An example of the type of situation in which the customer placed complete reliance on Goldman, Sachs' recommendations is that of a textile manufacturer in Clinton, S.C. The relationship between the customer and Goldman, Sachs originated in 1960 at the time the customer was considering a merger. Goldman, Sachs was consulted to help prepare the rate of the exchange. Although this merger fell through, a subsequent merger attempt in 1964 in which Goldman, Sachs worked out the details (and for which they were paid a fee) was

a success.

The two had intermittent contact through the sixties. Goldman, Sachs set up a revolving credit agreement for the customer to enable it to build another plant.14

In the fall of 1968, Goldman, Sachs assisted the customer in another merger. In the course of this merger, Goldman, Sachs was furnished with complete financial information on the custc ner.

In August of 1969, the customer had accumulated $1 million in cash in anticipation of another merger (although it had drawn down $4 million from the revolving line of credit). Since it would be months before the merger took place, the customer contacted the individual at Goldman, Sachs with whom it had been dealing and explained the situation. The individual recommended commercial paper. The customer reminded him of the limitation on commercial paper placed by the revolving credit agreement and stated that it would be relying on the recommendation of Goldman, Sachs and no one else. In fact, the customer's president gave instructions that the company was to buy whatever was recommended by Goldman, Sachs. In September of 1969, Goldman, Sachs by letter recommended certain commercial paper. The customer purchased it. When this paper matured in December, Goldman, Sachs recommended the company's paper. The customer bought it. When this matured in March of 1970, Goldman, Sachs recommended repurchasing the company's paper, which the customer did. This paper and an additional amount, which Goldman, Sachs had at the same time recommended to be placed in the company's paper, were not repaid because of the company's bankruptcy. The treasurer of a small college in Pennsylvania described, in an affidavit, the circumstances surrounding the college's purchase of the company's paper on March 30, 1970, as follows:

At this point the availability of Penn Central was mentioned. I hesitated because the college already held $400,000 in Penn Central. On asking for pertinent information from the latest financial report, I was informed the company reported consolidated revenues of $2,251,716,000 compared with $2,102,770,000 the previous year and preliminary earnings of $4,388,000 versus $86,961,000. At this point the problems of consolidation as a result of the merger were pointed out. I next questioned the current asset to current liability ratio, which was indicated at approximately one to one. When I indicated my concern over this, the representative reassured there was no need for concern since total assets exceeded 621⁄2 billion. With some hesitancy I agreed to the purchase of 300M of Penn Central paper.

On April 3, 1970, I received the letter of confirmation and a copy of the financial data on Penn Central. I was dismayed to learn the information conveyed over the phone was as of December 31, 1968, and not December 31, 1969. This, coupled with reports in the newspapers of the increased financial plight of the company, prompted me to call our representative to attempt to sell the paper held by the college. I was informed our representative accepted another job and the college had been assigned a new representative. I do not know what efforts were taken by Goldman, Sachs & Co. to resell the paper, but in any event they were unsuccessful. "A clause of this agreement limited the customer to investing "in securities issued by the United States, CD's of banks and prime commercial paper as determined by generally accepted banking practice."

KINDS OF CUSTOMERS WHO PURCHASED THE COMPANY'S COMMERCIAL PAPER

The customers who purchased the company's paper during this period fall into diverse categories: Institutions sophisticated in securities analysis; companies primarily engaged in manufacturing; colleges and universities; small banks; and individuals purchasing through banks. The vast majority of the customers were institutions or corporations.

Almost all the customers did no investigation of the company before or after purchasing its paper from Goldman, Sachs for a number of reasons. First of all, most of the institutions and corporations were not sophisticated in terms of their ability to gather and analyze the necessary information. Secondly, they did not have access to the kind of information necessary to make a meaningful investment decision on Penn Central's comincial paper. In addition, the quickness with which the decision had to be made would have prevented them from undertaking such an analysis. And last, almost all of the customers were relying on Goldman, Sachs' recommendation, and on the NCO rating and on the general reputation of the company.

SUMMARY

Letween November of 1969 and May of 1970 Goldman, Sachs sold $83 million of Penn Central Transportation Co.'s commercial paper which was not repaid because of the latter's bankruptcy. During this time they became aware of information which cast doubt on the safety of this commercial paper. Most of the nonpublic information described above was not disclosed to customers. The information they did disseminate was out of date.

Despite repeated warning signals, Goldman, Sachs initiated no in-depth analysis. If they had, they would have found matters to be much worse.

In addition, Coldman, Sachs failed to disclose that they had reduced and were eliminating their inventory of the company's paper, that NCO had been induced to maintain the prime rating and that the company's paper was meeting strong resistance from customers.

GOLDMAN, SACHS' POSITION ON THE SALES OF THE COMPANY'S

COMMERCIAL PAPER

Goldman, Sachs' views concerning its sales of the company's commercial paper may be summarized in the following way. First of all according to Goldman, Sachs, its commercial paper operations were not lucrative when compared to its other activities. (For example in 1969 Goldman, Sachs had outstanding an average of $4.7 billion in commercial paper, but their net profits from these sales was only $435,000.)

According to Goldman, Sachs, the customers were sophisticated investors who purchased commercial paper in $100,000 denominations. Goldman, Sachs felt that these customers were capable of making their own investment decisions and did not have to rely on Goldman, Sachs' opinion. Goldman, Sachs viewed itself as merely a conduit of commercial paper which made no recommendations as to the quality of the paper or the credit-worthiness of the issuers. Goldman, Sachs

would merely inform the customers as to what paper was available, and the customer would decide which paper it wished to purchase. Goldman, Sachs also maintained that in the company, which was the country's fourth largest corporation, there were always sufficient assets which could be liquidated should the need arise, which provided sufficient protection for commercial paper holders.

Goldman, Sachs did take certain steps to disseminate information to customers and at least on two occasions did call in the company's top management for an explanation of what was happening. In addition, customers, if they so desired, could have obtained some information on the company since as a publicly held corporation it was required to make public its financial condition.

III-B. ROLE OF NATIONAL CREDIT OFFICE IN RATING THE COMMERCIAL PAPER OF PENN CENTRAL

The concealment of Penn Central's condition was aided by Goldman, Sachs as described in the preceding section. Another entity, the National Credit Office (NCO), also contributed to the misleading of investors. This section is concerned with the activities of NCO prior to June 21, 1970, the date of bankruptcy, with respect to the commercial paper issued by the Transportation Co. and sold by Goldman, Sachs.

National Credit Office is a wholly owned subsidiary of Dun & Bradstreet, Inc. (D. & B.) which until on or about August 23, 1971, functioned as a rating agency for commercial paper. On August 23, 1971, the commercial paper rating service of NCO was transferred to Moody's Investors Services, Inc., another wholly owned subsidiary of D. & B. which is a registered investment adviser.

NCO had been rating commercial paper since 1920 and prior to 1970 it was essentially the only national commercial paper rating service. NCO was never registered with the Commission as an investment adviser.

As a standard method of operation, NCO would enter into a subscription agreement with the prospective issuer of commercial paper wherein the issuer would agree to pay an annual fee to NCO for appraising commercial peper and pursuant to which NCO agreed to evaluate and assign one of the following classifications to subscriber's (i.e., the issuer's) commercial paper:

Prime.-Companies with a net worth or capital funds (net worth plus long-term subordinated loans) in excess of $50 million, which also meet NCO requirements and credit judgment in all other respects.

In the cases of "captive" finance companies, net worth or capital funds in excess of $15 million are required in addition to meeting NCO requirements and credit judgment in all other respects.

Desirable.-Companies with net worth or capital funds (net worth plus longterm subordinated loans) of $25 million to $50 million, which also meet NCO requirements and credit judgment in all other respects.

Satisfactory.-Companies with net worth or capital funds (net worth plus longterm subordinated loans) ranging from approximately $10 million to $25 million, which also meet NCO requirements and credit judgment in all other respects. Fair. Companies which do not meet a sufficient number of NCO's requirements for the three preceding classifications.

No Rating. Companies which do not meet any NCO requirements for inclusion in the commercial paper market.

Additionally, the issuer agreed to "furnish promptly to NCO pertinent financial reports and other data normally provided line banks, in order that NCO may accurately appraise the commercial paper."

From the foregoing it would appear that NCO's function was to rate the desirability of specific commercial paper. It would also seem apparent that as Mr. Eugene Schenk, the president of NCO, has stated:

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NCO is the agency on which virtually all prospective buyers rely for ratings in the commercial paper field. Through the years our authoritative appraisals have been of material assistance in making a market for these short-term notes.

The commercial paper market which NCO had been engaged in as the sole national rating agency had experienced phenomenal growth in the late 1960's, primarily due to the severely tight money markets of that period and the relative ease and privacy of raising short-term debt afforded by this market. As the market grew rapidly, NCO's rating responsibilities grew concomitantly as the following data illustrates: NCO rated the following number of issuers in the respective categories at the indicated date.

Thus in a period of 27 months the number of commercial paper issuers rated by NCO had increased by 388 or 271 percent. Further, by June 1, 1970, this number had increased to 647 issuers.

Included in this group of 615 issuers were Penn Central, King Resources Co. and Four Seasons Nursing Centers of America, Inc. all of which received a "prime" or highest possible rating.1

The relationship between NCO and the Transportation Co. which began in July 1968 was the customary one, described previously, between an issuer of commercial paper and NCO. After the execution of the subscription agreement and presumably after a customary review by NCO, the Transportation Co. was assigned a "prime" rating. This rating was listed by NCO and disseminated to all subscribers to its rating service.

Additionally, certain subscribers could at their election receive special service from NCO which consisted of a more extensive analysis of the issuer. In the case of Penn Central this would consist of excerpts from the latest annual report and interim financial data, if any, published by the issuer. The only other information contained in this report to subscribers not also contained in the annual report or interim financial statements were the rating classification by NCO, the identity of the dealer handling the paper and condensed information regarding the bank lines of credit available to the issuer, names of the lead banks, and amount of available credit, if any, from such banks.

All of the foregoing information plus, in the case of Goldman, Sachs, more detailed and current financial data was also customarily available to the dealer in the paper who also provided similar information to its customers.

Furthermore, the data contained in these NCO releases, except for the specific items heretofore mentioned, does not differ in any ma

It is interesting to note that not only was NCO's estimation of the quality of the notes issued by King Resources and Four Seasons deficient, but also that certain of such notes of both entities had a stated maturity of more than 270 days which would not qualify same for the statutory definition of commercial paper and exemption from registration.