most of whom owned only minimal amounts of Penn Central stock, had made significant sales for their own accounts during the postmerger period.40

The investigation revealed that, although the trading carried on by many officers raised few questions concerning its propriety under the securities laws, the conduct of a significant number of officers demanded serious consideration in this regard. The staff has selected from these questionable trades those which appear to raise the most serious questions under the securities laws, and has summarized them in this report.

41

Many factors complicated this retrospective study. The price of Penn Central stock slid ineluctably from a high of 861⁄2 in July 1968, to a low of 10 in June 1970, just prior to the June 21 reorganization announcement. The 2-year performance of the stock makes it very possible that some officer sales were legitimately made simply on the basis of public adverse information. On the other hand, it must be remembered that there were many investors not bailing out during this period. Indeed the optimism or thoughtlessness of a number of major outside investors found them with large amounts of Penn Central stock in the spring of 1970, the sales of which are dealt with in the previous section of this report.

Apart from insider trading questions, it should be noted that the extent of the bail-out by officers during the steady price decline of the stock is somewhat inconsistent with the concepts underlying the option system, whose supposed purpose of generating and rewarding corporate loyalty was lost in the shuffle as officers bailed out of Penn Central stock to protect their investments and realize their paper profits. Over the years, some Penn Central officers had built fortunes based on the company's large option grants.2 Although the officers had been allowed to profit from these grants on the theory that they, as key employees, were contributing to the betterment of the company, including the rise in price of the company's stock, many of them felt no compunction against bailing out in the down market, thus providing themselves with extra compensation due to the company's good fortunes and evading penalization for any adverse happenings. Further, the staff found that certain banks (some with Penn Central connections) had made a number of large, long-term, unsecured loans to high Penn Central officials, mostly in connection with their exercise of Penn Central stock options, and mostly at the very favorable terms of one-half to 1 percent above the prime rate. Even though these were unsecured loans, many Penn Central officers appeared to

40 This section is limited to examining officers' and directors' personal holdings of Penn Central common stock.

Sales by directors were as follows:

1. William L. Day* sold 450 of his 1,000 shares in 1968 and 1969, but purchased 450 shares in Nov. 1969. leaving him with the same balance of 1,000 shares at his resignation from the board on June 21, 1970, as at the time of the merger.

2. R. W. Graham* sold 3,568 of 83,708 shares owned by him in Nov. 1969, repurchasing 3,800 shares in March 1970. Graham maintained his investment in this large amount of Penn Central stock until after the bankruptcy.

3. Edward J. Hanley, who owned 200 shares during this period, reported that his wife sold 300 of 800 shares which she owned in Dec. 1969. Hanley, who was the chairman of the Conflict of Interest Committee, stated through his attorneys that the 300 shares had been sold "in order to establish a tax loss to off-set taxable gain on other securities which Mr. Hanley had sold."

*Day and Graham, directors of Penn Central Transportation Co., were both elected to the board of Penn Central Co., on June 18, 1970. Hanley was on the board of Penn Central from its formation.

41 Not the least of these complications was that in October, 1969, when the Penn Central Co. was formed, the Penn Central Transportation Co. became a wholly owned subsidiary, and only vice presidents of Penn Central Co. reported their purchases and sales to the Commission under section 16 of the 1934 act.

42 Although, prior to the merger, the New York Central had also had a generous option plan, Penn Central's officer compensation program, including options, was far more extensive.

have irrevocably associated them with their stock purchases, using the proceeds from Penn Central stock sales to pay off the loans. Obviously, the presence of these loans, which enabled officers, with no cash outlay of their own and at the most favorable terms possible, to bet efit from a price rise in Penn Central stock, also acted to encourage officers to sell in a down market to protect their investments.

A stunning example of such a bail-out is that conducted by David. Bevan, who was at the vortex of Penn Central's machinations, and who sold 15,000 shares of Penn Central stock in the first half of 1969 at prices ranging between $50 and $66, paying off a $650,000 stock option loan and managing to keep his personal fortune virtually intact. In contrast to this was the trading, or lack thereof, of Stuart Saunders, who has made no sales since 1967, even though his 45,000share block of stock represented almost his whole fortune, and large loans he had made to purchase the stock remian outstanding. Of course, Saunders was virtually locked in to his no-sale position both because of the potential liability which his insider knowledge would have caused for him, and the possible harm to the fortunes of the company which such a vote of no-confidence by him could have engendered.43

The heaviest concentrations of officer selling occurred in June and July 1969, a time when the accumulation of Penn Central's major problems in the areas of operations, earnings, and finance culminated with a discussion at the June 25 meeting of the board of directors as to whether Penn Central should withhold its time-honored quarterly dividend from its shareholders. Between June and July 1969, Bevan chose to make the last sale (2,300 shares) of his program of sales which halved his ownership of Penn Central stock; three other officers sold over 50 percent of their holdings-Roberts (2,000 shares), Haslett (3,000 shares), and Smucker (3,600 shares); and two more officers virtually liquidated their Penn Central investment-Flannery (236 shares-100 percent) and Knight (3,950 of 3,957 shares). The circumstances surrounding these sales, including each officer's reasons for them, are discussed below as part of the summary of each officer's trading.

All officers who were questioned denied that any of their sales had been made on the basis of material inside information. It appears that few officers were concerned that the public might be deluded about corporate affairs, and that the possibility that there might be inadequate disclosure had figured very little, or not at all, in their trading. Thus could a high fincancial officer try to explain his sale in February 1970, by stating blandly that he had merely waited until after the 1969 financial figures had been disseminated.45

Many of the explanations most commonly given by officers concerning their postmerger trading in Penn Central stock appear, under examination, to lack the sense of urgency reasonably required to cause an officer to make a forced sale. The most obvious example of this was the claim that some sales were made to pay off loans, when in fact the idea to pay off the loan had originated with the officer, and not the bank, or when the officer made a choice to sell Penn Central

"It is interesting to note, however, that neither of these reasons stopped Bevan. (See below for a full discussion of Bevan's sales).

"This discussion concerned the third quarter of 1969 dividend, which was ultimately declared. The fourth quarter dividend was the first one not declared.

Another officer, when queried concerning his trading, claimed the subject of insider trading had not atered his mind.

stock over other liquid assets. Likewise, the claims of some officers that they sold because they sought to diversify their assets, either for general purposes or in contemplation of retirement, lose credence when the officer is at a loss to explain how his interest in diversification happened to come to him at a specific time, particularly when such officer's financial situation and dependence on Penn Central stock had remained stable for a number of years preceding his sale. Trading based on a well-established window pattern of purchases and sales does serve to show a lessened reliance on inside information, although it cannot be assumed that such patterns excuse all insider sales.

The company and the board of directors had seen to it that all officers had been clearly informed of the prohibitions against insider trading. In October 1969 a "Penn Central Manual on Insider Securities Trading" was widely circulated at and below the top management level, and in December 1968, and March 1970, memoranda sent out discussing the company's disclosure policy emphasized the duty of insiders to refrain from trading prior to full public disclosure of important corporate news.

Penn Central did a very poor job of watching over the trading of its officers. Saunders claimed that he had turned over all corporate responsibilities in this area to the Conflict of Interest Committee when it was formed in 1968. The Conflicts Committee considered that it had discharged its duties in this area with the publication of various reports, memoranda and manuals prepared by the law firm it had hired.46 Although the 1969 Insider Trading Manual and the 1970 disclosure memo refer to procedures to be carried out through the office of general counsel in connection with undisclosed material information, no one, including the Conflicts Committee, the president and office of general counsel, paid the slightest attention to implementing the proposed procedures.

Over the years, many officers had been in the habit of consulting D. L. Wilson of the office of general counsel concerning the propriety of their trading under the short-swing trading prohibitions of the 1934 act. As the company drew closer to bankruptcy, a few prospective traders also broached the subject of insider trading. Without, apparently, a deep analysis of the subject, Wilson raised no major objections to these sales, with the exception of discussions he held with Saunders concerning the possibility of his selling at this time.

The secretary's office, under the direction of Secretary Bayard Roberts, prepared and relayed to the Commission the form 4 reports of officer and director trading. According to Roberts, preparation of these reports was a purely bookkeeping function, and the reports were not subjected to any sort of review. When Penn Central Transportation Co. officers stopped filing form 4 reports in October 1969, no one at any level of the company had any thoughts concerning monitoring

46 The 1969 manual and the 1970 memo had been prepared by an outside law firm at the direction of the Conflict of Interest Committee. Although sent out with the knowledge of this committee, the 1968 memo had been prepared by the legal department at Saunders' instigation. The Conflict of Interest Committee, which had been set up in September 1968, sent, in early 1959, an extensive questionnaire to officers and directors of the company and its subsidiaries seeking information concerning officers' trading and possible conflicts of interest. The committee's report on the questionnaires noted that officers had made substantial sales in 1968, but found no evidence of improper motives. The questionnaires also uncovered some potential short-swing trading violations which were referred to the company for action. The committee delved no further into the subject of officers' trading in general following the questionnaires, and although it did entertain the idea of urging that further questionnaires be sent out on a periodic basis, this suggestion was shelved within the committee and had not been acted on by the time of the bankruptcy.

the further trading of even those officers whose trading was no longer the subject of public scrutiny."

One caveat must be given concerning the individual trading reports: Although the numbers have been checked and rechecked for accuracy, many times the purchases and sales discussed will not balance out to the numbers given. This is because, for reasons of clarity, only major transactions have been signaled. Gifts and charitable donations have, in general, been omitted.48 Most officers were members of Penn Central's thrift plan, contributing up to 5 percent of their income to make regular purchases of stock at half-price. The major distribution of these shares came after bankruptcy (or after prebankruptcy retirement), but some small distributions were made on an annual basis and have been figured into an officer's total holdings, although not recorded as separate purchases.

OFFICERS-FINANCE

The finance department, run very much as a separate entity by David Bevan, dealt on a daily basis with the company's problems in obtaining cash and the enormous demands for cash made by the subsidiaries as well as the parent company.

It should be noted that the sales of the four men discussed in this section, all top finance department officers, pursue a remarkably similar pattern in that each of the four stated that his sales had been made to pay off bank loans whose need to be paid off at the time was questionable, to say the least. Three of these officers, Bevan, Gerstnecker, and Haslett, who all took part in the Penphil venture, all made their major sales during the beginning of 1969.

There is no doubt that David Bevan was the key financial officer at Penn Central, responsible for initiating or effecting all financial machinations of the postmerger period. He held the title of chairman of the finance committee throughout this period, and also served on the board of directors except for the period between February 1968 and the fall of 1969. He was one of the three top officers abruptly severed from the company following the dramatic June 8, 1970 meeting of the board of directors.

47 In October 1969, Saunders asked Cole for a list of officers' stock sales. Cole had the secretary's office prepare the list, and forwarded it to Saunders. When shown a copy of the list, Cole, Roberts, and Saunders all claimed they had forgotten about it, and could not remember why Saunders had asked for it or what he did with it.

48 Family gifts which remained under the control of the donating officer are counted as part of his Penn Central holdings.

Bevan liquidated his substantial holdings of Penn Central stock in two separate series of transactions. The first occurred between December 1968 and June 1969 when he ceased his program of buying Penn Central shares and sold almost half his holdings of Penn Central stock.49 The final sell-out occurred between June and August 1970. Between 1964 and 1968, Bevan had acquired a sizable amount of shares by exercising options at 21 and 2412.

By the end of 1968, he had acquired 34,400 shares of stock pursuant to these options, and he had outstanding with Mellon National Bank and Trust Co. an unsecured loan in excess of $650,000 which he had used to purchase these shares. Between January and June 1969 Bevan sold 15,000 shares of Penn Central stock in six separate transactions.50 The explanation that Bevan presented concerning the 1969 sales was that he had liquidated his $650,000 loan at the insistence of Mellon Bank, and that in any case he had planned as early as 1965 to sell Penn Central stock to liquidate his outstanding loans by 1970. As complete evidence of this, Bevan pointed to a December 1968 letter from Spencer R. Hackett, Mellon Bank vice-president, suggesting that Bevan consider making gradual periodic reductions on his loan, and Bevan's January response agreeing with the suggestion." Bevan claimed that in 1965 he had notified both the Mellon Bank and the Chemical Bank that he intended to pay off his loans within 5 years from the sale of Penn Central stock 52

Whatever Bevan's reasons for the 1969 sales, they were not caused by any pressure from Mellon Bank. According to Hackett's sworn statement, Bevan called Hackett in December, 1968, to ask for the letter from Mellon Bank requesting a pay-down. The only reason Hackett wrote the December, 1968, letter was to comply with this request; prior to Bevan's phone call, Hackett had had no thought of asking Bevan to reduce the loan.53 Bevan, however, denied categorically under oath that he had initiated the Mellon pay-down request.

49 Bevan left unexercised 3,600 option shares available to him at 241⁄2.

54

50 A reasonable guess as to why Bevan held on to the balance of his stock would be that Bevan, as chief financial officer of the company, was reluctant to make such a public show of no-confidence in the company, since he reported his stock transactions to the Commission on form 4's. It also appears that the company was very conscious of sales by officers and directors during this period. In its April 1970 proxy statement it listed, as required by proxy rules, sales of option shares made between 1965 and 1970 by Saunders (4,000) Perlman (9,2 0), Bevan (16,000) and eight other officers (29,411). Then it added a footnote to this breakdown which stated: "The sales by Messrs. Saunders and Perlman were made prior to February 1, 1968, the effective date of the Pennsylvania New York Central merger. Prior to the same date, Mr. Bevan sold 1,000 shares and other officers as a group sold 17,752 shares."

51 Bevan's letter to Hackett, dated January 8, 1969, reads in part, as follows: Thank you very much for your letter of December 24, and I understand perfectly the spirit in which it was written. You are quite right that my loan has been on the books for quite a period of time. Do not feel guilty about this. As I explained to you and John Mayer, I do not think anyone in top management should be a quick-buck artist. There is a limit to everything and the bank has been very good to me.

Your letter also made me stop and reassess my whole position. I have been so busy that I had not really stopped and considered what I had in the way of stock options. In December, I completed earning an additional 3,600 and on February 1 I will have earned an additional 10,000 and as of February 1, 1970, there will be another 10,000 for a total of 23,600 shares that has to be financed. Therefore, I agree with you that it behooves me to gradually reduce my outstanding loan.

52 A letter to Chemical Bank indicating this was submitted as an exhibit. No such letter to Mellon Bank has been located.

53 Hackett stated that Bevan gave no reason for the request, and Hackett did not ask for one, as "I did not consider this my affair or that of the Bank." In a further letter, dated January 9, 1969, Hackett took pains to assure Bevan that he was prepared to authorize further loans on his behalf.

54 Q. Did you ask Mr. Hackett to write the letter to you?

A. No.

Mr. GERMAN (attorney for Bevan). I didn't hear the question.

Q. The question was, Did you ask Mr. Hackett to write the letter to you?

A. No. I don't like the implication. The answer is no.

Q. Do you remember making a phone call to Mr. Hackett at any time in December of 1968 concerning your personal loan?

A. Concerning my personal loan, no.

Q. Information has been given to us that such a phone call was made and such a request was made. Do you remember anything about a phone call of that kind?

A. No. I don't recall any unless you indicated before maybe he said he was writing such a letter or that I should do it. He may have warned me that it was coming or something of that sort, but my answer still