If you had to call a meeting of the stockholders to approve this it would mean that whoever put up that money to pay for the controlling stock would have had to wait for days and weeks, and in addition, with that first provision about the change of investment, would have had to take a chance of the stockholders approving the change in investment policy, and in addition to that, would have had to incur the publicity.

Senator WAGNER. The publicity is very important, too, is it not? Mr. FULTON. The publicity is the most important feature.

The third provision I had in mind is section 17, on page 36, which refers to the purchase and the sale of securities between the investment trusts and those affiliated with it.

In each instance you can see that they sold securities to the investment trust and they purchased from the investment trust. Under section 17 they could not have done that without these attendant safeguards and attendant publicity.

For those reasons, I am sure that, whatever may be the merits or demerits of the bill generally, these particular frauds could not have been consummated.

Senator WAGNER. Mr. Fulton, you have had a chance to examine the charters of some of these organizations about which you have testified?

Mr. FULTON. I have.

Senator WAGNER. Is there any limit as to what their activities can be in relation to business transactions?

Mr. FULTON. Of course, it would be impossible to say there is no limit, because it is not infinitive, but, as you know, as a lawyer, those charters contain page after page of the most broad general powers, so that the investment trust could buy, sell, and exchange almost anything for almost any purpose. The only limit that I know of is the limit that at some point either someone like Mr. Cook or someone like the prosecution authorities would step in and say that "You have definitely done this with knowledge and intent to defraud the investment trust and not simply with mistaken business judgment." That is the only limit I know of.

Senator WAGNER. Of course, we do not want to have it understood that all investment trusts are of this type. There are very excellent investment trusts.

Mr. FULTON. There are, and in addition to that, the investment. trust is a very desirable instrumentality for enabling the small investor to spread his risk, and as such should be given real consideration. Senator WAGNER (chairman of the subcommittee). Thank you very much.

I think that we will take a recess until tomorrow morning at 10:30. (Thereupon, at 12:35 p. m. an adjournment was taken until tomorrow, Thursday, April 4, 1940, at 10:30 a. m.)

INVESTMENT TRUSTS AND INVESTMENT COMPANIES

THURSDAY, APRIL 4, 1940

UNITED STATES SENATE,

SUBCOMMITTEE ON SECURITIES AND EXCHANGE

OF THE BANKING AND CURRENCY COMMITTEE.
Washington, D. C.

The subcommittee met, pursuant to adjournment on yesterday, at 10:30 a. m., in room 301, Senate Office Building, Senator Robert F. Wagner presiding.

Present: Senators Wagner (chairman of the subcommittee), Maloney, Hughes, Miller, Downey, Townsend, and Frazier.

Senator WAGNER. The subcommittee will come to order. We will hear Mr. Carl S. Stern.

STATEMENT OF CARL S. STERN, ATTORNEY, SECURITIES AND EXCHANGE COMMISSION, WASHINGTON, D. C.

Mr. STERN. Mr. Chairman and gentlemen of the subcommitteeSenator WAGNER (interposing). I think you had better give your full name. As I understand it you have been one of the special attorneys who have studied the investment trust matter on behalf of the Securities and Exchange Commission, or appointed by them for that purpose.

Mr. STERN. Not quite, sir. My name is Carl S. Stern. I am one of the legal staff of the Securities and Exchange Commission. I was called into this Founders study after the preliminary work of investigation had been done, and I conducted the public hearings. I make this explanation because I do not want to come under any false representations, I wanted to keep within the limits of my connection with the investment trust study, for I merely conducted the hearings in connection with the Founders study. I had no part in the preparation of the reports, except a very tiny one-of reading them over and making suggestions. But I have recently refreshed my recollection so as to re-present this story very much abridged to the committee here. Senator TOWNSEND. You had no part in the preparation of the reports as I understand you?

Mr. STERN. A very small part, that of reading them over to revise them, or to suggest revision here and there. My work was entirely with other parts of the matter. As I have said, I conducted the hearings, and am fully conversant with the facts.

Senator WAGNER. And what you will tell us is in connection with your conduct of the investigation?

Mr. STERN. Yes.

Senator WAGNER. And the facts themselves?

Mr. STERN. That is correct. I was assigned to this from another branch of the Commission, and my part in it was limited to what I have said. I wanted to make that clear to the members of the subcommittee for the very good reason that I do not know as much about the general investment trust study as do a great many other men here, and my knowledge is more or less confined to the Founders system, to what I discovered there.

Senator WAGNER. Tell us about that.

Mr. STERN. In order that you might have some idea of this complex situation we have had these charts prepared, which give you the appearance of the Founders group as that group existed in 1929. This story is quite a different story from that already told to the members of this subcommittee; this is not a story where there was gross or crude fraud. This is a case in which the techniques, such as were used, were refined and which was the art rather of the prospectus writer and the skill in manipulation rather than in crude handling. However, the results for the stockholders were even perhaps more detrimental than in some of the cruder cases.

Senator TOWNSEND. Your first heading states that the United Founders Corporation was formed in February of 1929, and that the capital raised was $301,741,000. Will you state how that capital was raised?

Mr. STERN. Yes, sir; but I did not want to bother with this chart at this time; rather than go into the details just at the moment I wanted to give you the general picture. I will take it up from time to time, and will start at the beginning. The story of Founders starts out with two men and $500. It starts in 1922. One man put in $500, and the other man was a bankrupt, recently discharged from bankruptcy.

Senator TOWNSEND. Who were they?

Mr. STERN. They were William R. Bull and Christopher F. Coombs. From this small beginning, in 7 years the group had become the largest group of investment companies under a single control in this country, or as far as the investment-trust study disclosed, anywhere in the world.

By 1929 the capital paid into the 13 companies shown on that chart by the public exceeded $500,000,000.

Now, so that the subcommittee may get some appreciation of what this $500,000,000 amounted to in comparison with other concerns handling investment funds, I should like to state briefly that there are 564 principal savings banks in the country, and that only one of them exceeded that figure, and that is the Bowery in New York City, and the Bowery's resources as of January 1, 1939, were $583,000,000; that out of 14,931 commercial banks and trust companies in the United States, only 16 had resources in excess of $500,000,000; that of the 306 leading life insurance companies, only 12 showed total assets exceeding $500,000,000. So that of all these savings banks, commercial banks, trust companies, and life insurance companies in the country, only 29 had assets as great or greater than Founders had at its peak.

Looking at it from another point of view, in the six Southern States of North Carolina, South Carolina, Georgia, Florida, Alabama, and Mississippi, the total savings in savings institutions, including postal savings, savings banks, and commercial banks, were $484,000,000.

In the slab of 13 States between the Mississippi River States and the coast, not including Texas, the total savings amounted to $560,000,000.

And so it was that Founders became very much of an imposing edifice, completely unregulated. It became also a national institution. There were 90,000 stockholders, scattered through 44 States. Founders at its peak controlled or held a dominant position in companies that had resources in excess of $2,000,000,000.

Within 3 years after its peak this Founders Group had declined, and the losses to the public were staggering. We will go into those losses later, with your permission. But I might say now the losses amounted to some $390,000,000 considered on an over-all basis. As a matter of fact the losses in the case of some companies were even greater; the losses in the case of some companies were in excess of 90 percent, and in the case of one company, in which $133,000,000 were paid in, the loss was complete. In 5 years that company lost its entire capital. Well, now, that is a slight exaggeration. It did have $132 at the end of that time.

Senator WAGNER. When you speak of "companies" you mean companies indicated on this chart you have handed around to the members of the subcommittee?

Mr. STERN. Yes, and which I will take up in some detail a little later on. I am trying now to give you a general impression of what happened in connection with the Founders Group, what it meant to the American public. The losses to the public were much greater than $370,000,000. The American public poured out money in a great stream, into the various branches of the system, which we will describe in more detail later on, through the purchase of stock; but the figures we now give you are the figures of money actually paid into the company itself.

The people who bought stock bought at a higher price than was charged to insiders. These were the figures representing money paid into the company by the public.

Senator TOWNSEND. Then as I understand you, the public was purchasing the stocks of these companies.

Mr. STERN. That is correct.

The rise and fall of Founders was the subject of some 6,000 pages of testimony and some 900 exhibits which were greater than the testimony itself. It was one of those gigantic jobs done by the Commission; and I can speak of it with enthusiasm because I had nothing to do with it. I merely came in to present the case at the public hearings. But it was a tremendous job, and had taken over a year of preparation prior to the public hearings.

Senator WAGNER. And I think the evidence was not always easy

to secure.

Mr. STERN. Yes; and not only that, but the creative imagination of William R. Spratt, Jr., who worked long and earnestly on this matter, and I might say died as a victim of the Founders study. It was his constructive imagination that brought about a reconstruction of this situation so that we are able to present it as a lucid picture, as I think we can here; and because the picture is so large and the techniques so unusual, we will give you just the high spots. We could not hope to go into the particulars. The various ramifications are so great that we can only give you the high lights.

Starting with the men behind this Founders Group, the two original promoters were Christopher F. Coombs and William R. Bull. Coombs within a year had been discharged in bankruptcy in a case involving the failure of a Wall Street investment house of which he was a partner. Bull was and I think is today a Bridgeport security dealer, and he was then of quite limited means.

In 1925 these men were joined by two others, Frank B. Erwin and Louis H. Seagrave. Erwin was then a security salesman. He had, like Coombs, been one of the bankrupt concern's partners. Seagrave was earning a very modest salary in charge of sales of securities for a security affiliate of the First National of Boston.

I take these four men because they were the controlling inner circle and at the top of the pyramid shown on the chart. There were always these four men until 1928, when Bull dropped out of active direction of these things, and in 1928 the inner circle remained with Coombs, Erwin, and Seagrave. And Seagrave was the man who was known to the public. Mr. Seagrave became the prominent executive in the group, but Mr. Coombs was really the man with the great outstanding interests.

The $500 with which the group was started was furnished by Bull. Coombs did furnish something; he furnished what was called good will of a defunct organization-the good will and what were certainly the outstanding liabilities of a defunct investment concern. These were

the assets at the birth of what was later known as American Founders Corporation, the first functioning company in the group. The $500 was all there was in the way of cash and assets then. But the $500 did not stay there very long because it was borrowed by a company in which Mr. Bull was interested. This seems to have been a tradition.

If you gentlemen of the subcommittee will look at the chart a minute I should like briefly to sketch the way the organization started. First, I have the American Founders Corporation, which is the second company in the pyramid shown on the chart. That company was founded in January of 1922. The other company that existed at that time was International Securities Corporation of America, the first of these two columns of companies at the left. These two companies were all there were to the Founders Group for quite some time. International Securities Corporation of America was said to have been formed in 1921, but that was just on paper. It had no real existence until 1922.

The group remained with these two companies, American Founders and International Securities, and this continued until 1926. In 1926 the experience of International Securities had been such that Second International Securities Corporation was created. Thereafter, in 1928, they began to start more and more companies. They created United States and British International Company, Ltd., and American and General Securities Corporation.

In 1929 the thing really began to expand in enormous drives. Then they added United States Electric Power Corporation along with General Investment Corporation and American & Continental Corporation and United Founders.

It is not necessary to comment on any of these for the moment, except a company near the bottom, which is Founders General Corporation-the second from the bottom on the left-hand side.