a continued "hold" on Penn Central securities. At an initial meeting on April 20, 1970, after the opening of an account for a church organization, members of the trust department indicated that Penn Central was "under consideration" as a sale candidate. Subsequently, on May 15, 1970, 7,000 shares of Penn Central common stock were sold from this account. In another account, CIIT Equity Fund, CINB's pool-type common stock fund for smaller employee benefit trusts, CINB, on May 19, 1970, sold 20,000 shares out of a position of 60,000 shares of Penn Central held by that account. These sales were made to raise funds to meet the anticipated withdrawal of one of the larger participants in the CIIT Equity Fund. Other than these two instances, it does not appear that any substantial sales were made of Penn Central securities in accounts managed by CINB's trust department.

As of June 11, 1970, CINB held 422,337 21 shares of Penn Central stock for accounts managed and advised by its trust department, as follows:

Specifically relating to Penn Central, the members of the SSC were concerned about Penn Central for some time, but did not issue a sell recommendation until the morning of June 12, 1970, at which time they issued a flash memorandum which concluded regarding Penn Central:

[The SSC] recommends the sale of the common stock in all accounts.

Commentary: Recent events indicate that the likelihood of returning to a profitable basis appear quite distant at this point in time. Despite the possibility of government aid in securing additional financing, the basic operational problems of the railroad company will still remain and it is doubtful that substantial losses can be avoided for the foreseeable future.

Personnel from the SSC and TIC, including Thomas Larocca, chairman of SSC, Joseph Alaimo, member of SSC, and Philip J. Dambach, chairman of TIC and head of the trust department, were unable to recall precisely the sequence of events which led to the issuance of the June 12 "flash memorandum." Generally, these and other witnesses were able to recall some of the information reported in the press relating to the financial condition of Penn Central, including the omission of dividends, quarterly earnings reports, the cancellation of the proposed $100 million debenture offering of the Pennsylvania Co., the maturation of Penn Central commercial paper at a rate faster than it could be refinanced, and the resignations of Stuart Saunders, David Bevan, and Alfred Perlman. However, other than representing that these events evidenced to them a deterioration of Penn Central financially, they could not relate specific discussions among the members of the SCC, the TIC, or with other

21 These figures were supplied by CINB with a caveat that "despite the apparent specificity of the figures, complete accuracy cannot be guaranteed."

members of the trust department other than the fact that they were certain that Penn Central had been discussed.

The SSC concluded that Penn Central securities should be sold some time prior to June 12, but whether this was a few days prior or a week or more prior was not specifically recalled by any of the witnesses. In any case, at least by June 10, 1970, at the regular meeting of TIC, the SSC communicated its view to the TIC that it wanted to issue a sell recommendation. The SSC sought the concurrence of the TIC because of the substantial holdings of Penn Central by trust department accounts. The TIC continued to believe that Penn Central stock should not be sold, but again witnesses did not recall the specific views of individual members of the TIC. Apparently, Dambach, as the head of the trust department and chairman of the TIC, was the last to be converted to the view that Penn Central, should be sold. Dambach believed that because the Federal Government had been so instrumental in the merger of the Pennsylvania Railroad and the New York Central Railroad the Federal Government would come to the aid of the distressed Penn Central and not allow it to go bankrupt.

On the morning of June 12, 1970, Larocca reiterated his concern to Dambach that Penn Central should be sold. Dambach finally agreed apparently because of a news item in that day's papers which indicated that there was congressional opposition of a Government guaranteed loan to Penn Centra'. With Dambach's decision thus changed, Larocca relayed this to Alaimo who then contacted a trader for the trust department with instructions to execute a 100,000 share block trade. A "flash memorandum" was then drafted by an analyst and circulated throughout the trust department.

The initial trade after the decision to sell Penn Central was consummated through Salomon Bros., which sold shares in the market down to $10 per share and positioned the remaining 45,000 shares. The average price per share for the block was $10.18975. Alaimo testified that he contacted the group head of pension and profit sharings trusts so that he could have the advisors execute sale authorizations and allocate the trade among the accounts in this department. This department was chosen because it had the largest proportion of Penn Central common stock. Of this initial trade, 3,200 shares were allocated to profit sharing trusts, including 2,000 shares for the Continental Illinois Employees Profit Sharing Trust, and the remainder for various pension trusts including 6,800 shares for Continental Illinois Employee Pension Plan Trusts. Later trades on June 12 and in the following week were executed at prices slightly higher than the $10 for the initial block trade. The distribution of sales among the various accounts administered by the trust department is set forth in the following table:

Except for the 100,000 share trade on June 12 initiated by Alaimo as director of portfolios, sales were made upon the initiative of individual account advisors.

An advisory service offered by the bank recommended by a letter dated June 16, 1970, that its clients sell Penn Central and invest the proceeds in Howard Johnson securities. CINB also contacted other accounts over which it did not have discretionary authority in the usual manner by telephone.

SUMMARY

Although the commercial department of Continental Illinois National Bank and Trust Co. possessed nonpublic information concerning Penn Central's financial problems by virtue of its role as one of the banks attempting to secure emergency financing for Penn Central, personnel of the commercial and trust departments denied that such information was passed to the trust department. Rather, CINB maintained that the sales of Penn Central common stock between June 12 and June 19, 1972, were based upon publicly available information.

ALLEGHANY CORP. AND INVESTORS DIVERSIFIED SERVICES, INC.

Alleghany Corp. (Alleghany), a public corporation whose predominant business activity is investing in corporate securities, and Investors Mutual Fund, Inc. (IM), a mutual fund managed by Investors Diversified Services, Inc. (IDS), were included in this investigation because both sold substantial quantities of Penn Central common stock on May 27, 1970, a day prior to the announcement of the cancellation of the Pennsylvania Co. $100 million debenture offering.22 Because until a few months prior to this, three Alleghany directors had served as Penn Central directors, and because Alleghany controls IDS, the sale of a combined total of 212,000 shares of Penn Central common stock by Alleghany and IM raises questions as to whether these sales were prompted by knowledge of adverse nonpublic information and whether there was coordination in the sales of Penn Central stock by these affiliated entities.

Background

ALLEGHANY CORP.

Traditionally, Alleghany's principal business has been investing in corporate securities with particular emphasis, other than its investment in IDS, on the railroad industry. For instance, as of December 31, 1967, approximately 21.7 percent of Alleghany's assets of $187,794,396 was invested in railroad securities and approximately 58.8 percent of its assets were comprised of noncarrier securities including 40.7 percent of its assets invested in the capital stock of IDS. Even though the nature of Alleghany's business was somewhat altered in 1970 by the acquisition of the operating rights and licenses of a motor carrier (the Jones Motor Co.), as of December 31, 1970 investments in securities were $127,178,072 as compared to total assets of $176,465,

On May 27, 1970 the Penn Central board of directors was informed that the proposed debenture offering, was to be canceled. This information was not publicly released until May 28. 23 See Alleghany Corp.'s 1967 annual report.

216. In that year, securities transactions accounted for net profits of $1,800,753 and net income exclusive of securities transactions was $1,943,143.24

In 1954 and early 1955, Alleghany purchased 384,100 shares of New York Central Railroad (Central) stock. It increased its holdings by purchasing 600,000 shares of Central stock between 1955 and 1959 (200,000 shares were also acquired at the same time by Allan P. Kirby, Sr.). By 1966 Alleghany owned 984,000 shares of Central (15 percent of the total outstanding voting shares) and Allan P. Kirby, Sr., chairman of Alleghany at the time, owned 300,100 shares of Central or approximately 4.5 percent of the total outstanding. Seven of the 10 Central directors were members of Alleghany's board of directors, and, in addition, three of the five members of the executive committee of Central had joint affiliations with Alleghany.

On March 28, 1966, after the approval of the merger between the Pennsylvania Railroad Co. and Central, but prior to the actual consummation of the merger, Alleghany offered the Central securities in its portfolio to Alleghany shareholders in exchange for their Alleghany securities.25 As a result of this offer 833,181 shares of Central common stock were exchanged so that Alleghany continued to hold 150,919 shares of Central stock. The reasons for the exchange offer as stated in the offering circular were the inadvisability of maintaining a substantial portion of its portfolio in stock of a corporation Alleghany would not control; the ability to liquidate the Central holdings without incurring a substantial capital gains tax; the changing nature of Alleghany's portfolio from that of a railroad holding company to a more diversified portfolio. Although not so stated, another reason was that the Kirby family control of Alleghany would be ultimately increased.26

After the Penn Central merger, Alleghany owned 196,195 shares of Penn Central common stock representing .85 percent of the total outstanding and Allan P. Kirby, Sr., owned 390,130 shares of Penn Central common stock or 1.69 percent of the total outstanding shares. Although Alleghany and the Kirby family might not be considered in control of Penn Central, they had a substantial interest in its affairs as evidenced by the fact that five of Penn Central's 22 directors were also Alleghany directors: James S. Hunt, Fred M. Kirby, William G. Rabe, Carlos Routh, and Daniel E. Taylor.

This close relationship was obvious on its face and admitted by Fred M. Kirby at an Alleghany shareholders meeting on April 26, 1968, when he stated in response to a shareholder question: "We have incidentally very fine representation on the Penn Central Board and are very close to that situation and feel that we're in a very good position to appraise the desirablity of it as a continuing investment.""

24 From the above figures, it is readily apparent that more than 40 percent of Alleghany's assets are investment securities, thus placing the company within the definition of an investment company under Section 3(a)(3) of the Investment Company Act of 1940. However, Alleghany was exempted by the Commission from regulation as an investment company in 1945 and again in 1970 by reason that Alleghany was subject to regulation by the Interstate Cominerce Commission and thus excluded from the Commission's jurisdiction as provided in Section 3(b) (7) of the Investment Company Act of 1940.

25 Allan P. Kirby, Sr. did not include his Central shares in the offer nor did the Kirby family interests exchange any of their Alleghany securities.

26 Whereas on February 28, 1966, Allan P. Kirby Sr. owned 40.4 percent of the common stock of Alleghany, on April 15, 1966 after the exchange offer he was the beneficial owner of 55.36 percent of the Alleghany common stock. Notice of annual meeting to shareholders of Alleghany. April 19, 1966.

27 Fred M. Kirby became chairman of Alleghany in 1967 after his father, Allan P. Kirby, Sr., suffered s severe stroke. F. M. Kirby and Allan P. Kirby, Jr., were appointed guardians of their father's property also in 1967.

Unheeded investment advice

Information and documents received by Penn Central directors at board meetings did not permit sufficient time for thorough analysis by them. F. M. Kirby frequently relied upon John J. Burns, vice president of finance for Alleghany, for his analysis of the financial condition of Penn Central. Although Burns was not a rail expert as such, his background in motor carriers and his responsibilities at Alleghany for investment analysis of present and potential holdings included expanding his knowledge of railroads.

Beginning sometime in the spring of 1969 and continuing into 1970 Burns was formulating the belief that Alleghany should sell its Penn Central stock because of the operational and financial problems. The earliest evidence of the crystalization of Burns' growing belief that Alleghany should sell its Penn Central holdings is found in a March 11, 1969, memorandum to F. M. Kirby in which Burns stated that he regretted not having strongly recommended sale at a higher price and that he had "not firmly made up my mind but feel the odds favor a sell rather than a hold some time soon." The subject of selling Alleghany's Penn Central stock was presented at Alleghany's March 1969 board of directors meeting at which time Burns outlined the "pros" and "cons" of a sale. The minutes of that meeting reflect that counsel to Alleghany pointed out that substantial legal problems existed in that prior to a sale, Alleghany might have to announce its intention to sell, followed by a waiting period before the sale. The sense of the directors was to not dispose of the Penn Central holdings at that time.

Following the April 23, 1969, Penn Central board of directors meeting F. M. Kirby forwarded to Burns Penn Central's consolidated income statements for the first quarter of 1969 and an income statement for the parent railroad company. Kirby in an attached note to those statements said:

Directors impressed today with MGT position that Penn Central foul-up has been largely corrected. Will not show up in earnings for some time unless unexpected surge of volume develops.

I believe the attached figures, entrusted to you in confidence, contradict Wall Street assumptions.

In a reply memo Burns, using these first quarter figures, calculated the net railway operating income after fixed charges as a $20 million loss in the first quarter of 1968 and a $36 million loss in the first quarter of 1969. Annualizing these figures, losses would have been $80 million in 1968 versus $144 million in 1969. However, Burns pointed out that losses in 1968 were actually $150 million. Thus apparently $130 million of losses were attributable to the last three quarters of that year. Accordingly, with first quarter 1969 showing no turnaround, losses were predicted by Burns to be close to $200 million for 1969. In concluding this memorandum Burns referred to the legal problems of a sale by stating:

Since we have apparently no choice but to hold on to Penn Central for the time being, this memo is somewhat unnecessary, nonetheless, I did feel constrained to briefly comment on the confidential figures which you gave me.

In July 1969 Burns had reached the conclusion that Alleghany's holdings should be liquidated, but again this necessitated overcoming the legal problems which counsel had previously presented. Burns again wrote a memo to Kirby with a new approach of securing a