As you have seen, all of the so-called "profits" came from the intercompany transactions, but no one could tell that. When they did speak of them they called them investment profits, but they did not tell them what part of the investment profits was due to transactions in group

Senator FRAZIER. What did the accounting companies get out of it for keeping the thing covered up?

Mr. STERN. Substantial accounting fees. I do not believe they got any more, but the fact is, and that is one of the dangers of this thing, that it shows accounting firms of high reputation and distinction in the community just did not protect the public.

When they were asked on the stand about these practices they did not, of course, seriously defend them.

Now, there were certain other things designed for their protection

Senator WAGNER. I think it would be interesting at this point to inquire as to why these accounting firms of reputation did not disclose to the public the accounting system which suppressed the truth, or were they deceived?

Mr. STERN. Senator, perhaps you had better draw your own conclusion from these two facts. I will just tell you them and you can draw your own conclusion.

Senator WAGNER. All right.

Mr. STERN. Mr. Leland Rex Robinson had written a book on investment trusts, and the book had been written on company time, and the book told what the proper accounting principles were, only the principles were not followed in this case, and they were not followed in the case of Mr. Robinson's company, the Second International. Senator FRAZIER. I think some accountants must be like some attorneys they will do what they are told to do if they are paid. Mr. STERN. Senator, a lot of people did a lot of things in 1929. Mr. FRAZIER. Yes; I know.

Senator WAGNER. But you spoke of some dates after 1929. Some of those transactions came after that date.

Mr. STERN. 1929 and 1930, but the fact that the accountants did not do their work is shown by other transactions too.

I am not holding any brief for the accountants. I do not know whether their kind of morality that went into this was higher or lower than the prevailing level. It was rather low, if this is a fair example; I have no way of telling however.

I do not want to go into the details of that, because I understand Mr. Schenker wants to go into that as part of another hearing, but I wanted to tell why it was that these enormous profits could have been concealed not only from the stockholders but from the directors, so that director after director admitted his astonishment.

Then there were other things that were seemingly for the protection of investors. There were some fairly big names, as on the directorate. The directors on the whole-a great many of them--just did not know what was going on, I think, because the concern was run in a group, consisting of Coombs, Erwin, and Seagrave.

For the protection of the stockholders there were these restrictions that were advertised from time to time. I have told you of some that were advertised. Others were advertised and actually evaded, for restrictions could be easily evaded. For instance, I told you that

one company could only buy seasoned securities, defined as a company that had been in existence for 4 years. How did they get around that? There was a company that one of them owned, and it had been operating for 4 years. They did not sell the company. They sold the name. They took out all the assets and securities and they treated it as a new company, and that was one of the ways they evaded that.

Another way was that since it was a restriction in the bylaws, the bylaws were changed.

Still another way you could get around a restriction, as they did here, was to move the public by exchanges from the restricted companies to the unrestricted companies, and the restrictions were not of very much use to them then.

Senator WAGNER. The brokerage fees are perfectly legitimate if paid in a legitimate way. Were there insiders that received these fees in these transactions?

Mr. STERN. I think the brokerage fees, while they might have been fairly large, were fairly clean, but that was not a large matter compared with the others.

Just another word and I will complete my statement. I would like to quote for a minute from Robinson's book, because it seemed to me, after I had found out that one safeguard after another designed for the protection of the stockholders had failed, it was curious to note what Dr. Robinson had said.

He said that one of the evils of the British investment trusts was

The struggle to enhance earnings and increase dividends even by devious processes during times of rapidly accumulating capital and of multiplying security prices. Endeavor to realize trading profits led companies into transactions which would be universally condemned today as too unsound in character to warrant serious consideration on the part of responsible investment trusts.

Then Dr. Robinson continued in language which is curiously reminiscent, now, of what Founders actually did:

In order to realize profits from financing, dealing, issuing, and underwriting, several companies spawned flocks of new ones engaged in a vairety of promoting, financial, and investment activities, and creating a pryamid of paper values.

That, Robinson said, was the thing that had happened in British investment trusts and the thing that could not happen again today. That is exactly what did happen in Founders, and may I say that faced with the fact that this gentleman knew what had happened in the British trusts and the same thing happened over here, I thought it might be useful, for the sake of the record, to ask witnesses whether they thought these large pools of investment funds should go unregulated, and these witnesses were officers and directors of the Founders Group, and every one of the witnesses who was asked the question said that there should be regulation.

Senator WAGNER. May I ask one final question? You have read the bill that is pending now?

Mr. STERN. Yes.

Senator WAGNER. And you have had the experience that you just related to us. Is it your opinion that this legislation, if enacted into law, would prevent very considerably the manipulations you have related here, so that the public would be protected?

Mr. STERN. Senator, I have given very careful consideration to it for the last few days, and I think it may safely be said that while honesty in the last analysis is the only thing that really tells, this

legislation will go a great distance to prevent the kind of thing that happened in the Founders system; that fundamentally it will prevent or put under supervision and that is the only place where you can actually prevent it-the possible breaches of fiduciary relations; that the great fault in Founders was the transactions between companies; and that they will be substantially averted by putting them under regulation.

There is another point, too, about regulation that nothing else can accomplish, and that is the fact that although restrictions fail one after another and you have seen how easy it is to avoid restrictionsthe flexibility of the administrative process is such that a commission charged with the general duty of preventing violations of the fiduciary relation can chart and follow the various forms in which these violations might otherwise occur.

Senator WAGNER. Is it your opinion, as I read in various editorials, that the legislation, when one considers the abuses that have been disclosed, is very mild?

Mr. STERN. I think, Senator, in certain places it might have been heavier. For instance, the very officers of the corporation said that there should be no such thing as a wholly owned distributing company. The legislation does not go that far.

Others have said that there should be no such thing as a banker control of companies.

Senator FRAZIER. Can you tell us how Great Britain cleaned up the situation over there that Dr. Robinson described in his book?

Mr. STERN. I should like to do that, but I do not really think I can, because I do not know. I had nothing to do with that part of it, and my knowledge is so skimpy on that point that I would hate to try to tell you about it.

Senator WAGNER. Perhaps Judge Healy can tell us.

Mr. HEALY. We will have someone who knows about the subject. speak about that.

I would like to call attention with respect to something Mr. Stern mentioned. I would like to call attention to the fact that this bill sets up accounting controls, and this kind of accounting for these pseudo, make-believe profits, that were not profits at all, could not happen under any rational system of accounting control by any regulatory body or by classification of accounts.

I think that the accounting control that is provided for in this bill would be very effective to prevent the repetition of a thing like the Founders.

May I say one other word?

Senator WAGNER. Certainly.

Mr. HEALY. I have here--I do not offer it for the record necessarily a copy of the Commission's opinion in the matter of H. M. Byllesby & Co., where the Commission denied Byllesby's application for an exemption as a holding company as a result of what happened with regard to the Standard Gas & Electric.

I call attention to it because if any of the committee is interested in getting the further history of the relationships between the investment bankers and the companies in the Standard group, they can get from this opinion that is, I think it goes a long way toward demonstrating that the interest of the investment bankers in combining with the United Founders and the United States Electric Power Corporation to get a strong position in Standard Gas & Electric was actuated by

a desire to get the underwriting business of the Standard Gas & Electric subsidiary companies.

There was a company of about a billion dollars-a consolidated balance sheet-and these investment bankers, after this situation that Mr. Stern described, had divided up the banking business in percentages that were actually established in a written contract that is described in this opinion.

Senator WAGNER. I think perhaps the entire opinion ought to go into the record.

Mr. HEALY. Very well.

(The document referred to is as follows:)

[For Immediate Release Monday, January 15, 1940.]

Securities and Exchange Commission, Washington. In the Matter of H. M. Byllesby & Co. and The Byllesby Corporation, File Nos. 31-379 and 31-420. Findings and Opinion of the Commission

[Public Utility Holding Company Act of 1935, sections 2 (a) (7), 3 (a) (3), and 3 (a) (5)]

Appearances.-Gerhard A. Gesell and Sanford L. Schamus, for the Public Utilities Division of the Commission; Herbert H. Thomas, for H. M. Byllesby & Co. and the Byllesby Corporation.

H. M. Byllesby & Co. and the Byllesby Corporation have filed separate applications under section 2 (a) (7) of the Public Utility Holding Company Act of 1935 (hereinafter referred to as the "act") for orders declaring that each is not a holding company under clause (A) of that subsection. In the alternative, the applicants have requested that the Commission should find that they are exempted from the provisions of the act under sections 3 (a) (3) and 3 (a) (5) thereof.

Section 2 (a) (7) (A) defines the term "holding company" for purposes of the

act to mean

"any company which directly or indirectly owns, controls, or holds with power to vote 10 per centum or more of the outstanding voting securities of a publicutility company or of a company which is a holding company by virtue of this clause or clause (B), unless the Commission, as hereinafter provided, by order declares such company not to be a holding company; * * *""

Section 2 (a) (7) further provides:

"The Commission, upon application, shall by order declare that a company is not a holding company under clause (A) if the Commission finds that the applicant (i) does not, either alone or pursuant to an arrangement or understanding with one or more other persons, directly or indirectly control a public-utility or holding company either through one or more intermediary persons or by any means or device whatsoever, (ii) is not an intermediary company through which such control is exercised, and (iii) does not, directly or indirectly, exercise (either alone or pursuant to an arrangement or understanding with one or more other persons) such a controlling influence over the management or policies of any public-utility or holding company as to make it necessary or appropriate in the public interest or for the protection of investors or consumers that the applicant be subject to the obligations, duties, and liabilities imposed in this title upon holding companies." 1

H. M. Byllesby & Co. (hereafter called "Byllesby") is a Delaware corporation with principal offices in Chicago, Ill.; and branch offices in New York City, Philadelphia, Pittsburgh, and Minneapolis. Its primary business is the underwriting and distribution of security issues. Since 1930, Byllesby has owned 330,000 shares of common stock, series B, out of a total of 440,000 shares, of Standard Power & Light Corporation (hereafter sometimes referred to as “Standard Power"), a holding company which is registered under the act. Standard Power, in turn, holds the majority of the common stock of Standard Gas & Electric Co. (hereafter sometimes referred to as "Standard Gas”), another regis

The section likewise provides that the filing of an application thereunder in good faith shall exempt the applicant from any obligation, duty, or liability as a holding company until the Commission has acted upon the application. It is also provided in this section that as a condition to the entry of an order granting any such application, the Commission may require the applicant to apply periodically for a renewal of such order and do or refrain from doing various specified acts in order to insure that the conditions of clauses (i), (ii), and (iii) of the quoted paragraph are satisfied.

Since November 9, 1936, Byllesby's ownership has consisted of a voting trust certificate representing said shares issued pursuant to a voting trust agreement hereinafter described.

221147-40-pt. 1—8

tered holding company, and the dominant company in one of the largest electric utility systems in the United States.3

The Byllesby Corporation is the parent of Byllesby. It holds 217,622 shares out of the 398,592 outstanding shares of class B common stock of Byllesby, or approximately 55 percent of the total voting stock. The Byllesby Corporation is a "shell" holding company; its sole function is to hold a majority of the voting securities issued by Byllesby, and thereby perpetuate the control of the latter company by its officers, directors, and persons closely affiliated with them.5 Since the Byllesby Corporation admittedly controls Byllesby, disposition of its application turns upon our determination of whether Byllesby is a holding company within the meaning of section 2 (a) (7). If Byllesby is a holding company it is clear that the Byllesby Corporation is likewise a holding company under the statutory definition.

It is obviously impossible to comprehend the present relation of Byllesby to Standard Power and Standard Gas unless we undertake to examine the relationships previously existing between those companies. Accordingly, we briefly consider some of the relevant historical facts.

The predecessor to Byllesby, carrying same name, organized the Standard Gas & Electric Co. under the laws of Delaware in 1910. In return for the transfer to Standard Gas of utility properties previously acquired by Byllesby's predecessor company, Standard Gas transferred to it a majority of the voting stock of the company. From that time until 1930, Byllesby's predecessor and Byllesby, through ownership of voting securities, interlocking directors and officers, and otherwise, completely dominated Standard Gas and its subsidiaries.

Control of Standard Gas enabled Byllesby to guide the financial policies of Standard Gas and its subsidiaries and to obtain for itself primary participation in the underwritings of their securities. Byllesby's investment banking functions greatly expanded during this period; the growth of this phase of its business was largely commensurate with the increase in number and amount of security issues by Standard Gas and its subsidiaries.

Throughout this period, Byllesby, by virtue of its denomination of Standard Gas, caused Standard Gas and its subsidiaries to enter into transactions involving the purchase and sale of utility properties and securities, which netted Byllesby large profits. Through affiliated management corporations Byllesby likewise profited from charges for engineering, construction, legal and similar services to Standard system companies. The evidence taken before the Federal Trade Commission in its comprehensive study of the utility industry sets forth in detail a large number of these transactions. Illustrative of these transactions is the acquisition by Standard, Gas of a controlling interest in the Philadelphia Co. and affiliated corporations. For negotiating this transaction, Byllesby and Ladenburg, Thalmann & Co., a banking concern which previously controlled the Philadelphia Co., obtained a profit of over $16,000,000.7 Of this sum, Byllesby received over $4,000,000. Apparently, Ladenburg, Thalmann & Co.'s enormous profit represented the price paid for surrendering partial control of the Philadelphia Co. system to the Byllesby and Standard Gas interests.8

By September 1929, other interests including a number of investment bankers had accumulated substantial quantities of the common stock of Standard Gas, with the purpose of obtaining a voice in the management of that company. These interests included United Founders Corporation, American Founders Corporation, Hydro-Electric Securities Corporation, Harris Forbes & Co., W. E. Langley & Co., A. C. Allyn & Co., Inc., Victor Emanuel, Thomas A. O'Hara, J. Henry Schroder Banking Corporation, and the Seaboard National Corporation Thereupon, these interests pooled their stock in the United States Electric Power Corporation, a Delaware corporation (hereinafter sometimes referred to as U. S. E. P.), which they organized. There ensued what the lare R. J. Graf, formerly president of Byllesby, described as "a real fight for control" between Byllesby and the interest for which U. S. E. P. spoke, which endangered the banking position theretofore enjoyed by Byllesby. By the end of 1929, U. S. E. P.

3 It was conceded that the applicants, Standard Power, Standard Gas, and their subsidiaries make use of the United States mails in the conduct of their daily business, and that certain of the subsidiaries of Standard Gas transmit electric current across State lines.

Byllesby has issued and outstanding 60,012 shares of preferred stock, 458,380 shares of class A common stock, and 398,592 shares of class B common stock. The class B stock alone carries full voting rights.

The stock of the Byllesby Corporation is closely held. Its management stock, the only class having full voting power, is owned entirely by 7 individual stockholders. The common stock is held by about 30 individual stockholders.

The facts set forth on pp. 261 to 663, inclusive, of p. 36 of the Federal Trade Commission Report (S. Doc 92, 70th Cong., 1st sess., (1931)) were introduced into the record without objection.

Federal Trade Commission Report, supra, p. 36, p. 432.

8 See Examiner Thomas W. Mitchell's report, in Federal Trade Commission Report, supra, p. 36, p. 433.