the reserves for depreciation of utility plant and other physical property were inadequate. That determination, which was based on a study of the reserve requirements on a straight-line basis as at June 30, 1945, has been brought up to date by the company and indicates that as at December 31, 1947, reserves for depreciation of utility plant and other physical property should amount to $24,920,737, or $7,580,084 in excess of the present book reserves. Adjustment for this deficiency would result in charges to earned surplus of $7,576,659 and to miscellaneous debits of $3,425. 7 The New York Commission also found that the company's investments in the common stocks of its public-utility subsidiaries, Kings County Lighting Company ("Kings") and Queens, which are carried at $5,141,704 and $2,278,639, respectively, are impaired. The State Commission stated that the investments in these subsidiaries should be written down to the nominal amount of $1.00 each in recognition of their asserted worthlessness. Long Island proposes, in connection with its pending plan, to write down its investment in Queens to $1.00, but proposes to write down its investment in Kings to $161,000, representing the approximate amount of stated value of stock of Kings to be distributed to Long Island pursuant to the plan of recapitalization of Kings. These adjustments to the investment accounts, amounting to $7,259,342, would be charged to surplus reserves to the full extent of the balance therein of $4,219,175, and the balance of $3,040,167 would be charged to earned surplus. 8 While the New York Commission withheld the entry of an order directing the placing of the above adjustments on the books of the company pending final determination as to whether the company would be separately recapitalized or consolidated with Queens and Nassau, the company proposes making the foregoing adjustments as a step in connection with such consolidation. As a result of the described adjustments in respect of the reserves for depreciation and the investment accounts, there would be an earned surplus deficit of $6,601,586, which is $3,598,372 in excess of the aggregate of the stated value of the common stock plus unearned surplus. It should be noted that this determination of the adjusted common stock equity gives no effect to the very substantial undeclared dividend arrears which have accumulated on the preferred stock of the company, which arrears at December 31, 1947 amounted to $15,576,113. The adjusted net utility plant at December 31, 1947 (exclusive of other physical property) amounted to $63,180,517. First mortgage bonds of $30,035,000 represented 47.5% of such net 7As will be apparent from our later discussion of the financial aspects of Queens, the investment that Long Island has in the common stock of that company is of such little, if any, value that it is appropriate for our present purposes, to write down such investment to the nominal amount of $1.00. See Note 7, supra. utility plant, while total long-term debt, including notes payable to banks, of $46,732,000 amounted to 74.0% thereof." On December 16, 1944, Long Island filed in the office of the Secretary of State of the State of New York, with the approval of the New York Commission, a Certificate of Reduction of Capital for the purpose of effecting a revision of its capital and changing the rights and privileges of the holders of its preferred and common stocks. That Certificate, together with certain journal entries ordered by the New York Commission to be placed on the books of the company, provided, among other things, that (a) the par value of the outstanding 253,800 shares of preferred stock was to be reduced from $100 per share to $60 per share, and the liquidation, redemption and future dividend rights were thereafter to be determined upon such reduced par value, (b) the accumulated dividend arrears on the preferred stock at June 30, 1944, were to remain unaffected, (c) the company was to issue 503,800 shares of new common stock to its preferred and common shareholders on the basis of one share of new common stock for each share of preferred stock and each twelve shares of common stock outstanding, and (d) the unearned surplus arising from the reduction in capital and from the elimination of paid-in premiums on preferred stock, together with the existing balance of unearned and earned surplus as at June 30, 1944, was to be used to increase the depreciation reserve by $6,000,000 and to provide $4,979,320 as a special reserve for depreciation and for investments in securities of associated companies. As a result of certain legal proceedings between this Commission and Long Island and Long Island's registration as a holding company under the Act on April 23, 1945, 10 none of the certificates contemplated by the Certificate of Reduction of Capital has been issued and none of the accounting entries authorized in connection therewith has been made upon its books. The Certificate of Reduction of Capital would have had the effect of reducing the aggregate par value of the preferred stock from $25,380,000 to $15,228,000, but would not have affected the accumulated dividend arrears on the preferred stock as of June 30, 1944 in the amount of $9,984,688 which would have been required to be paid before any dividends could have been paid on the new common stock. The aggregate stated value of the common stock was to be reduced from $3,000,000 to $2,519,000. The preferred shareholders were to receive 50.38% of the new common stock and the common shareholders 49.62% thereof. 9 In this connection, it may be noted that the indenture securing the company's 3-3/4% sinking fund debentures due 1956 provides for a cumulative sinking fund under which the company deposits annually with the trustee $600,000 in cash, which amount, together with interest on reacquired debentures which are held alive in the sinking fund, must be used to redeem debentures at principal amount. 10 S, E. C. v. Long Island Lighting Company, 59 F. Supp. 610 (E.D.N.Y. 1944), affirmed 148 F. (2d) 252 (C.C.A. 2, 1945), reversed and remanded to the District Court with direc~ to dismiss the proceeding on the ground the cause became moot, 325 U.S. 833 (1945). Table 11-A below presents a condensed balance sheet of Long Island, as at December 31, 1947, as adjusted to give effect to the Certificate of Reduction of Capital. Special reserve for depreciation and for investments in securities of associated companies - 4,979,320 Reserves appropriated from net income for sinking fund and unsecured notes - 4,219,175 237,001 Earned surplus 3,677,010 Total Liabilities and Other Credits 106,666,742 Note: The above balance sheet does not reflect accumulated dividend arrears on the preferred stocks. On the basis of giving effect to the Certificate of Reduction of Capital, the arrears at December 31, 1947 would amount to $13,339,542.50, or $58.45 per share on the 7% series and $50.10 per share on the 6% series. It is apparent that if effect be given to the Certificate of Reduction of Capital, the extent of the adjustments found necessary in the New York Commission's memorandum of August 6, 1946 would be materially reduced, in view of the fact that, coincidental with the reductions in capital provided for in said Certificate, a total of $10,979,320 would have been added to the company's reserves for depreciation of property and for investments in subsidiaries. If effect be given to said Certificate, the additional adjustments required to conform the accounts of Long Island to the findings of the New York Commission as set forth in its memorandum would result in an equity for the reclassified common stock of $6,558,504, represented by $2,519,000 of stated value, $3,677,010 of earned surplus, and $362,494 of surplus reserves. It should be noted that no effect has been given in this determination of the adjusted common stock equity to the accumulated undeclared dividend arrears on the preferred stocks of the company. At December 31, 1947, on the basis of the Certificate of Reduction of Capital, the arrears would have amounted to $13,339,543. There is set forth below in Table III the capitalization and surplus and surplus reserves of Long Island as at December 31, 1947, as adjusted to reflect the adjustments to the accounts as described above, and as further adjusted to give effect to undeclared dividend arrears on the preferred stock. The table is prepared on bases both before and after giving effect to the Certificate of Reduction of Capital. As indicated in Table III below, if no effect be given to the Certificate of Reduction of Capital, the common stock is "under water" to the extent of 5.3% of adjusted capitalization and surplus without consideration of undeclared preferred dividend arrears, and is further "under water" to the extent of 27.9% if provision be made for such arrears. If effect be given to the Certificate of Reduction of Capital, the recapitalized common stock provided for in said Certificate would constitute but 9.6% of adjusted capitalization and surplus before considering undeclared preferred dividend arrears, and would be "under water'' to the extent of 9.9% of adjusted capitalization and surplus if arrears be taken into account. B. Earnings Comparative statements of income of Long Island, per books, for the ten calendar years, 1938 to 1947, inclusive, are annexed hereto as Appendix A. There is presented below in Table IV for the ten-year period a summary of gross income, net income, and balance of net income applicable to the common stock (before allowance for accumulated preferred dividend arrears) after deducting current preferred dividend requirements, together with coverages of income deductions and income deductions plus preferred dividend requirements. As will be noted from the following table (Table IV), the balance of net income applicable to the common stock is computed both before and after giving effect to the Certificate of Reduction of Capital, which provided for a 40% reduction in preferred dividend requirements, beginning July 1, 1944, from an annual amount of $1,597,550 to $958,530. As indicated in Table IV, the net income applicable to the common stock, without giving effect to the Certificate of Reduction of Capital and without giving effect to reservations of et income ordered by the New York Commission, averaged 79,599 per year for the ten-year period, 1938-1947, and |