you can present your share for redemption and ask that it be held to be redeemed at the next advance instead of at the time you offer it. It seems almost incredible that after paying 8% percent to cover selling cost and a profit to the distributor and paying in addition the same person, as manager, one-half of 1 percent per year of the money which you have invested, for the purpose of having him handle in a fiduciary capacity, and protect and enhance your assets, he would sell an interest comparable to yours worth $6.70 for $5.60 and thus lessen the value of your interest, so that he might make himself an additional underwriting commission and an additional management fee. It doesn't make sense, but investment trusts do it.

In addition, there are dealers under this system who can, and some do, withhold orders until these two prices are determined and known, and if the price to go into effect next morning, for example, is lower than the price at which the dealer accepted the order, he will hold the order until the lower price goes into effect and send the order in at the lower price, pocketing the difference. He can't lose.

If the next price is to be higher, he will send the order in at the lower price at which he accepted it, a practice by which he cannot lose but he is not bound to win.

Likewise the dealer, when he knows these two prices and the next day's price is to be higher, can, and many do, buy in advance of orders at the lower price and sell the shares the next day at the higher price, pocketing the difference, all to the detriment of the trust.

In the 78 cases that we studied that replied to our questionnaire, practically all of the underwriters also act in a fiduciary capacity as managers or sponsors of their respective trusts, and yet in 50 of the 78 cases no effort was made to prevent dealers thus taking positions against the trust.

I would like to give you an actual illustration of a case we had in the Registration Division. Sometime ago we encountered an investment trust sponsor and underwriter who was found to be purchasing shares in advance of the orders received by him and conversely holding back orders placed with him by dealers and purchasers until such time as it was advantageous for him personally to fill these orders or sell from the shares purchased by him in advance of orders.

This sponsor sold trust shares to the public directly and to four or five so-called installment plan companies. Each day after 3 p. m. this particular sponsor or underwriter valued his portfolio as of the close of the New York market. He found the net asset value and divided it by the total outstanding shares. This gave the net value per share. Let us assume that this is Tuesday, and he finds that each share is worth $1.10 without the load charges. This price of $1.10, however, does not go into effect until Wednesday morning. This sponsor employed dealers and salesmen and they begin selling at

$1.10 net.

Generally, about 3:30 p. m. Wednesday afternoon they begin to send in the orders. Orders are accepted by the sponsor all afternoon, evening, and until the next morning at 10 o'clock. The sponsor knows the sales are being made at $1.10 net.

Shortly after 3 o'clock p. m. on Wednesday he figures the price again of the net asset value of the shares and finds that it is $1.06. He has gotten orders at $1.10 a share. Does he fill them? No; he puts them in his drawer, so to speak, until the next day, when he can fill them at $1.06 and make a profit of 4 cents a share.

Thursday's orders come in and he has received orders on the $1.06. He values them again and sees they have declined to $1.03. He has got more orders by Thursday. Does he fill them at $1.03? He does not. He has figured his price and found it is lower again, so he puts them in his drawer again.

This particular sponsor did it for 19 consecutive days. The price kept sinking until it declined from $1.10 to 88 cents per share. On the nineteenth day the market jumped up to 96 cents, and then at 88 cents he bought all the shares necessary, something over 190,000 shares, to fill the orders he had, and put the difference in his pocket, and to that extent diluted that trust.

Senator WAGNER. That amounted to a substantial sum of money? Mr. BANE. A substantial sum of money.

Senator WAGNER. Do you know how much?

Mr. BANE. For a short period it amounted to $25,000. We figured out that for a period of 10 months it amounted to about $60,000. Senator WAGNER. This one case?

Mr. BANE. This one case. He did not stop there at merely filling all those orders that had been accumulated at higher prices at 88 cents. He knew the price was going to be 96 cents the next day, so he bought another 190,000 shares at 88 cents to offer them the next day at 96 cents. If he could not sell them all and the market took a sudden drop, he might take a loss, but it was unlikely, because he knew that the large volume of investment-trust shares is sold on a rising market, and here he had these 190,000 shares at 88 cents and he had these four or five installment plan companies that were buying from him, and he knew he could dispose of part of them there, as he could gage their orders.

The effect, of course, of all of that was to impair very seriously the interest of the shareholder already in the trust, the man who had been paying him to look after his interest, and he, the fiduciary, taking a position against him on which he could not lose. It was impossible to lose on the short position; he might have lost on the long position, by a long chance.

We issued a stop order against him, and that was as far as we could go. We obtained a stop order to discontinue sales because of his failure to disclose material facts. The Commission wrote an opinion in that case, known as the case In the Matter of T. I. S. Management Corporation. If you would like to have that opinion for the record, I have a copy of it here.

Senator WAGNER. It may be inserted in the record.

(The document is as follows:)

[For immediate release Friday, February 25, 1938)

SECURITIES AND EXCHANGE COMMISSION,

(Securities Act of 1933, Release No. 1689)

Washington.

UNITED STATES OF AMERICA, BEFORE THE SECURITIES AND EXCHANGE COM

MISSION

In the Matter of T. I. S. Management Corporation. File Nos. 2-1303, 2-2316, and 2-3485

FINDINGS AND OPINION OF THE COMMISSION

This is a proceeding under section 8 (d) of the Securities Act of 1933 to determine whether stop orders should issue suspending the effectiveness of three registration statements on Form C-1 filed by the T. I. S. Management Corporation, hereafter referred to as the "registrant". These covered blocks of 862,069 shares, 3,000,000 shares and 18,000,000 shares of "Trusteed Industry Shares," an unincorporated investment trust of the restricted management type. The registrant acts as depositor and sponsor of the trust and hence is the "issuer" of the trust shares.1 The registration statements became effective on April 20, 1935, as of April 15, 1935, August 8, 1936, as of August 5, 1936, and November 29, 1937, respectively.

These proceedings were commenced through confirmed telegraphic notices to the registrant on December 4, and December 6, 1937, citing misstatements or omissions in items 28, 36, and 38, exhibit D, and the prospectus of each registration statement. The principal deficiencies are alleged to result from the registrant's failure to disclose its practice of trading for its own account in the registered shares in connection with their distribution and the full extent of the profits which it had thus realized at the expense of the trust and the shareholders. In accordance with the notices a hearing was held before a trial examiner on December 14, 1937, at which it was stipulated that the evidence introduced should be applicable to all three registration statements.

At the hearing the alleged omissions were admitted and consent was given to the entry of stop orders. However, the registrant specifically denied the materiality of the omitted information.

On December 2, and December 10, 1937-that is, before the commencement of the hearing-the registrant filed proposed amendments to all three statements in an attempt to correct the alleged omissions. Under section 8 (c) of the act these amendments become effective only upon declaration by the Commission. The trial examiner has filed an advisory report in which he found that the registration statements omitted to state material facts as alleged. Although registrant has filed exceptions to this report, it subsequently stated in a letter to the Commission dated January 12, 1938, that instead of pressing its exceptions it desired to petition the Commission:

"(1) To declare effective forthwith the amendments filed by the registrant after the effective date of the latest registration statement, and (2) to exercise its discretion in favor of a dismissal of the stop order proceedings."

In support of this petition, the registrant argued that the omissions were not material; that there is no evidence of an attempt to mislead or defraud investors but only, at most, mistakes as to matters concerning which reasonable men might differ. that in sympathy with the purposes of the Securities Act the registrant has attempted to cooperate with the Commission and to correct promptly the alleged omissions; that the registrant will promptly supply all its shareholders with copies of the post-effective amendments if they are declared effective; that the issuance of stop orders would in this case cause an irreparable injury to the registrant; and, finally, that niether the public interest nor the protection of investors would be served by stop orders.

Therefore, as the case now stands, we need only determine whether the admitted omissions are material, and, if so, whether we should consider the post-effective amendments in reaching a decision on whether stop orders should be issued.

1 Section 2 (4) of the Securities Act of 1933. See In the Matter of Underwriters Group, Inc., 2 S. E. C. — (1938); Securities Act Release No. 1653.

The

The registrant is engaged in distributing Trusteed Industry Shares through dealers or to subordinate investment trusts which, in turn, sell monthly deposit plans to the public using the proceeds to buy Trusteed Industry Shares. trust agreement provides that the trust shares are to be sold only to the registrant. Although this agreement fixes the terms as between the trust and the registrant, the price and conditions of resale by the registrant are not determined by the trust agreement. However, full description of the terms and conditions upon which registrant may resell the shares is required by the Securities Act of 1933. The admitted cmissions are the same in each of the three registration statements except for a minor differerce in figures. A discussion of one registration statement will suffice for all. We shall refer particularly to the representations made in the latest registration statement.

Item 36 requires disclosure of

"the method by which the price of the certificates to be sold is calculated, giving a full statement of all of the component parts thereof, including the so-called service or leading charge."

In order to understand the full lead involved in the distribution of the securities here considered, it is necessary to discuss the price at which these shares are created and issued by the trust to the registrant, and then compare this with the price at which the registrant passes them on to purchasers.

By the terms of the trust agreement the price paid by the registrant for Trusteed Industry Shares on any particular day is based on the bid prices on the portfolio securities held by the trust as of the close of the previous day's securities markets. To the aggregate of the securities, valued at their bid prices, and the cash in the trust, certain brokerage fees, taxes, and accumulated dividends are added, and this total is divided by the number of shares of the trust outstanding in order to determine the price to the registrant of each share. On the other hand, the registrant itself bases the price at which it resells the shares, not on the bid prices, but on the previous day's closing sale prices of the trust's portfolio. To the total of this valuation plus brokerage and tax charges the registrant adds 91⁄2 percent thereof as its premium. If a fractional cent results from this computation of the resale price of the trust shares, the registrant charges the next full cent and retains this so-called breakage as part of its profits.

Furthermore, the registrant purports to act as a principal rather than as an agent, not only in selling shares to others but also in purchasing shares from the trust. Because of this fact, registrant can buy shares from the trust in such quantities as it desires and thus can take long or short positions in the shares to its own profit. It has been its practice to make delivery approximately 4 days after orders are received. Since it has also been its practice to buy new shares from the trust only after the close of the market on each day at a price fixed by the market on the preceding day, it has been able to determine with precision the following day's sale and resale prices and has been able to use this knowledge to its own advantage. Thus, if it has taken orders during today for a certain number of shares (the prices of which orders are fixed by yesterday's markets), it can determine at the time set for its purchases from the trust whether tomorrow's prices will be lower or higher, since tomorrow's sale and resale prices are fixed by the close of today's market. These short positions can be maintained for a period of 4 days until delivery is required. Consequently, it has been customary for the registrant to buy less shares than its orders call for, when the next day's price will be lower, and, conversely, to buy in anticipation of the next day's sales when the price will be higher.

The evils of this practice are graphically illustrated by the fact that on or about October 21 or 22, 1937, immediately after the severe market break of October 19, registrant bought 190,000 shares from the trust at depressed prices with which it covered its existing short position at a substantial profit. Thus the misfortunes of the trust and its shareholders were turned to registrant's advantage. Registrant's trading positions have in fact resulted in a profit of approximately $25,000 for the 9 months ended September 30, 1937. Dealers can also take similar positions and similar profits as a result of information on next day's prices supplied by the registrant. Necessarily, the positions taken by the registrant, and by others in distributing the shares diminish the dollar amounts being paid into the trust, since, in effect, investors pay the current prices whereas the trust receives the lowest prices, the registrant keeping the difference. Indeed registrant admits that this practice, to the extent that it produces profits to it results in the trust's being deprived of funds which would otherwise flow to it. In answering item 36, the registrant disclosed only the method of computing the offering prices and the fixed 91⁄2-percent premium charged by it in selling the

shares. Counsel for the Commission contended that the terms "service" or "loading charge" as used in item 36 included the gross profit accruing to the registrant, that is, the difference between the amount purchasers paid it and the amount which the trust received. On this theory it was contended and admitted that the registrant should have disclosed: (1) the profits made by taking long and short positions; (2) the difference in the original sale price to it of the trust shares figured on bid prices on the underlying securities and the offering price figured on their closing sales prices; (3) the fact that registrant also receives 91⁄2 percent on the difference between the bid price and the last sale-price valuations of the trust shares; and (4) that a profit resulted to the registrant from fixing the price at the next full cent when fractions were involved.

We believe that all of these factors are material in determining the load and should have been disclosed.

The registrant argued that the long and short positions taken by it were immaterial in their effect on the trust, since when it took a long position on a rising market the trust received the funds earlier than it otherwise would, and could invest the receipts in securities which would rise in direct proportion to the registrant's gains. Likewise, it was contended, when the registrant took a short position, the trust did not have the funds to invest in the falling market and could invest them later at the lower prices when payment was made. This argument does not take into consideration the fact that the registrant buys the shares after the close of the market on the basis of the market for the previous day, and that the trust cannot invest the funds at the same prior market prices which determined the amount paid by the registrant. Furthermore, the argument disregards the time lag between payment to the trust and subsequent purchases by the trust for its portfolio, as well as the inability of the trust to take advantage of the daily market fluctuations.

The registrant also argued that under the terms of the trust agreement it has the right to take positions. If the registrant's argument is that the mere fact that it has the right to trade in the shares is due notice to shareholders that it is exercising the right, we cannot agree. The power to buy and sell the shares is necessary in order that the registrant may meet its orders, but certificate holders are given no notice that the right would be exercised in order to make trading profits in addition to the 92-percent premium specifically set forth. Nor do we believe that the registrant's balance sheets, which show that it was taking positions in the securities, can cure the failure fully to disclose the information as to its profits required in the answer to item 36.

It may be noted that the short positions taken by the registrant involved no risk and perfect assurance of gain. The long positions involved only the slight risk that the relatively even demand for shares in the trust would not materialize before the market turned down.

With respect to the omission to state that the methods of calculating prices for the creation and issuance of the shares to the registrant and for the price at which it resells them were different, the registrant asserted that both the trust agreement and the sample make-up sheet included as exhibit D to the registration statement gave notice of the difference. We recognize that it may be possible for an investor to deduce from the trust agreement and exhibit D that this differential between the sale and resale prices is a further source of profit to the registrant. However, this disclosure in the exhibits is more than offset by the fact that the answer to item 36 does not refer to the trust agreement at all. We have often held, and we now reassert, that items must be answered in such a way that a reasonable examination of the particular item of the registration statement will disclose either by inclusion or appropriate reference the material facts. (In the Matter of Income Estates of America, Inc., 2 S. E. C. (1937); Securities Act Release No. 1480: In the Matter of Underwriters Group, Inc., 2 S. E. C. - (1938); Securities Act Release No. 1653; In the Matter of Ypres Cadillac Mines, Ltd., 2 S. E. C. (1939); Securities Act Release No. 1652. Moreover the answer to item 36, although it does refer to exhibit D, gives no notice that it contains information showing a difference in the offering and creation prices. Finally, the computation of the creation price in exhibit D is labeled "For Trustee's Fees and Deposits." Thus even a close examination of exhibit D might not disclose to an investor the method of computation by which the price to the registrant was fixed.

If an investor is not made aware of the difference between the creation and offering prices, he could hardly be expected to understand that the registrant has been receiving not only a premium equal to 91⁄2 percent of the amount paid into the trust but also 91⁄2 percent of the difference between the bid price and the last sale price valuations for the trust shares.