fraud. Also, an individual named Spooner and others once secured a right of purchase on a mining option for $20,000, whereupon they organized the Pittsburgh Mining Company, and induced subscribers to its stock to pay $100,000 with the understanding that the property had cost $90,000. Then the option was bought, and the $70,000 difference between its cost and the price at which it was turned over to the corporation was converted to the use of Spooner and his pals. It is not difficult to understand why the court held that the company had good cause for action. This case was sheer burglary.

Here

The case of Gluckstein v. Barnes 1 shows more finesse. a company whose affairs were being wound up was in such straits that it was believed that its assets would not cover its bonds (debentures), and these bonds were consequently selling cheap. Accordingly, a group of capitalists bought up the bonds, and at the same time purchased the business from the receiver for about $700,000, thus putting themselves in a dual capacity as creditors and owners. As owners of the bonds, the purchase price of the business would stand to their own credit. Indeed, they made some $100,000 on the bonds. Then, as planned all along, they promoted a corporation, and sold to it the business for about $900,000, stating publicly that they had paid $700,000 for it, but saying nothing about their ownership of the bonds. Thus, they virtually stated that their profit would be $200,000, whereas it was really $300,000. It was held that the corporation could recover the $100,000 profit.

In the other class of cases, the promoter is in collusion with some third party who has some property or service to dispose of. A owns a patent right on a mortising machine and arranges with B to help him promote a company for purchasing the patent, agreeing to pay him a commission. Then the C Speciality Machine Works is organized with B as a director, and that disinterested individual advises the purchase of A's machinery, secretly pocketing his commission. All such cases are similar in principle, there being differences in the methods of sharing the loot.

1 English case: A. C. 240 (1900).

Without carrying the subject any closer ad nauseam, it is apparent that such promotions are predatory and not conducive to production in any economic or legal sense. They constitute one of the most serious evils under the head of the corporation problem, and we will return to them later on. One of the first steps which should be taken along the line of publicity is to follow England's example in providing statutory means for securing publicity of promotion.

All this suggests the common-law rules as to the promoter's liability to the corporation.

No discus

Relation of the Promoter to the Corporation. sion of promotion would be complete without a statement of the relation that exists between the promoter and his corporation. The underlying idea of this relation is that it is one of trust; and the promoter is supposed to safeguard the interests of the corporation as well as his own. Their relation to the proposed corporation, when formed, is a fiduciary relation, or a relation of trust and confidence."

It follows, then, that while a special profit is regarded by the law as being just and legal, it must be made in a manner that is consistent with a relation of trust. The law is well settled that a promoter must not take advantage of his position to make a secret profit. An old but leading decision is that handed down in the English case of Erlanger v. New Sombrero Phosphate Company (aff'd, 3 App. Cases, 1216 (1878)). Erlanger and others, having secured a phosphate island for £55,000, formed a company to purchase their property. They named five directors, of whom two were out of the country, two were public officials who knew nothing of the business and made no investigations, and one was Erlanger's secretary. They were virtually "dummies." However that may be, they voted to buy the island for £80,000 in cash and £30,000 in stock, and the promoters all but got away with their ill-gotten gains. Their greed was their undoing, for when they realized on their stock, the stockholders came into power and brought suit. The sale was ordered canceled and the price returned. Said the court:

1 Clark and Marshall, Private Corporations, I, Sect. 110 b.

he is bound to take care that he sells it through the medium of a board of directors who can and do exercise an independent judgment on the transaction, and who are not left under the belief that the property belongs not to the promoters but to some other person." Independent directors should have been named and material facts should have been disclosed to them.

When he does not actually own the property sold, any special profit made by the promoter is illegal unless made with the consent of an independent and informed board of directors, or with disclosure of conditions to the stockholders before their purchase. If a promoter says that he owns property when the truth is that he merely holds options upon it, or that he is selling for cost when the truth is that he is making a profit, he is misrepresenting essential facts and renders himself liable for the profits received on the transaction. But if the consent of a bona fide board of directors is obtained, or the facts are disclosed to the stockholders before purchase, the promoter may make any profit he can. He is then only subject to suit by the creditors of his corporation. The courts have held that “any men . . . owners of any kind of property. . . may form a partnership or association with others and sell the property to the association at any price which may be agreed upon between them, no matter what it originally cost, provided there be no fraudulent misrepresentations made by vendors to their associates." 1

When, however, the promoter actually does own the properties to be exploited or combined, and owned them prior to the promotion, any profit appears to be lawful, barring positive misrepresentation. In the great majority of cases, however, the promoter merely has an option or acts as an agent of the vendors, and such possession establishes that relation of trust which is the underlying idea of the relation between promoter and promoted.

1 Densmore Oil Co. v. Densmore et al., 64 Pa. St. 43 (1870); Morawetz on Private Corporations, Sect. 293.

? For some conflict of authority and for further information concerning remedies and other points discussed above, see: Old Dominion Copper Co. v. Lewisohn, 210 U. S. 206; Bigelow v. Old Dominion Copper Co., 203 Mass. 159; Harvard Law Review, Vol. XXIV, p. 356; Illinois Law Review, Vol. V, p. 87; University of Pennsylvania Law Review, Vol. LVIII, p. 226.

CHAPTER XIX

UNDERWRITING AS A STEP IN ORGANIZATION

AFTER the promoter has discovered his opportunity, one of the great difficulties that confront him is that of getting the funds with which to equip his projected corporation. This difficulty has given rise to a distinct function in the organization of corporations called "underwriting."

Definition and Illustrations. To underwrite is to insure, and, as the term is used in the financial world, underwriting may be defined as insuring the sale of a corporation's securities in advance of a public offering. At law, it appears, the term is used in a narrower sense, and indicates an agreement to take such part of a specified number of securities as may not be subscribed for by the public before a specified date. According to the legal definition, the underwriter binds himself to take stocks or bonds which are not bought by the public, and the corporation can put his name on the stock record book and hold him as a shareholder to the extent of such unsold securities. As we shall see, however, there are other kinds of agreements, under which the virtual sale of a corporation's securities may be guaranteed, and, following economic usage, they will be included as underwriting.

Suppose that a promoter has secured his options and laid his plans for organizing a corporation to take over the properties concerned. Say that he needs $5,000,000 in cash - $4,000,000 for purchasing plants, etc., and $1,000,000 for working capital: how shall he get the funds? The first plan that occurs to one is, let him sell the bonds of the new corporation. But a moment's consideration shows one that this would probably be very unsatisfactory if not impracticable. The success of the project is still in doubt, and securities based upon it, if they would sell

at all, would not yield immediate, cheap, or certain returns. There would be delay, and a large discount from the face value would have to be made. Some one with financial power is needed to stand behind the securities and vouch for them, or even to insure their sale. It is here that the underwriter comes in. The promoter seeks to get a capitalist or group of capitalists (1) to certify his securities and (2) to guarantee a market for them.

He goes to a firm of private bankers, say J. P. Morgan & Company, and, having first laid before them the facts of the case -the expenses to be met and the probable earning capacity of the new concern - makes the following proposition. The bankers are to form a syndicate to raise the cash; in return for the $5,000,000 in cash, or its equivalent, he proposes to turn over to the syndicate $10,000,000 in the stock of the new company, half in preferred and half in common; the banker is to receive $5000 in common stock as a special commission, and in addition may share in the chance to make a profit on the stock offered for funds by joining in the syndicate himself. If in doubt, the banker makes a thorough investigation, going as far as to have appraisers estimate the value of the properties, accountants certify as to the state of the business, and lawyers look into titles and the legality of the organization. When the banker has satisfied himself as to the soundness of the venture, he may accept the promoter's proposition, in which case he proceeds to form a "syndicate."

A syndicate is a temporary association of capitalists for the purpose of financing an enterprise which needs large funds. The chief reason why financial houses generally enter into syndicates for underwriting purposes is that their financial standing would be endangered if they were to embark all their funds in one or two enterprises, as they would have to do if they took in no associates. The danger might come about in two ways: either so large a part of their funds would have to be tied underwriting that they might be unable successfully to meet a general panic, or so much might be involved in a single industry that a special depression in it would cause serious loss. Furthermore, a syndicate has an advantage from the fact that when a

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