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,

and it had the disadvantage that Mr. Schenker spoke of in the other connection.

Instead of the entire price, if they were selling stock as capital of American Founders going in as capital, part of the price came to -American Founders as a profit and could be distributed as dividends, again inflating the income account at the expense of capital account. These gentlemen, the former officers and directors, were examined as to this feature of a wholly owned distributing concern, and witness after witness condemned it in no uncertain terms. They thought the effect upon American Founders had been disastrous, and they so testified. They also said that distribution was a business entirely different from investment. The preoccupation with distribution called for entirely different methods and entirely different techniques.

We have more or less touched upon the profits to the insiders. The insiders then had this big stake in making profits by forming new companies along with the Group, but the insiders became a little bit nore audacious than that. They began trading. They began trading on margin.

There were two rather distinguished economists connected with this group. They formed their own trading company, bought and sold securities on margin. These economists, who were supposed to have this detached, fine investment judgment, began buying and selling for quick turns. The investment department, in 1929, according to their testimony, instead of being used for investment had their facilities frequently used to predict short turns in the market, and they used these short turns in order to try to make profits. They did not succeed and, of course, like everybody else, they lost on the short-term trading; but not only did the economists form their little separate company, by which they traded, and lost their shirts, incidentally, but the heads of the investment department also formed their separate company, which was financed by a favored broker of the company, and these investment heads likewise traded in large quantities in securities, both company securities and outside securities, and they likewise suffered heavy losses in the end.

The fact is, however, gentlemen, that all the time while the public was being given the picture of this conservative management making its investments with skill and detachment and on the basis of science, what they actually were doing was making the so-called profits for the company out of tricky distribution, and they themselves were preoccupied with similar "profits" of distribution and with their own personal trading.

As one of the witnesses said, everybody, from the bootblacks and the office boys up to the president of the company, traded. Everybody traded.

Therefore, the picture given to the public of skill and science and detachment was a very different picture from what was happening inside.

Senator WAGNER. Of what years are you speaking now?

Mr. STERN. 1928 and 1929, Senator.

We might note one case where one of the officers, an officer of General Investment, had tradings which were fairly conspicuous. That company lost its shirt. It lost its shirt and practically everything else.

Senator WAGNER. I do not like to interrupt you, but I want to be informed on this. Was he trading with his own money and with his own securities or was he using the portfolio?

Mr. STERN. No; this was his own private enterprise. This man, who was a high officer in a company that lost $70,000,000 out of $78,000,000 paid in by the public, had succeeded in making, in trades of the preferred stock of that company, nearly $1,000,000-the actual figures are $941,000 and he did that between 1933 and 1937.

I think it is rather interesting that while the officers were trading they held out to the public that "the shares of American Founders Corporation are essentially an investment for the long pull, as they always had been. They should be owned outright and regarded as a relatively permanent investment. Market fluctuations may be ignored."

The general portfolio losses ran to $130,000,000, and undoubtedly some of this was caused by market declines, but not all of them. Some were caused by other transactions, which I will now go into very briefly.

As I said before, this story is so long that I will just take up briefly what happened in the case of the three largest losers: The General Investment Co., the United States Electric Power Corporation, and the United Founders Corporation.

As you gentlemen will recall, the advertising by the group emphasized that they were independent of investment bankers-in fact, the statement was made that United Founders and subsidiaries formed the largest independent group of the kind in the United States and that it is not dominated or controlled by any bank, investment banking house, or other institution.

Now, as stated, that might have been correct, but the fact is that they did proceed to put millions of dollars in affiliated companies which were controlled by investment bankers and with the disastrous results that I am now about to mention.

I asked, "Why did you advertise that you were independent of investment bankers? What did you fear?""

They said that they feared that the public might think that what had happened abroad might happen here.

Now, what had happened abroad was told in a book at the time. This book was written by Mr. Leland Rex Robinson, and Mr. Leland Rex Robinson had been an officer of one of the group companies-in fact, he had been president of the Second International Co. Mr. Robinson pointed out as an earlier evil in the British companies that there were connections with banking houses and that these banking houses were not above using these affiliated companies as a dumping ground for issues which the public failed to absorb. Then Mr. Robinson added:

It speaks much for the growth of professional ethics that in London a repetition of such practices seems hardly conceivable and an enlightened public opinion has fostered a position of greater independence among institutional investors holding investment trusts.

Let us see what happened to General Investment Corporation. The General Investment Corporation was formed with Harris Forbes. Harris Forbes had probably put out more securities than any other investment banker in the United States during that particular period. Members of Harris Forbes became officers of the General Investment Corporation. The General Investment Corporation was this com

pany in which $78,000,000 was paid in and $70,000,000 was lost. The bankers were given control of this company, although the Founders group had the largest single interest in it.

Now, I think it will be probably as illuminating as anything else I can do to run briefly over some of the transactions that happened and the amount of the losses in those transactions.

The Associated Gas & Electric Co. is a company which recently has gone into bankruptcy, and Harris Forbes & Co. were the bankers for that company. Harris Forbes turned over its entire utility portfolio to General Investment Corporation. That was the start. Their entire utility portfolio was turned over to the General Investment Corporation.

Senator WAGNER. When you say "turned over," the General Investment Corporation must have paid for that?

Mr. STERN. Exactly, sir. I should have said that.

Senator WAGNER. Yes.

Mr. STERN. That is, Harris Forbes subscribed and the General Investment Corporation took the money and bought the investment portfolio of Harris Forbes.

Senator WAGNER. At the market price?

Mr. STERN. At the then market price, which was substantially in excess, apparently, of fundamental prices and asset value.

Among the securities that were taken over from Harris Forbes were 51,000 shares of common stock of Associated Gas & Electric, and they paid $3,000,000 for that, and the Associated Gas & Electric investment was later increased to $15,000,000, acting under the advice of Harris Forbes, with Harris Forbes being the Associated's banker at that time.

Of that $15,000,000, $14,437,000 was lost.

Then a more complex story, but I think we can follow it, is the case of the Central Public Service Corporation. Immediately after the formation of General Investment Corporation about 30 percent of the assets were invested in a utility, into the Portland Electric Power Co. So that General Investment then found itself in the possession of an electric company, but it had no particular facilities for running it.

It thereupon sold Portland Electric to Central Public Service, which was a holding company. Central Public Service was a banking client of Harris Forbes. Central Public Service raised the money to pay for Portland Electric Power in large part by a new issue of securities, which Portland Electric Power Co. put out.

This bond issue was an issue of $16,000,000 and that about doubled the oustanding indebtedness of Portland Electric Power.

Harris Forbes floated the bond issue. Both Portland Electric Power Co. and Central Public Service went into reorganization a few years after that. As a matter of fact, at the time Portland Electric Power Co. was sold to the General Investment Corporation, which was the group company, Portland Electric Power Co. was not in very good shape. It had been getting along, but not too well. The ultimate loss in that transaction

Senator WAGNER. Was that a bond issue of the Portland Co.?

Mr. STERN. No, sir. General Investment bought the stock of Portland Electric Power Co.; then turned over Portland Electric Power Co. to this other corporation, Central Public Service, the holding company, and then lost their shirts on the holding company.