PUBLIC RELATIONS COUNSEL AND THE

FEDERAL SECURITIES LAWS

Address of

Edward N. GadsbyChairman

Securities and Exchange CommissionWashington, D. C.

New York Chapter of the American publicRelations As sodation

New York, New YorkApril 8, 1958

PUBLIC RELATIONS COUNSELANDTHE

FEDERAL SECURIT;IESLAWS

It is an honor and a privilege to talk with the members ofthe Greater New York Chapter of the American Public RelationsAssociation today. As I told your Program Committee, I -assignedas the topic of this discussion the question of "Public RelationsCounsel and the Federal Securities Laws." I was not too sure ofwhat was covered by the term "Public Relations COUDsel"and Iasked one of my educated assistants to do a little research intothe matter. He came up with a number of suggestions, all ofwhich indicated that your organization and our Commission havesome problems i~ common that would bear discussion between us.

As you mayor may not know, the Securities and ExchangeCommission was established to administer certain statutes passedby Congress as the result of several Congressional and otherinvestigations of the stock market in the late 19Z0's and early1930's. The first of these Acts is the so-called Truth-in-SecuritiesAct, professionally described as the Securities Act of 1933. Oneof the fundamental purposes of this legislation, as indicated by itspopular title, is to make sure that investors are furnished withtrue and complete information concerning the corporations whichseek to tap the savings of the American people. Right here wefind an interesting sidelight on our mutual relations which 1 trustis not truly descrlptive of the functions of the Public RelationsCounsel of today, assuming that the term ''press agent" is to adegree descriptive of your work. My learned assistant found inthe files of the Congressional Library that some years ago, oneindividual described the activities of his group with a refreshingcandor.' He said "Ordinarily, the business of a press agent is notthe decimation of the truth, but the avoidance of its inopportunediscovery. II

The second Act of this series under which we operate, andprobably the last in which you and lllave any mutual problems, iathe Securities Exchange Act of 1934. This legislation in general

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extended the scope of Federal regulation to the stock exchangesand to brokers and dealers in securities. The particular areain which we have mutual interests under this Act involves thejurisdiction of the Commission over proxy contests, since weare required to supervise and review the proxy solicitationmaterial circulated among holders of securities which are listedon a national stock exchange.

The Securities Act of 1933 is based upon the postulatethat the stockholders and, for that matter, the general publicare entitled to know all of the material facts regarding a publicly-held corporation which might influence their judgment as to thevalue of the securities of the company. This is all a part of abroader concept that directors and officers of corporations are,after all, only fiduciaries as respects a stockholder and employeesas respects a corporation, that the stockholders own the corpora-tion, and, consequently, that the beneficiaries of their trust andthe owners of the property which they are managing are entitledto an accurate and complete accounting with respect to the com-pany's affairs. In accordance with this approach, and as a resultof some rather bitter criticism which has from time to time beendirected against corporations in this country, I understand that itis fairly common practice for a company to retain such skilledprofessional help as is represented by you gentlemen who arehere today.

Let me make clear to you, however, that under theSecurities Act, the Securities and Exchange Commission doesnot supervise or have any interest in the affairs of any corpora-tion except insofar as they are associated with or involved in theissuance or sale of securities to the public. Nor do we have anypower to pass on the merits of any securities issue, or to controlits price or to control the corporate morals in any respect exceptas regards corporate securities. Unless the corporation or acontrolling person or someone in its behalf is issuing or about toissue its securities to the public, ordinarily you need pay noparticular attention to our Commission under the SecuritiesAct.

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However, once your corporate client decides that itmust go to the public for financing, then the broad scope ofyour otherwise perfectly legitimate and praiseworthy activitiesin publicizing its affairs must be reviewed in the context ofthe provisions of the Securities Act. This is true because ofthe nature of the mechanics by means of which the Congresshas directed the Commission to supervise these securitiesissues. Section 5 of the Securities Act, when read with otherSections of the Act, forbids a corporation to offer to sell itssecurities before it has filed a so -called registration statementincluding a form of prospectus with the Securities and ExchangeCommission. Once it has filed such a registration statementand until some later date when that registration statementbecomes effective, the corporation, or its underwriters, mayoffer to sell but may not actually sell such securities by meansof certain specifically defined material consisting of the prospectuseither in preliminary form or in condensed form. After theregistration statement is effective, which may be anywherefrom twenty days to an indefinite period after filing, firm offersto purchase and binding sales of such securities may be made forthe first time. However, for forty days after the effective dateor until the underwriters have cleared their shelves of the securi-ties, the purchaser must be furnished with a copy of the prospectus,although other material may accompany it. At the end of that time,things go back to normal and you need pay little attention to us.

The catch in this situation, so far as you are concerned,lies in the question of what is an offer to sell or, to put it anotherand broader way, what activity of the corporation constitutes apart of the selling effort. Any release by the corporation's PublicRelati,ons Counsel which might be considered to fall within thedefinition of these terms might seriously and adversely affectthe corporation's financing plans.

There have been a number of such incidents which haveresulted in embarrassment both to the issuing corporation and itsunderwriter and to those responsible for releasing the information.As with many generalities which look perfectly simple in theory,the practical analysis of various situations involves very great

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difficulties. Nevertheless, a study of the Commission's activitiesover the years reveals certain ground rules which, if followed,will probably avoid any question being raised.

A corporation cannot, as I have said, begin to offer asecurity to the public prior to the filing of a registration statementnor can its officials or employees engage in a publicity campaignprior to the filing which is part of an effort or plan having forits purpose the sale to the public of a non-exempt security. Thisdoes not mean, of course, that a corporation which is planningto bring an issue to market must dismiss its Public RelationsCounsel, close its advertising department and gag its officialsand employees. Most certainly an issuer may continue thenormal conduct of its business and may communicate with itssecurity holders and customers prior to the filing of a registra-tion statement or during the so-called "waiting period. II Thus,it may continue to publish advertisements of its products andservices without interruption. It may send out its quarterly,annual and other periodic reports to its security holders. Itmay publish its proxy statements, send out its dividend noticesand make routine announcements to the press and to employeeswithout objection from fhe Commission. Normally, we do notregard these activities as any of our business nor do we wish tobe concerned with them. However, when, shortly before thefiling of a registration statement or during the pre-effectiveperiod, public communications of various sorts begin to appearwhich discuss such aspects of a business as its finances, itsearnings or its growth prospects in glowing and optimistic terms,stressing the favorable over the unfavorable, I think we may bepardoned if we are so unkind as to suspect that this activity maynot be entirely motivated by the desire to sell soap or machinetools or what have you.

The questions relating to corporate issuers which areof the greatest interest to you and which are most frequentlypresented to us concern press releases and publications bycorporate officials and articles about the corporation duringthe pre-filing or pre-effective periods. A press release by acorporation announcing some event in its business would notseem to us to present any particular problem. Nor would the

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announcement of a dividend, the r.eceipt of a contract, the settle-ment of a strike, the opening of a plant or any similar event ofinterest to the community in which the business operates causeus any particular concern. However, that does not mean thatpurported news items which tout the company's securities orwhich dwell upon the financial aspects of the business ordinarilyassociated with the sale of securities shall be viewed in the samelight. It would be well for Public Relations Counsel to be onspeaking terms with the financial officers of their corporateclients in order that they might be aware when the companycontemplated going into the securities markets to secure ad-ditional financing.

Once it appears that this is the situation, 1: can do nomore than recommend that you work very cloa.elywith counselfor your client and counsel for the underwr ites-s in order tomake sure that you do not throw a monkey wrench into theirmachinery.

As I indicated when I began, the second area where wehave mutual interest is in the field of proxy solicitation. If thereis no proxy fight in sight, the material which is submitted to usis generally drawn up by the lawyers .and is pretty much cut anddried. When management is threatened with ouster by disgruntledstockholders, however, the situation very often takes on an entirelydifferent aspect, and we have found that both management and itsopposition have called in skilled assistance from members of yourown profession.

Some of these proxy contests have been rather spectacular.You will all recall the successful attempt of the late Robert R. Youngto gain control of the New York Central Railroad in 1954 and thebitter struggle that was involved in the unsucce ssful attempt of LouisWolfson to get control of Montgomery Ward in the Spring of 1955and the unsuccessful attempt of Leonard Silberstein and the Penn-Texas Corporation to gain control of the Fairbanks-Morse Compaay.Right now we are in the midst of the' so-called proxy season andcurrently we have twice as many .contest s on our hands as we did

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at this time last year. These contests are carried on undercertain proxy rules which have been adopted by the Commissionin accordance with the Congressional directive contained inSection 14(a) of the Securities Exchange Act of 1934. Thissection essentially makes it unlawful for proxies to be solicitedin connection with a security which is registered on a nationalexchange in contravention of such rules and regulations as theCommission may prescribe.

The proxy rules to which I have alluded require certainspecific disclosure in respect of various corporate matters suchas the election of the directors, the various rights of the securityholders, the remuneration of management and other importantrna.tte r s , all of which information must be embodied in a proxystatement and the shareholder must be furnished a form of proxywhich will allow him to vote for or against any specific matterfor which his approval is sought. Similar disclosure is requiredof soliciting material filed by persons other than the managementand the original proxy soliciting material for each party must befiled ten days prior to its use. Any supplemental material mustbe filed two days before its use. The Commission can go so faras to apply to the Federal Courts to enjoin the solicitation ofproxies in violation of the rules or to compel their resolicitationor to restrain the voting of proxies illegally solicited.

It is important to understand that in proxy contests, theCommission must be, and always is, scrupulously neutral; itnever takes sides or plays favorites. In examining the proxymaterial of participants. the role of the Commission is that ofan objective. impartial umpire. It is not unusual in such acontest for each side to feel that the Commission favors theopposing group, since each side is sensitive to and aware ofthe Commission's adverse comments on its own solicitingmaterial and at the same time is unaware of the equally strongcensure applied by the Commission to the material of the opposinggroup. This stems from the fact that it is not the Cornrnfssiontapractice to advise one side what it has required to be strickenfrom the preliminary material submitted by the other group.

One feature of the proxy contests of recent years hasbeen the extensive use by the contending parties of all modern

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media of opinion formation and communication. FrequentlyPublic Relations Counsel are retained to dete rmine the generalstrategy of the campaigns. As a result, the appeal for thestockholder's votes has been increasingly made by means ofradio, television and the press. The use of the press release,the press conference and speeches before stockholders them-selves and before groups having an important influence uponstockholders have become a normal part of the tactics of suchcontests. Reprints of published material tending to favor onegroup or the other have also been used. Moreover, in manycases the opposition groups have attempted to conceal financingdevices in connection with the purchase of shares both by them-selves and by others whose support they seek. Such agreementshave included arrangements by the contestants to purchaseshares of others after they have been voted, agreements toguarantee profits on the purchase of shares by those willing tovote for such groups, agreements to guarantee against lossand other contractual arrangements for financing. Disclosureof these financing arrangements is necessary to enable stock-holders properly to evaluate the purposes of the group whichengages in them. If such financial arrangements exist, theCommission's present rules require their disclosure.

A large number of the more difficult problems in anyproxy contest result from the fact that a considerable proportionof the corporation's outstanding shares are often held in streetnames and their ownership is constantly changing. No longer canparticipants in a proxy contest rely on being able to communicatewith the beneficial owners indirectly through the solicitation ofstockholders of record. As a result, the use of paid advertise-ments, prepared press releases, press conferences, and radioand television broadcasts, has become common in attempting toreach stockholders and to sway the opinion of the public andpersons who may advise or influence stockholders with respectto giving, revoking or withholding proxies. Whether such state-ments are written or oral, or are prepared in advance or arespontaneous, they nevertheless constitute a part of a continuousplan to influence stockholders and are deemed subject to theCommission's standards of fair disclosure and specifically tothe rule prohibiting false and misleading statements.

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Since it would be impractical for the Commission's staffto scrutinize in advance of publication all statements made to thegeneral public by participants in an election contest, the proxyrules require that copies of soliciting material in the form ofspeeches, press releases and radio or television .scripts must befiled with or mailed for filing to the Commission not later thanthe date such material is used or published. If the participantsso desire, such material may be filed in advance, and if filed,will be reviewed by the Commission in advance of use as anadministrative convenience to the parties.

All advertisements used as soliciting material in a proxycontest are required to be filed with the Commission prior to .publication. Reprints or republication of any previously publishedmaterial used in soliciting proxies also must be filed prior touse, together with a statement identifying the author and anyperson quoted in the article, and disclosing whether the consentof the author and of the publication to use it as proxy solicitingmaterial has been obtained and if any consideration has been, orwill be, paid for its publication or republication.

The most important point for you to remember about theCommission's proxy rules is the statutory standard, expressedin the rules, that no solicitation shall be made by means of anyproxy statement, or other communication written or oral, con-taining any statement which, at the time and in the light of thecircumstances under which it is made, is false or misleadingwith respect to any material fact, or which omits to state anymaterial fact necessary to make the statements therein not falseor misleading. This is the fundamental theme running throughvarious specific provisions of the Commission's proxy rulesalready discussed.

The Commission's proxy rules contain examples' of state-ments which, in the heat of bitter proxy fights, may be made andwhich, depending on the particular facts and circumstances, maybe misleading within the meaning of this rule. These include:

(a) Predictions as to specific future market values,earning s , 0r dividends.

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(b) Material which directly or indirectly impugnscharacter, integrity of personal reputation, or~rectly or .indirectly makes charges concerningImproper, Illegal or immoral conduct or associa-tions, without factual foundation.

(c)

(d)

Failure to so identify a proxy statement, form ofproxy and other soliciting material as to clearlydistinguish it from the soliciting material of anyother person or persons soliciting for the samemeeting or subject matter.

Claims made prior to a meeting regarding theresults of a solicitation.

At least one leading firm of professional proxy solicitors,with wide experience in proxy contests, makes it a practice ofadvising corporate clients anticipating a proxy fight to list theirsecurities on a national securities exchange in order to bringthemeelves and the opposition within the purview of the S. E. C. 'sproxy rules.

Too often in the past the Commission has foundpatternsof misrepresentation in heated proxy contests which focus uponthe primary issue of the comparative managerial ability andintegrity of the two groups. Mention must be made of threeparticular categories of misrepresentation that have too ire-quently occurred in past contests. The first is the use of unfairstatistics to mislead, through the use of unwarranted statisticalcomparisons or statistics selected to distort the true facts.Secon41Y, a particularly unfair and misleading device is that ofimputing guilt by association -- often the most remote type ofassociation. The third misleading and unfair device is therhetorical question based on an assumption for which no founda-tion in fact is laid. This is the "Whendid you stop beating yourwifell type of question.

The standard by which statements in soliciting materialshould be judged is not whether the most astute investor wouldbe

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misled. Statements are not necessarily adequate merely becausea lawyer or a trained financial analyst could recognize the falsityand not be misled by them. ,Presumably, soliciting materialwould not contain misleading representations if it were not in-tended that the deception would be successful. The Commission'sposition has been that if an uninformed investor could reasonablybe deceived, the manner of the fraud is immaterial, whether ittakes the form of a direct lie, or a half truth, or a question, oran innuendo. In this, the Commission has been sustained by thecourts.

If Public Relations Counsel are to play an important rolein the financial arena in proxy contests, they should subject theirmaterial to careful legal scrutiny, because it is the lawyers whohave been trained to advise their clients as to legal liabilitiesand they are accustomed to the responsibility of assisting themin compliance with the proxy rules and the Federal SecuritiesLaws.

In the past, it has been argued that the clash of debateand the charges and counter-charges of the opposing two groupsin a proxy contest will bring out enough of the facts to enableshareholders to form an adequate judgment as to the merits ofthe contending parties. Therefore it has been contended thatintervention by the Commission is unnecessary. This veryargument was made in the Libby, McNeill & Libby proxy fightin 1955 and the Court held that this was not the policy of Congressas contained in the Securities Exchange Act.

The end result of the proxy rules, insofar as the PublicRelations Counsel is concerned is to circumscribe his activitieswithin very definite limits. If those limits are exceeded, hemay be subjecting his client to being enjoined from using theproxies which his activities have helped to bring in, and he maybe opening up his client to other and even more serious proceedings.This is no light responsibility which rests on your shoulders atsuch a time, and it is one in which you are not only justified inseeking the most astute legal counsel, but in which you are under-going extremely grave risk in not doing so.

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It is not very often that our Commission has had anopportunity to discuss these problems with a representative groupof Public Relations Counsel. I may not and doubtless have notcovered all of the fields in which you are interested, and Idoubtless have failed adequately to cover those which I havediscussed. I assure you that I should be very happy to answerany questions which you may have either on the materiall havecovered or on any other matter relating to our work.

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