knowledge of what was going on at all. He had no information of any kind. Mr. Cook. So far as what was done here, and that is the provision in the bill requiring information about changing your policy, changing your management, if you want to throw out some directors. I am entirely in accord with things concerning which the stockholders should be and must be consulted. One cannot overnight put somebody in charge of a portfolio which you have trusted, if you please, to the efforts of somebody else and not know the slightest thing about the person who disposes of the portfolio, and that is evidenced by what was done by the Continental Securities, where you have $3,300,000 of a perfectly good portfolio disposed of in 5 months so that you have $50,000 left.. I am obliged for your patience. I am sorry I did not speak a little louder. Senator WAGNER. Are there any questions of Mr. Cook? Thank you very much, Mr. Cook. You have been very helpful. Senator DowNEY. I wonder if I could intervene with a comment that is not concerned with Mr. Cook's statements at all? Senator WAGNER. Yes. Senator DOWNEY. Is there not a better arrangement or better table we could get for this hearing? Senator WAGNER. The other day I pleaded with two members who are on the Committee on Rules. I have been after those two members about that. One of them was here a little while ago, Senator Miller, and the other is Senator Tobey. I realize that we need it very badly. Senator DowNEY. Mr. Chairman, there are a hundred people here who are vitally interested in this and they cannot hear what is going on. Senator WAGNER. I realize that. Our next speaker is Mr. Hugh Fulton. STATEMENT OF HUGH FULTON, ASSISTANT UNITED STATES ATTORNEY, SOUTHERN DISTRICT OF NEW YORK Senator WAGNER. Mr. Fulton, you are the Assistant United States Attorney for the Southern District of New York, and you have had charge of some of the prosecutions and investigations? Mr. FULTON. I am the attorney who has brought the prosecution of those persons who were convicted in connection with the looting of investment trusts, some of which Mr. Cook has referred to and some of which he has not. I might give something of my background. For 8 years I defended corporate litigation in the offices of Cravath, de Gersdoff, Swaine, and Wood, and after Mr. John F. Cahill was appointed district attorney he asked me to go to his office and prosecute certain of these complicated corporate cases. Now, among those there came up the question of the looting of these investment trusts. In the first place, I think an investment trust is a very useful thing. A person who has a small income and small savings is particularly interested in it for the reason that it enables him in effect, you might say, to bet on the United States. He could not possibly afford to buy a share of stock of each of the numerous corporations that are dealt in on, say, the New York Stock Exchange board, but if an investment trust were pooled with the savings of thousands of these small savers into a fund of some millions, it would be able to buy blocks, which would be substantial in size, of a great number of corporations, so that the small investor would be able in effect to take an interest in all of those corporations which he could get through no other means. Now, the particular investment trusts that are involved in Mr. Cook's litigation, and in my trial in the southern district, in the first instance issued securities to the public on circulars which made representations as to an investment policy, but, of course, that is a mere statement of future expectancy, and as the years went by the investments of those companies were changed from time to time. In all instances they were set up in such a way that a large part of the investment was made by persons who had nothing whatever to do with the management or control of the company. For example, in the Insuranshares Corporation of Delaware case fifteen millions of securities were sold to the public, but the control of the company was vested in stockholders who had contributed only $50,000. That difference between management and ownership interest is quite important because of the temptation which it affords to any person who might be dishonest to sell the corporation something that is not worth what he sells it for or to buy from the corporation something that is more valuable than he paid. Worse still, they may make an exchange, and that, of course, makes it necessary for anybody in the position of Mr. Cook and myself to establish in any litigation that we may have that the exchange was not only a bad exchange but that it was an exchange that was intentionally bad, because a mere honest. mistake is a defense. In cases such as the ones that we have had we really have situations where to some extent amateurs, without sufficient financial backing, were doing it in such a raw, crude way that it was apparent, or could be made apparent. After 6 weeks' trial the jury concluded that it was intentional and convicted them. Those convicted consisted of lawyers, some of whom Mr. Cook referred to, and two financial people, one of the financial persons being the individual who in the first instance loaned the money that was necessary to acquire the stock. The whole thing might be said to stem back to a barroom meeting in the Hotel Book-Cadillac in Detroit. There is always the temptation on the part of a dishonest man to buy this stock which would control an investment trust. He does not care whether it has any value. He does not care what the price he pays for it might be, because he intends to foist all of it off on the corporation itself, but those who own the stock cannot, of course, sell it unless they get paid. for it. They are unwilling themselves to participate in what you might term the looting of the trust, so they want to be paid-before they turn over the management-that is, before they cause their directors to resign and before they cause new directors to be elected who are nominees of the purchasers. That means that anyone seeking to buy an investment trust would have to have cash, and in this Book-Cadillac Hotel one of the lawyers who had been convicted realized that another lawyer, who was a former associate of his, was an attorney of supposed reputable standing for one of the largest brokerage houses in the United States, and he conceived the idea that they in the first instance, through deceiving that firm, would get the firm to advance the hundreds of thousands of dollars by a certified check temporarily, so that they could pay for the stock and get control, and in that first instance the First Income Trading Corporation-the old management-changed the board of directors and then in effect wrapped up all of the securities that were readily salable in the investment trust, took them downstairs in an elevator, and delivered them to the brokerage firm against the receipt of the check, which was then, of course, used by the sellers as the payment for their worthless stock. That, of course, was a very easy transaction, and the conspirators went on to further fields. Senator WAGNER. Using the same methods? Mr. FULTON. Yes; they immediately contacted a second trust and in that case they found that the sellers would not cause the board of directors to resign until after the sellers were paid, so that there had to be what they termed an hiatus; in other words, the banking firm or brokerage firm had to loan its money without any security at all for the time being and then wait until the conspirators could get control and could loot the investment trust, by this method that Mr. Cook has described, and hand back to the brokerage firm the portfolio of the investment trust. Now, that meant that as time went on and as transaction piled on transaction, the brokerage firm, I think-beyond a question of doubt through this one partner, at any rate, and the jury has so found by convicting him-knew that this method was being pursued. Now, an investment trust, while it may have hundreds of thousands and even millions of dollars of assets, is little more than a safe deposit box. The securities, which, of course, represent millions, could be placed on several square feet of this table, and they are usually in the custody of a banking house. In addition to that, the investment trust is nothing more than a set of books, ledgers, journals, and minute books, and letters back and forth to security holders. There were one or two people who would determine what investments were to be purchased, and their whole offices in some instances were put in a space less than a third of the size of this room, and, of course, the securities are extremely liquid, and the very nature of an investment trust presupposes that there will be purchases and sales. The only way you can approach one to see whether or not it is legal or illegal is by determining the motives which actuated the sale, and if you have got, in effect, to get into a man's mind and determine that he really knew that it was improper, it is a very difficult thing to do. Now, Mr. Cook has described several of them and I will not describe those any further. I could not do as well as he did on those. To proceed to the next one after his, there was a corporation called Insuranshares Corporation, which was organized through the sale of $10,000,000 of securities to the public and ultimately of another $5,000,000, and, as I say, the management contributed $50,000 and it got in return the voting control which enabled them to change the board of directors and thereby to control the policies of the company. The depression naturally resulted in losses, and at the end of about 1932 the portfolio had declined in value to about $4,000,000, making a realized and unrealized total loss of $11,000,000, if they sold out at that time. Control of that company was sold at that time for $2,000,000, and the stock had been reclassified, so that the $2,000,000 was probably a fair enough price, but the persons who got in control of this company adopted this policy of paying for the control shares in installments and they sold to the investment trust such securities as were necessary to get the money to make the investment trust in effect finance its own purchases at its own expense, and in a year's time the securities of that investment trust had declined from $4,000,000 to about $300,000 in value. Senator WAGNER. Where did that money go? Mr. FULTON. The money went in this way: the securities of the investment trust were sold for securities which were not worth as much as the securities which were sold. Of that sum $2,000,000 went to pay for the investment trust Senator WAGNER. Were there any personal profits made? Mr. FULTON. To the management? Senator WAGNER. To the management, yes. Mr. FULTON. After all, if they paid $2,000,000 for the management and then the investment trust paid that for them in effect by overpaying them in transactions in which they were interested, you could term if you wished to do so, the $2,000,000 as a profit to the management. Now, had they been honest and kept the same securities in that portfolio, they would have gone, through the rise in the market that occurred in 1933, from $4,000,000 to about $7,000,000, so you see the result of that management was the depletion of assets by something over $6,000,000. Senator FRAZIER. In these cases you mentioned did the original investors lose all the money they put in there? Mr. FULTON. You can see that the people who had originally invested now had investments in a company that had only $300,000 of assets. Senator WAGNER. Out of $15,000,000? Mr. FULTON. Out of $15,000,000 originally. Of course, suits were instituted and they were waged over a period of years and they resulted in a net recovery in 1937 of about $300,000 after all expenses and all difficulties had been incurred. Now, at that time that $300,000 was invested by Insuranshares in the stock of another investment trust, New England Fund, which is what we term an open-end trust. It is one of those trusts that values its securities periodically and will give any stockholder his proportionate share of his investment if he cares to turn in his securities. In addition to that block of New England Fund, Insuranshares had about $200,000 of good, salable stock exchange securities, and in addition to that it had a third set of securities that you might term cats and dogs. They had value. Some of them had substantial value and some of them had practically no value and they were not readily salable. The sum total of these assets by that time was, according to the management's own methods of computation, as set forth in their own contract of sale, about $815,000, and the book value, if you had liquidated the company as of that date and accepted the management's estimate of value for each share of stock, was about $2.80 to $2.90 a share. The control of that company was held by a loosely affiliated group of individuals and bankers who held probably 30 percent of the stock, but 30 percent in many instances is working control, because proxies are sent out and not all stockholders come in, anyway. They agreed to sell that 30 percent for a price of about from $3.60 to $3.70 a share, and in the contract by which they agreed to do that they specifically covenanted that the value of the securities would be around $2.80 a share, thereby recognizing a differential for the control value of almost a dollar a share. Now, the company was in such shape that its investment adviser and counselor testified in the Federal Court that he had advised the directors that the only thing to do was to liquidate the company and to hand back to the stockholders whatever share of the assets were left for them. Instead of doing that, they sold this control and the provision in the contract was that they had to deliver the resignations of the directors, and they did just as Mr. Cook indicated before. The old directors, upon the payment of the purchase price for this control block of stock, and one by one as they resigned, elected the nominees of the purchasers. Now, these purchasers were lawyers who had been convicted and are now serving time in the Lewisburg Penitentiary. They are lawyers who had no substantial assets, and their method of buying this control was this: They organized a Canadian company which they called Northern Fiscal Co., Ltd. They had previously participated for commissions in the looting of the other trusts, but this was a venture of their own, and they gave to that company some penny gold stock that they had paid about $1,800 for, but which, of course, amounted to many thousands of shares and looked well. They gave also a thousand dollars in cash for organization and legal fees in return for the entire common stock-that is, the entire stock which had the right to vote. They thus had invested in that corporation less than $3,000, and what they did was to have that corporation sell to an agentI would term him a stooge of theirs-$500,000 of its preferred stock, and then he in turn entered into a contract with the new directors of the Insuranshares Co. to sell Insuranshares that $500,000 par value block of preferred stock for $500,000 in cash. Now, that meant that Insuranshares had given up five-eighths of all of its assets, and substantially all of its readily salable assets, for preferred stock of a company which had total assets of only $3,000. That could not be permitted, so in order to give the Northern Fiscal Co. the appearance of having assets, they had the Northern Fiscal Co. receive this common stock of Insuranshares-precisely the same type of thing that Mr. Cook has described-and then have it receive the sum of about $350,000 in cash. This meant that the net result of that transaction on that day was that Insuranshares had sustained an initial loss, any way you want to figure it, of at least $115,000, and had bought its control stock for the benefit of these lawyers when I say it had sustained a loss of $115,000, that is on the assumption that whatever assets were put in the Northern Fiscal were at least available to sustain some value for its preferred stock. But that is a pretty broad assumption, because the preferred stock had no voting power except in certain events which did not and were not expected to take place, and consequently all of the assets of Insuranshares were |