Charles E. Bailey, Gordon W. Kirk, Marion J. Stanko, and Max W. Bolhover.

Herbert L. Waller, pro se.

FINDINGS AND OPINION OF THE COMMISSION

These are proceedings to determine whether Charles E. Bailey & Company ("registrant"), a Michigan corporation registered as a broker and dealer since 1946, and the designated individual respondents willfully violated the anti-fraud provisions of the Securities Act of 1933 ("Securities Act") and of the Securities Exchange Act of 1934 ("Exchange Act"), as well as the registration provisions of the former statute, in the sale of the capital stock of H. D. Smith Manufacturing Corporation ("Smith Corporation"); and if so, whether the public interest requires revocation of registrant's registration pursuant to Section 15 (b) of the Exchange Act, and whether the individual respondents, officers and salesmen of registrant, should each be held to be a cause of any order entered against registrant.2

Under Section 15 (b) of the Exchange Act, a willful violation of any provision of or rule under the Securities Act and the Exchange Act by, among others, any officer, director, controlling or controlled person of a registered broker or dealer requires us to revoke the registration of the broker or dealer if we find this to be in the public interest. Preliminary investigation in this matter indicated the likelihood of such willful violations by Charles E. Bailey, registrant's president, principal stockholder, and controlling person, and by Gordon W. Kirk, Marion J. Stanko, Max W. Bolhover, Herbert L. Waller, and Lee D. Walker, officers, directors, or controlled persons of registrant during the period under review, May 5 to October 17, 1949. In order to give these persons appropriate notice and the opportunity to participate fully in hearings in which their own conduct would be among the principal issues, and our findings as to such conduct might impose future disabilities upon them, each of these persons

1 Section 15 (b) of the Exchange Act provides in pertinent part:

"The Commission shall, after appropriate notice and opportunity for hearing, by order . . . revoke the registration of any broker or dealer if it finds that such . . . revocation is in the public interest and that (1) such broker or dealer . . . or (2) any partner, officer, director, or branch manager of such broker or dealer (or any person occupying a similar status or performing similar functions), or any person directly or indirectly controlling or controlled by such broker or dealer . . . has willfully violated any provision of the Securities Act of 1933, as amended, or of this title, or of any rule or regulation thereunder . . ."

The notice and order for hearing also raised as an issue whether registrant should be suspended or expelled from membership in the National Association of Securities Dealers, Inc. and the Detroit Stock Exchange pursuant to Sections 15A (1) (2) and 19 (a) (3) of the Exchange Act, respectively. As pointed out below, registrant has ceased its operations and has resigned from membership in the Association and the Exchange.

was made a party to the instant proceedings along with registrant, to which procedure no objection was raised.

A private hearing was held before a hearing officer. Proposed findings of fact and supporting briefs were filed by the respondents and the Division of Trading and Exchanges ("Division"). The hearing officer submitted a recommended decision in which he found that each of the respondents had willfully committed the violations alleged in the order for proceedings, and recommended that registrant's registration be revoked and that each of the individual respondents be held a cause of such revocation. Respondents filed exceptions to the hearing officer's recommended decision and the Division filed a brief in support thereof. We heard oral argument. Subsequently, registrant ceased doing business and filed a request for withdrawal from registration. Upon an independent review of the record, we make the following findings.

FRAUDULENT MISREPRESENTATIONS

Pursuant to an underwriting agreement of January 31, 1949, registrant undertook to sell on a "best efforts" basis 125,000 shares of Smith Corporation capital stock at $2.00 per share, for which registrant was to receive a commission of thirty cents per share sold. Between May 5, 1949, and October 17, 1949, registrant sold to the public 110,000 shares of this stock, and in connection with these sales the mails and facilities of interstate commerce were used.

Smith Corporation was organized in 1946 as the continuation of a partnership formed originally to manufacture metal moldings and subsequently expanded to include the manufacture and sale of bicycle fenders and braces. As of January 31, 1949, in exchange for shares of its stock, the corporation acquired the assets and assumed the liabilities of another company. The assets acquired included an automatic roller chain assembly machine and an exclusive license for the manufacture and sale of this machine and of a new type roller chain to be assembled by it. From the outset, the corporation had constant difficulties with the assembly machine, which was used mainly to assembly bicycle chains, and which never obtained continuous production at its designed capacity of 1,000 chains daily, so that only between 30,000 and 50,000 chains were produced in about fourteen months of operation.

For the eleven months ending January 31, 1949, the corporation sustained a net operating loss of approximately $12,000. As of that date, after reflecting the acquisition, its current liabilities were $327,

Neither Waller, who appeared in his own behalf, nor Walker, who entered no appearance, filed proposed findings, exceptions, or any briefs.

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474, with current assets of only $241,654, of which $104,915 were assigned to secure loans. The funds received by the corporation from the sale of its stock were quickly consumed by the payment of already accrued liabilities and current expenses. On March 17, 1950, five months after the conclusion of the public offering, an involuntary petition in bankruptcy was filed against the corporation. It was adjudicated a bankrupt, and its assets were sold for the benefit of creditors.

It is alleged that to induce the purchase of stock by investors respondents made and caused to be made numerous false or misleading written and oral statements.

1. In conenction with its sales, registrant used a prospectus dated May 5, 1949. The prospectus stated that Smith Corporation had an automatic chain assembly machine which was designed to and did produce three bicycle chains per minute; that for the preceding 45 days the machine produced a daily average of 400 chains; that, with the completion and use of automatic inspection devices to eliminate imperfections in chain parts fed into the assembly machine, daily production would in the management's opinion average 1,000 chains, and that, based on tests conducted by the company, workmen using the assembly machine could achieve five times greater production than by using conventional methods of chain assembly. In fact, however, the machine had turned out three chains per minute only in isolated instances and had not attained continuous production over any 45-day period; satisfactory mechanical inspection devices were never completed, and the maximum daily production of the assembly machine, even with an adequate supply of inspected parts, did not exceed about 800 chains and was rarely attained; the results of the production tests referred to related to the corporation's obsolete hand-assembly method but not to the conventional and speedier semi-automatic processes used in the industry, of which issuer knew nothing.

According to the prospectus, the company had, as of the prospectus date, domestic and foreign orders for chain totalling more than $1,000,000; foreign orders aggregating $385,250 were supported by irrevocable letters of credit, and the company's chain was, in the management's opinion, of a quality acceptable to the market. Included in the recited total were purported orders in the amount of $670,000 from three leading American bicycle manufacturers, but in fact such orders never exceeded $200,000 and had been cancelled prior to the date of the prospectus because of the unsatisfactory quality of the chain. In addition, letters of credit for foreign orders never exceeded $194,000 and had long since expired.

The prospectus further recited that four million bicycle chains annually were required in the United States alone; that foreign chain requirements were ten times the United States figure and that, because of the limited availability of chain domestic distributors were eager to buy from an additional potential source. These allegations presented a misleading picture of the then existing demand for chain and Smith Corporation's ability to participate in supplying such demand. Prior to the issuance of the prospectus it was well known in the industry that domestic production of bicycles had so far outdistanced demand that over half a million bicycles were held in inventories. The demand for chain had consequently slackened, rendering it unlikely that Smith Corporation, not having produced a qualitatively competitive product could make inroads in the reduced markets of established chain manufacturers. And as to issuer's ability to participate in supplying foreign demand, Smith Corporation had been informed by a Dutch customer not only that its chain was defective, but that European manufacturers could furnish chain at a lower price.

The prospectus also stated, under a bold-faced caption entitled “Dividends,” that the company had agreed to put in force a policy of quarterly dividends of 5¢ per share, beginning with the first quarter following the completion of the public offering, in the event that sufficient earned surplus was available. This statement was clearly deceptive and misleading in view of the misrepresentations as to the company's operations and prospects. It was particularly significant in that it provided an aura of authority for respondents' irresponsible oral statements, made throughout the sales campaign and discussed below, concerning dividends and future market value.

2. A press release, a two-page document furnished by the Smith Corporation, was first distributed to members of a potential selling group and to registrant's salesmen at the beginning of the offering. Copies of the release were available at registrant's office and were distributed to investors by certain individual respondents.

Statements were made in the press release as to the capacity and economy of the chain machine and as to issuer's potential development which were even more extravagant than the correlative misstatements in the prospectus distributed at the same time. Thus the release recited that the chain assembly machine turned out a daily minimum of 3,000 accurately made and tested chains at only 60% of its maximum capacity and with only 15 of the labor force needed to produce a like volume with conventional semi-automatic equipment. According to the release, the assembly machine was supplemented by automatic inspection machines inspecting all chain parts at a speed equal

to that of the assembly machine, supplanting about 50 people previously inspecting by hand, and doing a better job, automatically, at 50 of the cost of hand operation. In fact, however, the inspection machine for one chain part was 80% deficient, and two of the three remaining inspection machines were completely unsatisfactory, so that, on occasions when it was desired to have the assembly machine operate at a high rate and without frequent jam-ups, sometimes for the purpose of demonstrating it to investors, the inspection machines would not be used and sufficient parts would be hand-inspected in advance. As to the cost, according to one expert's estimate, issuer's chain cost some 50% more to make than its selling price.

A substantial part of the press release dealt with alleged foreign and domestic demand for bicycle and industrial chain, and issuer's ability to participate in filling same. The misleading nature of such statements, in the context in which they were made, has already been shown in connection with the correlative but less sweeping representations in the prospectus.

3. Each of the individual respondents repeatedly made representations concerning, inter alia, the quality of the Smith Corporation's stock, the likelihood of its quick and substantial appreciation and dividend returns, and the similarity of issuer's stock to that of successful companies.

Investors were given to understand that issuer's stock was a safe investment. Thus, Bailey represented that safety was assured because Smith Corporation could profitably sell its chain at a competitive price advantage. Stanko told different customers that the venture was a "sure thing," with "everything to win, in a sense nothing to lose," and that success was assured. Walker told an investor that issuer had an established and profitable molding business so that profits from chain sales would be "gravy," and that he would get his money back at any time. Bolhover, who later characterized the stock as "never anything but a rank speculation," told three customers, respectively, that the investor could not lose, that issuer's backlog of orders and the quality of its chain assured its success, and that he would sell a customer's stock at a profit at any time.

There was no basis for a reasonable belief in the truthfulness of these representations. The high cost and poor quality of issuer's chain did not make it a profitable competitive product. The prospectus itself, which had carefully been explained to each of the respondents, showed that, prior to the beginning of the public offering, Smith Corporation was in dire financial straits, had incurred a loss in its molding and fender business for a preceding period, and was now venturing into a new and untried field.