enabled to buy securities at such times as they desire.
Whenever makers of securities or investors require all or any of these three services, the investment banker is needed, and payment of compensation to him is proper. Where there is no such need, the banker is clearly superfluous. And in respect to the original issue of many of our state and municipal bonds, and of some corporate securities, no such need exists.
WHERE THE BANKER SERVES NOT
It needs no banker experts in value to tell us that bonds of Massachusetts or New York, of Boston, Philadelphia or Baltimore and of scores of lesser American cities, are safe investments. The basic financial facts in regard to such bonds are a part of the common knowledge of many American investors; and, certainly, of most possible investors who reside in the particular state or city whose bonds are in question.
Where the financial facts are not generally known, they are so simple, that they can be easily summarized and understood by any prospective investor without interpretation by an expert. Bankers often employ, before purchasing securities, their own accountants to verify the statements supplied by the makers of the security, and use these accountants' certificates as an aid in selling. States and municipalities, the makers of the securities, might for the same purpose employ independent public accountants of high reputation, who would give their certificates for use in marketing the securities. Investors could also be assured without banker-aid that the basic legal conditions are sound. Bankers, before purchasing an issue of securities, customarily obtain from their own counsel an opinion as to its legality, which investors are invited to examine.
It would answer the same purpose, if states and municipalities should supplement the opinion of their legal representatives by that of independent counsel of recognized professional standing, who would certify to the legality of the issue.
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