by transferring $13,000,000 from existing surplus and a further $10,000,000 from capital surplus created by the proposed reduction of the stated value of the company's common stock. The effect of these transactions was to reduce the "cushion" or capital stock equity beneath the company's debentures to slightly over $74,000,000. Under the indenture securing the debentures, any further reduction in such cushion might have necessitated cessation of dividends until the full $74,000,000 of stock equity was restored. Standard Gas and Electric Company depended on these dividends for the payment of interest on its notes and debentures.

In its findings, the Commission seriously questioned the adequacy of the $23,000,000 reserve for losses on the traction investments, but permitted the declaration to become effective. The Commission noted that the company was committed by its amended declaration to a provision whereby the sum of $500,000 a year out of earnings available for the payment of common stock dividends will be restricted in earned surplus until the amount so restricted amounts to $2,500,000 and no subsequent declaration of common dividends will be made which will impair this restricted surplus except with the consent of the Commission. The Commission indicated the necessity of providing for the contingency that the loss in the traction investments might exceed $23,000,000 and reserved jurisdiction over dividend payments under Section 12 (c) of the Act.

UNDERWRITERS' AND FINDERS' FEES

Under various provisions of the Act, the Commission is charged with the "maintenance of competitive conditions," and under Section 1 of the Act is directed to interpret the provisions of the Act so as to eliminate the enumerated evils including those “which result from an absence of arm's-length bargaining or from restraint of free and independent competition" in the transactions of public utility companies.

Under Section 7, the Commission is directed to withhold permission to issue or sell a security when it finds that the fees, commissions, or other remuneration are not reasonable or the terms and conditions are detrimental to the public interest or the interest of investors or

consumers.

To regulate the activities and transactions between issuers and bankers where there may be, an absence of free and untrammeled bargaining, the Commission has adopted Rule U-12F-2 (based on Section 12 (f) and other provisions of the Act) to control the payment. of fees to underwriters and "finders" who may be in a position, by reason of stock ownership or other relationship, to gain an unfair advantage in bargaining. Persons affected by the rule are (substan

tially) those falling within the statutory definition of "affiliate" in Section 2 (a) (11) of the Act, which includes, in addition to officers, directors, and persons having specified stock ownership, any person whom the Commission finds to stand in such a relation to the issuing company "that there is liable to be such an absence of arm's-length bargaining in transactions between them as to make it necessary or appropriate in the public interest or for the protection of investors or consumers that such person be subject to the obligations, duties, and liabilities" imposed upon affiliates. The rule, like the statutory provision which it parallels, recognizes the impracticability of precisely defining the facts which make for absence of arm's-length bargaining, and permits the disposition of each case in the light of the evidence therein developed. By the terms of the rule, no fee can be paid, unless on the basis of competitive bidding, to underwriters or "finders" subject to the rule, unless the justification is clear or unless such person merely has a participation of not more than 5 percent and the fee is the same as that paid to non-affiliated underwriters.

During the fiscal year, there were five proceedings under Section 12 (f) and Rule U-12F-2 relating to underwriters' and finders' fees:

Halsey, Stuart & Co., Inc., filed an application for determination of its status under the rule as a possible or a prospective underwriter of various securities proposed to be issued by Public Service Company of Colorado. On the record presented, the Commission found that the applicant did not bear to the company any of the relationships specified in subdivision (a) of the rule."1

Morgan Stanley & Co., Incorporated and Bonbright & Company, Incorporated filed an application for a determination of their status. under Rule U-12F-2 as participating underwriters for an issue of first mortgage bonds of Consumers Power Company. It was stipulated that those two underwriters would not receive any underwriting fees in connection with the sale of the bonds in the event that they were found to be affiliates of Consumers Power Company and The Commonwealth & Southern Corporation within the meaning of the rule.72 At the close of the fiscal year the case was pending.

The Commission instituted a proceeding under Rule U-12F-2 with respect to The Dayton Power and Light Company and Morgan Stanley & Co., Incorporated, in connection with the issuance and sale of first mortgage bonds of The Dayton Power and Light Company. The Commission accepted the suggestion. of Morgan Stanley & Co., Incorporated that the financing be permitted to proceed as proposed on condition that Morgan Stanley & Co., Incorporated receive no fee pending final determination of the issues raised by the proceeding pur

71 Holding Company Act Release No. 1707. 12 Holding Company Act Release No. 1854.

suant to Rule U-12F-2.78 73 At the close of the fiscal year the case was pending.

Following a preliminary investigation, the Commission instituted a proceeding pursuant to Rule U-12F-2 with respect to Northern Natural Gas Company and Dillon, Read & Co., in connection with the issue and sale of securities of Northern Natural Gas Company. Prior to the hearing on the issues in this proceeding, Dillion, Read & Co. agreed to waive its right to claim or receive its finder's fee, with the reservation that the claim might be reasserted in the event that Rule U-12F-2 should be held invalid or that subdivision (a) (3) of the rule should be repealed with retroactive effect.74

The Commission also instituted a proceeding under Rule U-12F-2 with respect to Michigan Consolidated Gas Company and Dillon, Read & Co., in connection with the issue and private sale of bonds to two insurance companies. The Commission agreed to the respondents' request to postpone consideration of the issues raised by this proceeding on condition that no finder's fee in connection with the proposed transaction shall be paid to Dillon, Read & Co. pending completion of the similar proceedings involving Dillon, Read & Co. and Northern Natural Gas Company.75

In a number of other instances where the question of affiliation under Rule U-12F-2 existed, the investment banking firms concerned limited themselves to an underwriting participation of not more than 5 percent, thereby avoiding the problems and issues involved in a proceeding under the rule.

Since proceedings under Rule U-12F-2 may involve lengthy hearings on more or less intangible corporate relationships, the Commission has been considering alternative techniques which may be less burdensome from the standpoint of the issuer and more effective from the standpoint of the Commission in meeting the requirement of the Public Utility Holding Company Act of 1935 to preserve competition and arm's-length bargaining in the distribution of utility securities. As it has done in other instances, the Commission has solicited the views of interested and informed members of the public as to a method that would best insure the reasonableness of fees and commission, the fairness of the terms and conditions of any proposed issue and sale of utility securities, and the elimination of "transactions in which evils result from an absence of arm's-length bargaining or from restraint of free and independent competition."

Holding Company Act Release No. 1925. Commissioners Henderson and Eicher expressed dissenting views on this point in both the Consumers Power Company and The Dayton Power and Light Company

Pases, asserting that in their opinion the proceeding under Sections 6 (b) or 7 should not be disposed of until the issues involved in the affiliation proceeding under Rule U-12F-2 were determined.

24 File 43-229.

Holding Company Act Release No. 1984.

The Commission has received numerous responses from investment bankers and utility executives, and conferences have been held with the National Association of Securities Dealers, Inc., and others. It is now considering the suggestions received for the improvement of its regulatory procedure relative to the issue and sale of securities.

DIVIDEND DECLARATIONS AND PAYMENTS

Pursuant to Section 12 (c), no dividends may be paid or securities redeemed in contravention of any rules or order which the Commission has deemed necessary to protect the financial integrity, to safeguard the working capital, to prevent the payment of dividends out of the capital or unearned surplus of public utility companies, or to prevent the circumvention thereof. Pursuant to this section, the Commission has promulgated Rule U-12C-2 which, except by specific order, prohibits the payment of dividends out of capital or unearned surplus.

In the matter of the Securities Corporation General, a subsidiary of International Utility Corporation,76 which had a deficit in the earned surplus account (there was a capital surplus), the Commission has permitted the payment of dividends out of current earnings when it was for the purpose of making a distribution on preferred stock held by the public and its financial integrity was not jeopardized. Similarly, the International Utilities Corporation, which also had a deficit in the earned surplus account, was permitted to pay dividends out of current earnings on its two classes of preferred stock on two occasions. Subsequently, permission was granted to pay dividends only to the senior issue because current earnings were inadequate to cover both issues." The need of reorganization of both companies was noted.

The Commission, however, did not allow the payment of dividends out of what was alleged to be earned surplus after an accounting reorganization of the Associated Gas and Electric Corporation (hereinafter called AGECORP) because it was found to be, in fact, capital surplus. The Associated Gas and Electric Company (hereinafter called AGECO) is the top holding company in the Associated System in which the public has an interest. AGECO owns all the stock of AGECORP, which owns the stock of 5 subholding companies which in turn, directly and indirectly, own the controlling stocks of 70 electric and gas utility companies and 85 miscellaneous companies. The operating subsidiaries render services to a population of over 7,000,000 in more than 6,200 communities in some 20 States and the Philippine Islands. The system was put together by H. C. Hopson (now under indictment for alleged mail fraud and income tax violation) and his associates. Acquisitions of properties were financed to a large extent by the issuance of stock and debentures of Associated

76 Holding Company Act Releases Nos. 1704, 1775, 1923.

77 Holding Company Act Releases Nos. 1643, 1753, 1910, 1924, 2036.

Gas and Electric Company and subholding companies in the system, over $1,000,000,000 of such securities having been issued in the process. About $270,000,000 of this money was represented by debentures of AGECO.

In 1933, AGECO found itself unable to meet the interest on these debentures. A few years before, the underlying system properties had been transferred to AGECORP. AGECO partially extricated itself from its difficulties by persauding the holders of approximately $200,000,000 of its debentures to accept therefor lesser principal amounts of fixed interest and income debentures of AGECORP. These conversions of AGECO debentures for AGECORP debentures constituted a large-scale recapitalization plan, generally called the Recap Plan.78 The exchange of AGECO debentures for AGECORP debentures pursuant to the Recap Plan was induced in part by the belief that the converters would thereby follow the system assets downstream and obtain a more direct claim to the income of the system. Holders of some $70,000,000 of AGECO debentures refused to exchange and thus remained dependent for their interest upon dividends paid by AGECORP up to AGECO. The interest of the holders of AGECO debentures demanded a flow of dividends from AGECORP irrespective of AGECORP's earnings. The interest of the AGECORP debenture holders was, of course, opposed to this. The interest of the management of the Associated System demanded that sufficient funds be brought up to AGECO to permit payment of interest and retention of themselves in office. This situation resulted in pressure upon the operating companies to pay up cash irrespective of its effects upon the operating properties and their consumers. Simultaneously with the flow of cash upstream there was a steady increase in bank loans throughout the System.

It was extremely doubtful whether the earnings and earned surplus account of AGECORP were such as to permit future payments of sufficient dividends to cover AGECO's interest requirements. Accordingly, on November 27, 1935, four days before the effective date of the registration provisions of the Act, AGECORP declared a dividend to AGECO consisting of $90,000,000 in notes. This dividend was declared out of an alleged capital surplus, the laws of Delaware, under which AGECORP was organized, permitting such dividends. Thereafter, over $16,000,000 was paid by AGECORP to AGECO on account of interest and principal on the above notes. This money was used by AGECO to meet its own interest obligations.

AGECO registered as a holding company on March 28, 1938, following the decision of the Supreme Court in the Electric Bond and Share

"This Recapitalization Plan is critically examined in Part VII of this Commission's report on the Study and Investigation of the Work, Activities, Personnel, and Functions of Protective and Reorganization Committees, pp. 23-108.