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MEMORANDUM ON CERTAIN PRACTICAL AND LEGAL ASPECTS OP

THE DISSOLUTION PROVISIONS OF THE PUBLIC UTILITY FOLDING CO. BILL OF 1935

I. INTRODUCTION The proponents of the public-utility bill have prepared and widely disseminated various arguments in support of this bill, the purposes of which arguments are three-fold: First, to charge the utility and banking interests and the press with circulating unfair publicity playing upon the fears and calculating to mislead the public in regard to the effect of this bill on investors; second, to summarize the abuses alleged to have existed in certain situations in various forms (consisting mainly of three types, (a) the issuance of unsound securities by holding companies, (6) burdensome contracts and practices imposed by holding companies upon affiliated interests, and (c) unwarranted concentration of control) and to undertake to lay the foundation for the bill on the proposition that the bill helps and does not hurt the operating companies; and, third, to present legal theories to support the contention that the bill in its present form may be adopted and made effective without injury to investors.

Insofar &s the charge of unfair publicity is concerned, we believe that this committee will appreciate the anxiety with which the companies affected and the investing public have viewed this proposed legislation. It is clearly based upon a policy of destruction of utility holding companies and Federal regulation of utility operating companies extending far beyond any measures which have heretofore been adopted in comparable situations, such as railroads, telephones, and other types of public-service regulation. We submit that it is the right and duty of the industry to inform its investors as to the contents of the measure as proposed. We have had no basis on which to inform the public except to take the bill as submitted and point out the meaning of the language used and its probable consequences on the industry.

Insofar as the arguments deal with the substance of the abuses alleged to exist, nothing new is presented by the proponents. These are the same charges, by and large, which have been made during the last several years in connection with the Federal Trade Commission investigation. That there have been abuses in certain situations, there appears to be no doubt. The evidence presented to this committee shows that, in some of the companies, probably none of the alleged abuses has existed to any considerable degree; in most of the companies, only a few of the abuses have existed; and rarely has it been shown that all or the greater part of the alleged abuses have existed in any company. To the extent that any real abuses do still exist, the industry itself desires that they be eliminated. The industry is entirely content to leave to the sound judgment of this committee and of the Congress the adoption of appropriate measures designed to prevent a recurrence of the alleged abuses based upon the evidence submitted rather than upon the theories of the proponents. It is sufficient to say that it has been clearly shown that, with adequate enforcement of the laws now in effect, State and Federal, and with such supplementary legislation as the Congress may deem necessary or desirable and with regulation as the objective rather than destruction, all of these abuses can be prevented in the future.

The declared policy of the bill is to eliminate these alleged abuses, (1) by abolition of the public-utility holding company and (2) by strict Federal regulation of the operating companies. If legislation of a different character can be provided which will fully and effectively regulate the industry and prevent a recurrence of the alleged abuses but with a minimum of loss to consumers and investors, there can be no valid reason for adopting the abolition policy set out in section 11. Moreover, when the proponents of this bill, now for the first time, make the bold assertion, and propound legal theories in support of it, that the abolition provisions of this bill may be adopted and made effective without injury to investors either in operating companies or in the holding companies, then it is time that we stop and consider whether these suggestions are sound and whether they are in fact supported by experience in other fields of regulation.

At the threshold of any consideration of the dissolution provisions of this bill, grave constitutional questions are presented as to whether the Congress has power to require disintegration of holding companies, but for the purpose of this memorandum it is assumed that Congress has such power.

The purpose of this memorandum is to examine the suggestions of the proponents in the light of the provisions of the bill. As a basis for such consideration it may be well to restate in summary terms the dissolution provisions of the bill.

II. THE DISSOLUTION PROVISIONS OF THE BILL The program for disintegration of holding companies laid down by the bill proceeds in three distinct steps. As the first step, it is made unlawful by section 8 (a) of title I for any holding company to have any interest, on and after January 1, 1937, directly or indirectly, in any business other than the gas and electric business, with certain minor exceptions. By paragraph (b) of the same section it becomes unlawful, on and after January 1, 1937, for any holding company which is interested directly or indirectly in electric-utility companies to have any interest, direct or indirect, in any natural-gas company. Paragraph (c) of the same section makes it unlawful, on and after January 1, 1937, for any holding company interested in properties within the United States to be interested in companies organized or doing business outside of the United States, and certain further restrictions are imposed by paragraph (d) of the same section.

The second step begins on January 1, 1938, at and after which time the Securities and Exchange Commission is directed (by section 11 (b) (2)) to require every holding company to dispose of any securities or capital assets whenever it appears to the Commission that the continued ownership or control thereof by such company is not necessary or appropriate to the operations of a geographically and economically integrated public-utility system. By subparagraph (3) of the same paragraph the Commission is directed, from and after January 1, 1938, to require any holding company or subsidiary thereof to be reorganized or dissolved whenever it appears to the Commission that the corporate structure or continued existence of any such company unduly or unnecessarily complicates the structure of the public-utility system of which it is a part or is detrimental to the subsidiary companies thereof or to investors or consumers, with a proviso that the Com ission may defer such action to a time not later than January 1, 1940, if it considers that earlier action “would cause unnecessary injury to investors or consumers". There is no such proviso applicable after January 1, 1940. It is evident that the framers of the bill expect that there will be injury to investors.

The third and final step in the program laid down by the bill is that, immediately after January 1, 1940, the Commission is directed by section 11 (b) (4) to require every holding company to dispose of its securities or to be reorganized or dissolved insofar as may be necessary to make every such company cease to be a holding company. This mandate is subject to only two exceptions of limited availability and in each case within the discretion of the Commission (a) if a certificate is obtained from the Federal Power Commission that "the continuance of the holding company relation is necessary for the operation of a geographically and economically integrated public-utility system serving an economic district extending into two or more contiguous States or into a contiguous foreign country” and the merger of such holding company with its subsidiaries is impossible under the local law, and (6) if neither such holding company nor any of its subsidiaries is organized or doing business within the United States. One further exception may be available under section 4 (c), which authorizes the Commission in its discretion under certain circumstances to exempt from registration a holding company engaged in exclusively intrastate business in the State where it and all of its subsidiaries are organized.

No clear definition has been offered of what is a geographically and economically integrated public-utility system. No economic justification for such a restriction has been suggested, and it ignores the recognized advantage of investment diversification. Whatever such a system may be, moreover, the exemption will not apply unless for the accidental fact that a merger happens to be prohibited by State law. It seems evident, therefore, that this exemption will be of limited availability, and the proponents of the bill do not present a fair picture when they speak of “a little rearrangement” as being sufficient to satisfy the bill. It is obvious that the other two exceptions have very restricted application. The purpose of the bill is unquestionably to force a general abolition of holding companies under the compulsion of the Commission.

In order to assist it in carrying out this mandate the Commission is authorized by section 11 (c) to apply to a court to enforce compliance with any order made by it. The court is directed, upon any such application, to take possession and exclusive jurisdiction of such assets of the company wherever located as may be held in contravention of such order, or, in the case of any order for reorganization or dissolution, of all assets wherever located, without limitation, and is also directed to appoint the Commission as sole trustee to administer such assets. The Commission is authorized with the approval of the court to dispose of any of such assets and to do so only in accordance with a reorganization plan which shall have been approved by the Commission. Such a plan may be prepared in the first instance by the Commission or by any person having a bona fide interest in the reorganization subject to such rules and regulations as the Commission may prescribe. The Commission is also given extensive powers over bankruptcy proceedings under section 77B of the Bankruptcy Act.

Within a year and a half, therefore, all holding companies must, under the proposals of the bill, dispose of any interest in any business other than gas and electric utilities, any interest in any natural gas company, and any interest in any public-utility company which is organized or doing business outside of the United States. Beginning 1 year later the Commission is authorized to require any holding company to dispose of any securities or capital assets whatever, or to be reorganized or dissolved. Two years thereafter the Commission is put under a mandatory duty to effectuate the complete abolition of all holding companies, subject to the above-mentioned inconspicuous discretionary exceptions which do not restrict the general application of the dissolution requirement.

The bill decrees, therefore, that in this brief period, there shall be a progressive disintegration of holding-company systems and requires a practically complete abolition beginning at the end of a 5-year period.

The hearings have shown that the effectuation of this policy will necessarily impose great injury to investors, anticipation of which is evidenced by the proviso in section 11 (b) (3) of the bill. It seems certain that a great sacrifice of values will result, in many instances sufficient to destroy the entire investment in the junior securities, particularly the common stocks, and that the entire industry will be plunged into confusion and litigation with great delay and expense before any final reorganization of the industry can be achieved.

It is unfortunate that these consequences have not been candidly recognized by the proponents of the bill, in order that the issue might be clearly presented for a weighing of the interests involved. Deliberate efforts have been made, however, to produce an impression that these drastic readjustments can be effectuated without any such general disturbance and destruction of values as should be a cause for concern by the Congress or by the investing public. In a matter of such importance it is worthwhile to consider the various suggestions which have been proposed as a means for accomplishing this result, in order to see what weight should fairly be attached to them.

III. SUGGESTED MEANS OF VOLUNTARY DISSOLUTION It is suggested first that the lawyers who created these companies can surely find a way to take them apart, so that the Congress need not concern itself about the way in which this can be done. The committee will recognize, however, that it is much easier to create a debt than it is to terminate one. Anyone can incur a debt, even without the advice of counsel, but the most capable counsel cannot, and should not try to, find a way to escape that debt while his client is still solvent. The debt must be paid or the consequences suffered unless the debtor is a bankrupt.

This is but an illustration of the fact that lawyers can contribute nothing to the solution of a business problem except the legal forms and mechanisms for accomplishing an object which is in itself practicable and lawful. The object to be accomplished here is to find purchasers for millions of dollars of utility securities. No lawyer can do that. He can only write the contracts if purchasers are found.

1. DISTRIBUTION IN KIND Then the suggestion has been advanced that “in some cases it may be possible” before the expiration of the 5-year period to divide the securities owned by a holding company among the holders of its own securities. It is not believed that any serious importance has been attached to this suggestion, in view of the recognized fact that many, if not most, of the important holding companies have issues of debt and preferred stock outstanding which would make impossible any distribution of the underlying securities in the simple way contemplated by the suggestion.

No very complicated capital structure is necessary in order to make such ready distribution impossible. Assume a holding company having only two classes of securities outstanding, an issue of preferred stock and an issue of common stock. The underlying securities, priced under the conditions of today, are far below their real value and often do not equal the par value of the outstanding preferred stock, which in the ordinary case is entitled to preferred payment in cash on dissolution. Will the common-stock holders give their approval to a plan of dissolution which contemplates distribution of all the assets of the company to

the preferred stock only? If such approval cannot be secued, and the company in question is solvent, how is distribution to be voluntarily achieved?

Even without a complicated capital structure of the holding company, the variety of stocks in its portfolio to be divided among its own numerous stockholders would make the problem of distribution in the ordinary case so complicated as to be impracticable on account of the small fractions into which the underlying stocks would have to be divided.

Since, generally speaking, the common stocks of the operating companies have been owned 100 percent by the holding companies and accordingly have no ascertainable market price, it will be difficult for the average investor to form a wise judgment with respect to the value of his holdings. This situation, in previous experience, has played into the hands of speculative elements, to the great injury of the small investor, and it is certain that similar consequences would follow here any attempt to carry out a dissolution in this manner.

2. EXCHANGES

The next suggestion has been that during this 5-year period some holding companies may exchange certain of their operating properties for properties of other companies, making possible the reorganization of some holding companies into integrated operating units or their continuance as holding companies under the limited exceptions above mentioned. Aside from the limited situations in which the bill proposes to permit a discretionary continued existence of holding companies, this suggestion really means no more than that the holding companies must dispose of their properties in one way or another, if not for cash, then for other properties. The suggestion that other properties may be received in lieu of cash does not materially assist in a solution of the problem. In whatever medium these purchasers are to pay, it will still be necessary to find purchasers for the properties, and the problem of finding a method, if any is available, for accomplishing such a disposition is not simplified by the nature of the consideration which the company is to receive.

The substitution of physical properties for dollars as a medium for the dissolution and reorganizations of these systems cannot simplify the problem unless it be assumed that the measurement of value is easier in terms of property than in terms of dollars. Anyone who has had experience in utility valuations knows that this assumption cannot be true.

Furthermore it must not be forgotten that before any such exchanges of operating properties can be made, two holding companies must be found, each of which happens to own properties which can be usefully employed by the other company in the light of the location of their systems and the requirement of the bill that such systems be restricted to geographically and economically integrated units. Past experience shows that exchanges of operating properties are not to be expected. Such exchanges will be even more difficult if the proposed bill is enacted with the various restrictions which it imposes, particularly the mandate requiring geographically and economically integrated units, which is as yet undefined.

Many other difficulties in the way of accomplishment of any such exchange could be pointed out. For one thing, it is highly improbable that two properties could be found with approximately equivalent value; in nearly every case there would be a substantial balance of cash to be paid by one or the other party; and provision for raising substantial sums of cash would have to be made. For another, it will more often be found that the only way of arranging any practicable exchange would be through a succession of parties rather than between any two parties that could be found, and the corporate problems presented by such elaborate disposition would become overwhelmingly complicated. Then, too, the very size of the properties involved raises a formidable obstacle to the effectuation of any such exchange. If the properties were small grocery stores scattered through various parts of the country, it might be possible to find a basis for their exchange, although the problem of determining fair exchange value would be difficult even there. In the case of important public utility operating properties, however, the investment is so great and the property so complicated that this difficulty is immeasurably increased. An insuperable obstacle will very frequently exist in the provisions of mortgages which rest upon the operating properties. The difficulty of arriving at barter values of the common stocks involved, without using a dollar medium, would in many instances involve valuation problems as complicated and impracticable as in the case of physical properties themselves, particularly where these common stocks are held by banking institutions as collateral for loans made under more favorable conditions.

3. SALES OF SECURITIES

It has been further suggested that during this 5-year period some companies may be able to sell through investment bankers the securities of operating companies which may be held by them, in such manner as to enable them to retire their funded debt and then distribute the residue of their assets among the stockholders. This is, of course, exactly the method of dissolution which it is feared will produce the most disastrous consequences upon all persons having an interest in the industry. Any liquidation means sacrifice; liquidation under threat means greater sacrifice; liquidation under court order means still greater sacrifice. This is a simple fact of common knowledge. The forced disposition of enormous volumes of stocks involving an entire industry, in the depressed conditions prevailing generally, and certain to be prolonged in an industry subject to disorgan. ization and dismemberment after 5 years, cannot be expected to yield prices any. where near their fair and reasonable value. It is certain that very little if any assets would remain for distribution among those who have invested their money in these companies' junior securities.

The same considerations apply to the suggestion that holding companies might in this same way reduce the amount of their holdings in subidiary companies to a point where they no longer exercise, or are capable of exercising, control over such companies, and thereby cease to be holding companies within the meaning of the bill

. The enormous liquidation involved in such a process would be practically as complete and disastrous as the one just discussed.

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4. TRUSTEESHIP The suggestion has also been made that a holding company might divest itself of control of its operating companies by the simple process of conveying its stock in such companies to trustees for the benefit of its security holders as their interests might appear, divesting itself in this way of all voting power over the operating companies and vesting such power in the mass of its individual security holders, such voting power to be evidenced by certificates of beneficial interests, or otherwise. Liquidation and sale by these trustees, it is supposed, could then proceed more gradually and with more opportunity to protect the interests of those beneficially entitled to the property.

This suggestion is apparently made with greater confidence than any of those previously mentioned, and it is the most deceptive. At first sight it might be supposed that such an arrangement would leave the property interests of the holding company and its security holders substantially intact, eliminating only the holding company's power to vote these securities, and leaving the ultimate satisfaction of the rights of the various classes of security holders for gradual realization. Not much reflection is necessary, however, in order to see that this proposal, plausible though it may seem at first sight, will produce exactly the same destructive consequences that immediate liquidation is apparently admitted to involve.

With the elimination of the control through voting power exercised by the holding company, the system has been destroyed. This act of severance in itself involves an immense destruction of value. The unity of the system is the basis on which the securities were purchased. This unity must be a unity of operation for the common end of the advantage of all the operating properties as a group. Where the operating properties are set adrift as semiautonomous bodies without concerted direction as constituents of a system, the securities which rest upon the maintenance of that system cannot retain their value.

Certificates of beneficial interest in various operating subsidiaries, which this suggestion assumes will be issued in lieu of the original securities of the holding company, are not securities in a living organism, but evidences of proprietary interest in an aggregate of paralyzed parts. These certificates can be nothing more than legal machinery adopted as a transitional device pending the ultimate effectuation of disintegration. They would permit an extension of the time for this reorganization but would not delay its destructive consequences for the value of the securities. Sooner or later, in any event, these securities will hare to be sold by the trustees, and thus, through a more roundabout method, we come back to exactly the same fundamental problem with which we started.

In other words, the trust has been created as a mere legal form incident to the ultimate sale and liquidation. The interposition of these legal forms does not solve any difficulties, but merely postpones the time when those difficulties will have to be faced, The fundamental question still remains, how and when and to whom can these securities be sold?

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