financial information to the managing underwriter. Six of the managing underwriters for the 22 issues stated that they had a formal agreement with the issuer that the latter would provide periodic financial information to its shareholders. Several of the managing underwriters indicated that they had informal understandings with issuers that such information would be provided. Underwriters had varying views on the necessity or desirability of membership on the board of directors of companies going public for the first time.140

The managing underwriter may feel an obligation, as described by Loeb, Rhoades above, to maintain a trading market for the issue. Kidder, Peabody felt a similar obligation to customers purchasing new issues:

When a customer buys a security in a new offering, we believe that he is entitled to expect that he is buying a security with reasonable liquidity and that there will be an orderly market in which he can sell the security at some future time if he so desires. It is no answer to say that others than the managing underwriter could make a market. In many securities the appearance of dealers in the "sheets" does not mean that they are actively making a market. Frequently, their willingness to buy or sell is for very limited volume.

Of the 22 new issues, 10 had trading markets maintained by their managing underwriters on November 2, 1962.141 The issues having "sponsored" trading markets were, in general, those issues underwritten by the older investment banking firms.142

(2) Disposition of equity interests

In general, the Special Study found that managing underwriters who received shares or options purchased in interim financing or as underwriter's compensation tended not to dispose of them during or shortly after the offering. At the time of answering questionnaire OTC-1, only 3 of the 15 managing underwriters who received noncash compensation had disposed of their interests. The Special Study selected an additional 33 new issues offered pursuant to registration statements and regulation A in 1959 and early 1960, in which the underwriter received equity compensation. Of these, only 12 had disposed of their compensation as of the date of the questionnaire. It is perhaps not surprising that underwriters tend to retain these equity interests, since they generally take the position that such interests are received for purposes of long-term investment.143

Since 1947 the Commission has required that stock or options received by underwriters in connection with a public offering must be registered along with the shares being offered, even if the underwriter does not intend to offer its securities to the public immediately.144 The issuer is also required to undertake to file a posteffective amendment to the registration statement when the compensation stock is finally distributed. Within the past 2 years, it has also been the practice to require an undertaking to file, prior to any public offering of these securities commenced after 90 days from the effective date of the original registration, a posteffective amendment disclosing such cur

140 For a discussion of the role of underwriters and other broker-dealers as members of the boards of directors of publicly held companies and the problems that arise from this relationship, see pt. F of ch. III. 141 On Nov. 2, 1962. 4 of the 22 new issues were listed on the American Stock Exchange. 142 For further discussion of the role of the managing underwriter in the after-market, see ch. VII and subsec. 3.c (2), below.

143 See subsec. 2.c(2) (b), above.

144 Securities Act release No. 3210 (Apr. 9, 1947).

rent information as would be required in a new registration statement. In the case of offerings made pursuant to regulation A, compensation stock is usually put into escrow for 13 months, in order to insure that the total offering to the public does not exceed the $300,000 limitation of the exemption. After this "sterlization" period, the managing underwriter may sell the stock to the public or otherwise; if the sale is public, the stock must be registered or offered pursuant to regulation A.

Several of the firm interviewed by the Special Study stated that they surround their disposition of compensation stock with careful safeguards. Representatives of Hayden, Stone stated that in order to avoid any possible effect of their market-making or retail activities. on the price of the securities being distributed, the following steps would be taken where the compensation took the form of warrants distributed to principals of the firm; the holders of the warrants would exercise them, a posteffective amendment would then be filed, and at the same time the firm would suspend all trading as principal and instruct its research department to stay away from the stock and its salesmen to stop soliciting orders. In order to obtain capital gains tax treatment, the firm generally would not sell the underlying shares until six months after exercise of the warrants, so these restrictions would be in effect for a 6-month period. It was pointed out that the firm's withdrawal from trading may create problems, since rumors are apt to start that something is wrong with the issuer when the "sponsor" ceases to make a market.

Other firms, however, do not believe that it is necessary to impose similar restrictions on their activities as soon as the decision to file a posteffective amendment is taken. A partner of Loeb, Rhoades stated:

you might be talking about 6 months before the registration statement becomes effective, which we think is an unnecessarily long length of time. This firm does not forbid all solicitation after filing of the posteffective amendment to the registration statement, but discourages solicitation by taking the stock off the firm's recommended list; trading continues until an estimated 10 days before effectiveness of the amendment.145

Underwriting firms receiving substantial amounts of stock or options prior to an issuer's first public offering often state that such securities are received not as underwriter's compensation but as part of interim financing arrangements.146 In many instances these firms do not register the securities with the public offering, on the grounds that they are taken for investment with no intention of resale. A partner of Lehman Bros. testified, for example, that this is the practice of his firm and that in many such instances the stock is sold in a nonpublic offering. Loeb, Rhoades gave similar testimony but with the difference that when warrants taken for investment are eventually exercised or sold, they will either be registered or an opinion from counsel will be obtained that no registration is needed.

145 Rule 10b-6 under the Exchange Act does not prohibit "purchases or bids by an underwriter, prospective underwriter or dealer otherwise than on a securities exchange, 10 or more business days prior to the proposed commencement of [a] distribution (or 5 or more business days in the case of unsolicited purchases), if none of such purchases or bids are for the purpose of creating actual, or apparent, active trading in or raising the price of [the] security."

140 See subsec. 2.c(2) (b), above.

The methods by which underwriting firms dispose of compensation stocks vary considerably. Some firms take the position that it is unethical to solicit retail customers to purchase stock being sold out of the investment accounts of the firm or its principals. A partner of

Lehman Bros. stated:

We have a standing rule that we never sell a share of stock that is owned for investment to any retail customer. We sell it to brokers. As to who buys that stock eventually, we don't know. But it is not sold by us on any solicitation to any customers of ours.

Where stock has been listed on an exchange, Hayden, Stone stated that it would sell shares on the exchange in small lots over a long period of time, in order not to disturb the market. In other instances, firms will place their compensation stock with institutional buyers. The attitude of many firms was expressed by a partner of Sutro Bros. who stated that "we would not dream of" selling compensation stock under a posteffective amendment to public customers after having solicited their purchases, and that "we would not use our customers for an unloading operation." A representative of Maltz, Greenwald & Co. stated, in much the same vein, "I cannot very well sell stock to my customers if I think it is time it should be sold; therefore, I sell it in the open market." On the other hand, some firms do not see anything wrong with soliciting customers to purchase compensation stock if a prospectus is used and the Securities Act is complied with. These attitudes contrast sharply with the methods of disposition used by some firms during the years 1959-61. The views of a small underwriter who had just entered the business help explain the importance of disposition of non-cash compensation:

Actually [in] the underwriting business, the big profit is made in options and in positions ***. I felt that if I had only one or two very good underwritings per year, the cash compensation would pay for the rent, salaries, and what have you, and the so-called gravy would be the options which, if the underwritings were the right kind, if the company grew well, et cetera, could be quite substantial.

Globus' disposition of its noncash compensation illustrates some of the problems in this area. 147 On February 20, 1961, Globus, with Ross, Lyon as co-underwriter, made an offering of 150,000 shares of Geochron Laboratories, Inc. (Geochron) common stock at $1 per share. Although the offering could have been made pursuant to regulation A, a registration statement was used, because, according to Globus' counsel, if the "front" stock which Globus had received for providing interim financing were included with the issuer's stock the regulation A limit of $300,000 would have been exceeded. About 4 months prior to the offering Morton Globus and his associates, Ross, Lyon, a trading firm, and the wives of principals of two other trading firms, together advanced $31,500 to Geochron and received notes convertible on the effective date of the registration statement into 30,000 shares of stock and 60,000 warrants exercisable at $1 per share for a period of 5 years. The stock and the warrants were registered for sale as part of the Geochron offering and were proposed to be sold from time to time at the then prevailing market price. Thus, 2 underwriters and

147 The Globus underwritings used as illustrations here were not among the 22 new issues. The Globus issues were selected for study to illustrate the problems of an uncontrolled distribution of compensation stock. Some of the findings of this study were derived from an NASD examination of Globus underwritings.

persons connected with 3 trading houses were offering 90,000 shares or warrants, or 60 percent as much as offered by the company.

Geochron had no operating history-the purpose of the interim financing was to keep the company going until it could make a public offering. Two of Globus's employees were elected to the board of directors and Globus received fortnightly progress reports from the company's president. During the months of April, May, and June of 1961, the broker-dealer firm of Harold Shore (whose wife had made an investment in Geochron) and Shaskan & Co. the clearinghouse for Shore) appeared in the sheets with steadily increasing bids.148 By May 8, Geochron stock was quoted by these firms at 4% bid, 53% asked, or about five times its initial offering price. By June 28, 1961, Globus and the others who had provided the company with interim financing had sold 23,175 shares and 17,525 warrants which they had received, for a total consideration of $164,800-an amount exceeding the total public offering.

Most of the "front" stock and warrants held by this group were first sold to Shore, who in turn sold them to Shaskan, who then sold the shares to Northeastern Securities Co.149 The latter firm, through a sales campaign, sold about 50,000 shares of Geochron stock to public customers-who did not receive the statutory prospectusin a 2-month period at prices ranging from 334 to 614. These securities were disposed of at a time when the president of Geochron was reporting little progress to Globus and no earnings. One such report indicated that after 5 months of effort the company, whose business was determining the age of rocks, had been able to obtain only three rock samples for testing. By October 1961, one of Globus's employees, after visiting the company, reported to him in a memorandum headed "Geochron-Time To Pull the Chain," that the company was failing. On February 15, 1963, Shaskan-the only firm quoting Geochron in the sheets-was bidding 316 and offering 3.150

Some underwriters distributed options and warrants received as compensation to salesmen and traders at their own or other firms. For example, a customer's man at Irving Weis & Co. stated that this firm gave part of its compensation options or warrants to customers' men "for payments of services rendered in the distribution of the stock.” 151

148 Shaskan first appeared in the sheets on Apr. 14, and Shore on Apr. 21. During the 24 trading days between May 1 and June 5, 1961, Shaskan quoted the high bid and asked in the sheets on 9 days and the high bid on 1 day.

149 The president of Northeastern testified that he received an allotment of 600 shares of Geochron stock from Ross, Lyon in the original public offering though he did not place an order for the stock. Northeastern also received an additional 2,500 shares of Geochron from Ross, Lyon at a price of $1 below the lowest asked price.

150 Geochron was not an isolated example. Globus, Inc., and Morton Globus received 4,000 shares and 13,600 warrants to purchase Wings & Wheels, Inc., common stock as compensation for underwriting 85,000 shares of this company's stock in February 1961. The warrants were exercisable at $3, equal to the public offering price. Morton Globus was on the board of directors of the company. During the period from Nov. 17. 1961, through January 1962, he sold personal holdings of warrants and stock equivalent to nearly 10,000 shares through Shore and other trading firms at prices ranging from 3 to 7. Late in December 1961, about midway in the distribution of his shares, he recommended Wings & Wheels at a price of $6 per share to his customers and those on his mailing list in a brochure entitled "Science and Investment Survey," subtitled "Our Choices for 1962!!!" On Nov. 2, 1962, the stock was quoted at 2% bid. 2% asked.

151 Under an unwritten policy of the New York Stock Exchange, registered representatives apparently are permitted to share in cheap stock, options, or warrants only if received by their firm as a finder's fee and not as underwriting compensation (unless the employees are in the syndicate department).

(3) Controls over trading activities

The basic antimanipulative rule governing market activities is rule 10b-6 under the Exchange Act, which makes it "a manipulative device or contrivance" for a person in any of certain specified categories, including underwriters and prospective underwriters in a particular distribution of securities

to bid for or purchase for any account in which he has a beneficial interest, any security which is the subject of such distribution, or any security of the same class or series, or any right to purchase any such security or to attempt to induce any person to purchase any such security or right, until after he has completed his participation in such distribution ***.

The rule, which exempts from its prohibitions certain specified transactions, has an important impact on the underwriter who sells in the after-market securities of issuers which he has brought out.152

The varying approaches which underwriting firms have taken to making markets, soliciting customers, and sending out investment advice in connection with their disposition in the after-market of securities acquired as an investment or as compensation in part reflect their uncertainties concerning the scope and meaning of rule 10b-6. Where an underwriter receives stock from an issuer with a view to immediate resale, the distribution is not complete until the stock has been sold, and the prohibitions upon trading and the solicitation of agency purchases remain in force during such period. If, on the other hand, the stock is taken "for investment" with no immediate intention. of resale, the picture is not so clear. The Commission recently informed one underwriting firm that, where its partners had purchased cheap stock a few months prior to a public offering but stated that they had no present intention of selling these shares, rule 10b-6 prohibited the firm from soliciting agency transactions in the stock until after the partners' shares had been sold. Nevertheless, the Commission told the firm that, under an exception to rule 10b-6 permitting an underwriter to bid for or purchase the securities in the course of making a normal trading market until 10 or more business days before a distribution, it might maintain a market until 10 days before beginning to distribute the investment stock. The basis for the Commission's view apparently was that the distribution of the investment stock constituted a new distribution separate from the original offering and that this new distribution was contemplated from the time of the original offering,153

The applicability of rule 10b-6 to the retailing and advisory activities of underwriters or other broker-dealers holding investment positions, both in the period when the investment remains "locked up" and when disposition is undertaken, would appear to be in need of clarifica

152 See pt. C of this chapter for a discussion of the term "distribution" and of the application of rule 10b-6 to unregistered distributions. 153 The investment stock was registered in a shelf registration (see below) at the request of the Commission. For further discussion of trading markets in connection with unregistered distributions, see pt. C of this chapter.