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But, when the boom collapsed, leverage worked in reverse, and many holding companies and their subsidiaries were forced to default on their obligations and had to cease dividend payments to stockholders. The complex capital structures of these entities also afforded many opportunities for the manipulation of accounts and finances and for diverting profits or losses through intercompany channels to the detriment of public investors. Equally important was the way in which the corporate pyramids defeated or obstructed local regulation of the underlying operating companies.

2.

Enactment of the Public Utility Holding Company Act of 1935. The Public Utility Holding Company Act of 1935 was enacted "to subject to effective public control public-utility holding companies which transcend State lines in their interests and activities."4/ The Act followed an exhaustive investigation by the Federal Trade Commission, and extensive hearings and debates by the Congress. These inquiries disclosed in public utility holding company finance and operations a variety of abuses which the Act was designed to correct. The more significant of these are enumerated in Section 1(b) of the Act:

(1) Inadequate disclosure to investors of the information necessary to appraise the financial position and earning power of the companies whose securities they purchase;

(2) the issuance of securities against fictitious and unsound values; (3) overloading operating companies with debt and fixed charges,

thus tending to prevent voluntary rate reductions;

(4) the imposition of excessive charges upon operating companies for various services such as management, supervision of construction and the purchase of supplies and equipment;

(5) the control by holding companies of the accounting practices and rate, dividend and other policies of their operating subsidiaries so as to complicate or obstruct state regulation;

4/ H. R. Rep. No. 1318, 74th Cong., 1st Sess. 3 (1935)

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(6) the control of subsidiary holding companies and operating companies through disproportionately small investment;

(7) the extension of holding company systems without relation to economy of operations or to the integration and coordination of related properties.

In passing the Act, Congress sought to deal with these problems by:
Requiring each holding company registered under the Act to con-

fine itself to a single intergrated public utility system, with provisions for the retention of additional utility systems and related incidental businesses under certain designated circumstances;

b. Providing for the simplification of registered holding company structures including the elimination of unnecessary holding companies and the reorganization of those that were unduly complicated and over-capitalized, and the redistribution of voting power among securities holders of holding and operating companies in order to assure the investing public a voice-or at least a potential voice-in these enterprises, commensurate with its capital contributions;

c. Requiring the securities issued by registered holding company systems to meet specified statutory standards to assure the soundness of the capital structure of the system;

d. Halting the loading of excessive charges by affiliated service companies in registered holding companies on the operating utility subsidiaries, by requiring that all services performed by affiliates for any company in its system be rendered at cost fairly allocated; and

e.

Regulating companies in registered holding company systems to eliminate fictitious or deceptive accounts and unsound business practices.

The Act was particularly designed to eliminate those holding companies serving no useful purpose, and thus to afford to the operating companies the

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advantages of localized management and to strengthen local regulation. 5/ This objective finds its most direct expression in Section 11 of the Act. 6/ Section 11(b) (1) requires the operations of holding company systems

to be limited to one or more integrated systems and to such additional businesses as are reasonably incidental or economically necessary or appropriate to the operation of the integrated systems. Section 11(b)(2) requires the elimination of undue complexities in the corporate structures of holding company systems, and the redistribution of voting power among their securities holders on a fair and equitable basis.

The Act provides for the registration of holding companies (Sec. 5) and substantive provisions such as those in Section 11 are generally limited to companies in registered holding company systems; these substantive provisions include the regulation of securities transactions of holding companies and their subsidiaries (Secs. 6 and 7); the regulation of the acquisition of securities and utility assets by holding companies and their subsidiaries (Secs. 9 and 10); the regulation of sales of public utility securities or assets, payment of dividends, solicitation of proxies, intercompany loans and other intrasystem transactions (Sec. 12); the control of

5/ American Power & Light v. Securities and Exchange Commission, 329 U.S. 90, 113 (1946); North American Company v. Securities and Exchange Commission, 327 U.S. 686, 704-706 (1946).

6/ Section 11 has been characterized as the "heart of the Act". See S. Rep. No. 621, 74th Congress, 1st Sess. 11 (1935). See also, Securities and Exchange Commission v. New England Electric System, 384 U.S. 176, 180 (1966); North American Company v. Securities and Exchange Commission, supra, 327 U.S. at 704 n. 14.

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services, sales, and construction contracts (Sec. 13); and the control

of accounting practices (Sec. 15).

Certain types of holding company systems were not intended to be

so regulated. Section 3 of the Act specifies five categories of holding companies that are entitled to an exemption from substantially all of the Act's other provisions. 7/ The Act's broad exemptive provisions

1/ Section 3(a) of the Act provides that holding companies shall be exempted from the Act when:

"(1) Such holding company and every subsidiary company thereof which is a public utility company, are predominantly intrastate in character and carry on their business substantially in a single State in which such holding company and every subsidiary company thereof are organized;

"(2) Such holding company is predominantly a public-utility company operating as such in one or more contiguous States, in one of which it is organized;

"(3) Such holding company only incidentally is a holding company, being primarily engaged or interested in one or more other businesses other than the business of a public-utility company and (A) not deriving, directly or indirectly, any material part of its income from any one or more subsidiary companies, the principal business of which is that of a public utility company, or (B) deriving a material part of its income from any one or more such subsidiary companies, if substantially all the outstanding securities of such companies are owned, directly or indirectly by such holding company;

"(4) Such holding company is temporarily a holding company solely by reason of the acquisition of securities for purposes of liquidation or distribution in connection with a bona fide debt previously contracted or in connection with a bona fide arrangement for the underwriting or distribution of securities; or

"(5) Such holding company is not and no subsidiary company thereof is a public-utility company operating within the United States."

S. Rep. No. 621, supra at 6.

reflect one of the delicate compromises reached in Congress between those
who believed that holding companies should be completely abolished in view
of the numerous abuses that had been perpetrated upon investors and consumers
through the holding company structure, and those members of Congress who vig-
orously resisted the creation of federal regulatory authority in this area.
As a result, Congress concluded that not all public utility holding companies
would be subjected to pervasive federal control and, indeed, structured the
Act in a fashion so as to permit numerous holding companies to avoid regu-
lation under the newly-created legislative scheme particularly where the
characteristics of the system were such that the component companies could
be subjected to regulation by the states.

3. Regulatory Direction of the Commission's Administration of
the Public Utility Holding Company Act.

The title of the Comptroller General's Report 8/ and Chapter 2 thereof 9/ state that the Commission's regulatory approach has changed over the years since passage of the Act. That conclusion apparently is based, without more, upon an observation of the level of the Commission's efforts in administering the Act over the years, rather than upon a reasoned and thorough examination of the purposes for federal regulation of public utility holding companies. In fact, contrary to the conclusion of the Comptroller General,

8/ The Report is entitled "The Force of the Public Utility Holding Company Act Has Been Greatly Reduced by Changes in the Securities and Exchange Commission's Enforcement Policies."

9/ Chapter 2 of the Report is entitled "The Commission's Regulatory Approach Has Changed Over the Years."