argument that such disclosure would be a violation of foreign law. We are particularly interested in this organization's activities in this country, including the number and amount of its acquisitions and any general patterns which may have developed therefrom. This would include its influence in the management of American companies in which it has acquired an interest. The Investigation In early 1965, the Commission's staff first became aware of the very substantial positions which had been acquired by The Fund of Funds, Ltd. ("FOF") in the shares of several registered investment companies.1 FOF was incorporated in Canada but its securities are not sold there. It was operated from Geneva by I.O.S., Ltd. (S.A.) ("IOS"), a Panama company also controlled from Geneva by a group of expatriate Americans headed by Bernard Cornfeld and Edward M. Cowett. Because of the size of FOF's holdings and the apparent scope of the activities of both FOF and IOS, in early 1965 the Commission directed the staff to conduct an investigation of IOS to determine (1) the impact of the activities of FOF and IOS on registered mutual funds and on the securities markets and (2) to determine whether FOF, IOS, or any of its other subsidiaries violated the Federal Securities Laws. At the time the investigation was ordered, IOS was a registered broker-dealer. It had registered in 1960 because its principal business then involved the purchase of securities through the use of the jurisdictional means and the sale of such securities to Americans overseas. As a registered broker-dealer, IOS was required to keep copies of its books and records in the United States, or file an undertaking to produce any or all of its books and records in Washington, D.C. on demand by the Commission. It had filed such an undertaking and consequently was permitted to keep its records and books in Geneva. The staff's investigation uncovered a number of violations of the Securities Act of 1933 ("Securities Act"), the Securities Exchange Act of 1934 ("Securities Exchange Act") and the Investment Company Act of 1940 ("Investment Company Act"). 1. IOS had sold interests in FOF within the jurisdiction of the United States in violation of the registration requirements of both the Securities Act and the Investment Company Act. The prospectuses and selling literature used by IOS to describe FOF contained statements which fell far short of the disclosure standards of the Securities Act and the Securities Exchange Act. 2. The investigation revealed that IOS was causing registered investment companies to directly execute transactions for their portfolios with certain broker-leaders, or directing such companies to require that their own executing broker-dealers give up a portion of their brokerage commissions to the brokerdealers designed by IOS. IOS or its affiliated persons apparently were able to benefit from such brokerage commissions, although as discussed later, we were stymied in tracing the flow of the monies, which over a relatively short period of time aggregated several millions of dollars, by the secrecy laws of the Bahamas. IOS also caused the registered investment companies involved to inadequately describe such arrangements in their prospectuses. 3. The investigations also disclosed that IOS had violated Section 17(d) of the Investment Company Act in that an investment company under its control engaged in a transaction with certain registered investment companies in which FOF had substantial stock holdings, in violation of the Act. During the investigation, we also conducted an inspection of a wholly-owned subsidiary of IOS, Investors Continental Services, Ltd. (“ICS”), also a registered broker-dealer, at the principal office of ICS in New York City. During that inspection, the staff found, reviewed and then requested ICS to furnish a copy of a certain letter written by Mr. Cowett to another employee of the IOS organization in Geneva with a copy sent to Mr. Cornfeld. Although the letter was not turned over and apparently destroyed, a hand-written copy of the letter had been made by the Commission's staff when they were in ICS' offices during the inspection. In that letter,2 Mr. Cowett stated in part: "As you are probably aware, the ICS files are always open to complete examination by the NASD or SEC. One improper paper in the file, if discovered, could lead to a complete investigation of the entire workings of ICS. Such an examina. tion would include, in all probability, a review of all correspondence coming into the office over a protracted period. Since the correspondence in any period of three 1 A schedule showing the size of FOF's reported holdings at June 30, 1966 is attached as Exhibit A. The full text is set forth in the Commission's order for public proceedings of February 3, 1966, a copy of which is attached as Exhibit B. or four or five days is bound to include at least one daming (sic) letter, you can see that the results could be disastrous. "I do not mean to panic everybody involved by this letter and my letter of even date. I can ask no more than that each person involved do his part in cutting down the extent of our obvious violations." After the investigation continued for some period of time, we concluded that it was necessary to determine the extent of the apparent violations of the registration provisions of the Securities Act and the Investment Company Act. Accordingly, the Commission then demanded that IOS produce, pursuant to its 1960 undertaking, its customers' records or its records of all transactions or accounts effected by IOS with or for United States citizens or nationals, whichever IOS preferred. Although that undertaking was still in effect, IOS refused to produce the records relying on Swiss secrecy laws. Also, during the course of the investigation, a subpoena was served on the manager of the IOS branch in Puerto Rico for production of the books and records maintained in that office relating to sales of interests in FOF to United States citizens. In response, in December 1965, IOS brought an action in the United States Federal District Court in Puerto Rico to enjoin the investigation and to quash the subpoena. The Litigation IOS' lawsuit to enjoin the Commission's investigation was, in effect, a final effort to prevent the Commission from further delving into IOS' activities, such as the reciprocal brokerage and give-up arrangements, IOS' sales of interests in FOF to Americans, the effect of its purchases and sales on the United States markets and the conflicts of interests of its affiliates. In the litigation, IOS sought a declaratory judgment that it could withdraw its broker-dealer registration and that it had not violated the Securities Exchange Act and the rules thereunder when it failed to comply with the Commission's demand. IOS questioned the Commission's jurisdiction and relied, in part, on alleged interdictions of the Swiss secrecy laws as justifying non-compliance with the Commission's demand. On February 3, 1966, shortly after IOS started the lawsuit, the Commission issued an order for public proceedings pursuant to Sections 15(b) and 15A of the Securities Exchange Act and IOS then sought to enjoin the conduct of the proceedings. The District Court in Puerto Rico flatly rejected IOS' jurisdictional arguments, quickly dismissed the complaint to quash the subpoena and subsequently granted the Commission's motion for summary judgment. The District Court rejected IOS' argument that the Commission's jurisdiction was limited and also did not accept the argument bottomed on the provisions of the Swiss secrecy laws. The Court accepted the view that Swiss law did not preclude IOS from producing its records for staff review in accordance with the provisions of the Securities Exchange Act. Moreover, the Court held that even if there were such a conflict, IOS, as a registered broker-dealer, was nevertheless under an obligation to comply with the United States law to which it submitted, and, if the public interest requires disclosure of its books and records to the staff, then IOS had to decide whether or not it wished to continue to do business in the United States. If IOS wished to do so through the use of the mails and facilities of interstate commerce, the Court said that it must be willing to comply fully with the United States law. If not, it was up to IOS to determine whether it wants to do business. IOS appealed and also sought a temporary injunction blocking the conduct of the proceeding pending disposition of the appeal. The Court of Appeals for the First Circuit unanimously turned down the request for a temporary injunction," stating that: "... it is unthinkable that an administrative agency cannot even institute a proceeding until it has had, in effect, the permission of the district court and of the court of appeals whenever the parties to be investigated choose to deny its jurisdiction." The Commission's Proceeding The Commission's order for proceedings set forth staff allegations of various securities laws violations. First, there was Section 5 of the Securities Act and Section 7 of the Investment Company Act-the registration provisions-in connection with the offer and sale of the IOS Investment Program for the Accumulation of Interests in FOF. This charge was based upon the allegation that the instrumentalities of interstate and foreign commerce were used in connection 3 See Exhibit B attached. A copy of the District Court's opinion is attached as Exhibit C. with such offer and sale. The order went on to point out that as a consequence of such registration full disclosure would have been made "with respect to matters which have been inadequately and inaccurately disclosed. Those matters included misleading statements of performance, failure to disclose IOS' actual control of FOF, failure to disclose IOS' actual control of FOF's investment policies and also the changes that IOS has caused and could continue to cause to be made in FOF's investment policies, and failure to disclose the various respects in which IOS profited from its operation and control of FOF. The second charge set forth in the order was based upon staff allegations of the violation of Section 17 (d) and Rule 17d-1 thereunder arising from the joint acquisition and ownership of certain securities traded on the American Stock Exchange by International Investment Trust, another investment company controlled by IOS and certain registered investment companies in which FOF held substantial positions. The third charge made in the order was that ICS, aided and abetted by IOS, Cornfeld, Cowett, and the president of ICS, violated Section 17 of the Securities Exchange Act-the record-keeping provision-in failing to keep and preserve the letter from Cowett already referred to, and for failing to honor the Commission's demand for copies of IOS' books and records relative to transactions with or for U.S. citizens. Finally, by way of matters relevant to the question of public interest, the order set forth allegations describing various undisclosed arrangements established by IOS in order to benefit from very substantial amounts of brokerage commissions which IOS was able to direct to specificed broker-dealers by reason of its control of FOF and influence over the advisers of certain registered investment companies, and certain inaccurate disclosures IOS caused those registered investment companies to make relating to the arrangements. Essentially, those arrangements worked this way. IOS directed certain registered investment companies, the shares of which were purchased for the portfolio of FOF, to effect securities transactions for their own portfolios with, or to cause a portion of the brokerage commissions on such transactions to be given up to, certain broker-dealers designated by IOS. The principal broker-dealer so designated by IOS during the years 1963-1965 was Jesup & Lamont, a New York Stock Exchange member firm. Jesup & Lamont was selected by IOS as the recipient of these commissions because the firm then had in its employ Mrs. Gloria Martica Clapp. Mrs. Clapp was a registered representative and was credited by that firm with all commissions received by or given up to the firm as a result of the designations made by IOS. She was a citizen of Bermuda, resident of Nassau, Bahamas and operated out of what the firm described as its branch office in her home on Paradise Island in Nassau. Between July 1963 and May 1965, Jesup & Lamont realized gross commissions as a result of such directed brokerage and give-ups in excess of $1,500,000. The relationship between Mrs. Clapp and Jesup & Lamont terminated after some time and she became associated with another New York Stock Exchange member firm, bringing with her the IOS business. For all intents and purposes, business generated by IOS or related to IOS accounted for all of her income which ultimately rose as high as 60 per cent of the total commission dollars funneled through the firms she was connected with. We understand that ultimately the net amounts received by Mrs. Clapp under this arrangement through Jesup & Lamont and other firms were well in excess of $3,000,000. When paid by her firm to her, Mrs. Clapp then arranged for the deposit with Fiduciary Trust Company, Ltd., Nassau, the Bahamas (Fiduciary), of most of the money. It was represented to the Commission's staff that this money was deposited in trust for her children at Fiduciary. It was further represented that this money was not in any way turned over or flowed through the trust to IOS or its principals. We could never verify these representations since the trail ended at Fiduciary, But, it appeared at the very least that Fiduciary, in turn, transferred substantial sums of money to banks controlled by IOS or to banks which had material banking relationships with IOS. All of the money so routed through Mrs. Clapp was, presumedly, free of any U.S. income taxes levied on her, her firm, IOS or its American principals, Messrs. Cornfeld and Cowett. Subsequently, on the basis of trades executed for Fiduciary, Mrs. Clapp was barred by consent from being associated with any U.S. securities firm and her husband was enjoined by consent from the sale of securities in violation of the Securities Act and from violating the registration provisions of the Securities Exchange Act. Shortly after the Order for Proceedings was issued, IOS initiated settlement discussions with the Commission's staff. The Settlement After a very extended period of negotiation, the proceedings were settled on May 23, 1967 when the respondents submitted an offer of settlement, under which they proposed that the proceedings be terminated without any findings, and in return consented to an order of the Commission under which they agreed to more relief than the Commission could have obtained had the matter gone to hearing and decision. This was not a mere settlement of technical jurisdictional matters-it involved a permanent bar prohibiting IOS and its principal officers, including Cornfeld and Cowett, from conducting any activities subject to Commission jurisdiction. Under the order, the respondents were required to: 1. Withdraw the broker-dealer registration of IOS and, of course, also that of ICS. The order thereafter prohibits IOS and all of its affiliates from conducting any activities subject to the jurisdiction of the Commission. 2. Sell ICS or merge it into Investors Planning Corporation of America ("IPC"), a large distributor of mutual fund shares in the United States which IOS had then recently acquired (they chose to merge the two corporations). 3. Sell the IOS interest in IPC but only after consent of the Commission to the circumstances of the transaction and the independence of the buyer from IOS. 4. Dissolve several registered investment companies which IOS had previously organized in the United States for the purpose of serving as investment vehicles for FOF. 5. Cease all sales of any securities to United States citizens wherever located. 6. Agree that no IOS officer or employee will engage in any activities subject to the jurisdiction of the Commission and that the individually-named respondents, that is Messrs. Cornfeld, Cowett, Cantor, Lovett, Nagler, and Feld, would in no event at any time ever engage in any activities subject to the jurisdiction of the Commission. 7. Agree that IOS and its affiliates will refrain from acquiring any controlling interest in any financial entity doing business in the United States or whose activities directly or indirectly are subject to the jurisdiction of the Commission. 8. Agree that a life insurance subsidiary then owned by IOS and doing business in United States, would refrain from conducting activities subject to the jurisdiction of the Commission. 9. Agree that all investment companies controlled by IOS will operate in the future as if the limitations of Section 12(d) (1) of the Investment Company Act are applicable. This means, in effect, that unregistered investment companies under IOS control will generally acquire no more than 3 per cent of the shares of domestic mutual funds, thereby protecting such funds and their shareholders from the possibility of direct or indirect control by IOS or other possible adverse consequences which might be caused by unlimited large scale foreign holdings of the shares of such companies. This aspect of the order was very important because present law provides no such protection, although the Commission has recommended to Congress that the Investment Company Act be amended in various ways, one of which would be to provide this type of protection in the future, and H.R. 11995 which is now before the House Committee on Interstate and Foreign Commerce would accomplish this purpose. Despite the representations made by IOS that it would refrain from any exercise of control of and refrain from causing any disadvantage to registered mutual funds, without this provision in the Order the possibility of such control still existed. In this connection, we are aware now of a situation involving a pre-existing position of FOF in a domestic registered investment company where the investment adviser of that company has complained that a redemption by FOF of its holdings in the registered mutual fund would cause injury to remaining investors in the fund. On July 2, 1969, an article in the "New York Times," reported that Arnold Bernhard, the controlling person of the investment adviser of Value Line Special Situation Fund, another pre-existing holding of FOF, indicated that sometime apparently between April and June, "the fund's biggest holder, the Fund of Funds, 'liquidated its entire position in ten days' and that this caused some difficulty because 'we had to pay them right away. Thus, we viewed this agreement to comply with the limitations of Section 12(d) (1), as if applicable, as a very important part of the total relief achieved by the Commission. A copy of the Commission's Order of Settlement of May 23, 1967 is attached as Exhibit E. Finally, as a condition to the Commission's accepting the Order of Settlement, IOS agree that it would offer to refund to FOF investors who were (i) members of the Armed Forces, (ii) employees of the United States or (ii) residents of the United States the sales load they paid if they desired to redeem their FOF holdings or to allow them to exchange their holdings for shares of registered investment companies on a load-free basis. To repeat again, we viewed the Order as far-reaching, providing more relief than would have been possible if the matter had been fully litigated. We would like to report to the Committee on the other matters concerning IOS that the Committee specifically asked about. Other Matters Involving IOS Since the termination of the administrative proceeding against IOS in May of 1967, we have had a number of other matters involving IOS, its affiliated organizations and their officers. These matters reveal a continuing involvement on the part of IOS with American companies and foreign companies traded in our securities markets. For example, in August this year, we obtained a permanent injunction in Federal court against IOS and affiliates with regard to violations of the provisions of the Securities Act of 1933, which requires the registration of shares to be sold in a public distribution. The injunction, which IOS consented to without admitting the allegations, is far reaching in that it bars the unregistered sale of any securities in our markets. It resulted from an investigation concerning the sale of shares of Revenue Properties Company, Limited, a Canadian company engaged in developing real estate in this country as well as Canada. As alleged in our complaint, during the period from April 1968 through March 1969, certain controlling persons of Revenue Properties sold approximately 1,000,000 shares of stock without any registration statement being filed. The IOS defendants purchased approximately 635,000 of these shares, at prices below the then market price. Subsequently, approximately 535,000 unregistered shares were sold by IOS at a profit of several million dollars. At least 40,000 of these unregistered shares were sold on the American Stock Exchange. In light of developments concerning the company which came to light subsequently, trading on the American Stock Exchange has been halted since April 21, and there is at present no indication whether or when trading will be resumed. There is also presently pending before the Commission, staff charges that IOS and certain of its affiliated persons violated certain of the anti-fraud and Investment Company Act provisions of the Federal securities laws. Because the matter is pending before the Commission it would be inappropriate to discuss this case at length. Essentially, the staff has alleged that IOS and companies under its control unlawfully shared in brokerage commissions and other monies arising out of portfolio transactions effected on behalf of The Fund of America, Inc., a registered investment company then controlled by IOS. The staff has alleged also that similar practices were employed in connection with transactions of FOF and other foreign-based investment companies under the management of IOS. We also know of several instances where IOS has participated in the management of publicly-owned corporations. In one case involving Commonwealth United Corporation, a conglomerate, IOS, in order to protect its interests as a $40 million creditor of the company, in the summer of 1969 provided the company with an additional $10 million worth of financing. At the time, the company was experiencing severe financial problems. In connection with the infusion of this additional money, IOS required that Commonwealth permit three IOS designees to join the company's board of directors and also required that two of the three be given control of the company's three-man executive committee. These persons managed and operated the company for a period of approximately three months at which time arrangements were made to bring in a new management group. Before this was effected, however, IOS and its designees arranged to he substantially compensated by Commonwealth. Included in the compensation to be received were warrants and options to purchase 1,450,000 shares of Commonwealth common stock as well as substantial cash compensation. Just prior to a recent mailing of proxy materials we inquired into these arrangements as well as the disclosures reflecting them. For example, questions were raised |