You infer this bill will give the Federal Trade Commission the power to make the day-to-day investigation of which you speak?

Mr. CUNNINGHAM. Yes.

Senator O'MAHONEY. Suppose that it does not, how would you feel about it?

Mr. CUNNINGHAM. Suppose it does not?

Senator O'MAHONEY. Suppose the bill does not, or we should amend it so as to make unnecessary what you call a day-to-day investigation? Mr. CUNNINGHAM. That would bring it back to the specific provisions of the Federal incorporation charter. I think that possibly benefit can he had by a law of that kind. I would like to study the charter provisions before passing a general endorsement on such a program. The objection there is to writing an antitrust law into a corporate charter, and writing a child-labor provision. I think those laws should be separate and distinct. Child labor ought to be State legislation, all over the country.

Senator O'MAHONEY. How many of your corporations are employing children under 16?

Mr. CUNNINGHAM. None.

Senator O'MAHONEY. Then they would not be injured if they agreed not to do it, would they?

Mr. CUNNINGHAM. I think this association has only 3,000 members out of probably 300,000 licensees.

Senator O'MAHONEY. When a corporation has acquired gross assets of $100,000, and is operating in interstate commerce, it has already become a sizable institution with a national aspect, has it not?

Mr. CUNNINGHAM. It need not be national with $100,000.

Senator O'MAHONEY. I mean engaged in interstate commerce.

Mr. CUNNINGHAM. That could be between two States, just a little local area.

Senator O'MAHONEY. Such a corporation, if a member of your association, and you are correctly advised, is probably not employing children now.

Mr. CUNNINGHAM. That is right.

Senator O'MAHONEY. Then, what would be the objection to making that a charter condition?

Mr. CUNNINGHAM. Under the present bill there is the general question of the administration of that provision, the Federal Trade Commission's power to supervise and investigate, and the penalty attached to the violation of it. A stockholder of a corporation could be fined a percentage of its capital stock. An officer could be prevented from doing business, because of a violation of that sort, and that might run all the way down. You might say the court may be lenient, but the penalties are here. I favor strict means of stamping out child labor in industry, but when you couple these extreme penalties with the power of the Federal Trade Commission, that presents a serious problem to many businessmen.

Senator O'MAHONEY. But you have already said that if it be a fact that you are mistaken in your opinion this bill would require the day-to-day investigation by the Federal Trade Commission to which you referred, it would be a different picture, would it not?

Mr. CUNNINGHAM. Yes; but the penalty attached to the violation of the charter would still continue.

Senator O'MAHONEY. Do you have any fundamental objection to Congress laying down the charter conditions of corporations engaged in interstate commerce?

Mr. CUNNINGHAM. No. I understand that the Constitution grants that right, and that is your right.

Senator O'MAHONEY. Congress does not always exercise its rights or all the power it has.

Mr. CUNNINGHAM. I take no position against Federal incorporation. I would want to see the bill before I would comment on it. Senator O'MAHONEY. Have you anything further you would like to say?

Mr. CUNNINGHAM. Nothing further, thank you.

STATEMENT OF JOHN D. BATTLE, EXECUTIVE SECRETARY, NATIONAL COAL ASSOCIATION

Senator O'MAHONEY. Mr. Battle, you may proceed. First give your name and occupation.

Mr. BATTLE, My name is John D. Battle. I am executive secretary of the National Coal Association, a voluntary trade association composed of individuals, partnerships, and corporations.

Senator O'MAHONEY. You may proceed with such statement as you desire to make.

Mr. BATTLE. Mr. Chairman, I do not care to discuss the merits of the bill at all. I merely wish to point what I feel is an obvious oversight. I have before me S. 3072, the committee print, and in section 14 it is noted that common carriers are exempted, because they are now subject to Government control or regulation. That includes not only railroads, but pipe lines, telegraph and telephone companies, because they are common carriers and are now regulated by the Government. It exempts the broadcasting companies, because they are under governmental regulation. We are confident that it is an oversight that the bituminous-coal industry is not exempted, as it is now subject to control by the Federal Government. Not one phase of its business is not under complete control of the National Bituminous Coal Commission. That control is bottomed on the commerce clause of the Constitution.

I also notice that banks and publishing houses are exempt. We therefore suggest the following amendment in section 14, by inserting after the words or figures "1934", in line 25 of the page 23, in the committee print of the bill of February 19, 1938, these words: to any corporation, partnership, or person engaged in the mining and selling of bituminous coal subject to the Bituminous Coal Act of 1937.

I have no particular pride in the exact wording of that suggested amendment, but inasmuch as we are under complete governmental control I feel that the coal industry should not be subject to dual control by two Federal agencies. In order to function in the coal industry, there must be submitted full and complete information to the Coal Commission, subject to rules and regulations promulgated by that agency, and we feel there is no more reason for including those engaged in producing bituminous coal than to include railroads and others that are already exempted. I had not expected to take a definite position on the measure itself, but do feel that exemption should be granted.

Senator O'MAHONEY. It was the intention of those who drafted the bill to exempt such corporations as are already affected by any regulatory provisions of the Federal statutes.

Mr. BATTLE. That was my understanding.

Senator O'MAHONEY. I think you will have no difficulty about that amendment.

Mr. BATTLE. Thank you. If the language is not exactly correct, that control is covered by the Coal Act, Seventy-fifth Congress, first. session.

ADDITIONAL STATEMENT OF ROBERT H. O'BRIEN, REPRESENTING THE SECURITIES AND EXCHANGE COMMISSION

Senator O'MAHONEY. Mr. O'Brien, I understand you have brought the material for which the committee made a request yesterday. Mr. O'BRIEN. Yes. There is some additional material which we will submit as soon as we collect it.

Senator O'MAHONEY. This letter which you hand me covers what? Mr. O'BRIEN. That includes a brief statement and description of the nature and jurisdiction and functions of the Commission in administering the Securities Act of 1933.

Senator O'MAHONEY. Have you brought a statement covering the use of surplus for distribution as dividends?

Mr. O'BRIEN. Yes.

I have here 14 separate memoranda which consist of brief summaries of registration certificates on file with the Commission. These memoranda relate to questions arising as to which type of surplus may be so used, particularly with respect to the restriction against the use of the surplus. These memoranda show how that surplus may be used, and in each instance the opinion of counsel is rendered, supporting the validity of the particular use under the law and the State in which the corporation is organized.

Senator O'MAHONEY. To what counsel do you refer?

Mr. O'BRIEN. These are various counsel.

Senator O'MAHONEY. Employed by the Securities and Exchange Commission?

Mr. O'BRIEN. Employed by the companies.

Senator O'MAHONEY. In other words, the attorneys employed by the companies file statements and arguments with the Securities and Exchange Commission as to how surplus may be used under the laws of the States in which the corporations are organized?

Mr. O'BRIEN. Yes. There are opinions to that effect included in these memoranda, or excerpts from those opinions.

Senator O'MAHONEY. Those documents may be inserted in the record.

(The documents referred to are here set forth in full, as follows:) SECURITIES AND EXCHANGE COMMISSION, Washington, March 3, 1938.

Hon. JOSEPH C. O'MAHONEY,

United States Senate, Washington, D. C. MY DEAR SENATOR O'MAHONEY: To supplement my statement before the subcommittee of the Judiciary on Tuesday, March 1, I should like to add a few words with respect to the function of the Commission under the Securities Act of 1933. In general, the Securities Act requires that the material facts essential to a judgment of the character of the security offered for sale be made available

to the investor in the form of a prospectus. The prospectus itself is a condensation or summary of certain information required to be included in a registration statement filed with the Commission. The Commission in no way approves or disapproves a particular security. Indeed, it is a criminal offense under the statute for any issuer or distributor of securities to represent that the Commission has in any way passed upon the merits of or given approval to a registered security. The Commission's power is limited to requiring that full and fair disclosure of the material facts be made. It cannot control or supervise corporate practices or procedures. For example, facts reflected in certain registration statements sometimes indicate that the registrant company may be violating or may have violated, certain State or Federal statutes in the conduct of its business. The Commission in such cases insists that the company's actions in this respect and their effect on its business and the securities being offered be clearly set forth in the registration statement and prospectus. If such disclosure is made the Commission is not authorized under the Securities Act to prevent the registration statement from becoming effective. Where a corporation is acting in accordance with State law but its conduct would seem to be unfair to the security holders, again the Commission is not authorized to prevent the registration from becoming effective, but merely to require a full disclosure of the facts. If the registration statement appears to contain untrue or misleading statements of material facts, the Commission may institute proceedings under section 8 of the act, either to prevent or suspend the effectiveness of such statement.

I have made an effort to ascertain, as requested by the committee, the number of corporations engaged in business in interstate commerce which do not come within the jurisdiction of the Commission under either the Securities Act of 1933 or the Securities Exchange Act of 1934. I regret that it has so far been impossible to obtain any figures on this point which would be at all reliable. I shall further endeavor to determine the number of such corporations and advise the committee shortly of the results. Of course, there are many large corporations doing business in interstate commerce which have not made any public offerings since the enactment of the Securities Act of 1933 or the Securities Exchange Act of 1934, and whose securities are not listed on any national securities exchange. Accordingly, although the securities of those companies may be extensively bought and sold in interstate commerce, they are required to make no reports whatsoever to this Commission. A typical instance is a well-known oil company which apparently has approximately $900,000,000 of securities outstanding which are traded in actively. No data have been filed by this company with the Commission. It is improbable that these corporations make generally available to their security holders information of the character and scope contemplated by the Securities Act and the Securities Exchange Act.

The question was raised as to whether the laws of certain States permit payment of dividends out of paid-in surplus and like practices. As bearing on that question, I am enclosing a number of memoranda summarizing certain statements made by registrant companies with respect to limitations or the lack of limitations upon payment of dividends from different classes of surplus, and excerpts from opinions of counsel relating thereto.

Very truly yours,

ROBERT H. O'BRIEN,

Assistant Director, Registration Division.

OUTLINE OF CONTENTS

A. Mergers, consolidations, recapitalizations.

I. Limitations on the effectiveness of voting rights.

II. Jurisdiction shopping.

B. Services and property in exchange for stock.

C. Surplus restrictions.

D. Participations in earnings and management of corporation in relation to

capital contribution.

E. Officers and directors.

I. Compensation.

II. Interest in contracts.

F. Annual meetings.

G. Reports to stockholders.

A. MERGERS, CONSOLIDATIONS, RECAPITALIZATIONS

I. LIMITATIONS ON THE EFFECTIVENESS OF VOTING RIGHTS

In December of 1932, The Equity Corporation was formed for the purpose of gaining control of investment trusts and investment trust companies and consolidating them "into one corporation or into a coordinated, controlled group." Incidents in the history of this company's expansion program bring into clear focus existing deficiencies in State laws, which permit action by dominant stockholders in corporations with small regard to the wishes of other investors in the enterprise (Investment Trust Study Proceedings Questionnaire in the matter of Equity Corporation, et al).

In the year 1935 The Equity Corporation acquired or brought under its direct control by merger or consolidation net assets of 12 corporations amounting to almost $50,000,000. This was done under the laws of the States of Delaware and Maryland. The mergers all affected Delaware corporations and were all consummated under the Delaware law. Thus, Interstate Equities Corporation and Chain & General Equities Inc., were merged into Equity on March 25, 1935. And Reliance International Corporation and American, British & Continental Corporation were merged into Equity on September 6, 1935. In addition, eight corporations-seven incorporated in Maryland and one in Delaware-were consolidated to form American General Corporation, a subsidiary of Equity, on November 23, 1935.

The Delaware statutes authorize merger or consolidation by the vote of "stockholders of each such corporation representing two-thirds of the total number of shares of its capital stock, * * * each share entitling the holder thereof to one vote." As a result, the class of stock which has the most votes wields the greatest power, regardless of the proportion of the corporation's assets that may be applicable to it. In its most pernicious aspect such a provision may permit common stockholders, if sufficiently numerous, to bind the preferred stockholders of the corporation into a merger or consolidation on terms dictated by the interests of the common stockholders, even though all of the assets of the corporation are applicable to the preferred stock and none to the common.

The possibility just described is not a hypothetical one. In the case of three of the four corporations merged into Equity, the control of common stock alone, apart from its preferred stock holdings, gave Equity control of the vote necessary to effect the merger. And at the time of the mergers these common stocks had no asset values. This control of the common stock was also sufficient to give Equity control of the managements which determined the terms of the mergers. By these terms the preferred stockholders of the four corporations merged into Equity experienced severe losses in preference rights on liquidation. Before merger these stockholders were entitled to approximately $9,800,000 on liquidation. After merger into Equity their preference on liquidation amounted to about $6,200,000, a loss of over $3,600,000 in preference rights. In addition, preferred stockholders of two of these corporations suffered appreciable losses in the asset values of their securities.

The provisions of the Maryland law, as distinguished from that of Delaware, ostensibly guard against this abuse. The applicable statutory provisions require a two-thirds vote of each class of voting stock for the adoption of a merger or consolidation agreement, as distinguished from two-thirds of all the capital stock. The history of Equity Corporation's expansion, however, illustrates how this apparent safeguard may be effectively circumvented.

Thus, the consolidation of eight corporations into American General Corporation has been referred to above. Seven of these eight companies had been incorporated in Maryland, and of these, five had preferred stock outstanding. Equity controlled virtually all the common stocks of these corporations. But control of the common alone, however overwhelming, would not enable Equity to force preferred stockholders of the Maryland corporations into the consolidation without their favorable vote as a separate class. Equity's holdings of the preferred stocks, on the other hand, were relatively small. In no instance did it control the twothirds required for a favorable class vote. Its combined holdings of both preferred and common, however, were in excess of two-thirds of the total shares of both classes outstanding. Its predominant interest lay in the common stock, in direct conflict with the interests of preferred stockholders. Accordingly, it employed devices to deprive preferred stockholders of the protection of a class vote.

The corporate maneuver which effected this result was based on another provision of the Maryland corporation law. This stated that irrespective of statutory