dominated EJA through Bevan and Hodge; 303 that under the influence of Bevan, EJA was acquiring foreign airline interests and advancing funds to one Fidel Goetz among others; 304 that Penphil (whose shareholders include Bevan and Hedge) had improper arrangements with EJA through Holiday International Tours which caused a waste of EJA funds; 305 that operational losses were in excess of $9,500,000 and that indebtedness to Penn Central exceeded $19,500,000. The complaint also alleged a waste of corporate funds on the personal pleasures of Lassiter and others. Kunkel was in a position to know of these matters. He was formerly the treasurer and the chief financial officer of EJA.306

The directors had not been successful in insuring the competency of management or the company's compliance with laws. Now they were confronted with a direct challenge to the integrity of the company's chief financial officer. The allegations made by Kunkel were basically true. The directors had ample reason to be sensitive to any allegations of impropriety in connection with the affairs of EJA. The directors had been aware for some time that the Civil Aeronautics Board considered Penn Central's involvement in EJA to be illegal.307 They also knew that sizeable amounts of money had been advanced to EJA and the Penn Central had received no return on the money. Up to this point they had relied on Bevan for information about EJA. The fact that Bevan was being sued was of such significance in light of all the circumstances that an independent inquiry by the board was certainly called for.

303 From Kunkel complaint:

"6. Continuously up to the filing of this action defendant Penn-Central Railroad, dominated and controlled the election of the board of directors and officers and the management and business policies of EJA, Inc. through the American Contract Co., Glore Forgan, Wm. R. Staats, Inc., Charles J. Hodge, and David C. Bevan. Disregarding the corporate well-being of EJA, Inc. and the rights of the minority shareholders the defendants entered into an illegal conspiracy to enable the Penn-Central Railroad to dominate the world air transportation market."

304 From Kunkel complaint:

"He (Lassiter) directed EJA, Inc. on a course of action designed to gain control of and acquire foreign air carriers with funds supplied through various means of financial subterfuge by the Penn-Central Railroad and Glore Forgan, Wm. R. Staats, Inc. in violation of the rules and regulations of the Civil Aeronautics Board and the laws of the United States. This agreement (on European operations) was consummated without the approval or concurrence of the board of directors, the management, or the shareholders of EJA except the coconspirators named herein. Financial reports later obtained by the treasurer of EJA showed a loss of approximately $72,000 for Transavia in the first 3 months of 1968 and accumulated losses of nearly $500,000 as of May 31, 1968. To finance this and other similar conspiratorial transactions the Penn-Central Railroad caused $500,000 to be made available to EJA, to be placed in the bank (sic) of America and had one Fidel Goetz loan EJA $650,000 for which Mr. Goetz received interest and a warrant for 40,000 shares of EJA. Mr. Goetz is a German textile magnate and the controlling stockholder in Sudwestflug, a German supplemental carrier.

"Subsequent to the agreement of February 1968 EJA leased a Boeing 707 to Transavia and is presently owed in excess of $1 million by Transavia for the use of this airplane and attempts to collect this bill or to have the airplane returned to EJA have not been successful."

305 From Kunkel complaint:

"During the month of February 1968 the coconspirators embarked upon a plan whereby EJA would control and operate International Air Bahamas and absorb all losses therefrom while the conspirators would personally benefit from a wholesale tour agency known as Holiday International Tours which had been hired as general sales agent for International Air Bahamas. Holiday International Tours was financed and controlled by an investment company called Penphil which had a list of stockbrokers including O. F. Lassiter, Charles J. Hodge, and David C. Bevan, in fact half of Penphil's shareholders are either present or retired employees of the Penn Central Railroad or Glore Forgan, Wm. R. Staats, Inc. The conspirators charged EJA, Inc. with large sums of money for plush and elaborate entertainment expenses and ballyhoo far beyond any reasonable corporate expenditures for promotional purposes. International Air Bahamas is presently indebted (sic) to EJA, Inc. in excess of $1,500,000 in back lease payments, maintenance costs and air crews for Boeing 707 furnished by EJA, Inc. and every attempt by the former treasurer of EJA, Inc. to (collect) this account was hampered and stopped by O. F. Lassiter for reasons unknown. This indebtedness grows monthly while EJA, Inc. goes further in debt to Penn-Central Railroad to finance this operation."

106 The directors were not furnished with copies of the complaint. Apparently no director asked for a copy. 307 The directors also admitted their growing concern about Bevan's inability to sell EJA as required by the CAB. Bevan had repeatedly assured the board that EJA would shortly be sold. At the time of this meeting previously reported efforts to sell to U.S. Steel and Burlington Industries had failed. Penn Central was also being fined $65,000 by the CAB for its continuing involvement with EJA.

The directors state that they had relied in good faith on the opinion of counsel that the investment was legal.

The directors in fact realized the significance of the matter. During an executive session which was called to discuss Bevan's appointment to the board, Stewart Rauch questioned whether Bevan's appointment should be delayed until an inquiry of the EJA matter could be made. The directors finally decided to proceed with the appointment of Bevan to the board, but to authorize an investigation into the charges. Although Rauch wanted a wholly outside group to conduct the investigation it was decided, apparently at the suggestion of Thomas Perkins, who was a member of the conflicts committee, that the conflicts committee of the board would conduct the investigation. Bevan was out of the board room when this discussion took place.

After the meeting adjourned, Saunders informed Bevan of the board's decision on the investigation. Bevan bécame angered. He stated that he would consider an investigation to be a vote of no confidence and that he would resign. This alarmed Saunders and the directors who learned of it. Edward Hanley, the chairman of the conflicts committee and a friend of Bevan 308 decided that the resignation of Bevan would be extremely harmful to Penn Central because of the financial crisis being experienced by the company. Penn Central could not afford to lose its chief financial officer, expecially one who seemed so adroit at raising cash. Despite Saunders' general animosity toward Bevan, he was aware of Bevan's importance at that critical time. Saunders called John Seabrook to warn about Bevan's threatened resignation:

Question. Did Mr. Saunders indicate that he wanted to keep Bevan?
Answer. He sure did. He surely did.

Question. Had you understood that there was any animosity between Mr. Bevan and Mr. Saunders?

Answer. Yes. I didn't think they were fond of each other at all.

Question. Well did you see any reason why this was not a good time for Mr. Saunders to accept Mr. Bevan's resignation?

Answer. Well, keep in mind that timing, August was 2 months before we passed the cash dividend and he regarded Bevan as a wizard at raising cash and so I think he didn't want to lose his services at the time.

Rauch was prevailed upon by Saunders to call Bevan and mollify him. Rauch called Bevan on September 3. It was an awkward call because Rauch had raised the question of what was happening in EJA and it was Rauch who had suggested postponing a salary increase for Bevan until the EJA matter could be examined. Bevan rebuked Rauch and emphasized that the company was in serious financial difficulties, with the implication that he was indispensible. Rauch's notes reflect that Bevan spoke of:

Cash drain of $295 [million through 1970] 5 minutes on that.

Near miracle to save company next year $200-$300 million in equipment no where to come from.

Rauch concluded:

Dave must stay-what action can rectify appt. comti [appointment on August 27th of committee to investigate EJA and Bevan].

308 Hanley was chairman of the board of Alleghany Ludlum and had caused Bevan to be named to the Alleghany Ludlum board in 1967.

Hanley conducted a telephone poll of most of the directors and 309 explained Bevan's position on the matter of the investigation.310 The directors agreed that they could not afford to let Bevan go at that critical time. Hanley worked out a compromise. First, reference to the authorization of the investigation would be deleted from the minutes. Second, Bevan would prepare a statement explaining the EJA and Penphil matters and this statement would be presented to the board. Such a statement was prepared by Bevan and reviewed by Hanley. At the next board meeting on September 24, 1969, the statement was read by O'Herron.311 The statement dealt with the foreign investments of EJA and made them appear to be minor and to be a result of a misunderstanding. The report mentioned Penphil briefly and identified only Bevan as a shareholder.312 The report did not discuss the other allegations of the complaints, including the wasting of corporate assets. The statement was so innocuous that the directors could not recall the mention of Penphil in the report. If the board had not abandoned its intention of conducting an investigation or if the directors had merely read the complaint the unacceptable conduct of Bevan would have been apparent.

The directors explain that the reason for abandoning the inquiry was their concern because of Bevan's importance and the lack of a suitable replacement that he could not be permitted to resign.313 It was an admission that the directors realized Penn Central's financial condition was critical. The public did not know this. Indeed the directors had avoided the dividend issue at the very meeting at which the suit was brought up. The shareholders were disserved doubly: (1) Bevan's activities were not uncovered and he was not removed; and (2) the financial debacle was kept from investors for a further period.

300 Principally the Philadelphia area directors.

31Q. Was this matter (of the Kunkel allegation) taken under advisement by the Conflict of Interest Committee, at that time?

A. No, it was not. My recollection of what happened was that Tom Perkins said that he thought an investigation should be made of Executive Jet and Bevan took this to be a vote of no confidence.

Q. To the board?

A. To Saunders.

Q. How did you learn of that?

A. I think I learned about it from Bevan.

Q. Did anyone else know of this, to your knowledge? That is, did any of the other directors indicate that they had knowledge of the resignation?

A. Well, if they didn't then they did subsequently because I didn't think we should permit Bevan to resign from his job at Penn Central at that time, for sure.

Q. And was this discussed before the board, as a whole, then as to how they came to know it?

A. Well, I did a lot of telephoning on it.

Q. Did you talk to everybody on the board?

A. I don't think I talked to everybody, but I talked to most everybody. I know I talked to all of the people on the board who were from the Pennsylvania Railroad, so I know I talked to a lot of them. And, I talked to others. I know I talked to Del Marting, who was recently on the board. Finally, I wound up talking to Stewart Rauch.

Q. Would it be fair to say that the main reason for your not going ahead with the investigation of EJA at this period-sometime between August and September of 1969-was the fact that the financial condition or the financing status of Penn Central was in such a condition that the resignation of its chief financial officer would have made its financial condition or status even more precarious than it was?

A. I think so. We were getting into this. We weren't full-scale bankrupt at that moment, but were headed that way awful fast.

311 Bevan was not present at the meeting.

312 The complaint identifies Lassiter, Hodge, and Bevan as Penphil shareholders and states: "in fact half of Penphil's shareholders are either present or retired employees of Penn Central RR. or Glore Forgan, Wm. R. Staats, Inc."

3 The directors stress the dilemma they faced. They believed that Bevan could not be replaced at that time without serious harm to the company and yet they were troubled by the charges concerning EJA. It should be noted, however, that the board did not attempt to place any constraints on Bevan and he was only replaced in June 1970 at the insistence of banks and the Government.

An immediate consequence to the directors' backing down under Bevan's threats was that Bevan could continue wasting corporate assets in the EJA activities and could continue to conceal the need to write off Penn Central's entire investment in EJA in light of the effective bankruptcy of the company 314 Bevan had arranged for Fidel Goetz, a European investor mentioned in the Kunkel suit, to financially support EJA's "world operating rights program" in Europe. When EJA was forced to withdraw its application to acquire Johnson Flying Service, a supplemental carrier which was to be Penn Central's avenue to the air cargo business, the European plan collapsed. Goetz had advanced funds for this project and demanded compensation. In August of 1969 the Transportation Co., through American Contract Co., a subsidiary, was obtaining a $10 million equipment rehabilitation loan from Berliner Bank in Germany. As part of a scheme to reimburse Goetz for his EJA losses and for other reasons, Bevan arranged to have the $10 million transferred to First Financial Trust, an account set up in Liechtenstein by Goetz and Francis Rosenbaum.315 On September 18, 1969, when the $10 million arrived in Liechtenstein, $4 million was immediately transferred to another account, Vilede Anstalt, controlled solely by Goetz. The $4 million was never recovered. This diversion of funds, which occurred just as the directors were backing away from their investigation, was not mentioned by Bevan in his memorandum to the board of September 24, 1969.316

The consequences of Bevan's successful intimidation of the board and the board's knowing and willing refusal to examine direct and accurate challenges to his integrity were far more serious than the continuation of the EJA scandal. Bevan was the sole representative of Penn Central in dealing with lenders. He had responsibility for billions of dollars of financings. He was actively involved in raising several hundred million additional dollars during the period after August 1969. While engaged in this activity he made misleading statements to lenders.317 These are set forth in greater detail in other sections.318 In connection with keeping out $200 million of commercial

314 The history of this and related EJA matters is discussed at page 71.

315 Rosenbaum is currently serving a prison sentence for defrauding the U.S. Government.

316 The loss was not discovered until after the bankruptcy. The board apparently had continuing aversion to facing reality. When the EJA problem was again raised by a lawyer in Florida in early 1970, the conflicts committee referred the matter to Gorman for investigation (partly because there appeared to be a possible conflict on the part of the committee's counsel, Skadden, Arps, which represented Pan American, an intervenor in the EJA action before the CAB). Gorman's investigation was carried out under the supervision of Dechert, Price & Rhoades. As in other matters which that firm handled for Penn Central, its conclusions did not challenge company practices. It appears that Dechert did not talk to Bevan, Gerstnecker or EJA officers, and did not know of the diversion of $4 million to Goetz even though they specifically did conclude that the company's officers did know they were violating the law through the foreign investments. Gorman then reported to Hanley by letter on May 28, 1970:

*

"During the course of the investigation, there was concern, of couse, over the recitals in the CAB's consent order of possible knowing violations of aviation law by company officers. These related to EJA's dealing with foreign interests. Nothing brought out by this investigation persuades me that our people knew that EJA was doing more than having preliminary negotiations subject to CAB approval.

"The important thing now is to devote the company's efforts to salvaging as much of the investment as possible under present circumstances. [EJA was in fact effectively bankrupt and should have been written off Penn Central's books]

In fact, no independent investigation of EJA was ever made by the directors. Even a superficial investigation would have uncovered the conduct, the deception and the wasting of assets involving among others, the chief financial officer of Penn Central.

317 Bevan asserted that he was doing what he could to keep the company going. While his motivation may be unclear (he had bailed out on much of his stock holdings in early 1969 when he could see the crisis which the company was in), he must have realized that his departure would expose him to liability for the activities which his successor might uncover, including EJA and Penphil.

318 See in particular, Finance, Underwriting, Great Southwest.

paper, Bevan repeatedly made misstatements to the commercial paper dealer. Purchasers were continually buying this unsecured debt until May of 1970.319 Bevan also made misleading statements to bankers to induce them to lend an additional $50 million to Pennco. Bevan attempted to have an underwriter's lawyer who was becoming suspicious removed from an underwriting.320 The board never asked about his dealings and they had not established any procedures for limiting Bevan's power or for monitoring his activities and representations.

FALL, 1969: GORMAN/GENGRAS-A BEGINNING REQUEST FOR

INFORMATION

As reflected in their deference to Bevan following the August 1969 board meeting, the directors were aware by the fall of 1969 of the serious financial condition of the company. They were also generally aware that the railroad operations were experiencing continuing and serious difficulties which were causing large losses. They were unaware of the precise extent or cause of the financial or operational problems because that information was not being supplied to the board. The directors hoped for some kind of turnaround and cited the employment of Paul Gorman, which the board approved at the August meeting. Gorman. None of the directors could comment authoritatively on Gorman's hiring because the directors were not kept informed of the search. Saunders conducted the search and negotiated with Gorman on his own. The directors were not consulted during the search and no directors' committee was formed. Gorman was first approached about the job by Charles Hodge who knew of Gorman as a member of a country club of which Hodge was also a member.321 Bevan and Saunders then discussed the position with Gorman.322

The hiring of Gorman was not a solution to Penn Central's problems. Without challenging Gorman's reputation as a cost controller, it can be said that in light of all the circumstances his hiring was an indication of Penn Central's dire condition. Gorman was Saunders' choice only after he had tried and failed to get any major railroad executive to take the job.323 Despite the staggering crisis at Penn Central, Gorman's employment was not to begin until December 1, 1969, more than 3 months after he was hired. 324 Although he had no railroad experience he made no effort, aside from reading some annual reports, to inform himself about the railroad industry or about Penn Central. When he arrived he received some surprises. He had assumed that he would.

319 Commercial paper purchasers lost $83 million. Despite misrepresentations by Bevan, the commercial paper dealers had ample warning of Penn Central's problems and should have taken appropriate action. See the section of this report on the sale of commercial paper.

239 See section on Public Offerings.

in The directors cite the arrival of Gorman as an example of the efforts to secure competent management after they discovered the problems plaguing the railroad. The directors, however, played virtually no role in selecting Gorman or even in deciding whether a new president was needed. Saunders presented the whole matter as an accomplished fact.

In fact, Hodge first approached Gorman at the country club. Hodge was not a director of Penn Central but he was influential; he was involved in the diversification efforts (particularly with GSC and Macco); he was a member of Penphil; he was involved in EJA. The directors knew nothing of Hodge's role in the hiring of Gorman.

13 The directors ackowledge that they knew this to be the case. They still felt that Gorman would be the right man. This view would appear to be a result of wishful thinking and lack of an understanding of the fundamental problems.

824 One month was spent on vacation.