(9) Excessive use of conversion privileges for bonds and preferred stocks and of purchase warrants and options with the effect of inducing investors to part with conservative investments for speculative ones.

(10) Misstatement of earned surplus, or failure to distinguish earned from capital surplus, and making payment of dividends from the latter.

(11) Deceptive or illusory methods of dividing, or pretending to divide earnings or profits.

(12) Including imaginary (or "putative") interest in construction costs of a public utility and counting it as a part of earnings.

(13) Deceptive or unsound methods of accounting for assets and liabilities, costs, operating results and earnings, including write-ups unrealized or fictitious profits, stock dividends, etc.

(14) Corporate organization which gives powers inconsistent with a just division of responsibilities and emoluments as between various groups or parties furnishing capital by loan or by contribution, either directly or indirectly by purchase, succession, or otherwise.

(15) Issuing special voting or management stock giving control at small cost in order to promote the interests of selfish cliques, against the interest and safety of the general stockholders.

(16) Unsafe or mischievous methods of securing loans to the detriment of the lender.

(17) Intercompany financing on a basis disadvantageous to operating companying borrowers or lenders.

(18) Evasion of State laws in effecting sales of security issues.

(19) Effecting pretended corporate reorganizations principally for the purpose of evading the payment of Federal income taxes.1

In the last analysis the foregoing practices and the conditions which they have created must be judged not only by economic results but by ethical standards. It is not easy to choose words which will adequately characterize various ethical aspects of the situation without an appearance of undue severity. Nevertheless the use of words such as fraud, deceit, misrepresentation, dishonesty, breach of trust, and oppression are the only suitable terms to apply if one seeks to form an ethical judgment on many practices which have taken sums beyond calculation from the rate paying and investing public.'

The evils recited have flourished in spite of such regulation as has existed. As shown in an exhaustive study made by this Commission, printed in part 69A and discussed at length in chapter XII of this summary report, such evils have to a substantial degree resulted from and even been promoted by legislation and policies in some of these States. It is there shown that no substantial progress is being made, or can be made, by the States generally, toward effective regulation of holding companies. In a few States efforts are being made but generally the situation remains as it was 25 years ago, in spite of the rapid expansion of the holding-company systems and an even more rapid growth of resultant abuses. This refers particularly to the holding-company situation, because there the power of the States is, at best, handicapped by nonresidence and other causes. These compel the States, when any regulatory attempt is made, to resort to indirect methods of control, rather than to direct specific remedies. The States in general are quite helpless when certain of the States grant roving charters with practically unlimited power in what Justice Brandeis has characterized as a race "not of diligence but of laxity." General concerted or uniform legislation by the States is highly improbable. Appropriate Federal legislation would serve the twofold purpose of being regulatory in itself and of rendering futile provisions of the character mentioned and embodied in charters granted by some States.

The holding company in the utility field has been the chief device by which the control and ownership of operating companies has been rapidly concentrated into fewer and fewer hands with every prospect that the process will continue on to Nation-wide monopoly unless there be governmental regulation.* Due to a variety of causes, some perhaps proper and natural, this process of concentration has produced a vast superimposed structure of corporations which must, each in turn, derive its revenue from its underlying operating companies. These holding companies and their associated companies have generally issued securities of great variety and grade of preference, and frequently in excessive amounts. Their soundness must ultimately depend upon the

See: Erelyn F. Gregory, Petitioner, v. Guy 8. Helvering, Commissioner of Internal Revenue; decided Jan. 7. 1935, U. S. Supreme Court (55 S. Ct. Reporter 266; 293 U. S.). Compare article by President Rooseelt in Liberty, Sept. 10, 1932, p. 35. See appendix L-5.

288 U. S. 517.

See ch. IV, pt. 72-A.

revenues of the underlying operating companies. Inevitably this leads to pressure in many forms to derive the desired revenues from such operating companies and therefore has a substantial effect upon rates.

Many claims are made as to the advantages and functions of these holding companies. It is claimed that they afford advantages of supermanagement by staffs of highly skilled experts which independent operating companies cannot afford. It is also claimed that advantages result from group financing and from group purchasing. A large part of these claims have been seriously challenged. Some existing independent operating companies, both privately owned and municipal systems, particularly among the larger ones of each class, stand as contradictions to practically all such claims. Moreover, holding companies have acquired control of operating companies so large that the argument of the latter's inability to provide such services for themselves obviously has no application. The Commission is of the opinion on the whole that the detriment of utility-holding companies to the public has exceeded, thus far, their value to the public.

Summed up, the abuses of the holding company fall chiefly into two classes:

(1) Unsound and/or needless financial structures and practices which are a detriment and frequently a menace to the investor or the consumer or both. (2) The milking of operating companies through the device of numerous forms of contracts and arrangements. The Federal Trade Commission's investigation has disclosed that the tributes and profits thus exacted have in some instances ranged from 50 percent to over 300 percent on the cost of such services."

The holding company, as such, performs no producing function. For that reason, in the utility field it has not been treated as a utility company and, therefore, has not been subject to regulations as such. It is usually subject to no regulation or control whatever. Operating utilities are the companies to which the Commonwealths have granted the charters to perform a general public-utility service. These grants imply and definitely impose reciprocal duties, but as a result of holding-company control and management, many operating companies, under the compulsion of holding-company control, have contracted away the real performance of their principal charter functions to the holding company or to other companies designated by the holding company, thus leaving only a hollow corporate shell within the jurisdiction of the State where the operating company does business. The entire holding-company problem has grown up under the enactment of statutes which abrogated the common-law rule which forbade one corporation to acquire and own stock in another. Corporations, including holding companies, have traveled a long way from the time when a few persons incorporated for the benefit of their combined resources and combined ownership, with the combined advice and management of the owners. Holding-company corporations have stretched this still further until often there has been practically complete divorcement of ownership from management and responsibility. In fact, the very nomenclature now adopted illustrates this. The public is no longer invited to buy an interest in the control and management of the corporation. They are invited to "invest." Much of the induced investment is of nonvoting stock, and even when it is of voting stock, the wide dispersion thereof makes practically impossible any combined action against any managerial group that has once acquired control. Thus instead of the corporation, on the one side, and the public, on whom it will depend for trade and revenue, on the other. as was the case originally, we have a third party of minority ownership but with management and control which may be likened to absentee landlordism. Obviously, whenever this managerial group becomes swayed with lust for power and greed for excessive profits, the many other stockholders are treated as having few, if any, rights. In many instances, such managerial groups have failed to act as trustees for their corporations and other stockholders, as in equity they are supposed to do.

DISCUSSION OF REMEDIAL LEGISLATION

As previously stated, the Commission is directed to recommend

"what legislation, if any, should be enacted by Congress to correct any abuses that may exist in the organization or operation of such holding companies."

See appendix L-5.

The objective is restoration of soundness and common honesty in corporate and particularly in holding-company affairs and structures. It is to restrict the capitalization and rate base to a sound and correct basis not in excess of honest, prudent investment; to reunite ownership with control and responsibility; to compel the return of the controlling management to the position of being and functioning in all respects as trustees in fact for the corporation and guardians of its welfare; to reorganize on a sound and uniform basis the entire corporate structure; to simplify and regulate intercorporate relations; to require proper accounting with respect to the values of assets, whether in plant or in security investments, and also with respect to actual income and net profit; to eliminate the exploitation of one corporation by another which controls it; to abolish the manipulation of securities in the market or the speculation of officers and directors in the securities of their own companies.

The pertinency of some recommendations will depend on their relation to the fundamental policy which may be adopted. In response to the Senate resolution, this Commission conceives it to be its duty to make such suggestions as the Commission believes to be constitutional and workable and which may possibly aid the Congress in the determination of the character and form of such legislation as may be decided upon. If the public policy is to be one of toleration and regulation of holding companies, certain types of recommendation will be in order. If the public policy is to be one of suppression of holding companies, other recommendations are called for. There is also possible a form of regulation whose main purpose is a partial suppression through restriction. The weight of any given recommendation must be judged by its relation to the fundamental policy which it seeks to effectuate. Which of the above two fundamental policies shall be pursued is of course for the Congress to determine.

The choice between suppression and regulation of holding companies will turn logically upon a balancing of their relative advantage and detriment to the general public. If they provide advantages to the public which can be obtained in no other way, then it may be desirable to preserve the holding company in order to preserve those advantages to the public. If those advantages can be obtained in some other way, then the argument for retention of the holding company is correspondingly weakened and the decision will turn more largely upon the eradication of evils than upon the preservation of benefits.

This

If there be no practicable or constitutional way of redistributing the assets of holding companies so as to dissolve their monopolistic elements, or if that is not desired, it might be wiser from a public standpoint to force so far as possible the merger into the parent corporations of all operating subsidiaries. would simplify the capital structure and be an effective bar against such antisocial manipulation of corporate entities as has all too often taken place in the utility field. At the same time such a simplification of corporate organization and capital structure would preserve all the benefits which have been claimed for the holding company set-up, such as management and servicing. On the other hand, the evils of the holding company may be so inherent that they can be eradicated only by eradicating the system itself.

Assuming that a policy of suppression were adopted the suggestion is sometimes made that only the superholding company should be suppressed. This implies that the evils in permitting holding companies to directly own the stock of operating companies, provided such holding companies are not themselves subsidiary to another corporation, are not substantial enough to support a policy of suppression. The record of our investigation does not wholly support such a position. On the contrary, many important and injurious forms of manipulation are shown by the record to have been used by holding companies of that class, and the sums involved have been enormous. In the very important matters of write-ups, inflated security issues, and servicing contracts such a holding company is in just as good a position to manipulate the affairs of its subsidiaries as though it had a parent of its own. It may set its own profit just as completely as it would if such dealings were initiated through it instead of by it. Measured therefore by the evils of which it has actually been guilty as well as by the evils of which it is capable, the one-tier holding company presents most of the same problems as the pyramided holding-company system. If suppression be required as a solution it cannot stop short of suppressing all forms of the evil. A policy of suppression of the superholding company and only regulation of the remaining first-tier holding company must logically rest upon a showing that a substantially different kind and degree of evil exists in the one which does not exist in the other.

130254-35-10

If, however, only a single tier of holding companies were permitted, that would greatly simplify the situation. This is particularly true if the security issues and corporate relationships are also restricted and simplified as suggested elsewhere. If these things are done then at least we have a situation where there are only two parties and this lends itself powerfully to ascertainment of the real facts, the first essential to effective control and regulation. Restriction to one tier will also obviate the combined vertical pressure of innumerable pyramided tiers as well as lateral pressure of separate entities set up for servicing, or perhaps "milking." At any rate, there appears to be no plausible justification for the superholding company, i. e., the holding company above the first degree or one tier.

If the holding company is to be entirely eliminated the remedy is simple and consists, so far as the Federal Government is concerned, in prohibiting any corporation, any designated part of whose stock is held by one or more other corporations or representatives of such corporations, to engage in interstate commerce, to sell or transport their securities in such commerce, to enjoy the privilege of the mails, or to operate without a tax which may be made prohibitive. It would be necessary, however, in order to safeguard this proposal, to prohibit the acquisition of stock (in excess of a stipulated percentage) in interstate operating companies, and prohibit transfers in excess of that amount on the books of the operating company. Of course, such provisions should not become effective until some designated future date, so as to allow time for readjustments. If suppression of holding companies is to be the policy, it is also to be considered whether or not the antitrust laws are applicable. If applicable, they would be retroactive and thus avoid a serious constitutional question to which any new legislation would be subject if an attempt were made to give it retroactive effect.

It is not believed that any of the measures suggested herein would impinge on the legitimate State fields. The States would retain jurisdiction over the service and local rates of operating companies which are the chief matters of local concern. It is believed that the suggested measures will powerfully aid State regulation.

Considering the great number and variety of questionable practices or abuses disclosed and previously enumerated, there should remain no surprise that the enumeration of remedial proposals hereinafter set out seems formidable. Yet that enumeration is limited by the effort to treat the various abuses in a generic way rather than specifically in detail. Under any other treatment the list of remedies would be longer.

If the Congress does not regard the suppression of the holding-company system as a feasible and on the whole a preferable policy, the necessity of strict regulation becomes all the more apparent. If holding companies are to be permitted to continue to control and manage groups of operating or producing companies, there are three methods which seem especially to commend themselves for the exercise of Federal jurisdiction. They are: (1) The taxation method.

(2) Direct statutory inhibitions.

(3) A compulsory Federal licensing act.

There should also be mentioned

(4) A permissive Federal incorporation act.

The suggested methods are not conflicting. Any 1, 2, or 3, or all may be employed.

(1) THE TAXATION METHOD

The taxation method seems to have a number of advantages not possessed by any other. First of all, the question of limitation to interstate commerce is not involved. It can apply to all corporations of a class. The taxing power of Congress is broad. The greatest restriction placed upon this power appeared in the child-labor tax case. Since that case there have been indications of a return to the earlier doctrine of McCulloch v. Maryland,' that within the scope of the constitutional grant, the power is practically unlimited regardless of whether the tax objective is coupled with other objectives. A study of the Federal taxing power is attached hereto as appendix L-6.

This Commission recommends the following six tax proposals which are believed to be both comprehensive and effective:

259 U. S. 20. 74 Wheat. 316.

1. An annual tax graduated sharply upward on the net income of a holding company from the operations of its subsidiaries in States other than the State in which the holding company is incorporated.

This would tend to keep holding companies at home, and prevent those having roving charters of broad general powers from engaging in piratical and privateering enterprises in fields other than the State of incorporation. The only sovereignties that might perhaps object to legislation of this character would be those where so many corporations elsewhere incorporated have their "principal place of business", or in certain States where numerous companies incorporate because of tax and liberal requirements, and possibly a few others. But the reasons for their objections would be so obvious that they should not be persuasive.

2. An annual excise tax, sharply stepped upward as the amount increases, in proportion to the holdings by one utility holding, operating, or servicing corporation in another, or by any officer or director of one such corporation in another, or by any trustee or other person holding any such interest in any other utility holding, operating, or any form of supervising or servicing corporation in any representative or fiduciary capacity for a utility holding, operating, or servicing corporation.

3. An annual tax, graduated sharply upward, on the actual consideration received or par face amount, whichever is larger, of capital issues, including long-term indebtedness, in excess of the actual prudent cost of the fixed capital, plus working capital of each utility-operating corporation, and for each holding company such tax shall apply to the aggregate of all of its issues in excess of its owned share in the fixed capital of its several subsidiaries and affiliates.

4. A tax on each transaction between corporations, in which either corporation has an interest on more than one side of the transaction, or in which any officer or director has an interest on more than one side of a transaction, whether the transaction refers to the property or the affairs of such corporations. Such tax should be based on the actual or stated amount involved in each transaction, to be defined in the act, whichever amount is the larger. 5. An annual tax on the gross income, in excess of a determined amount, of all utility holding companies graduated upward sharply on the principle of the Federal income tax.

6. An annual tax graduated upward sharply upon that portion of the total authorized capitalization of any corporation which remains unissued.

As to each of the foregoing, where the tax is first paid by a holding company, provision should be made to prevent its amount being passed on to the operating or other companies.

In addition to the definite recommendations above made, consideration might be given to a graduated tax for the purpose of reaching certain other evils. One of these is the manipulation of the proportion of various obligations issued by holding companies. A form of such manipulation is the issue by the holding company of any sort of obligation other than current loans which carries a fixed charge or which simulates such an obligation. In either case such issues tend to delude the investor and in the first case the company is also likely to default in bad times. Hence it would appear reasonable to levy a heavily progressive tax on such issue of obligations insofar as they exceed in amount the obligations with a substantially equivalent margin of security in the investment account of the holding company. A similar rule might be applied to the issue of preferred stock, but as such stock does not purport to be a definite obligation carrying a fixed charge, but is merely a contingent promise of dividends, the weight of the tax and the severity of the progression should properly be less.

Another evil which might be reached by a graduated tax is the indiscriminate issue of nonvoting stock. One of the chief defects of many holding company systems is the effort to build up control of a vast congeries of enterprises or of investments therein on a very small investment of capital by the holding company. This is facilitated by the device of restricting the voting rights of various classes of stockholders to an excessive degree. Such a condition is full of danger both to the other stockholders and to the general economic order. Accordingly, it might well be remedied by progressive taxation.

To meet the possible objection that the tax in the higher brackets would have a subversive effect upon the industry, the law might postpone the taking effect of the higher rates until some specified time in the future within which the industry could adjust itself to the changed situation.