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The Columbia University Libraries reserve the right to refuse to accept a copying order if, in Its judgement, fulfillment of the order would involve violation of the copyright law. Author: U.S. Railroad Securities Commission Title: Report of the Railroad Securities Commission.. Place: Washington, D.C. Date: 1911 ^^^air.MH MASTER NEGATIVE • COLUMBIA UNIVERSITY LIBRARIES PRESERVATION DIVISION BIBLIOGRAPHIC MICROFORM TARGET ORIGINAL MATERIAL AS FILMED - EXISTING BIBLIOGRAPHIC RECORD 530.7 Un3 I U. S. Railroad securities commission. ... Report of the Railroad securities commission to the President, and letter of the President transmitting the report to the Congress ... Washington [Govt, print, off.] J.«/JLx. 42 p. 23"". (62cl Cong., 2d sess. House. Doc. 256) Dec. 11, 1911.~Message and accompanying papers ordered printed and referred to the Committee on interstate and foreign commerce. Arthur T. Hadley, chairman. Pub. also in an edition of 44 p., without document series note. HE2231.U5 1911a Copy 2. Washington, Govt, print, off., 1911. 44p. 23«*: J. Railroads y. 6. — Finance roads and state—U. S. Lil)rary of Congress O 2. Railroads— Wr-&— Valuation. 3. Rail- j^. Hadley, Arthur Twining, 1856- riEaZSl.TJS 1911 11-35949-50 RESTRICTIONS ON USE: TECHNICAL MICROFORM DATA FILM SIZE: ^fyu^fC^ REDUCTION RATIO: .gli IMAGE PLACEMENT: lA (JIA) B IIB DATE FILMED: 6-^-9^ INITIALS: IQ-ft /i^^g^ TRACKING # : FILMED BY PRESERVATION RESOURCES, BETHLEHEM. PA. > A? 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I' i.v 30.1 V)lyx5 LIBRARY School of Business ^.■^.; ■^B^:T»F-W,?-.-«iiwr--r,^a^^- t!^-:>_Ti^- ■tst i 62d Congress ) £d Session / HOUSE OF REPRESENTATIVES / Document \ No. 256 REPORT OF THE RAILROAD SECURITIES COMMISSION TO THE PRESIDENT AND LETTER OF THE PRESIDENT TRANSMITTING THE REPORT TO THE CONGRESS :: :: :: December 11, 1911.— Message and accompanying papers ordered printed and referred to the Committee on Interstate and Foreign Commerce ,^ ^MMitltfi u / / (B /OXUA li* a<3 550.1 LETTER OF TRANSMITTAL. To the Senate and House of Representatives: I transmit herewith for your consideration the report which has been made to me by the Railroad Securities Commission, appointed under the authority of section 16 of the act to create a Commerce Court, approved June 18, 1910 (36 Stat, 556). The report evidences for itself the careful consideration which it has received from the commission and I heartily concur in the recommendations it contains and urge that appropriate action be taken to carry these recommenda- tions into effect. Wm. H. Taft. The White House, December 11, 1911, 3 -^ -J •. rr LETTEE TEANSMITTING EEPOET TO THE PEESIDENT. I ^1 ■V. _, ^ November 1st, 1911. The President: We have the honor to present herewith the report of the Railroad Securities Commission, appointed by you in August 1910 in ac- cordance with Section 16 of the Act of Congress approved June 18th of that year, and organized in the month immediately following. Early in November, 1910, a notice was issued through the public press inviting all persons having information or proposals concern- ing the questions under discussion to transmit the same to the Com- mission. Specific invitations to appear before the Commission or to transmit opinions were also extended to railroad officials, members of various State Railroad Commissions, financiers, authors of books and articles regarding railroads, business men, representatives of commercial, manufacturing and shipping organizations, bankers, lawyers and promoters of railroads and of their securities. Public hearings were held as follows : Washington : November 28, 29, December 1, 1910. New York: December 15-22, 1910, inclusive. Chicago: January 23-27, 1911, inclusive. New York: March 6-7, 1911. At these meetings thirty-four witnesses were heard. The opinions of a still larger number were obtained at informal conferences and by individual members of the Commission. Several hundred letters were sent to other individuals or associations by whom the subject had been considered, and the views received in response to these re- quests were transmitted to the members of the Commission and duly considered by them. The accessible literature of the subject was collected by the Secre- tary and examined by the members of the Commission as fully as the circumstances allowed. Much study was given to the debates in Congress leading up to the passage of the Act under which the Com- mission was appointed. A personal inquiry into foreign conditions was made by the Chairman in October, 1910. 5 J ^:zi'-^ \ 6 REPORT OF RAILROAD SECURITIES COMMISSION. The Commission has not considered the comparative merits of government ownership of railroads and private ownership under governmental regulation ; nor has it attempted to enter into the dis- cussion regarding control of railroad rates, except as to their relation to the issue of securities. It has adhered to the terms of the Act of Congress which confines the functions of this Commission to the con- sideration of questions connected with the issuance of stocks and bonds by railroad corporations. Respectfully submitted. Arthur T. Hadley, Chairman. William E. S. Griswold, Secretary. REPOET OF OOMMISSIOK November Ist, 1911. The PREsroENT: The imdersigned have the honor to make to the President the fol- lowing report as responsive to Section 16 of the Act of Congress ap- proved on June 18, 1910, the material portion of which reads as follows : That the President is hereby authorized to appoint a commission to investi- gate questions pertaining to the issuance of stocks and bonds by railroad cor- porations, subject to the provisions of the Act to regulate commerce, and the power of Congress to regulate or affect the same * * *. 1. BAILBOAD SECURITIES AND INTERSTATE COMMERCE. The railroad companies of the United States, with only one im- portant exception, owe their present corporate existence to state charters and are subject to state laws regarding their issue of stoclis and bonds. But a large and growing proportion of their business is interstate commerce, regulated by federal authority. There is a widespread belief that the rates charged on this business are affected by ihe amount of stocks and bonds outstanding; that much stock has been issued without being fully paid; and that the dividends on this stock represent an unnecessary tax on interstate commerce. The railroad men as a rule deny that the amount of capital of the roads, either nominal or actual, is seriously considered by their agents in making rates. But it is frequently treated by counsel, commissions and courts as a thing of importance in determining whether rates are reasonable. If capitalization has an actual effect on interstate rates, the federal government is interested, in its ctm- trol. There is still another way in which the issue of stock for less than par may affect the conduct of interstate commerce. The bond- holders who loan money to the corporation may be led to believe that there is a real security behind the bonds equal to the face value of the stock, when in fact a portion of this value represents nothing more substantial than the expectation of the promoters. So far as this deception affects only the individual bondholder, we may leave it to state law to protect him. But if such deceptions become prev- alent they inevitably affect the confidence of investors as a body, and J \A 8 BEPORT OF BAILROAD SECURITIES COMMISSION. our American railroad systems fail to get the full amount of capital needed for their development and for the proper conduct of their yiterstate business. It is a matter of direct concern to the federal government that the facilities for handling commerce between the states should not be impaired. These facilities embrace not only steam railroads, but the other agencies of communication and transportation enumerated in the Act to Kegulate Commerce. While for brevity the language of this report is largely confined to railroads, the discussion and recom- mendations apply generally to these other agencies. 2. PRESENT REQUIREMENTS AND FUTURE POLICY. Starting from different points, investors and shippers, and through them the general public, have come to feel that state legislation has provided inadequate security for their interests in this matter. The question is therefore asked with increasing frequency whether the United States Government should not undertake to regulate the issues of securities by the roads engaged in interstate commerce as a necessary means to its effective control. This question naturally divides itself into two parts : First, what immediate action by Con- gress will best meet the existing situation ; and second, what general principles should guide the federal government in its future legisla- tion on this subject. As far as concerns the immediate action of Congress, we believe that stringent provisions regarding publicity of stock and bond issues, which will show how far the laws are obeyed, and will enable the federal government to hold the railroad officials responsible for the consequences of not obeying them, will be more salutary and more effective than any new statutory demands. So long as the rail- ways engaged in interstate commerce are chartered by the states and subject to state laws regarding their securities, added federal re- striction will tend to create further confusion in a situation already too complex. But we also believe that the time is near when the difficulties of the present' system of dual control, and the conflict of state laws, will become so manifest that further legislation on the subject will be im- perative. Unless the constitutional power of Congress to regulate the securities of railroads engaged in interstate commerce is defi- nitely established as being, to the extent that Congress acts upon the subject, exclusive of State control, one of two things seems likely to happen : Either the federal government and the governments of the several states will come to a common understanding as to the prin- ciples to be adopted in the control of security issues, or the railroad systems will be given the opportunity to exchange their State Char- ters for Federal ones. We have therefore discussed in some detail REPORT OF RAILROAD SECURITIES COMMISSION. 9 the principles which ought to govern the stock and bond issues of railroads in the United States. Whichever alternative we adopt, \^ e ought to have such a set of principles before us. If we are to bring about a common understanding, we need them as a basis of negotia- tion. If we consider federal incorporation of railroads the more de- sirable or practicable alternative, we need them as the groundwork of a federal incorporation law, of which our roads may avail them- selves when their interests and those of the public require it. Under the terms of the Act of Congress creating this Commission, it has not considered, as an alternative to these possibilities, the direct owner- ship of the railroads by the government itself. In that case the government would issue its own securities, and none of the questions submitted to this Commission would then arise. 3. THEORY OF RAILROAD STOCK ISSUES. Everyone knows that railroad securities are divided into two classes, stoclcs and bonds; very few people apprehend as plainly as they should the distinction between the two, or understand the real nature of a share of railroad stock. As to the real nature of a rail- road bond, there is no doubt at all. It is essentially a note made by the company; a promise to pay a certain amount of money, say one thousand dollars, at a specific date of maturity, and to pay interest at specified rates in the meantime. The obligation is definite. The value is limited by the terms of the instrument. But a share of railroad stock is of a different, and more complex, character. It represents two things instead of one: That a certain sum has been paid in, and that the holder of the stock has a certain share in the ownership of the property, of whatever value that may prove to be. The second of these things is what ultimately gives the stock certificate its value. In the case of a railroad bond the fact that it calls for one hundred or one thousand dollars is a determin- ing factor in what it is worth. But in the case of stock, the fact that the certificate represents one hundred or one thousand dollars is far from being the determining factor. It is but one incident among many. Even in theory it purports merely to show that this was the amount originally paid by the subscriber when the road was built. It does not create an obligation to pay its face value, nor does that face represent its money value as a share. The value varies with the development of the property as a whole. If it has been wisely located and well managed it will be worth more than the amount it represents. If it has been unwisely located, or badly managed, it will be worth less than the amount it represents. The shareholder chose his investment, elected his management and took his risl«. If he acted unwisely and fares badly he has no claim that the public should indemnify him. If he did well, the public can not either J 10 REPORT OF RAILROAD SECURITIES COMMISSION. M rightly or wisely fail to recognize and reward his foresight, so long as his road is managed with proper regard to the interest of the com- munity, and for the development of the traffic which it carries. The principal of a bond is a fixed sum, its interest a fixed charge. The value of a share of stock is essentially variable, its profit essen- tially indeterminate. There is a persistent tendency to ignore this distinction; to em- phasize unduly the face value of the stock; to treat the shares in a railroad or other public service corporation as claims against the community for the number of dollars they represent, rather than as fractional interests in a more or less hazardous enterprise, in which the investors took risks of loss and chances of profit ; to allow cor- porations to claim immunity from public regulation when the divi- dend on the face value of the shares is below the prevailing rate of interest ; and to subject them to vexatious attacks when this dividend is above the prevailing rate of interest, even when such profit may be a fair compensation for risks actually incurred in the past or a neces- sary incentive for the investment of new capital and the taking of new risks in the future. 4. STATE LEGISLATION REGARDING STOCK ISSUES. Nowhere has this tendency been more marked than in the legisla- tion of the several states regarding stock issues of railroad corpora- tions. It has led our law makers to lay too much stress on keeping down the nominal amount of stock, and too little upon getting the actual amount of capital needed and having it properly used. Nearly all the states require that railroad stock issues should be paid in full at their face or par value. Eighteen have this provision in their constitutions ; a majority of the others have more or less defi- nite laws to the same effect. Even without such specific statute the requirement that the shareholder may be called upon to meet the full value of his stock subscription is operative in the absence of legisla- tion to the contrary. Of such legislation there has been relatively little. West Virginia alone, among all the states, expressly sanctions the issuance of stock at less than par, although there are several others where exceptions to the rule of full payment have been allowed, either by general statute or by special act of the legislature in particular cases. 5. EVASION OF STATE LAWS. Where the strictness of the law regarding capital stock has inter- fered with the building of railroads in new communities, evasion of its letter or spirit by railroad companies have been frequent. The very rigidity of the statute has caused the public to be negligent in its enforcement. In some cases the laws have been so drawn as actu- REPORT OF RAILROAD SECURITIES COMMISSION. 11 ally to invite evasion, by specifically leaving it to the judgment of the directors to decide what constituted an adequate consideration for the shares. The companies have thus been enabled to represent that their stock was fully paid, when this was not in fact the case. Some- times stock has been issued by the promoters of a company to them- selves as a reward for their services in organization and management. Sometimes it has been issued in exchange for rights of way and other forms of assistance to the construction of a new road, without much regard to the cash value of the consideration received. Sometimes it it has been issued to stockholders to represent the increased value of their property, actual or prospective, on the theory that such value represents undivided profits which the stockholders have not received or do not receive in cash, and are therefore entitled to obtain in scrip. Sometimes it has been issued in reorganizations, consolidations, or in exchange for the stock of other companies, on terms not really war- ranted bv the facts in the case. Sometimes stock so issued as full paid has been given as a bonus to induce people to subscribe for bonds. Besides these direct methods of evasion, there have been more indirect means of reaching the same result. Lines have been built through the agency of construction companies and paid for by the issue of securities whose face value considerablv exceeded the actual cost of the roads themselves. All these practices, with the possible exception of the one last named, have been much more frequent in the past — particularly during the great periods of railroad expansion from 1853-57, 1869-72, 1879-82 — thtfti they have been in recent years. This change is not wholly due to increased stringency in the laws. It is partly due to wise admin- istrative measures for their enforcement, and partly to the increased demands of investors in bonds for the real data as to the security underlying them, which has compelled managers of corporations to give greater publicity as to the real facts. The Chicago & Alton reorganization is the only instance in the last decade which has been brought to our cognizance where the public has been offered a large issue of railroad stock (as distinct from the stock of a holding company), based merely upon an estimated increase of value. Re- cent attempts to capitalize expected profits in connection with other public service corporations or with industrials, do not come within the scope of this inquiry. 6. DANGER OF EVASION OF FEDERAL LAW. A federal law requiring full payment of all stock issues, without special machinery to enforce it, could be evaded as state laws have been evaded in the past. In fact, the liability to evasion might be li BEPORT OF RAILROAD SECURITIES COMMISSION. greater, because in some parts of the country a statutory require- ment of this kind, imposed by the federal government, would be regarded as an interference with the rights of the several states; and local companies attempting to build new lines with stock not fully paid might have the support of local public sentiment in so doing. It is possible that in some instances the federal government could not even count upon the vigorous assistance of the state authorities themselves in trying to enforce such an Act at all rigidly. Such a federal requirement superadded to the state requirement miglit simply mean that every company would be led to make two deceptive returns instead of one. A federal requirement conflicting with a state requirement might leave us in an even worse case; for the impossibility of obeying both authorities would be made an excuse for obeying neither. This would clearly be true until the paramount authority of the federal government was established. 7. ENFORCED UNIFORMITY NOT YET ATTAINABLE. To make legislation of this kind effective, it would be necessary to provide federal agencies for carrying out its requirements in detail. We should be compelled either to burden the Interstate Coinuierce Commission with a large amount of additional work, or to create a new commission to supervise railroad incorporation and construction in different parts of the country. If we were ready to substitute exclusive federal control for the jurisdiction of the several states over their railroad corporations, much could be said in behalf of the establishment of a national authority to supervise both the issuance of stocks and bonds and the actual expenditure of their proceeds. But, apart from the consti- tutional difficulties which might stand in the way of such a pro- cedure, your Commission is of opinion that, as a mere matter of expediency, the time is not ripe for any such immediate or forcible transfer of jurisdiction. The local needs of different parts of the country are still divergent. Many railroad problems, both of oper- ation and of control, are still in the experimental stage. Enforced uniformity under federal law would, in the opinion of many, dis- criminate against the development of new territory, and the forma- tion of independent companies; for a well established system has less difficulty in securing the necessary capital by pledging its credit than an independent projector wishing to develop a new district. These dangers and difficulties may have been somewhat exaggerated. While they undoubtedly exist in certain cases, they are of a sporadic, rather than a general, character. But they are urged with much force, both by state railroad commissioners and by independent builders; and they would constitute obstacles to the effective en- forcement of a federal statute. Before such a statute is enacted, REPORT OF RAILROAD SECURITIES COMMISSION. 13 it should be clearer than it now is that public opinion would support it. Under such circumstances the immediate assertion of exclusive federal jurisdiction under one general railroad law appears unwise. Until such exclusive jurisdiction can be established, the creation of a separate administrative body subjecting the railroads of the country to a new system of concurrent supervision, in addition to the many old ones which now exist, does not seem just, expedient or economical. 8. ENFORCED PUBLICITY IMMEDIATELY NEEDED. In place of any added federal requirements concerning payment for capital stock, your Commission recommends the adoption of provisions regarding publicity which will show the actual facts regarding stock and bond issues in the several states, and the con- sideration received therefor. Any railroad doing interstate busi- ness which issues bonds or stocl« should be required by statute to furnish the Interstate Commerce Commission, at the time of the issue, with a full statement of the details of the issue, the amount of the proceeds, and the purposes for which the proceeds are to be used, followed in due time by an accounting for such proceeds, as more fully hereinafter set forth. An Act of this kind does not limit the freedom of the several states to make any kind of laws which they please regarding their own corporations. If they want them stringent they may make them stringent. If they think they can encourage the investment of capi- tal by .permitting the issue of stock for less than par, they can allow such issues. If the result of enforcing existing laws interferes with local needs, they may change the laws. But the companies must indicate precisely what they are doing. They must not attract the bondholders' money by representing that there has been a payment of one hundred cents, when there has been a payment of only fifty cents. They may, if they please, direct the treasurer to set down their partly paid stock in the balance sheet as a liability in full ; but they must make it plain to the investor today and to the public to- morrow how much of that liability was represented by cash assets contributed and how much consisted of what is called in English balance sheets "nominal additions to capital." Such liability is of the corporation to its stockholders and not of the public to either. 9. MODE OF PROCEDURE. Two courses lie open before us in our effort to secure publicity regarding railroad securities: Either to require the express sanction of some administrative body (presumably the Interstate Commerce Commission) before such securities are issued, or to rely on general statutory provisions under which the directors may issue such 14 REPORT OF BAILBOAO SECURITIES COMMISSION. i5 securities and be held responsible for their proper use. In the case of either of these alternatives, the accounting required must be full and adequate in every respect, and the Interstate Commerce Commission or other administrative authority must be empowered to do whatever may be necessary in its judgment to secure compliance with the statute and to prevent injury to the public. Either alternative would mvolve the valuation of property and services whenever such valua- tion may become necessary in establishing the integrity of the finan- cial transactions involved. , The first alternative insures reasonably full publicity before the fact. Official inquiry following the formal application would twid to discourage attempts at evasion; and would probably in many in- stances prevent the filing of applications for issues which are ques- tionable either because of their financial unsoundness or because thev • duplicate existing lines instead of adding to public convenience. Your Commission nevertheless prefers the second alternative and doubts the expediency under present conditions of a general law forbidding railroads to sell securities without specific authorization in advance, it being understood that the face value of these securities is not to be construed as an obligation on the public. Authorization in advance would tend to create an impression on the part of the investing public of a guaranty or official recognition of values, which no administrative authority can safely give. The absence of such recommendation by this Commission is intended to make it clear that no such guaranty should be given. A growing railroad has con- stant need of money, and its officers and directors are the best judges of the amount of its annual i*equirements. It is manifestly to the interest of the company and of the public that a road should get its money as cheaply as it can. The policy of allowing a floating debt to accumulate with a view to its extinction by the sale of per- manent securities upon the completion of its improvements is not jbl good one, and should be avoided wherever possible. An adminis- trative body whose approval was required in advance for the sale of securities would have great difficulty in always acting promptly enough to enable the roads to avail themselves of favorable money markets, and avoid the creation of floating debt, and might do its work so carelessly as to result in shielding the directors from responsibility, instead of acting as i. safeguard to the public. We are disposed to leave for the present to state commissions the responsibility of passing upon the questions of public convenience and necessity involved in the building of lines to be constructed within the limits of their several states, and to rely on full publicity as to the use of the proceeds of the sale of securities and of other assets as a safeguard against financial abuses. REPORT OF RAILROAD SECURITIES COMMISSION. 10. FACTS TO BE DISCLOSED. 15 With this end in view, every company should be required to fur- nish to the Interstate Commerce Commission at specified dates a full statement, including the names of the parties concerned, of all finan- cial transactions that have taken place during the periods covered by the report, whether in cash, in securities, or in other valuable con- siderations, and whether embraced in income account or outside of it. This statement should also include the disposition of surplus. Every company should be further required to compile for the information of its shareholders facts in regard to the financial transactions of the company for its fiscal year, of such a character and in such form as the Interstate Commerce Commission may direct. The Interstate Commerce Commission should have the power to investigate all such financial transactions and to inquire into the bona fides thereof ; the right to call for the production of books and papers of railroad companies, construction companies or other com- panies with which the railroad company shall have had financial transactions, for the purpose of enabling it to verify any state- ments so furnished to it; and the power to examine into the actual cost as well as the value of property acquired or of services ren- dered. In all transactions investigated, from the purchase of sup- plies to the acquirement of new lines by consolidation, every interest of the directors should be disclosed, and adequate penalties provided for any failure to make such disclosure. This enumeration is illustrative and not inclusive. Some of these items the Interstate Commerce Commission now requires in the reports of the companies; other items are not now required and probably cannot be under the present Act to Regulate Commerce. All of them call for facts or groups of facts which the Interstate Commerce Commission should be empowered to ascertain in the administration of an amendment to the Act to Regulate Commerce, concerning which we have prepared and attach to this report a more definite suggestion. 11. PHYSICAL VALUATION. " Physical valuation " of railroads in its bearing on capitalization has been to some extent advocated, and to a greater extent opposed, upon the idea that, if undertaken by the United States Gover^iment, it will be made a justification for reducing the amount of the out- standing securities of the railroads to the figure thus ascertained, or for preventing them from issuing new securities when the amount of their outstanding stocks and bonds exceeds the physical value of their properties as so determined. Should a valuation of the physical property of railroads be made, it ought not, if properly applied, to involve either of those dangers. 16 REPORT OF RAILROAD SECURITIES COMMISSION. An attempt to scale down old securities is clearly out of the ques- tion. Apart from the obvious constitutional diflSculties of such a course, considerations of public expediency of themselves forbid it. The direct loss from the unsettlement of legal and equitable rela- tions would be very great. The indirect loss from the withdrawal of confidence in American railroad investments would be immeasur- able. Such a readjustment. would become archaic almost from the outset, because an adjustment of securities based upon the values of today might be totally erroneous tomorrow. It would be equally inadvisable, in cases where outstanding securities were in excess of the physical valuation, to prohibit the issue of new securities until physical value had become equal to the amount of securities out- standing; because this principle, if generally applied, would prevent roads so situated from securing the capital needed for the service of the community. Whenever a railroad company acquires new property in return for the issue of its securities, or in expending the proceeds of such securities, every means should be placed at the disposal of the Inter- state Commerce Commission to ascertain the value of such property as accurately as possible. A fundamental, though not necessarily a controlling, element in value, is cost of reproduction. This is true of property in general ; it has been specifically affirmed of railroad property by the Supreme Court of the United States. Emi- nent railroad men who have appeared before this Commission have stated that in their opinion cost of reproduction or physical value was the most important single element in determining the true value of the railroad as a whole. Indeed, we believe it to be in the interest of railroads, no less than of those who use them, that the Interstate Commerce Commission should be given broad powers and adequate means for valuation of the physical property of railroads as one element in determining fair value, whenever, in the judgment of that Commission, this is of sufficient importance to warrant such action. This will give the public information which it is entitled to demand, and which can, in our judgment, be letter and more eco- nomically obtained in this way than in any other. The attempt to oppose a system of physical valuation of this kind tends to give countenance to exaggerated estimates of the amount of water in rail- road stocks. 12. RESULTS TO BE EXPECTED. We believe that the powers granted to the Interstate Commerce Commission by the preceding recommendations may be found large enough to protect the public, without the necessity of passing a law that should require specific approval in advance of the amount and purpose of stock and bond issues. SEPOKT 01' RAILROAD SECUKITJES COMMiSSiOX. 17 We do not say that the enforcement of a law of this kind will be easy. The public in all parts of the country has become accustomed to the evasion of laws concerning capital stock. It is far easier to pww a radical measure which is going to be evaded than to secure obedience to a conservative one. But we are confident that full public knowledge of the facts will diminish the evils and misunder- standings described in the opening paragraphs of this report as being the chief .sources of the demand for immediate federal action, and will at the same time furnish the proper foundation on which to' base more thorough -going reforms. One of these evils was that bondholders were at times deluded into the belief that there was a security behind their bonds which did not exist, and that the railroad company was mortgaging a piece of property when it was only capitalizing an expectation. They thus entrusted the control of their money to men who had comparatively little at stake. If a profit was made, the promoters could appro- priate It; if money was lost, the loss fell on the bondholders. Roads built largely with borrowed capital at the beginning have been pre- vented from subsequently obtaining the credit which they mi<-ht otherwise command. They have therefore been less abl^ to give'' to the shippers or to the travelers the facilities which are requisite no less for the convenience and safety of the public, than for the profit- able utilization of the railroad itself. To the extent that we lessen debt, we shall increase the power of the roads to raise money when the public needs added facilities and shall at the same time reduce the chance of default and lessen the severity of commercial crises. But to most people the danger of these financial consequences seems a less serious thing than the danger that the railroads wiU tax the users of the road for the sake of making profits on capital not actually furnished. The necessity for paying interest on bonds, and the desirability of providing for dividends on stock are sometimes urged as a justification for increased rates; and they are frequently put forward as a reason why existing rates may not fairly be inter- fered with by law. To meet this danger, so far as it is a real one, and to avoid this misapprehension so far as it is a misapprehension^ it is essential that the stock should be what it purports to be. If it purports to represent one hundred dollars paid in on every share, one hundred dollars should actually be paid in. If it purports only to be a participation certificate, giving a proportionate interest in ony profits that may be earned, it must be understood that this is its e&sential character, and that if it claims any further rights than this, it must prove them by specific evidence. This is in the interest of all parties— of the honest investor and the progressive manager, of the shipper, the traveler and the general public. H. Doc. 2.56, 62-2 2 I. i.*rJ9^.*^-r •^.Tj-% 13 REPORT OF RAILROAD SECURITIES COMMISSION. If full publicity be given to the facts, we shall als^o lessen the fraudulent creation of debt. It is the degree of publicity as to the facts, rather than the stringency of the law, which gives the people any real protection. A stringent law inadequately enforced and secretly evaded is the worst thing that can possibly be offered the public, because it gives color to claims which have no foundation in fact. 13. CONFLICTS OF JURISDICTION. \ATiile we do not think that the time is ripe for a sudden and quasi- compulsory transfer of the direct control of the stock and bond issues of interstate railroads from the states to the federal government, we cannot help recognizing that there are conflicts of jurisdiction in the construction, operation and financing of interstate railroads which mav more and more embarrass interstate commerce and necessitate a larger degree of federal control, or even result in federal incorpora- tion. A road organized by an individual state is subject to state jurisdic- tion regarding certain rates and facilities and purposes for which securities may be issued, and is responsible to the state courts for the performance of its functions. The instant that its cars pass across the state line or that its shipments are routed to points in other states it becomes responsible to the Interstate Commerce Commission and to the federal courts. Constitutionally Congress has paramount au- thority over interstate commerce and by its action can abrogate any previous action of the states which may prove inconsistent therewith. Practically it is easy to see how a conflict may arise between local and national requirements regarding facilities or methods. The state may prescribe one way of doing business; the national government may prescribe another, and forbid the one ordered by the state. It is only by the care of our railroad commissioners, state and national, that serious difficulties of this kind have been avoided in the past. Even more perplexing are the questions which may arise in con- nection with tiie control of interstate railroad rates. The local leg- islatures and commissions have ideas of their own regardmg rates which may differ in some respects from the ideas of Congiess or of the Interstate Commerce Commission. But the relation between through and local rates is fi*equently so close that the two sets of things cannot be arranged on independent principles. The reason- ableness of the through rate may depend upon its relation to the local rate, and vice versa. It becomes increasingly difficult each year to leave a corporation free to fix its local rates subject to the jurisdiction of state commissions and state courts only. Thus the exercise by a state of its authority over railroads or- ganized or operating in its territory, prescribing terms on which, A^ REPOHT OF KAILROAD SECURITIES COMMISSIUN. 19 and the limitations within which, it may issue securities, may di- rectly interfere with and embarrass interstate commerce, when the issue of such securities is essential for raising funds to be applied in furnishing the necessary facilities for its interstate traffic. One or more instances of this have been brought to our attention. That they have not been more numerous is doubtless owing to the discre- tion and conservatism which have usually characterized the action of state commissions. Such state regulation of the security issues of interstate railroads may be wise or unwise from a local point of view; but the state determination cannot control the federal right. This danger of possible interference with interstate commerce nec- essarily tends to increase with the number and activity of state com- missions; and it was for the protection of such commerce against any interference that the power of regulation was vested in the fed- eral government 14. DEVELOPMENT BY INTERCORPOBATE HOLDING. Some states have laws compelling railroads within their borders to be organized under the laws of the states in which they are located and forbidding foreign corporations, so-called, from cqnstructing, owning and operating lines thus located. The effect of these and other similar statutes have been largely avoided by a system of inter- corporate holdings, under which a corporation organized in one state which owns the stock or the major part of the stock of a road in another state can secure the capital necessary for construction or betterment without subjecting itself to the restrictive laws of the state-where the money is actually spent. One or two instances will show how this system works. ' The state of Texas has a law which rigidly limits the extent to which roads in that state may be capitalized. It seems to have been the expectation of those who passed the Texas law that it would be a protection to all those interested in the proper operation and regulation of railroads. But it has had the practical effect of mak- ing it difficult to get directly by the sale of securities of railroads located in Texas, the necessary capital for their improvement; be- cau.se if a road was already capitalized to an amount in excess of the official valuation of the State Commission, no further securities could ordinarily be placed upon the property for necessary improvements, until this deficiency was made good. Under these circumstances companies organized in other states which own lines in Texas need- ing added investments of capital in order to handle their traffic in that state economically, frequently resort to a simple expedient. Instead of issuing securities of the Texas company they pledge the credit of the parent company and put into a collateral trust any hitherto unpledged securities of these Texas roads that they may h.'r ! 1 mm 20 REPORT OF RAILROAD SECURITIES COMMISSION. REPORT OF RAILROAD SECURITIES COMMISSION. 81 have in their treasury, and if they have none, then other securities or property, thus issuing under the authority of another state securi- ties whose proceeds are to be spent in Texas. When the Chicago, Milwaukee & St. Paul Railroad wished to build its Puget Sound extension it had to pass through several states whose laws forbade corporations chartered under laws of other states to build roads within their borders except as a connec- tion or prolongation of a road actually built to the state line. In order to conform to these restrictions, the St. Paul Road would have had to build its line slowly, step by step, instead of doing work in several states at once and putting the road through as promptly as possible. To avoid this difficulty it had to organize a separate company to build the road in each state which had such a law. This in itself was not a serious evil; it simply involved additional expense, to have separate corporations do things piece- wieal which might have been done as a unit without such interme- diaries. But it tended to render state control less effective, instead of more so. The system thus forced upon the St. Paul Road would give every opportunity for deception to a road which might want to deceive. Where a company builds its own roads, it is possible to find out what they cost and have the matter properly entered in the balance sheet; but where a corporation is artificially encouraged to divide Itself into several parts, the parts that do the constructing can sell their finished roads to another part, at an abnormal profit. This transaction may furnish the parent company an excuse for an over- issue of securities. If the securities thus over-issued are paid for in full, it will put a certain amount of cash into the treasury of the newly organized company for which it becomes very difficult to hold the directors of the parent company to strict account. If they are not fully paid for, it simply means that the alleged profits of the parent company may be made the excuse for furnishing its stockholders, in the shape of a dividend payable in its own stock, a number of pieces of paper whose face value is greater than the amount actually contributed. 15. OOKTBOL BY INTEBCOBFORATE HOLDING. Of the total amount of railroad capital outstanding on June 30, 1910, $3,952,000,000, or more than twenty per cent of the whole, was held by railroad companies themselves. About one-third of this was bonds, and two-thirds stock. There is also a large additional amount of railroad securities owned by various "holding com- panies," which are not, technically speaking, railroad corporations and do not make return of their capital to the Interstate Commerce Commission, but which control the policy and direct the operation of the roads whose securities they have purchased. Any artificial stimulus to these intercorporate holdings is a public evil. AVhere a railroad controls the operations of another railroad by owning a majority of its stock, or where a holding company controls the operations of several roads in the same manner, we have all the dis- advantages of consolidation, without getting all of its advantages. We get the centralization of financial power; we do not get all the economy of operation which should go with it. Apart from this general danger, we open the way to several specific evils. Where a railroad controls the operations of another road by the ownership of a majority of its stock, there is constant danger that the minority holders will not be fairly treated. The road thus pur- chased has become part of a large system, and is operated by the representatives of the whole system. It is almost certain that the advantage ol the whole will be preferred to the separate interests of the part in matters of operation, traffic and finance. Again, the existence of two or more companies under tlie same management, having separate organizations but united control, in- vites the concealment of financial transactions by the shifting of chai'ges from one company to another. We have already shown how this may happen in the construction of a new road. It is equally possible in the operation of an old one. 16. FINANCIAL DANGERS. A further effect of intercorporate holdings is to change contingent t'haFges into fixed ones. A railroad company buying the stock of another company almost always issues collateral trust or other bonds to pay for it ; in other words, it puts the stocks into its own treasurj- and sells the bonds to the public. As long as the road is prosperous this change does little harm. In fact, it may appear to do good. When a company has been able to buy a five per cent stock by the issue of its own four and a half per cent bonds, there is an apparent profit of one-half per cent annually on the transaction to the com- pany and an apparent reduction in total charges which it must meet. But with any diminution in traffic, the bad effect of the change is at once obvious. The interest on the bonds remains a fixed charge against the company. The effect of a loss of dividends w6uld ha^ e been felt chiefly by the individual stockholders; a default, or even fl threatened default, of interest has an effect on the credit and confi- dence of the country as a whole, and may precipitate a financial crisis. The extent to which the credit of our railroads is being pledged is evidenced by the change in the proportion of railroad stocks and bonds held by the public. In 1899 these were nearly equal; §. >* 22 REPORT OF RAILROAD SECURITIES COMMISSION. REPORT OF RAILROAD SECURITIES COMMISSION. 23 $4,307,000,000 stocks and $4,336,000,000 bonds. Eleven years later the figures given by the statistician of the Interstate Commerce Com- mission were $5,578,000,000 stocks and $8,866,000,000 bonds— a serious disproportion. The giowth of intercorporate holdings is responsible tor a considerable })art of this change. This disproportionate growth of fixed interest-bearing obligations as compared with stock is primarily the result of the issuance of bonds in payment of roads acquired, and would .still have taken place even if title had been taken in fee instead of through stock ownership ; but the latter method, by reason of its facility for the issue of collateral trust bonds, has un- fjucstionably been an important factor in creating this di.sproportion. So long as different i)arts of what is naturally a connected system of railr(;ads are chartered by separate states there are likely to be artificial obstacles to consolidation; and while these obstacles exist, we shall find it difficult either to check the tendency toward increased intercorporate holdings, or to deal with the evils incident thereto. Each instance of intercorporate holdings thus furnishes an added argument for federal charters. 17. ALTERNATIVE METHODS. In the present state of the law, there are two distinct methods by which we might avoid conflicts between the state and federal govern- ments in the control of railroad stock and bond issues, and deal with the problems of construction and finance incident thereto. One method relies on a full interchange of views between the Inter- state Commerce Commission and the commissions of the several states, as a means of securing harmony. If it is possiWe for the mem- bers of all these different bodies to arrive at a common understand- ing on a question of public policy, they usually have little trouble in getting the necessary authority from Congress and the state legis- latures to put a consistent policy into effect. This way of doing things was illustrated in the legislation regarding safety appliances a few years ago; it is just being illustrated in connection with control of railroad accounts to-day. In each of these matters a great deal of trouble was made by conflicting requirements; in each, a full discussion of the questions involved was followed by a substantial agreement on the main points, and the good sense of the several commissions prevented serious difficulties from being raised about minor ones. Whether we could secure a similar agreement on matters of finance, where the conflict of interest between different localities is more serious and the differences of opinion are more fundamental, is open to doubt. If the public interest of the United States as a whole should be jeopardized by these differences, we can perhaps have recourse to a Federal Incorporation Act, which shall permit railroads to exchange their state charters for federal ones. We believe that such an Act could be so drawn as to offer advantages in the conduct of interstate traffic without unduly conflicting with local interests. The most important of these advantages would be: (1) The right to construct lines needed for interstate commerce, under proper local supervision, and with proper regard for local needs, but without the agency of local corporate organizations; (2) The right to have rates super- vised by a single authority which could pay proper regard to the mutual relations of local traffic and interstate traffic, instead of two separate authorities dealing with the two things independently; (3) An equitable .system of taxation which would distribute to the several states their proportionate parts of taxes levied on both the tangible and intangible property of the railroad by some harmonious plan. It is too early to make definite choice between these two alterna- tives. But it is not too early to indicate the principles which should guide our legislation concerning stocks and bonds in either event. For our progress toward putting these principles into effect will necessarily be slow by either method. If we try to bring the views of different legislatures into harmony, the discussion must be de- liberate in order to have any chance of success. If we rely on per- mission to exchange state charters for federal ones, we must give both the railroads and the states time to learn the wisdom of availing themselves of this opportunity. If in the discussion that follows we have seemed to have more defi- nitely in mind the adoption of a federal charter than federal cojitrol of state corporations, it is because this method enables us to make our suggestions in clearer and more concrete shape; the underlying principles and aims would be substantially the same in the two cases. 18. TREATMENT OF EXISTING ISSUES. Whatever alternative we adopt, any disturbance but a voluntary one of the existing amounts or status of bonds or stocks validly issued is clearly inadmissible; and in general there should be as little disturbance as possible of the relations to-day existing between different classes of security holders. These relations often seem tinnecessarily complicated, both in their provisions regarding distri- bution of income and in their delegation of voting powers. But the confusion and litigation which would result from the attempt to dis- turb them would outweigh any possible good to be obtained. The absence of any attempt to base security issues upon revalua- tion will emphasize the true character of our American railroad stocks, as being essentially praticipation certificates giving a right 24 iy %\ REPOKT OF RAILROAD SECirRITIES COMMISSIOX. to a proportionate share of whatever profits may he earned, rather than evidences that a certain specific amount of money has actu- ally been invested in the property. 19. PRICE OF NEW ISSUES OF STOCK. A most important and difficult question is that of the price at which new stock may be issued. We believe that no restrictions ex- cept those of publicity should be placed upon the power of the direc- tors to issue new stock pro rata to their stockholders at or above par even though the price received be less than the existing market value' of the old stock. The experience of Massachusetts has shown that the attempt to prohibit the issue of stock below its market value has hampered the investment of capital and has distinctly interfered with the development of facilities. If this has been the experience of Massachusetts, where capital was abundant, we can hardly expect better results in states where capital is more scarce. A further objection to any attempt to compel the sale of new stock at a price above par is that it implies a certain warrant that this value, thus publicly fixed, will be maintained in the future, on the old stock as well as the new. In thus attempting to limit profits, it may actually tend to guarantee them. The question whether the directors should be allowed to issne stock below par is a harder one to answer. On the face of the matter it seems as though the requirement that no stock should be sold at less than par was a fundamental principle of sound finance. So it is, if it results in the sale of stock at par; not so, if it results in the sale of bonds at a discount. If a road whose stock, for any reason what- soever, sells below par is prohibited from issuing stock at less than par, it means that it must raise all its money by bonds. It is com- pelled to go more and more deeply into debt. The worse the finan- cial position of the road, the stronger is the compulsion and the heavier are the interest charges on the bond. To compel the weaker roads to pursue their present policy of issuing fixed interest-bearing obligations by reason of their inability to sell stock at par may before long, by reason of a large crop of receiverships, result in intensifying the acuteness of the next panic and in prolonging the subsequent business depression. If the stock bears upon its face the statement that each share rep- resents a contribution of one hundred dollars or any other specified sum which constitutes its par value, we see no easy way of avoiding this difficulty. If a document says one hundred dollars has been paid, one hundred dollars ought to he paid. The most that can properly be done is to allow companies which cannot sell such stock at par to arrange for the "amortization," or gradual cancellation, of REPOBT OF RAILROAD SECURITIES COMMISSION. u any necessary discount by appropriating, out of future income or surplus which may accrue subsequent to the issue of such stock an annual sum having precedence over dividend payment, to be so ap- plied on capital account as to make the deficiency good in a period of no very great length. If proper provision is made for thus can- celling or amortizing this deficiency, such stock may properly be made, by general law, non-assessable. The reluctance of directors to impair their ability to pay dividends for a term of years will prevent the abuse of this power. We believe the issue of stock at a discount, under safeguards like these, to be far preferable, in the interest of the public, to the sale of bonds at a high rate of interest, or what amounts to the same thing, at a large discount. 20. SHABES WITHOUT PAB VALUE. We do not believe that the retention of the hundred dollar mark, or any other dollar mark, upon the face of the share of stock, is of essential importance. We are ready to recommend that the law should encourage the creation of companies whose shares have no par value, and permit existing companies to change their stock into shares without par value whenever their convenience requires it. After such conversion any new shares could be sold at such price as was deemed desirable by the board of directors, with the require- ment of publicity as to the proceeds of the sale of such shares and as to the disposition thereof; giving to the old shareholders, except in some cases of reorganization or consolidation, prior rights to subscribe pro rata, if they so desired, in proportion to the amount of their holdings. As between the two alternatives of permitting the issue of stock below par, or authorizing the creation of shares without par value, the latter seems to this Commission the preferable one. It is true that it will be less easy to introduce than the other, because it is less in accord with existing business habits and usages: but it has the cardinal merit of accuracy. It makes no claims that the share thus issued is anything more than a participation certificate. The objections to the creation of shares without par value are two in number: First, that their issue will permit inflation, by making it easy to create an excessive number of shares : and second, that it will produce a division of roads into two classes, those whose shares ha^e a par value and those whose shares have not. The second of these objections does not appear to be a very serious one. There are listed on the stock exchanges today, side by side with one another, shares of the par value of one hundred dollars, shares of the par value of fifty dollars, shares with very much smaller par value, and a few, like the Great Northern Ore Certificates, with no par value at all. The share sells in each case simply for what the public 26 REPORT OF RAILROAD SECURITIES COMMISSION. supposes it to be worth as a share. The danger of inflation deserres more serious consideration. We believe, however, that it is more apparent than real, because shareholders will be jealous of per- mitting other shareholders to acquire shares in the association except at full market value, and will not permit the issue of such shares to themselves at prices so low as seriously to impair the market or other value of their holdings. Shares either with or without par value, and whether sold at par or above par or below it, should, except in cases of consolidation and reorganization, be offered in the first instance to existing shareholders pro rata. The issue of stock without par value offers special facilities for consolidation and reorganization. Where two roads have consolidated whose shares have different market values, it has been the custom to equalize the difference by the issue of extra shares of the consolidated company to the owners of the higher priced stock. This practice has* always tended to pro- duce increase of capital issues, and may readily cause the new stock to be issued for a consideration less than its par value. The only alternative was to scale down some of the old stocks; and this often involved serious difficulties, both of business policy and of law. By the simple expedient of omitting the dollar mark from the new shares, the number can be adjusted to the demands of financial convenience, without danger of misrepresentation or suspicion of unfairness to anyone. In the case of reorganizations, the advantage of shares without par value is even more obvious. It is here that the necessity and justice of getting money from stockholders is greatest. It is here that the impossibility of getting them to pay par for new shares is most conspicuous. We believe that in such cases the public interest would be subserved and the speedy rehabilitation of the roads pro- moted, by requiring the conversion of the common stock and encour- aging the conversion of the preferred stock into shares without par value: the certificates simply indicating the proportionate or prefer- ential claims of the holders upon assets and upon such profits as might from time to time be earned. All of these considerations seem to apply with equal force to the securities of railroads under state incorporations, and we believe the laws of the several states could with advantage be modified so as to provide for the issuance of stock without par value. 21. NEW ISSUES OF BONDS. It seems to be generally agreed that no limitation should be placed on the price at which bonds can be sold, but any discount should be cancelled or amortized during the life of the bonds by the appro- priation each year, out of annual income or surplus accumulated REPORT OF RAILROAD SECURITIES COMMTSSTOX. 27 after the issue of the bonds, of not less than the proportionate amount of the discount. In the case of convertible bonds, the same provi- sion should hold good, with the additional restriction that after ccm- version the laws governing the amortization of discount on stock sold below par should apply also to the unamortized discount'on con- vertible bonds. While the convertible bonds themselves may be sold below par, the conversion price of the stock should equal its face value; except of course in case of shares without par value, where no limit as to conversion price is necessary, nor any amortization after conversion. The premium on bonds redeemed before maturity or the unamortized discount on bonds thus redeemed should be charged to profit and loss, and provision made for the gradual can- cellation of this charge out of income. Issues of convertible bonds should be offered to stockholders pro rata, in the same manner as stock itself, to the extent to which they may choose to avail themselves of the privilege of subscription. 22. DIVIDENDS AND RESERVE FUNDS. No attempt should be made by statute to limit railroad profits to a fixed percentage, or to treat a high cash dividend as necessarily indicating extortion. Railroad charges must be reasonable; but to try to control rates by arbitrarily limiting profits is to put the manager who makes his profit by efficiency and economy on the same level as the one who tries to accomplish the same result through extortionate charges. Scrip, bond and stock dividends should be prohibited. They are commonly justified on the theory that the company has in times past put earnings into the property which it might have divided among the stockholders, and that the scrip dividend merely re- imburses the stockholders for what they have put into the road. But these sums were put in, either to make depreciation and ob- solescence good, or as actual additions to the property. In the former case the capital account ought not to be increased. In the latter case any such increase gives color to the claim that the ship- pers have been taxed to pay for the improvement of the property, and that the stockholders have appropriated the result. Many of the stock dividends in past years have represented an increase in the value of the property, not paid for either by in- vestors or by shippers, but due simply to the foresight of the management in locating and organizing. its business wisely. Under these circumstances a stock dividend to represent this increased value may possibly have been justified, but it is far better to let the increased value be shown by a higher rate of dividend on the exist- ing shares of stock, instead of by an addition to their nominal amount. » II I)" JK I w I r: 28 KEPOBT OF RAILfiOAD SECURITIES COMMISSION. If we prohibit scrip dividends, we can permit the creation of proper reserve funds without having them regarded with suspicion as being a pretext for future issues of unpaid stock. Sound finance demands that the companies should set aside such funds, out of income, to "defray the cost of progress." They can thus provide against obsolescence, or make improvements which add nothing to the earning capacity of the property and ought not therefore to be made the basis of increased capital liability. Failure to encourage the creation of reserve funds out of surplus earnings would cause a constant increase of fixed charges, already heavy enough. Whatever gain there might be in a present lower- ing of rates would be merely temporary. Investors and shippers would alike be misled; the former into a fancied security as to the permanence of dividends, the latter into the belief that such reduc- tion in rates was permanent. Ultimately such a course would lead either to higher rates or to steadily diminishing dividends and consequent impaired credit. Railroad credit is an important asset lo the entire country, and it should not be wasted. In encouraging, therefore, the creation of reserve funds, we are only suggesting that the present generation shall not be unmindful of its obligations to future users of transportation. Cash dividends are not likely to be as large as scrip dividends, because the former involve the distribution of a corresponding amount of cash, while the latter do not. Under these circumstances the pro- hibition of scrip dividends should of itself encourage the creation of proper reserve funds. In this as in other respects, all these three proposals — freedom from arbitrary restriction of profits, prohibition of scrip dividends, and creation of proper reserve funds — hang floselv together. Any one by itself mav be of doubtful value. Taken together, they should produce a result advantageous to all. 23. TREATMENT OF INTERCORPORATE HOLDINGS. Whatever may be the evils due to such holdings, an unqualified prohibition of the ownership of stock of one road by another involves too much disturbance of existing relations to warrant us in advo- cating it. Much will be accomplished if we do away with the unnecessary extension of these holdings and provide for equitable dealings between the representatives of the purchasing company on the one hand and the holdei-s of minority interests on the other. If a railrood company is allowed to build the necessary lines int<» other states for the handling of interstate business, instead of being compelled to create some separate company to do this, one fruitful reason for intercorporate holdings will be done away with. If we have full requirements of publicity regarding the purchase of stock if other companies, and have the disclosure of S. il 36 BEPORT OF BAILKOAD SECUBITIES COMMISSION. State laws prohibiting the issue of stocks for less than par were literally enforced all that the recitals on the face of a fully paid share of stock as to its par or money value would signify is that at the time of the issuance of the share there had been paid into the corporation an amount of money (or other valuable consideration) equal to the par value of the share. They do not even purport to indicate that at any time after the original issue of the stock the cor- poration was possessed either of the money or the money's worth. The real value of the stock certificate depends upon the manner in which the money has been invested. The Commission is, therefore, of the opinion that it is far more important to ascertain just what are the facts connected with the issue of securities and what is actu- ally done with whatever money has in fact been realized from the stock which is issued, than merely to make sure that the par value of the stock was paid in at the time of issue. 5th. If we were compelled to assume that rates are to be mate- rially influenced either in their making by the railroads or in their regulation by the Government by the amount and face value of the stocks and bonds outstanding, it seems to your Commission impos- sible to escape the conchision that these securities, should be issued only under Governmental regulation. Your Commission, however, believes that the amount and face value of outstanding securities has only an indirect effect upon the actual making of rates and that it should have little if any weight in their regulation. In so far as the value of the property is an element in rate regu- lation the outstanding securities are of so little evidentiary weight that it would probably be of distinct advantage if courts and com- missions would disregard them entirely, except as a part of the financial historv of the property, and would insist upon direct^ evi- dence of the actual money invested and of the present value of the properties. For this and other reasons discussed in the body of the report, your Commission recommends that the Interstate Commerce Commission should have authority and adequate funds to make a valuation of the physical property of railroads wherever the ques- tion of the present value of these roads is, in the judgment of that Commission, of sufficient importance. It is hardly necessary to add that your Commission does not believe that the cost of reproduction of the physical properties, however carefully computed, is the sole element to be considered in determining the present value of a rail- road, or that the outstanding securities could or should be made to conform to any such arbitrary standard. If railroad securities were to be issued only after express authori- zation of each particular issue by the Interstate Commerce Commis- sion or other governmental agency, it is difficult to see how the Gov- crnment can thereafter escape the moral, if not the legal, obligation REPORT OF RAILROAD SECURITIES COMMISSION. 37 to recognize these securities in the regulation of railroad rates. In view of the vast extent of the railroad systems of this country and the magnitude of the financial interests involved, both on the part of the railroads and of those who pay the rates, your Commission believes that the possible consequences of such a system of regula- tion are too serious to warrant its adoption at the present time. 6th. Upon the whole, your Commission believes that accurate knowledge of the facts concerning the issue of securities and the expenditure of their proceeds is the matter of most importance. It is the one thing on which the federal government can effectively insist today ; it is the fundamental thing which must serve as a basis for whatever additional regulation may be desirable in the future. Respectfully submitted. Arthur T. Hadley, Chairman. Frederick N. Judson. Frederick Strauss. Walter L. Fisher. B. H. Meyer. I »'t Kg^SVJBIHILIJT r: jy» INDEX. t 11; 1 Section. I'apre. 1. Railroad Securities and Interstate Commerce 7 2. Present Requirements and Future Policy % 8 3. Theory of Railroad Stock Issues 9 4. State Legislation Regarding Stock Issues 10 5. Evasion of State I^ws 10 6. Danger of Evasion of Federal Law H 7. Enforced Uniformity not yet Attainable 12 8. Enforced Publicity Immediately Needed 13 9. Mode of Procedure 13 10. Facts to be Disclosed 15 11. Physical Valuation 15 12. Results to be Expected 16 13. Conflicts of Jurisdiction 18 14. Development by Intercorporate Holding 1^ 15. Control by Intercorporate Holding 20 16. Financial Dangers 21 17. Alternative Methods 22 18. Treatment of Existing Issues ^ 23 19. Price of New Issues of Stock 24 20. Shares without Par Value 25 21. New Issues of Bonds 26 22. Dividends and Reserve Funds 27 23. Treatment of Intercorporate Holdings 28 24. Reasonable and Unreasonable Expectations 29 25. Promoters' Profits and Services 30 26. Standardization of Railroad Securities 31 27. Restoration of Public Confidence 32 28. Amount of Additional Capital Required 32 29. Present Return and Future Security 33 30. What Constitutes a Reasonable Return 34 31. Points to be Emphasized 34 39 _i; if ;^1 !^ SUGGESTIONS RELATING TO PUBLICITY, INDICATING POINTS UPON WHICH AMENDMENTS TO THE ACT TO REGULATE COM- MERCE MIGHT BE BASED. [This Commission has not considered it proper to present a formal draft of a statute.] Every railroad corporation subject to the provisions of the Act shall file with the Interstate Commerce Commission on or prior to the date of issuance of anj^ stocks, bonds, notes or other evidences of indebtedness payable at periods of more than twelve months after the date thereof, and now or hereafter to be authorized, a certificate of notification in such form as the Commission may from time to time determine and prescribe which shall show : First: (a) The total amount thereof authorized. (h) The number and amount thereof outstanding prior to the date of such certificate; the amount thereof theretofore retired; the amount thereof then undis- posed of, and whether such amount is held in the treasury of the corporation as a free asset, or pledged, and if pledged, the terms and conditions of such pledge. » (c) The number and amount thereof then to be issued and whether to be sold, pledged or held in the treasury of the corporation as a free asset; if such securities are to be sold, the terms of sale if a contract for such sale has been made, and if any part of the consider- ation to be received therefor is other than money, an accurate and detailed description thereof; if such securities are to be pledged, the terms and condi- tions of such pledge. (d) The number and amount thereof remaining unissued. (e) If the issue is of shares of stock, the certificate shall also show the par value thereof, or if the issue is of shares of stock that have no specified nominal or par value, the number of such shares, and the number of then outstanding shares previously issued. Second: The preferences or privileges granted to the holders of any such shares of stock; the dates of maturity, rates of interest of any such bonds, notes or other evidences of indebtedness, and any conversion rights granted to the holders thereof, and the price, if any, at which such shares or bonds may be redeemed. Whenever any securities set forth and described in any certificate of notification as pledged or held as a free asset in the treasury of the corporation shall subsequent to the filing of such certificate be sold or repledged or otherwise disposed of by the corporation, such 41 ,1 I I?- I 1 42 REPORT OF RAILROAD SECURITIES COMMISSION. corporation shall file a further certificate of notification to that effect, setting forth therein all such facts as are required by sub- division (c) of the foregoing first paragraph. The provisions in regard to certificates of notification shall apply to notes or evidences of indebtedness running for periods of twelve months or less, and to the pledging or repledging of stoclcs, bonds or other evidences of indebtedness to secure such notes or evidences of indebtedness running for periods of twelve months or less, except that such certificates may be filed within ten days after the issue thereof instead of on or prior to the date of such issue. Every such railroad corporation shall furnish to the Commission, at such time or times as the Commission may require, in addition to its income account, a balanced statement of its receipts and expendi- tures on capital account, and of the surplus of the income account accruing during the period covered by such statement, as well as of all other financial transactions that have taken place during such period, with whom had, whether in cash, in securities, or in other valuable consideration. The Commission may also require the carrier to furnish any fur- ther statements of fact or evidence that it may deem necessary or appropriate. The certificates of notification, and any other written statement furnished to the Commission under the Act, shall be signed and veri- fied by the auditor, comptroller, or other acting fiscal head of the carrier. It shall be the duty of the Commission to enforce these provisions, and to make public by appropriate means the information received, as, in its discretion, it may deem proper; and such certificates of notification shall at all times be deemed public records and open to inspection. The Commission may also require the carrier to compile for the information of its shareholders such facts in regard to the financial transactions of the carrier for its fiscal year in such form as the Commission may direct. The carrier may be required by order of the Commission to disclose every interest of the directors of such carrier in any transaction under investigation. The Commission shall have the power to investigate all such transactions and to in- quire into the good faith thereof, to examine the books and papers of carriers, construction or other companies or of firms or individuals with which the carrier shall have had financial transactions, for the purpose of enabling it to verify any statements furnished, and to examine into the actual cost and value of property acquired by, or services rendered to, such carrier. Appropriate penalties, including fine and imprisonment, should be provided for violation of these provisions. o asai » 9 ~t -tJR \ I T I COLUMBIA UNIVERSITY LIBRARIES 0041407873 hSH 0/20G f I APR 071994 tr^B 6^ NOV 29 id27 j-r :•* a 'm .'Ml I .iJV ;;|f§«i m ■■?t iV«i :!■ I«v'?» ■ END OF TITLE