Gas: A Study in Expansion: The Case of Associated Gas

I

IN face of the so-called utility problem, the public is in an uncomfortable dilemma: as consumers they wish lower rates, as investors they aspire to higher returns, and as voters they are called upon to regulate both. With the development of customer ownership of utility securities, this disconcerting position has become of immediate and pressing importance.

The conflict in public interests exists whether or not the government enters into competition with the established utility organizations. For lower rates mean lessened income to the operating companies and to the holding companies which own the capital stock of such companies; and in so far as the public holds the holding-company securities, it will lose through diminished dividends what it gains through lower rates. But of course it is not as simple as this. All consumers are not security owners; and those who are do not necessarily invest their money in the local company or in the holding company owning it — and assuredly not in the same proportion in which they consume electric energy. It does not follow, then, that what is lost through higher rates will be received back by the same persons in higher return on investment. It is not as if money were taken from one pocket and put in the other. The other pocket may be somebody else’s.

Before the public forms an opinion one way or another in response to exhortations from political candidates or power companies, and before state legislators and public service commissions commit themselves to definite action, the relationship between power rates and operatingand holding-company security values must be better understood. This is necessary not only in the interest of the consumer, but also in the interest of the investor. For the capital values of holding companies, which control by far the largest part of light and power properties in the United States, are so seriously involved in this matter as to threaten certain ones besides those already plunged into bankruptcy.

I shall try to explain this matter by ‘holding, as ’t were, the mirror up to nature.’ Nature in the raw, one might say. In short, I shall describe the plight of the Associated Gas and Electric Company. The policies of the Associated’s management give clearer outline to the points relevant to the problem in hand than those of any other system, because the Associated has shown a strange propensity to go to extremes. The phenomenal growth of this System, the complexity of its capitalization, the intricacies of its corporate structure, the ingenuity of its financial methods, and the one-sidedness of its relations with operating companies, defy any comparison in the utility field or elsewhere. In this paper only the last of these activities will be considered, with a view to clarifying the position of the public in its dual capacity as security owner and customer of utilities. Other activities of the Associated System, particularly in respect to methods and types of security issues, accounting, and annual reports, would easily provide material for a separate study. But these aspects will be considered here only in so far as they bear upon the problem herein defined.

This is, therefore, a case study of intercorporate relations. It does not imply that all public-utility holding companies indulge in similar practices, or to the same degree. Far from it. In due course I shall mention some notable exceptions.

II

What is the Associated Gas and Electric System? Its structure is indescribably complex. An unpublished chart of the System, as of March 31, 1932, shows 264 corporate entities, which are intertwined in ungodly confusion with the help of some 40 pure holding companies. The Associated Gas and Electric Company is not the top holding company, as is popularly supposed; neither does it stand immediately above the operating companies. Instead, it is suspended in the middle of a chain of companies reaching from the people in control — namely, Messrs. H. C. Hopson and J. I. Mange — to the operating companies, which are the geese that lay the golden eggs. There are, in places, as many as eight holding-company links in this chain.

The organization at the top of the chain is the Associated Gas and Electric Properties, which is a Massachusetts voluntary trust. This trust has two certificates of one-half beneficial interest outstanding, owned by Messrs. J. I. Mange and H. C. Hopson respectively. It owns the voting stock in Associated Securities Corporation, which in turn controls the Class B voting common stock of the Associated Gas and Electric Company — the company which has the greatest amount of securities outstanding. Through the Manson Securities Trust, the Associated Gas and Electric Properties controls the New England Gas and Electric Association. The relationship between the New England Gas and Electric Association and the Associated Gas and Electric Company is that of second cousins.

There is another misconception about the relationship of the Associated Gas and Electric Company to operating subsidiaries. It is popularly supposed that this company owns the operating properties directly. This is far from the truth. In fact, the Associated Gas and Electric Company owned, as of March 31, 1932, nothing but the bonds and stocks of another company — namely, Associated Gas and Electric Corporation (Delaware), of ‘Baby Bond’ fame. This company in turn controls other holding companies — Associated Electric Company (Delaware), Metropolitan Edison Corporation (Delaware), General Gas and Electric Corporation (Delaware), Rochester Central Power Corporation (Delaware), and General Utility Investors Corporation (Delaware). These are only a few of the wares the Associated System has bought from the Delaware Bureau of Corporations. They in turn have control of other holding and operating companies. The Federal Trade Commission’s examiner, Mr, Charles Nodder, in his admirable study of the System, writes regarding these holding companies: —

For the most part, the sub-holding companies and/or trusts are nothing more than bookkeeping units, having no employees, no real organization, but have singly a set of account books, minute books, and supporting papers. They have, of course, separate legal entities and possess, generally, very extensive corporate powers as set forth in their several certificates of incorporation. They are not active, although capable of being used for any purpose desired by System officials.

It is not safe to say what the corporate structure of the Associated System looks like at any given time because of the propensity the management has shown for redistributing the properties and sub-holding companies with bewildering rapidity. In the past some investments have been kept in motion among several sub-holding companies, shifting ‘as wind along the waste, I know not whither, willy-nilly blowing.’

In one aspect, however, the Associated System has found simplicity to be a profitable virtue. The operating companies within the System own no cash funds. All receipts of the local companies in NCAV England, including payments on customers bills, are deposited by them, usually in local banks, to the credit of New England Gas and Electric Association. And all receipts of operating companies falling under the jurisdiction of Associated Gas and Electric Company are similarly deposited to the credit of ‘Associated Gas and Electric Companies.’ The examiner of the Federal Trade Commission was informed that this is only a name. But the funds so deposited are subject to checks or withdrawal only by the Associated Gas and Electric Company. Yet many operating companies in their reports to the public service commissions indicate ‘cash’ on their balance sheets, though they are not allowed to spend more than a nominal sum without authorization from the central office. (Federal Trade Commission Exhibit 5156, MS. p. 44.) Thus all the complexity of corporate structure is ignored by the management where cash is concerned.

III

In its size and complexity the Associated System is a web of recent growth. The Associated Gas and Electric Company was organized as a holding company in 1906 by interests closely identified with Ithaca Gas Light Company, with the intention of consolidating public-utility properties in and around Ithaca, New York. For sixteen years it had an uneventful existence. From 1922 on, it budded forth into an expansive bloom like a sunflower under the clear skies of days now legendary. Beginning with total book assets of $1,200,000 at the time it started doing business in 1907, its growth has been erratic and phenomenal, as shown by the total book assets, according to the Trade Commission: —

In the last ten years the total book assets of Associated Gas and Electric Company increased 140 times. Its total consolidated assets also kept pace with this dizzy expansion.

The expansion since 1922 was due to the acquisition of control by Messrs. Mange and Hopson, who proceeded with haste to acquire properties all over the country. Under the caption ‘Strength from Diversity,’ the Associated Company states in its annual report for 1930: ‘Areas served by the Associated Company vary widely in location and characteristics. The 3000 communities served by the operating subsidiaries are situated in 21 states and the Philippine Islands. They range in size from agricultural villages to great industrial cities.’

IV

The only thing comparable in complexity to the corporate structure of the Associated System is its capitalization. Since 1922, when the present management obtained control of the Associated Gas and Electric Company for an investment of $292,060, the growth has been financed chiefly by the issue of non-voting securities of all descriptions: Stock Purchase Warrants, Common, Class A, Preference, and Preferred Stocks, Convertible Debentures, and Gold Bonds. In December 1931, there were outstanding over thirty-five different classes of securities of Associated Gas and Electric Company alone; one of the bond issues is due, believe it or not, in 2875. And yet this company owns little more than the bonds and stocks of another holding company, the Associated Gas and Electric Corporation (Delaware), which has begun to issue its own obligations — the Baby Bonds — to the public. The picture is still further beclouded by the fact that sub-holding companies below this Delaware corporation have their array of securities outstanding.

The Associated Gas and Electric Company sponsored a new policy of financing in that it preferred the issue of holding-company instead of operating-company securities. As a result, it has unwieldy amounts of holdingcompany bonds and debentures outstanding. On December 31,1931, it had funded debt of $253,040,269.70 and obligations convertible into stocks at the company’s option in the amount of $82,014,021.49; the latter were converted into Preference and Preferred Stocks during 1932. These securities, along with sub-holding and subsidiary-operating-company securities, constitute a hodgepodge approaching the now legendary 57 varieties.

The money, of course, came from the people. The number of shareholders in the Associated System increased from 150 in 1922 to 254,784 during 1932. And who are these shareholders? Over 25 per cent of them are housewives! Skilled and unskilled laborers, clerks, farmers, students, and minor children have also been attracted into the fond embrace of the Associated. But take heart: bankers constitute less than 2 per cent of the total shareholders!

Not all the holding-company securities of the Associated System were issued for cash. Through numerous exchange offers, operating-company creditors and shareholders were urged to turn in their holdings for parentcompany securities that have ahead of them hundreds of millions of dollars par value of parentand sub-holdingcompany bonds.

V

What were the objectives of this incubator process of multiplying and increasing holding-company securities? Up until the end of 1929, the Associated System exhibited a zealous avidity in acquiring any and all publicutility properties available for sale. This is indicated in the increase of book assets by nearly four hundred millions during 1929 alone. These acquisitions were made either with cash, using the proceeds of securities sold to the general public, or through exchange of holding-company bonds and stocks for the securities of the operating companies to be acquired, or by a combination of these two ways.

In building up the capitalization of the Associated System by new acquisitions, the management showed a matchless generosity. Examples are many of sums paid which were several times the value of the properties obtained, no matter what standard of worth one employs. In 1939, the Associated acquired control of 1,581,884 shares of common stock of Rochester Central Power Corporation for an applied cost of $85,674,687.02. This was $35,528,893.06 in excess of the book worth of the acquired properties. If objection is raised to the importance given to book value in the foregoing comparison, suffice it to point out that the return on the investment of the Associated was less than 2 per cent in view of the earnings of Rochester Central during 1928.

This case, however, is simply the embodiment of keen business acumen as compared with the acquisition of the Barstow properties. According to contracts dated February 5 and 11, 1929, the Associated obtained 94,005 shares of Barstow Securities Corporation and 11,760 shares of W. S. Barstow & Co., Inc., for a total price of $49,923,855.17. The only investment of the Barstow companies then was in the securities of General Gas and Electric Corporation. At the time that these securities were acquired for nearly fifty million dollars, their book value was $314,614.88. In other words, the purchase price was over 158 times the book value! (Federal Trade Commission Exhibit 5156, MS. pp. 535565.)

On the basis of the average market value during the six months before purchase, the securities for which an amount of $49,923,855.17 was paid were worth only $5,904,870.30. This is a payment of over eight times the market value.

The net income during 1928, applicable to the securities acquired by the Associated in February 1929, was $440,289.10. Therefore the return on the fifty million dollars paid for them was only 0.88 per cent. In making this purchase, the Associated Gas and Electric Company incurred obligations upon which the interest was in excess of $2,800,000 a year.

These cases are not isolated instances. The examiner of the Federal Trade Commission has found that up to December 1929 the Associated Gas and Electric Company apparently ‘paid $266,205,178.12 in excess of the cost of assets to the subsidiaries acquired and included in the consolidation, which would represent an excess purchase price of approximately 65 per cent over the cost to the operating companies of such assets of $402,483,924.41.’ (Federal Trade Commission Exhibit 5157, MS. pp. 1005-1009.) Of this excess purchase price, $40,988,391.43 represents appraisals on a reproduction new basis; so that the rest of the excess price paid represented an asset of an intangible nature.

VI

If the Associated Gas capitalization is a sort of container, — a stein, shall we say, — then the foregoing evidence shows that there is a good deal of foam in it, for which the public has paid its money.

The payment of excessive prices in the acquisition of properties has not been the only way in which this condition has been created. There are other methods by which the Associated has blown up its capitalization, causing it to inflate to dangerous dimensions. By a process of issuing bonds at discounts, repurchasing them at premiums, then reselling the same bonds at lower than repurchase price, and finally redeeming them at par, or above, before the date of maturity, the Associated Gas and Electric Company has created enormous liabilities. As a result of such transactions, the funds obtained have been far short of the face value of obligations created.

This procedure is well illustrated in the transactions involving the 5½ per cent Convertible Gold Debentures (Series of 1977). In February 1927, the Board of Directors of Associated Gas and Electric Company authorized the issue of $40,000,000 of these debentures. The whole issue was sold to an investment banking house at $90.75 for $100 par. Immediately the issuing company got busy to reacquire and resell these bonds. After two years of this process the net result was that, on December 31, 1929, the company had created for itself $8,019,000 of these debenture obligations, for which its net proceeds were but $2,017,471.93. This indicates a discount of over six million dollars, or little short of 75 per cent on the principal amount outstanding at the end of 1929. Against the eight million dollars of liabilities, the management acquired one quarter substance and three quarters froth. The cost of capital obtained in this liberal fashion is enormous. The company has to pay 5½ per cent on eight millions, which, calculated on the actual proceeds of two millions, comes to over 21 per cent. There are other instances of such gyrations. Each time the company has found that a dance of debentures calls for an expensive piper. (Federal Trade Commission Exhibit 5157, MS. pp. 832-836, 838-839, 852, 856-857.)

VII

The Associated Gas and Electric Company sways in the air, high up above the ground. It is like the Hanging Gardens of Babylon, a pyramidal structure, built in weird design, worthy of a Nebuchadnezzar, The luxurious vegetation in this ethereal garden, the many and varied types of securities that have germinated there, has grown with rare rapidity.

The problem, however, for the overlords of this garden has been how to nourish the plants. They must be irrigated with income, the lifeblood of liabilities, or they will dry up and the garden decay. So the lords of this little paradise have set up an elaborate scheme of pumping up income from lower levels. The operating companies are the artesian wells from which funds are drawn to nourish the vegetation of the garden above.

An attempt will now be made to decipher the hieroglyphics of Associated history and reveal the intricacies and mystery of the machinery in use. The first device by which income is drawn up as needed is somewhat complicated. The subsidiary operating companies transfer their ‘Current Net Earnings’ from Corporate Surplus to ‘Stated Capital for Common Stock.’ The Associated Gas and Electric Company ‘takes up’ this transfer as an enhancement in the value of ‘Investments’ and ‘Surplus.’ But at the same time the parent company enters these same items into its own income account as ‘Current Net Earnings of Subsidiary Companies Transferred to Stated Capital.’

‘It is found conclusively,’ writes the examiner of the Federal Trade Commission, ‘that large amounts of writeups made by the parent company in its security investment accounts as a result of the transfer of Current Net Earnings of Subsidiaries from Subsidiaries’ Undistributed Earnings have passed on to the Associated Gas and Electric Company as income, and dividends have been paid out of the same to the public on both preferred and several classes of common stock.’

In some cases this has been done without declaration of dividends by the subsidiary. At least $15,839,154.59 of such write-up in Investments was included in Corporate Surplus out of which dividends on parent-company securities were paid. This amount is almost 50 per cent of the total dividends paid on preferred and common stocks during the years 1922-1929. In this way the Company presumes to eat its cake and have it too.

Other methods of securing income to feed the parent-company securities have not been wanting. In many cases insufficient provision has been made for depreciation of subsidiaries’ capital. Through failure to make proper charges against gross revenue for depreciation, a larger net income is taken up by the owners of equity stock, the holding companies. Thus, what should properly be reserved for replenishment of capital is taken up as income. Like the radioactive elements, the live substance of the operating companies wastes itself away by radiation into income.

A third way of increasing income has been by the method of charging excessive rates of interest on capital advanced by the holding company to the operating companies through open accounts. Up to July 1, 1930, holding companies advancing money in this way charged 8 per cent interest. From then on, as a result of criticism by public service commissions, the rate was lowered to 6 per cent. The New Hampshire Public Service Commission states that ‘ there never was any action by the board of directors of the New Hampshire [Gas and Electric] company on that question’ of lowering the charge from 8 to 6 per cent, ‘neither was there any directors’ authorization to the payment of 8 per cent so far as the treasurer knew,’ and ‘neither the stockholders nor directors ever voted to pay interest on the open account.’ And, the last straw, ‘no effort to obtain money at lower rates has been made.’ These things are not hard to explain when it is borne in mind that the stockholders and the creditors, through open accounts, are the same Associated interests.

VIII

There are two additional methods of increasing the income of the holding companies at the expense of operating companies and their customers: to wit, the engrossment of the fixed capital account, and hence of the rate base on which the owners of the utility are allowed to earn a return; and the diversion of a part of gross income of the utilities by the holding company as service charges. The latter takes many forms.

The write-up of operating-company fixed capital account, usually under pretext of enhanced value of property according to reproduction cost, has for a long time been the stumblingblock in the way of attempts to regulate utilities. Not only has the practice been sustained by courts of law, but it has even crept into federal legislation on valuation of railroads. Its desirability from the owners’ point of view is well stated by the New Hampshire Public Service Commission: ‘The greater the value of the plant devoted to the public service, the larger the income must be to pay a fair return on that value. In all rate cases the engineers for the utility almost ahvays evidence a value in excess of that testified to by engineers representing the complainant.’

The only variation that the Associated management has introduced into this method of increasing earnings without any additional investment in fixed capital is the expeditious manner in which the enhancement of valuation is achieved. Although in many cases actual engineering reappraisals have been made, often the management has not been satisfied with the meagre results. It has adopted the much quicker method of charging to the fixed capital account a flat increase of 45 per cent of book cost. This is known under the euphonious name of ‘ Brooklyn Borough Overhead.’ In 1926, a district court in New York allowed approximately a 45 per cent increase in the value of Brooklyn Borough Gas Company capital. The Associated management took advantage of this liberality; with one fell swoop these overheads, to quote from the Federal Trade Commission’s study, ‘were applied by company officials to all properties, regardless of the similarity of the property of their respective companies to the Brooklyn Borough Gas Company’s property.’

IX

The procedure used in writing up the property value of the Derry Electric Company (New Hampshire) in 1930 illustrates this as well as many other points described in the foregoing discussion. It is one of those discoveries that give the research worker in the field of corporate morals and manners the same thrill as the finding of a weird statue of a Mayan god brings to an explorer. To begin with, we must picture the corporate set-up in New Hampshire: there is the New England Gas and Electric Association, sister company of Associated Gas and Electric Company organized in 1926 as a Massachusetts voluntary trust; it owns the common stocks of the two operating companies, Derry Electric Company and New Hampshire Gas and Electric Company; and the Derry Company has a 5 per cent closed first mortgage outstanding with a par value of $50,000, dated May 1, 1911, and maturing in 1931. This is at the end of 1928.

Now for successive steps of hairsplitting legal logic. (1) Early in 1929 the New England Gas and Electric Association acquired the 5 per cent $50,000 first mortgage. Thus the same company became both owner and creditor of the Derry Electric. (2) Notwithstanding that ‘the books of the company show net earnings sufficient to pay the interest requirements,’ the owner, the New England Gas and Electric Association, decided to default on the interest of said bonds held by itself. This took place on May 1, 1929, and in a letter to the Trustee, dated November 16, 1929, the Directors of Derry Electric waived any period of grace and consented ‘that the Trustee take immediate action to foreclose the mortgage securing its First Mortgage Bonds and sell the property described in or subject to the lien of said mortgage.’ (3) The Trustee, acting at the request of a majority of bondholders, — namely, the New England Gas and Electric Association, — proceeded to foreclose the property of Derry Electric Company, and sold it at public auction on March 18, 1930.

Until now the New England Gas and Electric Association, in the dual capacity of both owner and creditor of the Derry company, was acting like a versatile player who takes two rôles in the same play. But this is not the limit of its versatility. It appears in a third rôle in the next act. (4) The New Hampshire Gas and Electric Company, also owned by the New England Association, buys the Derry property at foreclosure for $547,591, although the New Hampshire Public Service Commission says, ‘At the time there had been no vote either by stockholders or directors of that company [New Hampshire Gas and Electric Company] to purchase or to bid.’ And the Commission goes on to state: ‘The decision to have the property bought in by the New Hampshire Gas and Electric Company emanated from the office of Mr. Hopson.’ (5) Later the bid price ‘was voluntarily increased by the purchaser to $873,950.29, which amount purports to represent the valuation of the properties as fixed by one Edward J. Cheney, an engineer associated with Associated Gas and Electric Company or its affiliated companies.’ (6) Finally, where did the New Hampshire Company obtain the money? It was advanced through open account by the New England Gas and Electric Association by a book entry as of April 30, 1930. The New Hampshire Company paid 8 per cent interest on this account from April 30, 1930, to July 1, 1930, since which time 6 per cent has been charged, ‘although the entry was not made on the books until December 16, 1930.’ The greater part of the $873,950.29 that the New England Gas and Electric Association charged to the New Hampshire Company with one hand it received with the other by virtue of its being the principal creditor of the Derry company on open account and through ownership of the $50,000 bonds, and by virtue of its being also the sole stockholder.

Thus the New England Gas and Electric Association acted in the triple capacity, directly or through subsidiaries, as owner (therefore debtor), creditor, and purchaser of the Derry properties. And the net result was, first, a write-up in the value of the Derry plant by nearly 60 per cent; second, an open-account indebtedness of the New Hampshire Company, on which it paid 8 per cent interest for a while and 6 per cent thereafter; and in the third place, whereas formerly the equity of the New England Gas and Electric Association was a part creditor and part ownership lien, it now obtained a creditor lien against an operating company in the amount of the inflated value of the Derry property. This transaction was one of the many activities of the Associated System in New Hampshire over which the State Supreme Court decided that the Public Service Commission had no regulatory authority at law!

X

After studying the methods of increasing holding-company income described above, one would think all possible ways of milking the operating subsidiaries would have been exhausted. This, unfortunately, is not true. Having purchased properties at exorbitant prices, the Associated management must make them pay. Having bought an expensive goose, the management subjects it to all sorts of treatment to make it lay golden eggs.

Further ways by which the Associated System forces the subsidiaries to yield golden eggs are the service contracts. All the companies in the System are directed from one centre and have no will of their own. And yet contracts are executed between service companies, of which there are several in the System, and the operating subsidiaries, by which the latter ‘agree’ to pay sizable service fees. There are four important types of services that are rendered in accordance with contracts. These are: management, engineering and construction, purchasing, and merchandising. The fee for management is 2½ per cent of the operating company’s gross revenue; that for engineering and construction is 7½ per cent of cost of construction; and the payment for purchasing services is 1½ per cent in the United States and Canada, and 2 per cent in the Philippine Islands, of the face value of purchases. The story concerning appliance sales is a different one, as will be shown presently.

A few examples of the way these contracts work to the advantage of the holding company will suffice to show their significance. The management of the Associated properties has been in the hands of the J. G. White Management Corporation, now called the Utility Management Corporation. Up to May 1, 1928, the J. G. White organization was independent. It received specified fees for managing Associated System properties. The Associated Gas and Electric Company, or some other holding company in the System, received 2½ per cent of gross revenue from the subsidiaries and paid J. G. White Management Corporation the specified fee. The amount the holding company received was much greater than the fee paid for the actual management. Thus, for the years 1925, 1926, and 1927 (to July 31), the J. G. White organization received $367,940.42 for management of certain System properties. The total fees collected on the basis of the 2½ per cent of gross revenue of the same properties were $841,423.20. The difference between this and the payment to J. G. White — namely, $473,482.78 — was a pure profit to two Associated holding companies. In regard to these receipts the Federal Trade Commission’s examiner writes: —

It is admitted by the representatives of the Associated Gas and Electric Company that the Associated Electric Company performed no services for the fees received. ... As for the Associated Gas and Electric Company, it also admitted that there were no expenses incurred in respect to any services rendered, and the statements made regarding such alleged services were of an indefinite and intangible nature.

By this token, three dollars out of every seven received from the operating companies on management contracts alone were sufficient to engage an independent concern to do the service, presumably at an acceptable profit to itself. The other four dollars were clear profit to the holding companies, for which they rendered an ‘intangible’ service.

That this profit of four dollars out of every seven received is not an exaggeration of the case is indicated when we compare the actual expenses of rendering services. During the same six years, ending with December 31, 1929, the operating companies in the Associated System paid, in addition to $4,994,738.38 for management, fees of $4,976,205.89 for construction and engineering. This makes a total of $9,970,944.27 for the two types of service. During this period the entire operating expenses of all companies within the System receiving fees amounted to $3,397,204.49. This indicates a clear profit of $6,573,739.78. (Federal Trade Commission Exhibit 5157, MS. p. 1102.) Thus, nearly two out of every three dollars paid by the operating companies for management and engineering was a pure profit over expenses. The same condition obtains in respecl to fees for services in purchasing.

The merchandising contract in effect is a beast of a different hide. Up to December 1, 1928, the business of selling appliances was in the hands of the operating companies, which received the profits and sustained the losses attendant thereto. It was, usually, a profitable business. Perhaps for that very reason the Associated management decided to ‘leave the chaff, and take the wheat.’ This they did by organizing the Associated Utilities Merchandising Company (later named Associated Appliance Corporation), which, beginning December 1, 1928, took title to the operating companies’ merchandise inventories at cost or market, whichever was lower. Since then the operating companies have been doing the work of selling, while the Merchandising Company, an indirect subsidiary of the Associated Gas and Electric Company, receives all the profits. From December 1, 1928, to December 31, 1929, the Appliance Corporation made a profit of $985,791.15. The New Hampshire Public Service Commission delivered itself on this subject in the following terms: ’It is merely a scheme whereby the utility does the same business it did before, in the same way, with the same facilities, through the same office and working force, and the profits are diverted to another subsidiary of the “System” for the benefit of the same ultimate owners.’

XI

Already the reader perhaps says, ’I have enough, my brother.’ But what is the writer to do if age and custom cannot stale the infinite variety of Associated’s ways? With every new occasion it changes its devices. A last variant of the methods of pumping income upward to the holding company must be stated.

Here is the Associated Gas and Electric Company, a holding company whose readiness to serve is considered such an asset to the subsidiaries. One is curious to know how much it costs to support this valuable organization. So we peruse the expense account in the annual report for 1931. And we are face to face with a strange fact. No operating expenses are charged against income! Has a miracle occurred? Has the Associated management found the secret of perpetual motion, or a way of running an engine without cost? Or is the gas register out of order so that we cannot learn how much it costs to run it?

Probing into this matter, we find that the latter hypothesis is the case. The Associated Gas found the proverbial aunt or uncle to pay the bills. And, as you may have guessed, the munificent relatives are the operating companies. The method by which this is accomplished bears the poetic name of ‘Ithaca Working Fund.’ This fund is an account to which the expenses of the holding companies are charged and which is replenished by contributions from the operating companies in proportion to their gross revenues. Except for $20,000 in 1928 and $60,000 in 1929, the expenses of the Associated Gas and Electric Company were paid by the operating companies through the Ithaca Working Fund.

It must be clearly understood that the charges made through the Ithaca Working Fund are in addition to the various contractual fees that the operating companies are obliged to pay. Previously the testimony of the Federal Trade Commission was introduced, according to which a good part of the fees received were pure profit, and the portion accruing to the holding companies was received in return for services of an intangible nature. Now we discover that the operating companies paid twice for these intangible services: once through the Ithaca Working Fund, and a second time through service fees, the latter yielding fat profits.

These duplicate charges are implicit also in the so-called ‘Hopson Bills.’ These are bills presented by H. C. Hopson and Company for accounting and financial services. They are partly charged directly to the operating companies for specific work done, or charged to Associated Gas and Electric Company expenses, which are in turn paid by the operating properties through the Ithaca Working Fund. And yet the management contracts, according to which local utilities pay 2½ per cent of gross revenue, are supposed to cover accounting, statistical, and financial help and advice. The magnitude of these various service charges, system expenses, and the like, is shown by the fact that Associated properties in New York State alone had to pay $7,708,906.54 in the two years 1930 and 1931.

XII

How fitting is Walt Whitman’s braggadocio: —

And indeed there seems to be no law to prevent the fleecing of operating companies. Within the past year the Supreme Courts of New Hampshire and of New York have thwarted the attempts of the Public Service Commissions in those states to regulate the payment of contractual service fees by operating subsidiaries of the Associated System.

For a long time the ruling opinion of the Supreme Court of the United States was the dictum enunciated in the Southwestern Bell Telephone Company vs. Missouri Public Service Commission case, where the court quoted another case: ‘The Commission is not the financial manager of the Corporation, and it is not empowered to substitute its judgment for that of the directors of the Corporation; nor can it ignore items charged by the utilities as operating expenses unless there is evidence of the abuse of discretion in that regard by the Corporate officers.’ This opinion was modified in the Smith vs. Illinois Bell Telephone case (1930) sufficiently to allow state commissions the right to examine the cost of rendering services. As yet the beneficial possibilities of this generous attitude have not been explored by lesser courts.

Even though a law was enacted in New York in April 1930, giving the Public Service Commission power to regulate service contracts, the Supreme Court of the state found, in a decision handed down on May 9, 1933, that the authority of the Commission did not apply to contracts made prior to April 1930. Supreme Court Justice F. Walter Bliss said in rendering the opinion: ‘If, as is alleged in the complaint, there were outstanding valid contracts of this nature before this law became effective, the parties to such contracts are bound by them, may execute them, and there is no authority in the Public Service Commission to prevent payments under them.’

These opinions, although perhaps the result of good legalistic logic, disregard the very obvious fact that the management of the operating company, being completely controlled by the holding company, has no will and judgment independent of the interests of the holding company. In fact, at least in one case that has come to the attention of the writer, the directors of an operating company in the Associated System did not ratify a service contract until fourteen months after it had gone into effect and payment of fees was being made. Under such circumstances the attempts made by the courts to distinguish between the will of the holding company and that of the servile operating-company management seems like solving the ancient difficulty of determining whether the Holy Ghost proceeds from the Father, the Son, or both. And yet a whole system of legal religion has been built upon the immodest solution of a similar difficulty.

XIII

What should be the attitude of the voter when the debate ‘Customer versus Investor’ is presented to him? We cannot expect an unbiased opinion from customer-owners of utility securities. But, even for the rest, it is not an easy matter to settle. The circumstances under which utilities operate are such that it is not only a matter of justice but also one of expediency, if adequate service is to be obtained, that people who put their savings into utility properties shall receive fair and adequate compensation. But, beyond that, should we expect the customers to support corporate liabilities that far exceed the cost value of the property in their service? And this is exactly what happens when the fixed capital account and the operating expenses of local utilities are boosted by extraneous charges.

Fortunately the problem is not as acute in the case of other utility systems as it is with the Associated. The Commonwealth and Southern Corporation and Columbia Gas and Electric Corporation voluntarily placed the servicing of their operating companies on a no-profit basis. The North American Company, and, so far as this writer is aware, the Niagara Hudson Power Corporation, never had any service charges. And the Electric Bond and Share Company reduced them materially in 1929, though it is not yet known whether this means sufficient change of policy not to necessitate further alterations in order to conform with Section 3 of the Constitution of the newly organized Edison Electric Institute, which states that ‘the charges to the operating company shall be reasonable and commensurate with the value of the services rendered and the fair cost thereof to the company furnishing the services.’

In the list of companies participating at the organization of the Institute, the Associated Gas and Electric Company was conspicuous by its absence. It is not known whether it has become a member by this time. It has made every effort to resist attempts at regulating the different ways in which it diverts funds from subsidiaries. This adamantine attitude is due to the fact that, unless the pumps that draw income are doing overtime work, the capitalization of the holding company would be in danger of decaying. So, instead of conforming to the trend in the industry toward self-regulation, it has resorted to public appeal. Here is the sort of diatribe it has begun to issue (annual report, 1931): —

Political agitation against public utilities no doubt has an adverse effect upon utility securities. The principal cause of government regulation of private business in the past has been the purported safeguarding of the public interest against the evils of unrestricted competition on one hand and of unrestricted monopoly on the other. Neither of these conditions obtains in the public-utility industry, and the current criticism comes not from a public that is seeking better service but from politicians who are seeking votes. This is a matter which warrants consideration by every holder of public-utility securities, because it is a matter that can be remedied only by an aroused public opinion.

A final reason why Associated securities are underpriced is that the abuses of holding-company power by some utility holding companies have been carelessly alleged against all holding companies, the Associated included. A careful inspection of Associated Gas and Electric Company history will show that it is not responsible for such abuses.

This, taken with the conflicting statements appearing in profusion in advertisements and in the plan of reorganization of capitalization made public on May 17, 1933, recalls the sad soliloquy of Gertrude, mother of Hamlet: —