managed railroad capitalizes certain amounts-new construction, usually double tracking, sometimes additional weight of rails-but I think the conservative men will admit that it is necessary every year to spend a large sum of money which is in the nature of betterment of property, in order to keep it up to the standard; because otherwise, if you capitalize every dollar, the time will come when your indebtedness will break any road in the United States.

At least I deny that it is conservative railroad management to go back thirty years, take the losses of the original stockholders, take all the money used during those years for the improvement and betterment of the railway, and charge them up as a part of the capital account, borrow money on a mortgage to pay it back to the railway company, and then turn around and pay it out to themselves in dividends and in profits on bonds sold to themselves at unreasonable and absurdly low prices.

Against that $12,444,177 they charged this dividend of $6,669,180, and $8,155,751 of discount on bonds. Now, what was that? It was not the discount on the $32,000,000 of bonds at 35, which would be the ordinary way. I have never known-I am not an expert in railroad accounting, but I have never before known discount on bonds to be charged in that way. But $8,155,000 for some reason seems to have been charged as discount on bonds, as against $12,444,000—I cannot for the moment think for any other reason than to cover it up. That probably, I suggest, may have been profits to these gentlemen on those bonds. Whether it was or not, it is certainly a discount on bonds charged against a raked-up old account of the Chicago & Alton for construction expenditures uncapitalized and losses of prior stockholders.

A few words more on that point. These gentlemen, having bought the Chicago & Alton Railroad stock, organized the Chicago & Alton Railway Company. They placed their stock in the treasury and they mortgaged it for $22,000,000. That transaction took this form-and I do not deny that it is a form which is sometimes used in transferring property into a railroad in order to get out the securities-but it did take this form. These gentlemen transferred their stock to Mr. Louis Stanton and transferred, or at least nominally transferred, this 58 miles of road to Mr. Stanton. Mr. Stanton made a proposition to the new Chicago & Alton Railway Company to sell it 34,722 shares of preferred stock, which had cost them $6,944,400, and on which they had received a dividend of $1,041,660, leaving a net cost of $5,902,740-they proposed to sell that to the new company for $10,000,000 in cash. The 183,224 shares of common stock which they had bought, which had cost them $32,064,200, on which they had received a divi

dend of $5,496,720, they proposed to sell to the new company for 390,318 shares of its stock, one-half of which was preferred and onehalf common. It does not appear what these gentlemen got for their common stock or their preferred stock, but if they sold it for anywhere near the market price, as shown by the table which Mr. Lovett put in evidence, they must have made a very large profit on this transaction. Now, they were to get $10,000,000 for this stock and they were to get $3,000,000 for the railroad, making $13,000,000; and the records show they sold the $22,000,000 of bonds for $13,000,000. But, as a matter of fact, they transferred all the stock and all the bonds for the securities.

That is the practical effect. But the bonds, if sold for $13,000,000, would be a little less than 60 cents on the dollar, and they never sold thereafter at anywhere near that low price; in fact, they averaged from 1900 down to the present time from 76 to 861, and during the two or three years after their issue they sold for 82 to 86.

There was the issuance of $40,000,000 of common stock and $22,000,000 of bonds which have been put on the market in addition to the $40,000,000 of bonds, much of which was an increase of the capitalization of this company.

There is another item that I wish very briefly to call to the Commission's attention, and that is the item of $973,477 of funded interest account which was added to the capital of this road. That mortgage was made to take up the prior bonds and coupons. From June, 1901, down to 1906, there was carried in the treasury of the Chicago & Alton Company $973,477 worth of the coupons of its prior mortgage bonds which had been paid. It was carried as an asset in the treasury of the Chicago & Alton Company. I take it that coupons from the bonds paid with that mortgage should have been canceled, and were not legitimate assets in the treasury. As a matter of fact, in 1905, after having carried them for four years as an asset, they were charged to capital account.

Again, it may not have been illegal, but it was bad business to mortgage that 34 miles of road in process of construction, sell all the bonds, and leave no way of raising funds to complete it.

Mr. CRAVATH. To build that road?

Mr. KELLOGG. To build that road; yes. As a matter of fact, when the new management took hold of the Chicago & Alton Company what was its condition? After having expanded its securities from $33,000,000 to $114,000,000, and only having spent $18,000,000 on the property, it found itself confronted with the necessity of buying additional equipment, and was compelled to issue $2,780,000 of trust certificates to do so. It was reduced to the necessity of giving its equipment notes

in order to obtain the facilities with which to serve the public. Not only that, but it had no money in the treasury, and no way of raising money, to complete the 34 miles of road in process of construction. Here was the Alton company, with all its splendid credit, in six years of prosperous times, unable to meet its demands, after this enormous recapitalization, made (as Mr. Harriman said) to meet modern conditions.

Now, I deny the necessity, I deny the morality, and I deny that it is good financiering, whether it was within the law or whether it was not. I believe that is a most conspicuous instance of taking a railroad with a splendid credit, with low capitalization, making it the object of speculation, for the purpose of increasing its securities and unloading them on the public for the purpose of enriching the managers, when the earnings of the road do not and cannot justify the increased capitalization. I deny that it is necessary, and I believe the law should not permit such transaction; that the law should require that money borrowed be used for corporate purposes of construction and acquisition of the property, improvement of the railway, or the funding of prior indebtedness, and that reasonable restrictions should at this date be placed upon the unlimited issue of securities of railroads.

One other suggestion. I do not believe that it is wise, as I said before, that unreasonable restrictions should be placed upon the acquisition of stocks and securities of connecting railways; but I do not believe it is in the interest of the railways themselves, or of the public, that they should be allowed to become great financial investment institutions, dealing in the stocks and securities of other railways. Their credit should be used in the expansion and development of their lines in the transportation business of the country. Their securities should return reasonable and generous dividends. Their credit should be of the highest. I should deplore action or legislation which would hamper them or show an unreasonable spirit toward their expansion, for the expansion of the railway systems of the country must go hand in hand. with its prosperity and its development. But I do not believe that the enormous credit of railway companies should be used for the purpose of purchase and sale of securities of other lines or used for other than transportation business, and that their solvency should not be imperiled by the rise and fall in the prices of stocks.

1

READJUSTMENT OF PUBLIC UTILITY 1

President F. G. Drum, of the Pacific Gas & Electric Co., San Francisco, in a circular of June 3, says in part (compare ann. report in V. 98, p.1773):

This plan is submitted after many months of deliberation, pursuant to an order of the California Railroad Commission requiring us to provide for existing short-term obligations and for future capital needs. The effect of its adoption will be as follows:

Reclassification (Without Increase) of Present Maximum Auth. Stock, Common Stock, no change, except the decrease of

authorized maximum by $50,000,000 to........$100,000,000 First Pref. (p. & d.) Stock-6% cumulative, dividends quarterly, a new class of stock authorized in place of a like amount of unissued common stock. It is to be issued as fully paid with the express covenant that it shall not be subject to assessment for any purpose. Present issue ($12,500,000), and all future issues to be made only with authority of California Railroad Commission for extensions, additions, betterments and for refunding as provided in the P. U. Act of California. Taxexempt in California... Preferred Stock-(Present issue 6% cum.) now to be made 2nd pref, with the right of exchange after July 1, 1916, for the new first pref. at the rate of 1.025 shares of the new stock for each share of the old

50,000,000

10,000,000

Necessity of Plan.-The recent annual report (V. 98, p. 1773) clearly shows the extraordinary growth of our business, the gross reve nue having increased from $8,947,162 in 1906 to $16,202,337 in 1913, being an average annual increase for the seven years of $1,036,453, and for 1913 an increase of $1,457,686. The future promises a still more rapid growth, for which additional capital must necessarily be obtained.

The present capitalization limits the practicable means of raising new capital to the General and Refunding M. 5% bonds, and the major portion of new capital required within recent years has been obtained in this way. This policy has made it necessary to reinvest in the property an undue proportion of the earnings, thereby divert1 From The Commercial & Financial Chronicle, June 13, 1914.

ing from the holders of the common stock a substantial portion of the profits of the business to which they were legitimately entitled, and which, under the present plan, will for the future be available for distribution. The Railroad Commission has also indicated quite clearly that it views with disfavor the practice of raising new capital entirely from the sale of bonds.

Our stockholders are familiar with recent conditions which have rendered it difficult for even the most prosperous enterprises to secure new capital in large amounts at reasonable rates through the sale of bonds. Your company's experience in this respect, notwithstanding its constantly growing profits, has been no different from that of other corporations, and since March, 1913, it has been compelled to carry on the largest construction program in its history entirely from earnings and from the proceeds of money secured on short-term notes.

This condition is reflected in our balance sheet (V. 98, p. 1778) in the item of "uncapitalized advances to Construction Account," amounting to $11,586,662 at April 30, 1914. Short-term notes are an admittedly costly form of financing and the diversion of earnings for plant additions affords little satisfaction to the stockholders, who are thereby deprived of dividends, but the unquestioned necessity of completing the new hydro-electric plants on the South Yuba and Bear Rivers, and of making other extensions and additions to meet the growing demand for the company's products, left no desirable alternative. Current returns indicate a saving in operating expenses of at least $400,000 from the operation of the new Drum power house during 1914.

Object of Present Issue.-While the results amply justify the course pursued, the provision must now be made for the payment of $7,000,000 one-year notes maturing March 25, 1915, and of certain other obligations aggregating about $1,000,000. It is proposed to accomplish this by the sale to the stockholders of $12,500,000 of the new first preferred 6% stock at 821⁄2, a price which will yield approximately $10,300,000 in cash. This amount will be sufficient to pay the entire floating debt, and with other assets accruing on account of past construction will give the company a net working capital in excess of $3,000,000, and place its treasury in the strongest position it has occupied since organization.

Outlook as to Dividends.-Annual dividends on the new issue of $12,500,000 preferred stock will amount to $750,000. As the payment of the floating debt will, however, reduce annual interest charges by about $400,000, and as the money remaining from the proceeds