Although the allowing of interest on margins is contrary to the regulations of the board of directors the practice has been common and has frequently been the subject of complaint.

THE DRAWING DOWN OF MARGINS BECAUSE OF PAPER PROFITS.-While there is nothing in the rules explicitly regulating the practices of members of the Board in relation to margins of future trading customers, the Board has, by resolution, by a rather strained interpretation of the rule prohibiting the rebating of commissions, made it apply to the paying out of paper profits. A resolution adopted August 4, 1914, provides―

That the payment of profits by a commission merchant or broker to a customer on open contracts is a distinct violation of paragraph F, section 9, of Rule XIV of the rules of the Board, and the rule will be strictly enforced.

It appears that this was a reaffirmation of an old ruling, which it transpired was being violated. A petition presented September 28, 1915, asking that this ruling be rescinded on the ground that such action “will greatly benefit one of the most important functions of our market, namely, its use for so-called hedging and spreading transactions," was referred to the violation of rules committee for report and its unfavorable report adopted. It has been found necessary to reaffirm and republish this rule from time to time; in fact, almost from year to year.

Although paper profits can not, under the above ruling, be withdrawn, it is still possible to withdraw a margin deposit when an open trade shows a sufficient profit. Such profits may also be used as a basis for further commitments. These regulations are evidently made primarily in the interest of the commission houses, perhaps chiefly with reference to their accounting convenience, but perhaps also with reference to encouraging the more prompt closing out of speculative open trades.

Hedgers may be considerably inconvenienced by not being allowed to draw down paper profits, as well as by margin calls when, by reason of the hedging nature of the future, they have lost nothing. If the intention is to check speculation, a uniform (or classificatory) margin rule, applicable to all customers, would be more effective.

DIFFERENCE AS REGARDS ACCOUNTING FOR SHORT SALES OF STOCKS AND OF FUTURES.-There is an interesting difference, which is suggested by the situation above discussed, between the bookkeeping treatment and conception of a margin in connection with a speculative stock account and the way it is handled in connection with a grain-futures account. In the case of a long stock account, the margin is the buyer's equity in the stocks held for his account; that is, his equitable interest in the property after claims upon it, specifically the claim of the broker in whose name the property is held, are satisfied. This marginal interest is created in the first instance by a deposit and may be changed by further deposits and withdrawals or by

paper profits and losses. But the broker's accounts and statements show, aside from any changes made by deposits and withdrawals or interest charges and dividend receipts, the net amount owing the broker on the securities held, the latter also being listed by name, but without assignment of value. The margin is the difference between this amount and the market value of the securities. How it was created makes no difference to either broker or customer. In the case of a short account the customer is credited with the price. of the stock sold, plus what he may have to his credit at the time, and his margin is the difference between this amount and the market value of the stock owed to his broker. It is clear, therefore, that as regards stocks there is no distinction, either from an economic or an accounting point of view, between margins and paper profits, except in the memory of the speculator. In grain futures, although it is scarcely to be said that there is an economic difference, there is a difference in the accounting involved. A margin deposit is credited to the customer's regular ledger account, while paper profits are not so credited, and, in fact, no future trade results in any entry in the customer's ledger account until the trade is closed. Then, of course, the profits or losses are not paper, but actual. Hence the accounting view of paying out paper profits on grain is naturally somewhat different from what it is in the case of stocks. The distinction, however, is formal and a matter of procedure, rather than fundamental or economic in character.

HOW PRACTICABLE TO CHARGE NO INTEREST ON CREDITS ALLOWED.Where a credit is allowed a customer on open trades, no interest is charged on the amount of credit used. How it is financially practicable for a commission house to extend credit on such terms appears upon consideration of the methods and effects of settlement by offset. While, theoretically, the commission house is under the necessity of exacting a margin from its customer because it in turn must put up margins on "the street" for trades made and open in the execution of customers' orders, in fact, it is not necessary, because trades of customers are open, that the commission house have trades open with other houses. Some customers are on the short and some on the long side. So far as the open trades are thus on opposite sides of the market, they cancel out on the street and have presumably been settled by the commission house in its dealings with other houses. Thus, if on the books of a commission house there are customers with 500,000 bushels of open trades bought in May wheat and 400,000 bushels of open trades sold in May wheat, the presumption is that, of the total 900,000 bushels of open trades, 800,000 bushels have been settled. If so, the commission house will, while receiving from customers margins on 900,000 bushels, have to put up margins

on only 100,000 bushels, or somewhat more. This does not always work out exactly, because some of the open trades of the broker may not ring out, perhaps because the house from which they are bought wants to make delivery. It might thus happen that of the 800,000 bushels that would ordinarily have been settled 100,000 will be open on both sides. In the nature of the case, the larger the commission house and the greater the variety of its clientele, the greater the proportion of the trades of its customers that will, in general, cancel against each other. Therefore, the larger the volume of business, the smaller the proportion of margins the house will need to put up relatively to the amount that it may exact from its customers on account of trades open on the customers' ledger. To illustrate, an instance is given (doubtless an extreme case) of a house having 30,000,000 bushels of future trades open in its customers' accounts, while breaking practically even on the street. Customers' margins in this case, if they were as much as 3 cents a bushel, would amount to $1,000,000. It is a reasonable inference, and it is known to be a fact, that in the case of some of the larger commission houses the concern has the use of several hundred thousand dollars of customers' money without having to pay interest.

Under such circumstances the commission merchant may be tempted to use margins obtained from customers to protect his personal trades. If it is proper for a broker in futures or a commission house acting for others to speculate on his own account, and if he is entirely solvent, the fact that most of his available cash assets at the moment may be the result of customers' margin deposits makes no essential difference. But it is especially the financially weak broker, who may already be technically insolvent, that is tempted to risk his customer's money.

On the other hand, the situation as regards the difference between customers' margins and margins between houses may work hardship for a small house with a big customer. This applies especially for trades that stay open for a much longer time than the average of future trades. "Of course, a margin is not required of a customer of such financial standing as the X Co.," apparently not even when the trades show a considerable unfavorable difference from the market. Naturally, under such circumstances the commission house will try to devise some way of making a settlement. The saving of margins, as will appear later, is a fundamental reason for various general and special practices in connection with clearings and settlements.

It is conceivable-though in the nature of the case it rarely happens-that the customers of a commission house may have closed their trades while the house is unable to settle them. This house may have 100,000 bushels sold to a second house that has nothing bought

with which to settle. Of course, the first commission house has 100,000 bushels open on the bought side, or else its customers could not be even. But it can not under these circumstances clear the 100,000 bushels off its books. It may, therefore, have to put up margins on both sides for 100,000 bushels, with no deposits from customers to help out. The first commission house under such circumstances will of course try to get out by accommodation transfers1 or some similar device.

IMPORTANCE OF STRICT ATTENTION TO MARGINS.—The selling out of a future contract because of the exhaustion of margins is likely to leave a customer in debt to the broker, because the latter tends to give the customer as much time as practicable, and because the conditions under which margin calls come are usually those of a wild market. With great and rapid fluctuations occurring in the market, it is difficult to cover or liquidate at or near a given price, hence the broker, in attempting to close out his customer's contract only just before or just as the margin is exhausted, is likely to have the order filled somewhat away from the limit or the stop.

The prompt and continual checking of margins, both as between customer and broker and as between house and house, is a matter on which much of the accounting procedure of commission houses hinges.

The extent to which the business of a broker or commission house, because of the employment of margin deposits and credits, takes on the character of banking rather than ordinary mercantile business, is a matter worthy of consideration.

Section 6.-Deliveries on futures in general.

In future contracts delivery is presumably "contemplated." Delivery is, however, not a contingency to be considered until the last month of the life of the option-the "delivery month "—is reached. Then future contracts of the given option that are still open may be the occasion of the transfer of actual grain. The conditions under which such delivery may occur are carefully defined and circumscribed with a view to securing interchangeability and merchantability.

TENDER OF REGULAR WAREHOUSE RECEIPTS.-Under normal conditions, deliveries on future contracts must be effected by the tender of warehouse receipts. Rule XXI, section 1, is as follows:

All deliveries upon contracts for grain or flaxseed, unless otherwise expressly provided, shall be made by tender of regular warehouse receipts, which receipts shall have been registered by an officer duly appointed for that purpose. All such warehouse receipts shall be made to run five days from date of delivery on regular or customary storage charges, which regular or customary charges shall follow such warehouse receipts and be chargeable upon

1 Cf. Ch. V, sec. 9.

the property covered by the same, and shall be issued by such houses as have complied with the rules of the Board of Trade and the regulations and requirements of the board of directors, and have been declared regular warehouses for the storage of grain or flaxseed by said board of directors.1

The qualifying clause, "unless otherwise expressly provided," makes it possible for a contract to be entered into that specifies a particular variety for delivery or other methods than by means of regular warehouse receipts. But the futures market is of course constituted by standardized contracts.

A further clause of the above rule declares that a warehouse must be "carrying on and continue to carry on the legitimate business of public warehousemen under the laws of the State of Illinois." This clause does not appear in the rules for 1887, but is included in 1892 (copies of the rules for intervening years not being available). It was therefore adopted at about the time when the merchandising private elevator began to be important in the terminal market. Minneapolis also provides for the use only of receipts of public warehouses for delivery on futures, while the Duluth and Kansas City rules permit the use of either private or public warehouse receipts.

STORAGE CHARGES.-The new owner of the warehouse receipt thereafter becomes responsible for storage charges, as appears in the rule quoted. This rule covers also the conditions (including location and shipping facilities) under which warehouses may be declared regular, maximum rates chargeable for storage, etc.2, Section 5 of Rule XXI provides that tenders must be of grain covered by insurance to at least 85 per cent of its market. value and protecting the purchaser until 12 m. of the next business day following delivery. The same section specifies the quantities that may be represented by regular warehouse receipts used in delivery, namely, 5,000bushel lots and 1,000-bushel lots. Five 1,000-bushel lots may be combined to effect delivery on a 5,000-bushel contract on the last day of the delivery month.3

1 This section appears in slightly different words in the 1877 rules (Rule XXIV, sec. 1) but not in those for 1869.

66

2 The Chicago Board of Trade supplements its rules by a special code of requirements for grain warehouses in order that their receipts shall be regular for delivery on grain contracts."

*

"On all time contracts of five thousand (5,000) bushels of grain or flaxseed, or any multiple thereof, deliveries shall be made in lots of five thousand (5,000) bushels, and on all time contracts for one thousand (1,000) bushels of grain or flaxseed, or any multiple thereof, except as provided above, deliveries shall be made in lots of one thousand (1,000) bushels." (Rule XXI, sec. 5.)

66

The clause referred to as above reads as follows: 66 On the last business day of any month a party having grain bought in 1,000-bushel lots and sold in 5,000-bushel lots may deliver five 1,000-bushel lots on 5,000-bushel lot contracts not later than five minutes after having received the last 1,000-bushel lot by attaching the five notices firmly to each other and making the usual indorsement on the last notice." (Sec. 2.) This provision appears in the rules for 1881, but not in those for 1877.

"A variation, however, of 1 per cent in the quantity of grain and flaxseed delivered, end that contracted for, shall not vitiate a tender or delivery. Any excess or deficit within the above limits shall be settled for at the current market upon the day of delivery." (Sec. 5.)