rnings from his securities in 1928 and in 1929, after the crash, his curities were worth between $20,000,000 and $30,000,000. The hers did not do quite as well as that, but quite well I would say. hey all made very substantial earnings, and the potentialities were me $54,000,000.

Senator HUGHES. By way of manipulation?

Mr. STERN. Yes. There was a second method of making profits id that method was by just shifting from one company to another. think that might best be shown by way of illustration, and while is not the most important instance yet it is one of the most fantastic. Mr. Chairman, I should like to also have this chart in the record: Senator WAGNER (Chairman of the subcommittee). The chart you ave heretofore been using, as well as that chart, may be made a art of the record.

(The chart entitled "Performance and Control of the Principal ompanies of the United Founders Corporation Group" and the hart headed "Intercompany Transactions in International Securities Corporation of America, Class B, Common Stock" and the chart eaded "Intercompany Transactions in United States Electric Power Corporation.)

Senator WAGNER (chairman of the subcommittee). You may proeed now with your statement.

Mr. STERN. If you will look at this chart you will find American Founders Corporation had purchased securities of International Seurities Corporation of America. It had those securities at $8.62. t sold some to Second International Securities Corporation, which hen sold later to United Founders Corporation. It sold some to Jnited States and British International Co., Ltd., which then sold ater to United Founders Corporation. Second International sold some to Investment Trust Associates, which sold to United Founders Corporation. So that by this whirligig method they all were sold, n this way.

Originally those stocks were on the books at $8.62 a share.

At the nd of this transaction, which took several months, they were back in American Founders at 35. Of course they were not profits at all. The sum of $600,000 went to inflate the income account of these lifferent companies by this process. Sometimes they were a little it more complex in their technique, as is shown by this second smaller chart which I believe has been made a part of the record.

Senator WAGNER (chairman of the subcommittee). Yes; that was ordered made a part of the record along with the other two charts. Mr. STERN. In this second chart the technique was a little bit more devious. There the United States Electric Power Corporation—and, Senators, if I go too fast stop me, because this was a rather complex transaction, both in the way it was handled and in the way it was recorded.

The American Founders Corporation held certain stocks of United States Electric Power Corporation. It gave rights to purchase those stocks to its stockholders. Among those stockholders was United Founders Corporation. United Founders Corporation had then rights to buy some 990,000 shares. Those rights it waited with until the very last day on which rights could be exercised and then sold them to an affiliate for $5,000,000. Then the affiliate exercised the rights, as you can see by the broken line on the chart; it subscribed for the

221147-40-pt. 1——7

1. Purchased 20,000 shares at $8.62 per share.

2. Sold 5,000 shares at $25 per share, profit $81,900.
3. Sold 15, 000 shares at $25 per share, profit $245,700.
4. Sold 7,000 shares at $30 per share, profit $35,000.
5. Sold 5,000 shares at $35.70 per share, profit $53,500.
6. Sold 8,000 shares at $35.70 per share, profit $85,600.
7. Sold 7,000 shares at $35.70 per share, profit $39,900.
8. Repurchased 20,000 shares at $35.70 per share, including
a total of $541,600 intercompany profits beyond original
cost of $172,400.

SECOND INTERNATIONAL
SECURITIES CORPORATION

DS-1478

INTERCOMPANY TRANSACTIONS IN UNITED STATES ELECTRIC POWER CORPORATION RIGHTS AND COMMON STOCK

23-1477

stock from American Founders, it exercised those rights, and then 3 days later sold them back to United Founders.

Well, United Founders recorded that it had made $5,000,000 profit in that transaction. It was not a profit of $5,000,000. They called those rights dividends and they were recorded on the books of American Founders as dividends, not even as investment profits. That was $5,000,000 by the mere process of passing it from one company and back again.

There were varying processes in these techniques. There were those two forms, one of selling to insiders on options far below the market; and the other form, that of running them around through the companies. Those two forms were forms by which United worked up this $46,000,000 profit. And I might add that the $46,000,000 does not include $5,000,000 of dividends I have just discussed. And that would have brought it up to $51,000,000 made out of these intercompany transactions.

I think one of the things important in connection with United Founders Corporation that complicates us as much as it probably did them, is this: There is something almost narcotic about these figures, so that they became almost meaningless to them.

Gentlemen, this question of the manipulation of profits assumed many forms and the techniques that were used were extremely skillful. Frequently the profits would be routed to one company just at the end of the fiscal year, so that the report would look good. In other instances the profits would be routed to a company to sweeten a public offering that it was just about to make. Thus, in one transaction where Investment Trust Associates was just about to offer its stockholders rights to buy additional shares of its stock, profits of $2,700,000 were routed to it within 4 days prior to the issuance. The other companies in the group made $4,000,000 on the offer of the securities to other companies in the group, so that the transaction was very skillfully recorded and used at the time it was necessary to show the profit.

Witness after witness, when they were questioned on the stand, expressed emphatic disapproval, in retrospect, of what had happened, and one of them at least stated that he was astonished to find, although he was a director, that the transactions had had anything like this magnitude—in fact, several of the directors stated that they just did not know this kind of process was going on to anything like that extent. Senator WAGNER. Did any of those who so testified participate in these manipulations of profits?

Mr. STERN. Some of them did.

Senator WAGNER. Were they surprised at their own manipulations? Is that what you mean?

Mr. STERN. I think, Senator, that a lot of people at that time had a notion that this was what was called an underwriting, although the essential difference between this and an underwriting was that they never assumed responsibility; for instance, in the General Investment Corporation case, between that spread of $12 and $30 there was not any binding subscription on the part of these gentlemen, and they did not take up other allotments until after a market had been established for about 15 days.

Senator WAGNER. Did you ascertain whether or not the market was established by wash sales at all?

Mr. STERN. Senator, we got admissions from these gentlemen that the Founders companies were the dominant factors in the market. It was a comparatively small phase of the Founders investigation, so we did not go into the question of wash sales, but you can draw your own conclusions from these facts: In 1 year Founders General sold $400,000,000 of group securities and in the same year it bought $220,000,000 of securities. In the next year Founders bought back more than it sold. So that had it been important, I think we might have established pretty definitely, and I think the record leads to the sound inference, that the market was very much made by Founders General. Of course, wash sales are not the only form of market manipulation. Senator WAGNER. No; they are a form.

Mr. STERN. They are a form.

Senator WAGNER. I take it that since the establishment of the Securities and Exchange Commission it has become almost impossible now to manipulate in that way?

Mr. STERN. Probably so, where the Commission has jurisdiction. Now, in order to make these profits, there, of course, had to be a very effective distributing organization, and it was the emphasis on distribution as much as anything else, I think that brought about the Founders' difficulties, because they found that they could raise money so easily, as one of the former officers of the company said, "the difficulty and the dilemma is that you can usually raise money at a time when it is least profitable to invest it"—that is, the easier it is to raise money, the harder it may be to invest it.

Therefore, there was no particular reason for creating the new company except the fact that they could raise money and there was great pressure on them to go from one enterprise into another and, also, the other pressure that it was lucrative to the insiders and essential for the making of their profits by the existing Founders companies to have this continual flow of capital.

Then there was one other feature in it. The very distribution, as you gentlemen will see on reflection, creates a vicious circle. Founders General was this wholly owned distribution concern and Founders General had a very heavy overhead. They had some 300 employees. In 3 years they had $5,000,000 of expenses. As Mr. Seagrave admitted on the stand, in order to keep that company you had to continue furnishing them with business, so that the thing became a vicious circle. The attention was taken off investments because of distribution. distribution grew, it had to get even bigger in order to keep this corporation alive.

As

There was another factor in the distribution. I think all of them deplored the fact that a company might buy and sell its own securities, but they seemed to have no difficulty with a wholly owned subsidiary buying and selling the securities and sending the proceeds up to them as a kind of dividend, and that looked good on the balance sheet and income account.

Senator WAGNER. Was that because it was a new name; or did you ascertain the reason why they could sell the stock more readily to the subsidiary?

Mr. STERN. They did not sell the stock to the subsidiary. American Founders, for instance, found it was not a very desirable thing for American Founders to buy and sell American Founders stock, but they though there would be no difficulty if Founders General, its wholly owned subsidiary, actually bought and sold American Founders stock,