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INVESTMENT TRUSTS AND INVESTMENT COMPANIES

FRIDAY, APRIL 5, 1940

UNITED STATES SENATE,

SUBCOMMITTEE ON SECURITIES AND EXCHANGE OF THE
BANKING AND CURRENCY COMMITTEE,

Washington, D. C. The subcommittee met, pursuant to adjournment on yesterday, at 10:30 a. m., in room 301, Senate Office Building, Senator Robert F. Wagner presiding.

Present: Senators Wagner (chairman of the subcommittee), Hughes and Frazier.

Senator WAGNER. I think the subcommittee had better proceed with its hearing. I have proxies of members to account for a quorum, and no doubt some of them will come in a little later on.

Mr. Schenker, were you to testify first this morning? I see that Mr. Mathews is here.

Mr. SCHENKER. Mr. Mathews will go on directly after I close, and I hope not to be long with this statement.

Senator WAGNER. Then you may proceed.

STATEMENT OF DAVID SCHENKER, CHIEF COUNSEL, SECURITIES AND EXCHANGE COMMISSION, INVESTMENT TRUST STUDY, WASHINGTON, D. C.-Resumed

Mr. SCHENKER. Yesterday Mr. Stern described the rise in the United Founders Corporation, and during the course of his discussion he showed that Founders raised $500,000,000 of the public's money. In 1933 the group that was controlling Founders sold their controlling block of stock to another investment trust-but I will discuss that a little bit more in detail shortly. At the time that this controlling block of stock was sold the assets of United Founders Corporation were $47,000,000, so that from $500,000,000 it was down to $47,000,000 in 1933.

Now, one would assume that after a person managing half a billion dollars of other people's money, lost all of it except $47,000,000, he would take his hat and coat and go home. But that was not the fact. After the assets of that company dropped from half a billion to $47,000,000, those insiders took their class A stock, which I will describe in a moment, and sold it for $1,200,000 to another group, controlling another investment trust, and turned over the $47,000,000 of other people's money to this new group.

The fact of the matter is that at the time of this transfer of $47,000,000 of other people's money to a new management group, the stock of the insiders was worth only $45,000.

You

Now, let me just describe briefly what this class A stock was. will remember that Mr. Stern described how, first, they organized one company and sold that stock, they organized another company and sold that stock, and organized still a third company and sold that stock, I mean to the public.

Now, the feeling one gets from this entire picture is that these companies were being created, not because those people had any faith in the economic soundness of these companies but organized these companies because the public was prepared to buy their stock. So you had this picture of company after company after company being formed merely because the public was prepared to buy stock and they could thereby increase their funds.

After they organized one, two, three, four, five, six and seven companies, and had interests in other companies, they wanted to solidify their control of this $500,000,000. What did they do? They organized United Founders Corporation, which is the top holding company shown on this chart, and this is the capitalization of that company: There are two classes of common stock, one being A stock, and the other being common stock. The class A stock, which is the voting stock, had this voting power: that regardless of the number of shares of other common stock outstanding the A stock had a vote at least equal to one-third of all the outstanding stock.

Now, ultimately there were 6,000,000 shares of common stock held by the public, and the A stock, which was issued to the insiders, then had a vote of 3,000,000 shares; because if you take the six million and the three million it gives you nine million votes, and their stock always had one-third of the voting power. So you had the situation where they raised half a billion dollars of the public's money—and through their management as described by Mr. Stern yesterday, you saw what happened in the case of United States Electric Power Corporation, and what happened in the case of General Investment Corporation, where the assets of General Investment went from $78,000,000 down to $8,000,000, and the assets of United States Electric Power Corporation went down from $130,000,000 to $132.

Well, those people still had the power to vote the A stock, and to control the A stock, so they sold it for $1,200,000, and thereby turned other people's money over to a new group. And we will see what the new group did with the balance of the funds which they had.

Now, we say and recommend, and the bill incorporates that recommendation, that this recurrent promotion of companies, which seems to be generated not through any impulse that there is any economic significance to that type of promotion but merely for the purpose of generating merchandise that they can sell to the public, we say that that is unhealthy economically and undesirable, and the bill says: Hereafter you cannot at your whim organize an investment trust every time you think you can sell stock to the public.

And what other situation do you have here? You have these companies, one piled on top of another, and then superimposed upon that still another company.

Now, I do not know much about holding companies, but it seems to me in the public utility situation at least a holding company performs some economic function. You have an operating company here, there and elsewhere, and you superimpose upon them the holding company which will keep those three plants together, and

possibly raise funds from the public which can be supplied to the underlying companies.

But there is nothing like that in the case of an investment trust. There is no economic purpose served by piling one company upon another. It is just a device to sell securities, to raise more money. When we come to discuss the section of the bill which deals with pyramiding of these companies, one investment trust owning another, we will give you not one but innumerable examples of where this has been done. In other words, pyramiding is not rare but exists at the present time.

The Commission says they feel the time has arrived, and it must not be forgotten that the bill at the present time does not try to disturb the pyramided situations as they exist; that such a situation as I have described is unhealthy economically and is undesirable. We say: A stockholder can never tell what the value of his stock is, but we say: You exist and we will maintain the status quo, but as far as the future is concerned you ought not to be permitted to pile one investment trust upon another.

You cannot get an idea of the complicated structure here until you learn that each one of these underlying companies had two, three, and four different kinds of stock. How to figure out the value of the stock is beyond us.

We feel that as far as the future is concerned nobody should be permitted to organize investment trusts just because he can sell their securities. We feel he should not be permitted to pyramid them, one upon another, so that he can get concentration of control of great wealth through the device of management stock.

Senator WAGNER. Can you offhand tell us what time intervened between the organization of these companies, one after the other in the group?

Mr. SCHENKER. The fact of the matter is, as I recall it, that the first company was organized in 1922. The United Founders Corporation, the one shown at the top of the chart, was organized in 1929. Do not be shocked by this, but we will give you cases where one group organized six investment trusts in 1 year and we will show why that sort of thing should not be permitted to continue.

One cannot organize six banks, one after another; one cannot organize six insurance companies, one after another; one cannot organize six building and loan associations, one after another; one cannot organize six mortgage associations, one after another, unless he gets permission from some governmental agency that there is nothing undesirable about these recurrent promotions.

Senator WAGNER. Didn't the shareholders sense the unfortunate situation in this other case?

Mr. SCHENKER. You might have got the impression yesterday from Mr. Stern that this was ancient history, and that this only took place back in 1928 and 1929. The fact of the matter is that the last little brush took place in the middle of 1939, after you had the 1933 act, and after you had the 1934 act, and after you had the 1935 act, because in November of 1935 what did they do? They sold this United Founders Corporation, which at the time only had $47,000 to The Equity Corporation.

Now, when I say The Equity Corporation you may think this is a simple little company, with one class of stock; but it was a pyramid of these investment trusts managing other people's money.

If you will take a look at this chart you will see the setup. Equit Corporation was even worse than United Founders Corporatio This chart shows Equity Corporation at the time Founders was so. to Equity.

Now, I would like to introduce, if I may, a picture of the Equit Corporation as of about the time the Equity Corporation got contr of United Founders Corporation.

Senator WAGNER. Have you more than one copy of that chart.
Mr. SCHENKER. We have plenty of copies.

Senator WAGNER (chairman of the subcommittee). This chart w be made a part of the record at this point.

(The chart entitled "Equity Corporation" is made a part of t record.)

Senator WAGNER (chairman of the subcommittee). You may pr ceed with your statement.

Mr. SCHENKER. Now, at the time control of United Founders Co poration was transferred to Equity Corporation, it owned the Yosem Holding Corporation, which in turn owned Chain and Gener Equities, Inc., which in turn owned Interstate Equities Corporatic and through these investment trusts they owned General Americ Securities Corporation, Majestic Fire Insurance Co., Americ Colony Insurance, Colonial States Fire Insurance Co., and Germai Fire Insurance Co. Owning all these insurance companies, wh did they do? They reinsured the risks and really made investme trusts out of these four insurance companies so that there was th complicated situation. I will introduce a chart in a few mome showing what was above Equity Corporation, but there you have th tremendously complex situation.

Now, what happened? They sold the A stock to an investme company subsidiary. The Equity Corporation, and this A stock h a vote equal to one-third of the total voting power outstanding.

Then the new group started out, with that control, messing rou with the capital structures of these underlying companies, all with view to collapsing the structure and making one company out of Ultimately, in 1935 this entire structure was collapsed and the name the Founders Companies was changed, and it became known as t American General Corporation.

I do not want to discuss in detail at the present time what ha pened to the stockholders in the process of recapitalizing these cc porations and in the process of the exchange phase. That is des with in two reports, one by the Commission and one by the protecti committee. These reports have been transmitted to the Congres Let me take a minute and tell you what happened to General I vestment Corporation, which was a part of the picture of Founder Mr. Stern told you how this company flopped from $78,000,000 1 $7,000,000 or $8,000,000.

Senator WAGNER. I did not quite catch that latter figure. you say it dropped from $78,000,000 to $70,000,000?

Di

Mr. SCHENKER. No. It went down from $78,000,000 to $7,000,00 or $8,000,000.

Mr. WAGNER. Oh, I thought the latter figure was $70,000,000. Mr. SCHENKER. No. And that loss was sustained how? Senatc Townsend asked whether that loss was not entirely attributable t that fact that there was a stock-market crash. Nobody denies the

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