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Hon. HARLEY 0. STAGGERS, Chairman
(With comments on H.R. 12128 by SEC and ICC)


Printed for the use of the Committee on Interstate and Foreign Commerce



For sale by the Superintendent of Documents, U.S. Government Printing Office
Washington, D.C. 20402-Price $1.50

HARLEY O. STAGGERS, West Virginia, Chairman
JOHN E. MOSS, California
HASTINGS KEITH, Massachusetts
JOHN D . DINGELL, Michigan
JAMES T. BRO YHILL, North Carolina
J. J. PICKLE, Texas
F R E D B. ROONEY, Pennsylvania
BROCK ADAMS, Washington
RAY BLANTON, Tennessee
JOHN G. SCHMITZ, California
W. S. (BILL) STUCKE Y, JR., Georgia
LOUIS FREY, JR., Florida
JOHN WARE, Pennsylvania
Professional Staff


HARLEY O. STAGGERS, West Virginia, Chairman
J. J. PICKLE, Texas
RAY BLANTON, Tennessee
DANIEL J. MANELLI, Acting Chief Counsel
JAMES F. BRODER, Special Assistant
JAMES R. CONNOR, Special Assistant

WILLIAM T. DRUHAN, Special Consultant

ALBERT J. MCGRATH, Special Assistant
MARK J. RAABE, Attorney

B E N M. SMETHURST, Special Assistant

On the occasion of the publication of the "Staff Report of the
Securities and Exchange Commission to the Special Subcommittee
on Investigations on the Financial Collapse of the Penn Central
Company/' I feel it appropriate that we take a comprehensive look at
the Perm Central bankruptcy, its causes and its results, and the
adequacy of the laws and regulatory agencies which administer those
The collapse of the Penn Central is the single largest bankruptcy
in our nation's history. The ramifications of that bankruptcy extend
far beyond those unfortunate enough to have been stockholders.
For them, as for those whose pensions were dependent upon investments in Penn Central, the bankruptcy was a major tragedy. In
addition to these investors and pensioners, however, the bankruptcy
had a major impact upon our national economy. The run on commercial paper caused by the Penn Central collapse could have created
a serious liquidity crisis for our nation's businesses except for the
timely action of the Federal Reserve Board. The Eurodollar offerings
which were being encouraged as a means of curtailing balance of payments deficits lost their investment attractiveness in the overseas
markets. Indeed, the interruption of commerce which is so dependent
upon our highly complex and interwoven transportation system was
A great many recommendations have come out of different studies
of the Penn Central Collapse. The first recommendations were
included in a Staff Study by the Special Subcommittee on Investigations entitled "Inadequacies of Protections for Investors in Penn
Central and other ICC-Regulated Companies." This report limited
itself to the interplay of the Interstate Commerce Act and the Federal
securities laws. Thereafter, in an extremely careful and detailed study
the staff of the House Committee on Banking and Currency reported
on its investigation of "The Penn Central Failure and the Role of
Financial Institutions." Now, we have the recommendations of the
SEC as a result of its staff study. The time has come for serious
consideration of what Government can do to protect the public
interest including the following:
1. Elimination of exemptions for rail and motor carriers from the
Federal securities laws,—The securities of carriers regulated by the
Interstate Commerce Commission are generally exempt from the
disclosure requirements of the Federal securities laws. Similar exemptions are not available for airline carriers regulated by the Civil
Aeronautics Board; wire carriers regulated by the Federal Communications Commission or gas and electric carriers regulated by the Federal
Power Commission. The intent of Congress in 1933 in creating the
first of these exemptions for ICC regulated carriers was based on the
assumption that the extensive regulation of rail securities then being


exercised by the ICC would be the best protection for investors. At
that time the SEC did not exist and motor carrier securities were not
regulated by the ICC. Thirt3r-nine years later, the SEC does exist and
the reasons for exempting rail and motor carrier securities no longer
seem valid.
On December 8, 1971, I introduced H.R. 12128, a bill "to extend
the protection provided by the Federal securities laws to persons
investing in securities of carriers regulated by the Interstate Commerce Commission." The SEC fully supported this proposed legislation. The ICC, on the other hand, generally opposed it. The comments
of both agencies regarding H.R. 12128 are included at the end of this
2. Improved legislative and regulatory control over diversification of
transportation companies,—Transportation carriers in their function
as utilities operating under a public license are in a position to monopolize a segment of the national economy and thereby insure a guaranteed
source of funds. Diversion of those guaranteed funds out of the transportation business and into other endeavors offering a more attractive
investment return is increasing. There are today significantly more
transportation holding companies and holding companies with transportation components than there were a decade ago. There is also
greater concentration among the major transportation companies.
One motor carrier, in order to further its program of diversification,
was found by the ICC to have exceeded its standard for an acceptable
working capital ratio and unreasonably mortgaged the carrier's operating equipment. The experience of the Penn Central with diversification proved that profits on acquired non-rail operations are often
illusory while the out-of-pocket costs of acquisitions are quite real. In
the same vein the increasing diversification by air carriers may result
in unreasonably encumbering airline operating equipment while the
costs of acquisition exceed the real benefits thereof.
The record is not clear that diversification is absolutely bad. In the
final analysis the process of diversification by transportation companies might possibly prove to be the boon to the transportation
industry which its supporters claim. On the other hand, it may be that
transportation holding companies will indulge in many of the same
abusive practices which electric and gas holding companies engaged in
before the passage of the Public Utility Holding Company Act of 1934.
Until a thorough analysis is made of the public interest benefits for
diversification by the regulated transportation utilities, a proper conclusion may not be reached. In <.rder to make this analysis, I have instructed the staff of the Special Subcommittee on Investigations tr
collect and study all the available data on diversified transportation
companies and to repoxt back to me.
3. Federal incorporation of companies regulated by the ICC and
CAB,—Public utility oriented companies which are regulated by the
ICC and CAB serve a national interest. As such, they cannot enjoy
the same latitude of business discretion as unregulated companies.
Directors and officers of those regulated companies may find a conflict in their responsibilities to their stockholders and in their responsibilities to serve the public interest. Incorporation of such companies
under Federal laws could insure uniformity of corporate and individual
4. Increased regulatory restrictions on dividend policy,—For a considerable period before the bankruptcy, Penn Central and its pred


ecessors had maintained a policy of paying dividends out of borrowings
rather than admit there were no real earnings. Stockholders were led
to believe they were being paid dividends when in effect they were
really receiving repayments of capital. It was this policy in particular
which lulled the small investors into trusting in the safety of their
In a period of severe negative cash flow, Penn Central continued to
pay attractive dividends through massive borrowings at higher and
higher interest rates. The great bulk of these borrowings were ultimately subject to ICC approval. Apart from any considerations of
fraud under the Federal securities laws, a policy of mortgaging future
operations to maintain a current dividend policy not justified by current operations should scarcely be the practice of a regulated utility.
A temporary market aberration may warrant occasionally retaining
an established dividend in excess of earnings, but not indefinitely.
In the event regulatory controls over dividend policy cannot be
implemented with existing laws, new legislation may be needed. I am
requesting the ICC to consider this matter and report back to me.
5. Extraterritorial application of the Federal securities laws.—One of
the more unfortunate aspects of the Federal securities laws is the
limitation of their enforcement to the United States. Capital markets
today are not territorial, and overseas investors are not solely large
financial houses. Foreign investors apparently are not entitled to the
full disclosure protections which U.S. residents enjoy. They should be.
Eurodollar offerings by major American corporations have played
an important role in limiting the outflow of U.S. investment. They
have also introduced individual European investors to the American
capital markets. When Penn Central had exhausted all reasonable
capital sources in the United States, it was able to borrow overseas
because of the goodwill established by other U.S. companies. Unless
overseas investors can rely upon the protections assured to American
investors, their confidence in U.S. investment will not be retained.
6. Restrictions on interlocking directorates.—Since 1914 Section 10 of
the Clayton Antitrust Act has prohibited a carrier from having any
dealings in securities in excess of $50,000 per year with another
corporation having the same officers or directors except pursuant to
competitive bidding under regulations established by the ICC. A note
or other evidence of indebtedness including commercial paper is a
security. A number of banking and other financial institutions made
loans to and engaged in other commercial transactions with Penn
Central while maintaining their control relationships through membership on the Board of Directors of the carrier. I am specifically
requesting the ICC to examine the record in fulfillment of its responsibility under Section 10.
The SEC report carefully documents the great conflict of interest
situations in which the banking and financial institutions found themselves whenever they had dealings with the Penn Central. One bank
with an interlocking director chose to make indirect loans "because a
direct loan would constitute a conflict of interest." In sum, any benefits
from interlocking directorates seem clearly outweighed by the potential
abuses which might flow from such relationships. An outright prohibition of interlocking directorates between public utility oriented companies and banking and financial institutions may be in the best
interests of the public, the regulated companies and their financial


7. Insulation of commercial banking functions from bank trust departments.—The flow of information into a banking institution which is
performing vital commercial banking functions must be of utmost
confidentiality. A bank trust department is no more entitled to intrude
upon the confidentiality of that banking relationship than any member
of the general public.
Whether or not the trust departments of the banks serving Penn
Central did intrude upon this relationship I am not in a position to
say. It seems to me that the mere appearance of evil is enough to
warrant stricter regulatory controls divorcing the commercial and trust
departments for all purposes including research and investment advice
and interchange of personnel.
The law is quite clear that the actual use of confidential information
to profit on a securities transaction is prohibited. To avoid the appearance of evil, I am requesting the SEC to consider whether pursuant to its rule making authority it could and should adopt a rule
limiting the investment activity of a trust department when a commercial banking relationship exists.
The chronicling of the Penn Central fiasco is not yet complete. Other
reports can be expected. The efforts of the staff members of the SEC
who were involved in the preparation of this report are to be commended. Their report will find an important place in the histories of
the Penn Central bankruptcy.

Chairman, Special Subcommittee on Investigations,
Committee on Interstate and Foreign Commerce.



Washington, D.C., August S, 1972.


Chairman, Special Subcommittee on Investigations, Cmmittee
Interstate and Foreign Commerce, House oj Representatives,
Washington, D.C.
D E A R M R . STAGGERS: I am pleased to transmit a copy of our staff's
comprehensive report of its investigation into the relationship between
the Federal securities laws and the financial collapse of the Penn
Central Co. We initially disclosed this investigation in testimony
before your committee in September 1970. Since that time, the Commission's staff has taken over 25,000 pages of testimony from 200
witnesses, studied tens of thousands of pages of exhibits and examined
relevant records of 150 financial institutions. Their report summarizes
one of the most extensive evidentiary and analytical records ever
accumulated in a single inquiry by the Commission's staff. This
extensive inquiry was needed not only to fully understand the application of the Federal securities laws to the Penn Central affair, b u t
also to point the way to possible modifications of these laws and their
implementing regulations.
I believe this report brings into sharp focus a cogent analysis of the
factors behind not only the failure of a major railroad merger b u t also
a failure to recognize in timely fashion and bring to public attention a
crumbling structure in which shippers, passengers, creditors, investors,
governments, and the public at large had such a major interest.
Because the Commission is considering possible enforcement actions,
I am refraining at this time from commenting specifically on possible
violations of existing law which might subsequently be alleged in such
actions. I believe, however, that it is appropriate for me to bring some
of the broader and deeper implications of this report to the attention
of the Congress, members of the business community who are required
to comply with the securities laws, and lawyers, accountants, and
other professionals who assist the Commission in securing compliance
with these laws.
The basic securities laws, enacted almost 40 years ago, provide for a
fairly comprehensive pattern of disclosure and regulation. For^ almost
40 years the Commission has worked steadily at implementing the
laws and adapting the emerging regulatory pattern to the needs of a
more sophisticated, more sensitive, and more involved investing
public. This report brings out areas in which both the basic law and
the implementing regulations should be strengthened.
The first thing I would point out is that the securities laws contain
exemptive provisions which permitted Penn Central and those involved in its financing and investments to operate free of several



important components of the regulatory and disclosure pattern which
the Congress and the Commission have established under the securities
The first of these exemptions frees companies regulated by the
Interstate Commerce Commission from registering securities sold to
the public with Securities and Exchange Commission. You introduced
legislation in December 1971 (H.R. 12128), which would eliminate
the exemptions for ICC-regulated carriers under the Federal securities
laws. We have supported that legislation. It seems to me that in an
era where so many corporations engage in multiple activities, exemptive provisions which permit the regulated and the unregulated to
engage in the same kind of activities should be reexamined to assure
that no corporate entity, regardless of what its principal activity
may be, would, in any particular activity, be held to any lesser standards of scrutiny or disclosure than others.
Another exemption frees the sale of short-term corporate or "commercial" paper from registration requirements. The Securities Act
of 1933 exempts commercial paper if used for "current transaetions"
and having a maturity "not exceeding 9 months." The Commission
in the past has given broad meaning to the "current transactions test."
Regardless of the maturity and the "current transaction" test, the
railroad company's paper was exempt from registration as a
security issued by a common carrier with the approval of the ICC as
provided in section 3(a)(6) of the Securities Act of 1933. The antifraud provisions of the 1933 act apply to the sale of securities exempt
from regulation, although commercial paper having a maturity up
to 270 days is not a security for purposes of the Exchange Act of 1934.
The staff report unfolds a picture of commercial paper which was
continuously rolled over so as to serve the purpose of long-term financing and used not to finance commercial transactions but to meet cash
requirements arising from physical improvements and operating
losses. Also, the report demonstrates scanty investigation of the
strength of the company, reliance on the management's verbal
assurances about the financial condition and prospects of the company,
and little or no effort to transmit to buyers information about the
company and developments which threatened its solvency. When
Penn Central went into bankruptcy in mid-1970, American corporations had some $40 billion of commercial paper outstanding. You will
remember that the shock waves set off by the $80 million loss in Penn
Central paper placed enormous strain on our banking system as more
than $2 billion in bank money went to help corporations pay off
maturing commercial paper. Only strong and prompt action by the
Federal Reserve Board prevented what could have been a liquidity
crisis disastrous to the health of the entire economy.
While the staff report identifies the Penn Central situation and its
impact on the commercial paper markets as one resulting primarily
from a lack of adequate disclosure concerning the issuer of the commercial paper and the dissemination and digestion of that disclosure
by the appropriate segments of the investing public, we also have
reviewed generally the regulatory framework within which commercial paper is issued. We believe that Congress should give
consideration to amending the exemptions for commercial paper in
order to provide more definite standards, for example, as to such
matters as the denominations in which it may be offered and sold, in


order to prevent this type of unregistered security finding its way into
the hands of the investing public in general, rather than financial
institutions, as it appears Congress originally intended.
The cornerstone of public confidence in our securities markets and
of the securities laws is full, accurate, and meaningful disclosure,
made on a timely, equal and public basis to all investors. The Commission's staff report shows a wide margin of failure on the part of
Penn Central in meeting this standard. The report itself and, in
capsule form, its Introduction detail this failure.
When evaluating the disclosure lessons to be learned from the Penn
Central affair, it is important to keep in mind that although the
securities laws exempted Penn Central from filing registration statements, sale of the company's securities was subject to antifraud rules
and the company was required to file financial statements with the
Commission. However, this latter requirement could be satisfied by
financial statements based on ICC's accounting rules, which are
primarily designed for ratemaking purposes and which do not call
for the special requirements designed by the Commission to protect
As we review the disclosure history of Penn Central, we get a picture
of high euphoria and inflated prospects about the savings to be achieved
by the merger with the manifest difficulties ignored or overlooked.
When these difficulties emerged as painful realities, they were inadequately disclosed. The annual reports put out for 1968, 1969, and 1970
obscured the railroad's further movement into debt amid mounting
operating losses. Instead they emphasized that efficiencies, improvement in service, and new exciting revenue sources were just around
the corner. The Commission has not sought to control the content of
the annual reports sent out to stockholders. However, for most public
companies, it does control the form and content of the quarterly and
annual financial reports filed with the Commission. We have been
encouraging companies to include in the annual reports sent to shareholders the kinds of detailed breakdowns and supplementary information which we have required to be included in the reports submitted and filed with the Commission, because we think these breakdowns and supplementary data have a special value to investors. We
have been only partially successful and, accordingly, we have released
a proposal that, in filing their reports with the Commission, companies
be required to indicate the items of information which have not been
covered in the annual reports sent out to stockholders. We believe
this will simplify the task of financial services in bringing to public
attention the information filed with the Commission but not included
in reports and help close the information gap between reports mailed
to shareholders and reports filed with the Commission.
The staff report shows that as both the operating and liquidity
condition of Penn Central deteriorated, its management made increasingly strenuous efforts to make a bad situation look better by
maximizing reported income. An elaborate and ingenious series of steps
was concocted to create or accelerate income, frequently by rearranging holdings and disposing of assets, and to avoid or defer transactions which would require reporting of loss. Accounting personnel
testified that they were constantly under intense pressure from top
management to accrue revenue optimistically and underaccrue expenses, losses, and reserves, to realize gain by disposing of assets and


to charge losses to a merger reserve which would not take them through
the income statement. Gains were reported on real estate transactions
in which the realization of benefits to the company depended on operating results far into the future and in which there was little if any real
change in the character or amount of assets owned by Penn Central.
In this connection, the Commission has already taken administrative
action to order correction of reported figures in the case of Penn Cent r a l ^ subsidiary, Great Southwest Corp.
The whole pattern of income management which emerges here is
made up of some practices which, standing alone, could perhaps be
justified as supported by generally accepted accounting practices, and
other practices which could be so supported "with great difficulty, if at
all. But certainly the aggregate of these practices produced highly
misleading results. The accounting profession is in the course of
reorganizing and accelerating its efforts to create more uniform accounting standards. A special committee of the AICPA is undertaking
a redefinition of accounting objectives. This report underlines the
urgency of those efforts. I t is essential that the end result of applying
accounting principles be a realistic reflection of the true situation of
the company on which a report is prepared. Here, there was no adequate presentation of the fundamental reality that reported income
was not of a character to make a significant contribution to the
pressing debt maturities and liquidity needs of Penn Central, nor was
it of the sort that might reasonably be expected to be evidence of
continuing earning power.
The public was left unaware of the absence of cash flow and the
magnitude of the cash loss. Management implied in its public statements that the cash drain came from improving the road's facilities
when in fact it came from poor operations.
Effective December 31, 1970, the Commission introduced a requirement to file a source and application of funds statement designed to
bring out an issuer's flow of cash and the source and use of cash resources. This applies to all reporting companies except those subject
to ICC and other governmental agency accounting regulations. The
report's findings emphasize the importance of requiring that all
companies make this kind of specific disclosure in order to alert investors to liquidity problems.
I have directed that the Commission's staff undertake a study of
other ways in which the liquidity position of a corportion can be
more realistically disclosed. At a minimum, it would seem that improved disclosure of pending debt maturities and contractual commitments requiring cash outflows in the near future and the cash
resources available to meet them would be required so that the
financial viability of publicly traded corporations would be brought
out as clearly as their operating performance.
I would also urge the national stock exchanges to review their
listing standards with a view to requiring that reports to shareholders
also bring out the relationship between liquid resources, borrowing
power, and imminent obligations to establish public disclosure of the
continued financial viability of a listed corporation.
Despite the absence of cash earnings, Penn Central continued to
pay dividends at an annual rate of $56 million until November 1969.
The company had to pay high interest for the dividend money and
face high cash demands with no idea of where the needed cash would
come from. I n these circumstances, we believe that there is an obliga


tion on the part of management to make full public disclosure of the
considerations and implications as well as the source of dividend
In its annual reports, Penn Central obscured the source of its income and losses. Railroad operating losses were combined with other
income sources until the underwriters forced a recasting of the figures
in the offering circular. To fully enlighten investors on the principal
sources of income and loss for a multiproduct compan}^ in 1970 the
Commission adopted a rule requiring a breakdown of sales and earnings for each line of business producing 10 percent of revenues.
The staff report clearly brings out the value of the requirement to
file a registration statement. Penn Central, because it was under the
jurisdiction of the Interstate Commerce Commission, was not required
to register its public offerings with this Commission. I t was required
to apply to the Interstate Commerce Commission for permission to
increase its debt obligations and ICC did find that the proposed increases in its debt were in the public interest but it had no explicit
responsibility for investor protection. Because the civil liability provisions of the securities laws do apply to the sale of railroad securities,
despite the absence of a requirement that offerings be filed with, and
subject to review by the Securities and Exchange Commission, the
threat of civil liability made it necessary for underwriters and their
counsel to apply SEC disclosure standards to the offering circular to
be used in the sale of Penn Central securities. The staff report shows
how the scrutiny applied and disclosure required by underwriters
and lawyers made it impossible for Penn Central to offer the securities
of a failing company to investors. I t is encouraging to note that Penn
Central management failed in its demand that the law firm acting for
the underwriter remove from the assignment a lawyer who was
particularly diligent in demanding full and unvarnished disclosure.
While the underwriters and their counsel resisted the distribution of
an offering circular that did not contain what they believed to be adequate disclosure, the placing of the entire focus of disclosure on the
offering circular does not appear, under these circumstances, to have
been the most appropriate way to make public the rapidly deteriorating financial condition of the company. Some analysts were able to
put items of information together to arrive at a judgment that the
solvency of Penn Central was threatened. If Penn Central management
had met its obligation of disclosure, it would, by direct statements,
have been bringing out and putting together the factors which these
analysts used in arriving at that judgment. I t might also be noted
that in order to evade this obligation, a Penn Central public relations
officer suggested that requests for information about the status of the
company might be dealt with by "saying that we are considered to be
in registration at this time and are not free to talk." Over the last year,
the Commission has emphasized strongly that the imminence of
a security offering does not relieve management of the obligation
to make prompt and independent disclosure of new material
The staff report shows how Penn Central, when unable to obtain
needed financing in this country, turned to foreign markets for funds.
This source of funds is an extremely important one, which we can lose
if we permit a credibility gap to develop with respect to disclosure
made by companies offering securities abroad. Consideration should be
given to steps necessary to assure a high quality of disclosure on the


financial condition and performance of U.S. corporations whether
they are dealing in domestic or foreign markets.
The staff report examines the role of the directors. The responsibility of directors is primarily a matter of State corporate law. But
directors have a responsibility to see that their corporation and the
management they select obey the Federal securities laws.
I t is difficult to see how this responsibility can be satisfactorily
discharged unless the directors themselves obtain from management
information which is adequate in both quantity and quality. To be
adequate, this information has to be both factual and judgmental.
I t has to deal with the past, present, and future. This was brought out
very effectively by a new director, joining the Penn Central board in
M a y of 1969, in a memo to the chairman of the board pointing out
that lists of new equipment did not particularly help him discharge
his responsibilities as a director and spelling out the kind of information
about objectives and performance and about problems and plans for
overcoming them which he would need to do his job as a director.
Today's more sophisticated investor needs, perhaps in a broader and
more general way, the same kind of picture and he is entitled to it if
the disclosure process is to do as well in the future as it has done in
the past in maintaining general public confidence in our securities
markets. The Commission, taking a look at the future, has paid
increasing attention to the role, the qualifications, the responsibilities,
and the independence of corporate directors, which appear to be
called for. Last month the Commission released a statement endorsing the establishment of audit committees composed of independent directors. The staff report points up the critical importance
of the whole subject of the responsibility of directors, the greater
utilization of public and independent directors, the prof essionalization of their function, providing staff support for directors and
judging their performance not on the basis of hindsight but on the
basis of the reasonableness of their judgments in the circumstances
and at the time it was exercised.
The report also examines the way throe major banks handled their
obligation under the securities laws to assure that nonpublic information obtained in the course of commercial lending is not used by the
trust department in its investment decisions. These institutions recognized tins obligation and set up procedures, with varying degrees of
adequacy, to meet it. The report points up the possibilities of conflicting
responsibilities where such inside information is available to operating
divisions of the institutions and the need for adequate procedures to
prevent misuse of such information where this situation exists.
Lastly, the report goes into the circumstances surrounding sales of
Penn Central securities by management officials during this period
in connection with the question whether sales by some individuals
occurred while they were privy to material adverse inside information
concerning the company. If this occurred, it might involve violations
of existing law, and accordingly, I express no view at this time on the
question. In addition, the report's analysis of the activities of a private
investment fund composed primarily of principal corporate officials and
their financial advisers raises questions of possible conflicts of interest
and misues of inside information and suggests the need for consideration of additional controls in this area.


The report represents the culmination of a lengthy and exhaustive
inquiry by our staff. I hope it will be a catalyst for considering significant improvements and reforms in the securities field. In this letter
of transmittal, I have tried to indicate some recent improvements in
our rules which are relevant to the problems brought out by this report
and to suggest other measures that should be considered.
Respectfully yours,



Letter of transmittal
Chronology of events
I-A. Railroad difl&culties: Merger and operating problems
Premerger period: History
Premerger period: Merger expectations
Premerger period: Planning
Postmerger period: Service problems
Earnings record
Merger savings and costs
The ICC study
Reported earnings
I-B. Income management
The maximization policy
Pressures on the accounting department to allow the reporting of
higher income
The November confrontations
The "spongy" areas
The merger reserve
Other devices to increase railroad earnings
Nonrailroad operations
Real estate activities
The search for investment income
Early 1970—The last gasp
Accounting treatment
Madison Square Garden Corp
Trucking company dividends
Washington Terminal Co
Lehigh Valley Railroad Co
Merger reserve: Separation of mail and baggage handlers
Executive Jet Aviation
The $10 million Liechtenstein account
The role of the independent auditor
I-C. Finances
Cash flow versus "earnings"
Some causes of the cash loss
Operations losses
Interest costs
Cash relationship
Management's vantage point
(1) Cash situation at time of merger (Feb. 1968)
(2) Immediate crisis (mid to end 1968)
(3) Crisis grows (end 1968 to fall 1969)
(4) Last efforts (fall 1969-June 1970)
Postscript: A case study
I - D . Public offerings
Fifty million dollar debenture offering
One hundred million dollar debenture offering
Warrants for Great Southwest and Penn Central stock
Discovery of underwriters of Penn Central's critical problems -



Part I—Continued
I - E . Great Southwest Corp
Great Southwest Corp
Great Southwest and Penn Central
Profit maximization
Some other methods
Tax allocation agreement
Officer employment contracts
Abandonment of proposed offering of Great Southwest stock
Failure of alternative efforts to sell Great Southwest stock
Exchange of Great Southwest stock for debt owed to Pennco
Great Southwest financing after abandonment of the public
Futile attempts at an earnings encore—1970
I - F . Role of directors
Introduction: Responsibilities and fundamental problems
Premerger period
Postmerger period
Financial problems and a first challenge to dividend policy
Investigation of Bevan abandoned
Fall 1969: Gorman/Gengras—A beginning request for information
Robert Odell on Great Southwest and management
The final months
I-G. Disclosure
Railroad operations: The merger
Railroad earnings
Nonrailroad earnings
Disclosures relating to 1968 earnings
Disclosures relating to 1969 earnings
Disclosures relating to 1970 earnings
Cash flow and
The professional analyst
Summary and conclusions
Part II
— 205
II-A. Sale of Penn Central stock by institutions
Chase Manhattan Bank, N.A
Morgan Guaranty Trust Co
Continental Illinois National Bank & Trust Co
Alleghany Corp. and Investors Diversified Services, Inc
I I - B . Trading by officers and directors
Officers—Real estate and taxes
Officers—Operations and labor
General corporate officers
Chronology of officer sales discussed in report
Part I I I —
III-A. Sale of commercial paper
Commercial paper
The market for commercial paper
Penn Central Transportation Co.'s commercial paper
Other financial relationships between Goldman, Sachs, and the
Transportation Company
Methods employed by Goldman, Sachs to sell the Company's
commercial paper to customers
Goldman, Sach's position on the sales of the Company's commercial paper___
III-B. Role of National Credit Office in rating the commercial paper
of Penn Central


Part IV

Summary of transactions
Chemical Bank
Kaneb Pipe Line Co
Great Southwest Corp
Tropical Gas Co., Inc
Continental Mortgage Investors
Florida Banks
Symington Wayne Corp
National Homes Corp
Appendix A—H.R. 12128
Appendix B—S.E.C. comments on H.R. 12128
Appendix C—I.C.C. comments on H.R. 12128



The bankruptcy of the Penn Central Transportation Co. on June
21, 1970 came as a surprise to much of the public, including many
Penn Central shareholders. Only 2% years earlier the company had
been formed by the merger of the Pennsylvania and the New York
Central railroads to fanfares of optimism. The merged road was going
to be more efficient and was going to produce sizable earnings. In
addition, diversification into real estate development and other areas
was seen as the beginning of a profitable conglomerate growth. These
heady prospects sent the stock price soaring from approximately 20 in
the early 1960's, when the merger was first announced, to 84 in the
summer of 1968, 6 months after merger. The day after the filing for
reorganization the stock sold for 6K- The loss to shareholders, bondholders, and other investors from the collapse of Penn Central is
measured in billions of dollars. Many of these investors were older
people who had invested in Penn Central because of its apparent
solidity and its long record of dividend payments. The Commission's
investigation was conducted to determine whether the events surrounding the collapse of this major corporate enterprise were associated
with violations of the Federal securities laws.

The staff undertook a thorough and extensive investigation of Penn
Central, comprehending all aspects which seemed relevant to its
collapse. This report is a distillation of that investigation, concentrating on certain areas which the staflf determined were most critical from
the viewpoint of the Commission's responsibilities.
The inquiry focused primarily on the events occurring between the
merger on February 1, 1968 and the bankruptcy. However, in some
instances, where the staff believed it was necessary for a full understanding of the facts, premerger conditions were also examined.
The report is arranged in four major parts. Part I involves the
company's possible failure to disclose adverse information to the
investing public. Within this area, the staflf examined the operational
and financial condition of the company and compared this with the
representations made by management. The staflf also inquired into
many of the accounting practices of Penn Central to determine whether
they provided adequate and accurate disclosure. Examination was
made of the affairs of Great Southwest Corp., to determine whether
adequate disclosure was made of the affairs of this important subsidiary. The role of the directors in overseeing the conduct of management and in insuring adequate disclosure was examined. The second
major area of investigation, Part II of the report, relates to possible
trading on nonpublic information by individuals and institutions.
Part III describes the role of Penn Central's commercial paper dealer
and a commercial paper rating service. The final area, Part IV,
involves an examination of a private investment club in which several


Perm Central financial officers were members and which raised issues
of possible misuse of position by these officers.
Nearly 200 witnesses were called to testify and approximately
25,000 pages of testimony were taken. Among the witnesses were most
of the major officers and directors of the corporation during the
relevant period. Voluminous documents were examined either on site
or by requesting that they be submitted to the Commission's offices.
Every officer or director who to the staff's knowledge had any significant trading was subpenaed and statements obtained through affidavits
or in the form of testimony. In connection with the trading inquiry
the roles of approximately 150 institutions were examined through
document submission or testimony. As a result of this analysis, those
treated individually in this report were selected for special study.

Because the Penn Central organization went through several changes
and contained numerous subsidiaries, a brief note on the organization
and the names used in this report may be helpful. When the New
York Central and the Pennsylvania railroads merged on February 1,
1968 the resulting company was called the Penns3dvania-New York
Central Transportation Co. The name was then changed to the Penn
Central Co. On October 1, 1969 the name was changed to the Penn
Central Transportation Co. upon the formation of a parent holding
company which took the Penn Central Company name. For convenience, the name Penn Central is often used in this report to refer to
the Penn Central complex generally. When reference is made specifically
to the entity containing the railroad in a context which might be
confusing, the name Transportation Co. is used. When reference is
made specifically to the holding company in a context where the
reference might oe unclear, the entity will be described as the holding
company. The Transportation Co. owned 100 percent of the common
stock oi Pennsylvania Co., an investment company, which is often
referred to in this report as Pennco.



Penn Central, despite attempts to convince the public to the contrary, was predominantly a railroad company and its future was tied
inexorably to these activities. Thus, before assessing the information
being disseminated to the public, it is essential to understand what
was occurring in the operations area in general and more particularly
the circumstances surrounding the merger itself.
The merger of the Pennsylvania and the New York Central railroads had been born out of the weakness of the two constituent parts.
Despite such an inauspicious beginning, however, and the obvious
dangers involved in such a situation, little thought appears to have
been given to the basic feasibility. In the premerger period management had conducted a study which purported to show sizable savings
through the elimination of duplicate facilities and in other areas. The
study, however, bore little relation to the consequences of merger of
the two roads. The merger involved more than was revealed in the
study; it involved complicated and costly rebuilding of two roads into
one. The resulting burden on the merged railroad would be twofold:
(1) ample funds would be needed for capital expenditures; and (2)
operational problems could be expected. This presented, in reality, a
bleak picture because the roads had no cash for the expenditures and
no planning or ready skills commensurate with the operations problems. Planning staffs were formed and consultants were hired but to
little avail. There was no adequate supervision or decisionmaking in
the planning process. Some departments, such as the accounting department, never even got to the meaningful planning stage. In the
crucial area of operations, a detailed plan was prepared but was then
abandoned just before the merger. Little or no training of employees
whose jobs would be affected was conducted.
In the postmerger period, as attempts were made to combine the
operations of the two roads, severe service problems materialized and
the losses on railroad operations increased at an astounding rate.
Management blamed the postmerger difficulties on elements beyond
their control including unions, the ICC, Government in general, the
necessity of continuing unprofitable passenger operations, high interest
rates, inflation and the recession. Without denying that these matters
had an adverse impact on Penn Central, as they had on other companies and other railroads, they do not explain the postmerger plunge.
It appears that the collapse was a result of entering a complex and
costly merger without adequate planning and adequate financial and
management resources. Conflicts among senior management officials
further complicated the problem.




Absent a major restructuring of the railroad operations, the drift
into bankruptcy was inevitable. The only question was the timing—how
long the company could keep going. The answer lay in great part in
Penn Central's ability to borrow money and otherwise finance the
continuing deficits from the railway business and the ability of the
company to generate earnings was a major feature which lenders would
consider. For some time prior to merger, management had engaged in
efforts to inflate reported earnings and, as the earnings plummeted due
to merger-related problems, these efforts intensified. The devices utilized involved not only rail operations but even more importantly the
company's real estate and investment activities.
In summary, all possible avenues of increasing reported income
or avoiding actions which would reduce reported income were explored.
Stuart Saunders, chairman of the Penn Central board, established the
policy and looked to other members of the top management team to
implement it. All were expected to watch for available opportunities,
within their own areas of expertise. The accounting department made
a substantial contribution b y watching for devices whereby they
might stretch accounting principles to cover novel situations, emphasizing form over substance on a number of major transactions.
Accounting personnel were expected to select the accounting method
that would provide a maximization of income in every possible
instance. This resulted at times in the taking of inconsistent positions.
I n other cases top management brought pressures on the accounting
department to accelerate or delay the recording of certain items in the
interest of improving currently reported earnings. While it was
recognized the benefit was generally only temporary and would have
to be made up in the future, the hope was that by then the operational
conditions would be improved. At times the pressures reached such a
point that management ran into resistance from accounting department personnel who were concerned with possible criminal liability
arising out of the schemes which were being suggested. And even on
legitimate transactions, Penn Central was often forced, by the immediate pressures for income, to take actions because of the short
term advantages, although from a longer term viewpoint the action
was detrimental to the company. Reported income in these situations
w*as a reflection of weakness, not of strength. Also relevant, considering: the financial condition of the company, was the noncash
generating nature of many of the earnings being recorded.


Although management was able to soften the reported losses by
methods described above, they faced an enormous cash drain of
approximately half a billion dollars between the time of merger and
the time of the bankruptcy. This loss was an inescapable reality for
Much of the loss was caused by the deficits from rail operations.
The payment of approximately $100 million in dividends in the postmerger period also contributed to the drain. The borrowings needed
to meet the cash drain required large interest payments in this period
of high interest rates. When the borrowings reached their peak, the
interest charges on the additional borrowings were approaching $50

million a year. Cash was even needed to support Great Southwest,
a real estate development subsidiary which management claimed
was helping to support the railroad.
The financial crisis was known to management even at the time
of the merger. Penn Central was forced into short term borrowings
because most of its assets were unsaleable, were mortgaged or were
otherwise restricted and Penn Central was not an attractive vehicle
for long term financing. By the beginning of 1969 management
realized that Penn Central was approaching the limits of its borrowing
capacity and that a continuation of the cash drain would spell disaster.
The drain never lessened.
The continuing cash drains created increasing difficulties for
management and an increasing need to conceal the true conditions.
Every additional borrowing created greater restrictions through
pledges of assets and restrictive provisions in the borrowing agreements, and as the need for borrowing increased, the necessity of
concealing the real reasons for the borrowings became greater. Toward
the end management was faced with a potential runoff of commercial
paper if the company's condition became public and with an inability
to raise cash through public offerings where disclosure through
public offering circulars would be required. Penn Central's last
financing was done at high interest rates in foreign markets where
the lenders were still willing to lend to a "name" company.


The only public offerings of securities were made in late 1969 and
early 1970 through Pennsylvania Co. (Pennco), an investment company subsidiary of Penn Central. Pennco's principal assets were large
holdings of the stock of the Norfolk and Western and the Wabash
railroads and the stock of the "diversification'' subsidiaries including
Great Southwest, Arvida and Buckeye Pipeline. Pennco had been
used earlier in 1969 to raise $35 million through a private placement
of collateral trust bonds. By late 1969 much of Pennco's most valuable
asset, the Norfolk and Western stock, was pledged and its large
holdings of Great Southwest stock which at one time had a high value
in terms of quoted market prices was rapidly diminishing in value
because of adverse developments in Great Southwest.
A $50 million debenture offering was completed in December 1969.
This was easily sold because it was convertible into Norfolk and
Western stock. Within 2 months of the completion of that offering,
Penn Central began efforts to sell a $100 million debenture offering.
This offering was never completed.
The offering quickly encountered difficulties related to the overall
problems of Penn Central at that time. The offering in its originally
announced form contained warrants for the stock of Great Southwest
Corp. and of Penn Central Co., a holding company which had become
the parent of the railroad in October 1969. Management had hoped to
delay registration of warrants until they became exercisable in the
future. Penn Central had abandoned a planned public offering of
Great Southwest stock in late 1969 because of the disclosure that
would be required in a registration with the SEC. After doubts were
raised about whether registration could be delayed, the warrants were
dropped from the offering. The Pennco offering circular was under ICC
jurisdiction and was not filed with the SEC.

A more serious problem developed as counsel for the underwriters
began uncovering information about the railroad which indicated that
it was heading for bankruptcy. Although the underwriters were going
to be offering a security of Pennsylvania Co., which they thought
could survive a bankruptcy of the railroad, they were aware that conditions which might so adversely affect the railroad would be important
to potential investors in Pennco. They determined to obtain disclosure
of these facts in the offering circular. Management initially resisted
these efforts and a management official even attempted to have one of
the underwriters' lawyers removed from the underwriting because of
the questions he was raising as a result of the inquiry made into the
company's financial condition.
Although the underwriters resisted these efforts and succeeded in
getting significant disclosures in the circulars, no steps were taken
to point out these disclosures in the public announcements about
the offering or otherwise. Large numbers of the circulars were distributed to broker-dealers and institutional investors and copies were
sent to financial publications. The underwriters were aware, however,
that the offering would only be of interest to institutional investors
and the adverse information in the circulars did not become generally
circulated although some large institutional sellers in May 1970 had
access to and read the offering circular.
Although it was unlikely from the outset that the offering could be
completed, management was able to use its pendency as a part of its
facade of the continuing viability of the company. The abandonment
of the offering was not announced until May 28, 1970.


Great Southwest, a real estate development subsidiary, played a
significant role in Penn Central's affairs. Great Southwest was touted
as an example of the success of Penn Central's diversification program; Great Southwest's financial results contributed significantly to
Penn Central's reported earnings; and the Great Southwest stock
owned by Pennco was Pennco's major asset when valued at market
prices. Perm Central, through Pennco, had acquired control of Great
Southwest and Macco Corp., which later became a subsidiary of Great
Southwest, in the early to mid-nine teen-sixties as a part of its diversification program. Macco quickly became a major problem because of its
large cash drains which had to be met by cash advances from the
At about the time of the merger of the railroads, Great Southwest
and Macco embarked on programs to drastically increase their reported earnings. The principal vehicle used was the "saie"# of large
properties for very large reported "profits" to syndicates of investors
who were motivated to participate because of tax benefits. These
transactions involved only small downpayments and principal payments deferred to future years. Typically there was no obligation that
the investors continue making payments. These were essentially paper
transactions which should not have been recorded as profit. These
transactions were effected in furtherance of the Penn Central program
of inflating reportable profits to offset losses in the railroad.
Senior Macco officials were under employment contracts which
provided they would be paid a percentage of the profits reported.

Because of large profits being reported, Macco paid the officers hundreds of thousands of dollars in 1968. Penn Central management then
renegotiated the contracts which resulted in the officers receiving a
total of $7 million to sign new contracts.
The real estate transactions described above were largely paper
transactions and so the serious cash problem continued. I n 1969 a
public offering of Great Southwest stock was prepared to raise cash.
The offering included a sale by Pennco of some of its holding of Great
Southwest stock. Shortly before the offering was to be filed with the
SEC, it was abandoned because of the disclosures which would have
been required in the prospectus. I t was feared that the disclosures
would cause a sharp drop in the price of Great Southwest stock. This
would have very seriously affected the value of Pennco's portfolio
and Pennco itself was about to be used as a financing vehicle for the
By late 1969 Great Southwest was disintegrating. Changes in
accounting guidelines and tax rulings were preventing further large
tax oriented sales. The cash drain was worsening. I n early 1970, Great
Southwest, like Penn Central turned to foreign financing and borrowed
approximately $40 million in Swiss francs. The nature of Great Southwest's earnings and the problems being encountered were never
disclosed to Great Southwest or Penn Central shareholders.


Pennsylvania Railroad and New York Central directors were
accustomed to a generally inactive role in company affairs. They
never changed their view of their role. Both before and after the
merger they relied on oral descriptions of company affairs. They failed
to perceive the complexities of the merger or the fact that appropriate
groundwork and planning had not been done. After the merger they
claim to have been unaware of the magnitude of the fundamental
operational problems or the critical financial situation until near the
end. They did not receive or request written budgets or cash flow
information which were essential to understanding the condition of
the company or the performance of management. Only in late 1969
did they begin requesting such information and even then it was not
made available in a form that was meaningful or useful.
On at least two occasions, the directors deliberately avoided confrontations with management on issues critical to testing the integrity
of management and providing adequate disclosure to shareholders.
On one occasion, in the summer of 1969, a law suit which claimed improper and unlawful conduct by David Bevan, chief financial officer
of r e n n Central, in connection with Executive Jet Aviation (effectively a subsidiary of Penn Central) and Penphil Co. (a private investment club) was brought to the directors' attention. As they were
obligated to do, they authorized an investigation. When Bevan
threatened to resign, however, they canceled the investigation even
though the charges appeared to be well founded and later proved to
be essentially correct. Without restraint Bevan continued to engage
in questionable conduct including the diversion of $4 million to undisclosed Liechtenstein interests. He also continued as the sole and
important contact between Penn Central and the financial community
to whom he repeatedly misrepresented the company's financial con-

dition. Even in the instance where a director was interested in inquiring into the affairs of a major subsidiary this initiative was not
favorably received by his fellow directors. If such an inquiry had been
made it would have uncovered the improprieties occurring in the
subsidiary and the concomitant need to provide full and adequate
disclosure of that entity's affairs. The directors permitted management
to operate without any effective review or control and they remained
uninformed throughout the whole period of important developments
and activities.


The picture within Penn Central was bleak. The company's disclosure policy, however, is illustrated by a comment which other
members of Penn Central management apparently made on a number
of occasions—"Well, it looks like Saunders has his rose colored glasses
on again." Stuart Saunders, Penn Central's chairman of the board,
set the disclosure policy and made it clear that the others were expected to comply. Professional analysts spoke frequently of the
"credibility gap" they discerned and of the difficulty cf getting adequate and accurate information from the company.
The railroad picture was always presented by management in optimistic terms. There was a stress on the hopes and promises of the
future, particularly those related to the merger, while the immediate
problems were ignored. When put in a position where the immediate
problems arising out of Penn Central's own limitations could not be
ignored Penn Central grudgingly admitted their existence but would
claim the situation had "turned the corner" and was on the upswing.
Yet there was no real prospect of an effective turnaround. The basic
industry problems remained, as did the financial and management limitations of Penn Central itself.
Most shareholders measure success in terms of earnings. Losses from
railroad operations were running at the rate of $150 to $200 million
per year, a rate which clearly could not be sustained for long. However,
this figure was never presented to the shareholders and in other ways
as well, the drain from railroad operations was downplayed. The earnings contribution of nonrail activities was emphasized. No mention
was made, however, of the questionable accounting practices which
had been utilized in recording many of these earnings and of various
factors which seriously affected the quality of significant portions of
the remaining earnings. In effect, the earnings figures being given to
the public were not an accurate picture of the earning power of the
corporation. Indeed, until 1970, the year of bankruptcy, the company
on a consolidated basis was reporting profitable operations.
The immediate cause of the bankruptcy, and the most obvious reflection of the problems discussed earlier, was the cash drain and the
inability of Penn Central to obtain additional financing. Disclosure to
shareholders in these areas was marked primarily by silence, although
on those occasions when Penn Central did reveal what financings it
was doing, it stressed the flexibility and strength of its financing program rather than the desperation of the company's financial condition.

Many institutions held Penn Central stock, particularly as it
approached its peak price in the summer of 1968. Most of these

institutional holdings were sold over the next 2 years as the price of
the stock continued to decline.
The examination focused on several institutions where the timing
of the sales and the possible access to inside information raised
questions. These institutions were Chase Manhattan Bank, Morgan
Guaranty Trust Co., Continental Illinois Bank & Trust Co., Investors
Mutual Fund, and Alleghany Corp.
As we conducted our inquiry in this area we were faced with difficulties of proof. Regardless of such difficulties, it is important to note
that in the case of at least two of the banks it is clearly established
that they had inside information at the bank at the time of the sales.
The banks deny, however, that this information was known to those
making the decision to sell. This points up the real possibility of
conflicting responsibilities and the need for procedures to prevent
misuses of information reposed with a bank in a commercial banking
Our inquiry also raised questions where Penn Central and banking
institutions shared common directors. One such director indicated
that at times in a meeting of a committee of the bank's board he was
called upon to speak about Penn Central in the presence of members
of the bank's trust department. Although in this case the director
stated that he provided no inside information, banks should not place
common directors in such a position where they might easily disclose
inside information.


From its extensive review of the trading of officers and directors of
Penn Central Co. which took place between the merger and the bankruptcy, the staff found that a number of high corporate officials had
made sizable sales during this period.
A detailed review was made of the transactions of 15 officers whose
trading was deemed to raise the most serious questions as to whether
it had been based on material inside information. The 15 officers, who
prior to bankruptcy had sold about 70 percent of the stock they
owned at the time of the merger, included officials of the finance and
operating departments. These officers had apparent access to information concerning the state of Penn Central's affairs which was reaching
the public only with a serious amount of distortion. This section of
the report summarizes the staff's investigation of the trading of
these officers, examining the timing and extent of these sales, and the
reasons given for them by the officers.
As in other major companies, Penn Central had an elaborate option
system for its key employees. Many of these officers exercised their
options through the use of large bank loans. As this study shows, the
presence of such loans can clearly distort the purposes of the option
system by encouraging officers to sell when the market in the
company's stock declines, even though material undisclosed information may exist at the time.

As the company's financial condition deteriorated, management
relied more heavily on the sale of commerical paper as a means of

financing the losses being incurred. The company was not using
commercial paper for short-term borrowing which is the customary
use of commercial paper. Instead, conditions developed in a way
which required that the full amount of commercial paper be continually rolled over as if it were long-term financing.
Goldman, Sachs & Co. was the sole dealer in renn Central's commercial paper and at its peak there was as much as $200 million of
paper outstanding. While some of the buyers of this commercial paper
were relatively sophisticated institutional investors, others were not.
Only limited information was supplied to buyers of Penn Central
paper. Even when Goldman, Sachs began receiving warnings of
critical problems no additional information and no warnings were
communicated to buyers. Goldman, Sachs maintains it was merely a
dealer and not an underwriter and that it did not have duties of disclosure.
The sale of Penn Central's commercial paper was greatly facilitated
by the receipt of a "prime" rating from the National Credit Office, the
only national rating sendee of commercial paper. This rating was
provided without adequate investigation of the company's financial
condition. I t is clear that NCO continued to provide the highest
rating at a time when the facts did not support such a rating.


Beginning in 1962, Bevan and Charles Hodge, an investment
counselor to the Pennsylvania Railroad, formed a private investment
club, Penphil Co. Its members included several other Penn Central
financial department officers. The club made investments with funds
borrowed from Chemical Bank. The bank made these funds available
because Bevan was the chief financial officer of Penn Central and
because the railroad had a substantial banking relationship with
The investment club made investments in companies where the
club had relationships which made inside information accessible to the
club. From time to time, officers and directors of the companies in
which investments were being made were invited to join the club.

January 15: Supreme Court decision authorizing merger.
February 1: Merger of Pennsylvania and New York Central railroads.
March 30: Announcement of mailing of 1967 annual report to shareholders. Press
release indicates merger proceeding smoother and more rapidly than anticipated.
May 7: Annual shareholders meeting.
June 21: Final of a series of drawdowns in early 1968 against the revolving credit.
This brings the total to $100 million.
July 3: OdeU writes to Saunders expressing concern about Macco.
July: Butcher & Sherrerd releases report on Penn Central reducing 1968 earnings
estimate. Because of firm's relationships to Penn Central, causes sharp decline
in price of stock.
July 15: Press release announcing no adverse changes in the company's affairs
to justify the recent market action.
July 17: Penn Central receives authority from ICC to sell commercial paper for
the first time. Authorization for $100 million.
Summer: Service problems developing.
September 5: Saunders speech to New York Society of Security Analysts—
critical response.
September 30: Washington Terminal Co. dividend-in-kind paid.
October 9: Bevan memo reviewing critical cash situation and calling for cutback
in capital expenditures.
October 23: Third quarter earnings announcement. Consolidated earnings up.
Company-only figures not given.
November: Penn Central draws down a $50 million Eurodollar loan.
December 11: ICC approval of $100 million revolving credit.
December 26: Year-end statement issued by Saunders.
December 31: Madison Square Garden transaction consummated.
December: Sale of Bryant Ranch by Macco.
December: Sale of Six Flags Over Georgia by Great Southwest.
December 31: Acquisition of the New Haven Railroad.
January 7: Bevan seeks financial advice from former chairman of First Boston
Corp. and from consultant who was president of International Bank for Reconstruction and Development.
January 23: Board approves plan to form holding company—announced to public.
January: Penn Central claims this is peak for service problems.
January: EJA withdraws application to acquire Johnson Flying Service.
January: Penn Central discussions with Peat, Marwick and ICC relating to
charging of mail handlers against the merger reserve.
January 30: Preliminary earnings for 1968 announced. Results show consolidated
earnings of $90.3 million, up from 1967, and a parent company loss of $2.8
million, down from a profit of $11.5 million a year earlier.
February 13: Penn Central issues release on results of diversified subsidiaries.
February: Meeting with officers of First National City Bank concerning increase
in revolving credit.
February 20: Saunders' "turning the corner" claim set forth in release.
March 1: Smucker replaced by Flannery in charge of operations.
March 19: ICC authorizes increase in commercial paper from $100 million to
$150 million.
April: Flannery objects to budget cutbacks. Cites danger of affecting service.
April 23: Penn Central announces first quarter consolidated earnings of $4.6
million, down from $13.4 million a year earlier. Parent lost $12.8 million compared to a profit of $1.0 million in 1968.
May 12: ICC approves increase in revolving credit agreement from $100 million
to $300 million, with $50 million reserved to refund commercial paper.

June 4: Settlement of employment contracts with Great Southwest officers.
June: Sale of Six Flags Over Texas by Great Southwest.
June 13: Extraordinary joint finance—executive committee meeting to discuss
the situation.
June 25: Board discusses possibility of omitting dividend, but ultimately decides
to declare dividend with special meeting on August 27, to review payment.
July: $35 million private placement of Pennco debentures.
July 28: Second quarter earnings announced. Consolidated earnings at $21.9
million, down 7.5 percent. Railroad company lost $8.2 million versus year
earlier profit of $2 million.
August 27: Kunkel suit discussed at meeting of Penn Central board. Investigation
of EJA and Bevan approved. Bevan's subsequent threat of resignation causes
cancellation of investigation.
September 18: Bevan diverts $10 million of equipment loans to Leichtenstein
account of Goetz in connection with EJA and other matters.
September 8-12: Bevan and Saunders discuss bleak financial condition and call
for cutbacks on capital expenditures.
September: Saunders orders halt of retirement of properties until accounting
authority received, thereby avoiding writeoffs against ordinary income.
September 23-24: Penn Central announces that Gorman named president, effective December 1. Saunders denies presidency offered to several others first.
September 24: O'Herron reads to board Bevan's statement on Kunkel, EJA and
September 25-26: Saunders testifies before congressional committee on passenger
October 1: Holding company becomes effective.
October 20: Penn Central reports consolidated third quarter loss with 9-month
earnings down substantially. Railroad lost $19.2 million.
October 29: ICC approves increase in authorization to sell commercial paper
from $150 million to $200 million.
October: Great Southwest offering called off because of disclosure problems.
November: Service deterioration noted.
November 7: Attorney representing Penn Central tells ICC that since merger
company has failed to regain its competitiveness and remains financially shaky.
November 10: Odell invites all outside Penn Central directors to a dinner on
November 25, to discuss financial and management problems.
November 12: Saunders testifies before congressional committee7on passenger
service losses in connection with pending legislation.
November 19: Saunders meets with Kirby in Alleghany offices re management
November 26: Odell moves for dismissal of Bevan and Saunders.
November 29: Board of directors votes to omit fourth quarter dividend.
November-December: Commercial paper dealer evidences concern about financial
condition of Penn Central.
December 1: Letter to shareholders concerning elimination of dividend.
December 1: Day's letter to Saunders suggesting better disclosure of railroad
December 1: Saunders speech at staff luncheon concerning critical nature of service situation.
December 15: Saunders makes impossible demands for increased revenues and
reduced expenses by yearend.
December 17: Pennco sells $50 million debenture offerings—proceeds passed up
to Transportation Co.
December: Writeoff of long haul passenger facilities.
December: Discussions concerning sale of Great Southwest stock to Great
Southwest officers.
December-January: Bad winter weather. Later blamed for poor earnings.
December 31: Pennco accepts Great Southwest stock in exchange for previously
created debt.
January 22: Meeting on possible foreign financing leads later to Swiss franc loan.
January 27: Bevan and O'Hereon approach First National City Bank about
"bridge" loan in contemplation of $100 million Pennco offering. First National
City Bank asks for more security.
February: Discussions concerning $20 million Eurodollar offering through Penn
Central International.

February 2: Initial contact with First Boston conerning Pennco $100 million
debenture offering.
February 4: Penn Central announces 1969 earnings of $4.4 million versus $86.9
million a year earlier; railroad lost $56.3 million versus $5.1 million loss.
February 5: Odell submits resignation letter to board.
February 6: Bevan et al., meet with Gustave Levy and others from Goldman,
Sachs to review commercial paper situation.
February 12: Penn Central buys back $10 million in notes from Goldman, Sachs
February 13: ICC orders Alleghany to sell its Penn Central shares.
February: "Bridge" loan arranged with Chemical Bank.
March: Various evidences of concern with status of EJA.
March 12: "Comfort letter" from Bevan to Peat, Marwick re: (1) EJA; (2)
Madison Square Garden; (3) Lehigh Valley.
March 12: Peat, Marwick signs opinion letter, qualified only for the failure by
Penn Central to provide for deferred taxes.
March 20: Counsel for underwriters questions possible major writeoff. Bevan
denies it, but appears evasive.
March 25: Pennco applies to ICC to sell $100 million debenture offering—announced in press release.
March: O'Herron tells commercial paper dealer first quarter losses will be
March 28: Bevan seeks removal of "troublesome" attorney from underwriting.
March 30: Penn Central files with ICC for discontinuance of 34 East-West longdistance passenger trains.
March 31: Meeting at Sullivan & Cromwell offices with senior officers of each of
comanagers of $100 million offering. Possible bankruptcy of Penn Central
March 31: Wabash exchange transaction recorded.
April 6: Decision made to drop warrants from $100 million debenture offering.
April 14: O'Herron tells commercial paper dealer that first quarter losses will be
April 14: Fred Kirby resigns as Penn Central director.
April 22: Penn Central announces first quarter consolidated loss of $17.2 million
and Transportation Co. loss of $62.7 million.
April 27: Pennco $100 million prehminary offering circular.
April 28: Pennco announces proposed offering of $100 million debenture. Proceeds will be passed up to the Transportation Co.
April 30: Penn Central representatives, led by Saunders, meet with Volpe of
DOT. Discuss possible assistance on equipment financing and passenger losses.
May 4: Due diligence meeting with underwriters—indications that initial interest
in issue is poor.
May 8: O'Herron speaks with Volpe. Tells him situation more critical than revealed
by management.
May 5: Gorman calls for special finance committee meeting. Objects to various
reporting practices.
May 10: Saunders announces austerity program until Railpax program adopted.
Capital spending cut.
May 12: Annual meeting.
May 13: Butcher & Sherrerd switches recommendation to "sell" after reviewing
first quarter earnings.
May 15: Standard & Poor's reduces Pennco rating from BBB to BB.
May 15: Dun & Bradstreet (NCO) gives Penn Central's commercial paper a
"Prime" rating.
May 16: Revised offering circular issued, including information on commercial
paper runoff. Underwriters indicate issue is expected to carry interest rate of
10J4 percent.
May 19: Saunders discusses Government guaranteed loan with Kennedy of
May 19: Penn Central spokesman announces he knows of no reason for the
stock's decline.
May 21: Bevan meets with representatives of Chemical Bank, New York Trust
and First National City Bank.
May 21: Penn Central notifies underwriters that it has decided not to go forward
with the offering.
May 21: Chemical Bank and First National City Bank representatives meet with
Bevan. Bevan tells them of decision to postpone debenture offering and seek
Government loan.

May 23: Penn Central hits new low amid conjecture about financial difficulties.
Butcher & Sherrerd who strongly recommended Penn Central in January is
rumored to have liquidated its holdings.
May 26: Bevan and others from Penn Central meet with representatives of Chemical Bank, First National City Bank, and counsel for the banks involved in the
$300 million revolving credit agreement to discuss Government guaranteed
May 26-27: Broad tape and WSJ announcement on commercial paper runoff.
May 27: Finance committee meeting. Saunders tells Penn Central board that the
debenture offering is being called off, that further issues of commercial paper
will be halted and that substantial additional amounts of cash will be needed.
May 28: Bevan and others meet with the 53 revolving credit banks about current
status of Penn Central and negotiations with Government.
May 28: Postponement of Pennco debenture offering announced to public.
Alternative financing methods to be considered.
June 1: National Credit Office withdraws "Prime" rating on Transportation Co.'s
commercial paper.
June 2: Announcement made that First National City Bank heads 73 banks
applying for Government guarantee of $200 million loan.
June 8: Bevan, Saunders, and Permian dismissed.
June 10: Administrative support announced for $200 million loan guarantee with
a possible total of $750 million.
June 19: Administration withdraws loan guarantee support.
June 21: Chapter 77 Bankruptcy reorganization filed.


The concept of realining the various eastern roads into a small
number of major systems to insure their continued economic viability,
dated back many years. The poor railway industry conditions of the
mid-fifties, however, gave the idea new impetus. It was under these
-circumstances that in 1957 James Symes, chairman of the Pennsylvania Railroad (PRR) and Robert Young of the New York Central
Railroad (Central) first discussed a merger of these two roads. Alfred
Perlman, president of the Central, objected when the matter was
raised with him, particularly because his own view of a balanced
Eastern realinement was not consistent with this merger. He agreed
to further studies, but these were terminated when Young died a few
months later.
Subsequently, the Norfolk & Western (N. & W.), which was a very
strong road, became involved in plans to combine with certain smaller
eastern lines. This would involve expansion into areas where they
would threaten some of Central's major markets. Perlman looked
around for another merger partner, and had his eye on the Baltimore
& Ohio (B. & O.) and Chesapeake & Ohio (C. & O.). This three-road
combination, he felt, would offer a balanced entity, able to effectively
compete in the markets it served. However, the B. & O. and C. & O.
decided to merge without the Central. It began to look like Central
would be left out in the cold in the major realinements then occurring,
and faced with a strengthened group of competitors. When PRR again
raised the possibility of a merger with the Central and agreed to dispose of its interest in the N. & W., resolving one of Perlman's major
objections to the merger, talks between the PRR and the Central resumed.
The merger discussions were often rocky. Much emphasis was placed
on who would hold what management positions in the new company,
as various parties maneuvered for good jobs for themselves and their
associates. The situation was further complicated by personality
conflicts and by the significant differences in philosophy and approach
of the two roads. Blunt discussions took place, with representatives
of each company expressing dissatisfaction with the management of
the other company. Each felt its own officers should hold certain key
positions. Ultimately, in compromise, it was decided that the PRR
would name the chairman, who would be the chief executive officer,
while the Central would name the president and chief operating officer.
Both Perlman and Symes, who had been focuses of controversy, would
be relegated to the position of vice-chairmen. After Stuart Saunders
succeeded Symes as chairman of the PRR, however, he agreed to the
naming of Perlman as president, in part because by this point there
was no other logical candidate available.



The formal application for approval of the merger was filed with the
ICC in March 1962 and this was followed by lengthy hearings over the
next 2 years. The thrust of the position presented by the two roads
was clear. As stated by Symes in the merger hearings, the merger was
necessary "to preserve and strengthen these railroads in the public
interest and for the national defense, to arrest their physical deterioration of the last 15 years, and to avert possible bankruptcy/' Perlman
warned that if the two were not allowed to merge "their ability to
compete * * * will continue to decline to the point of ineffectiveness."
Throughout their testimony, witnesses for the two roads stressed the
poor earnings record, the resulting difficulties in attracting capital,
and the detrimental effect of this on railroad operations and thus on
service. The precarious position of the two roads was alluded to again
and again.
Symes then described the solution to these problems. "In my opinion
there are no two railroads in the country in better position than
Pennsylvania and Central by reason of their location, duplicate facilities and services, and the similarity of traffic patterns to consolidate
their operations and at the same time substantially increase efficiency
and provide an improvement in service at a lower cost." Extensive
testimony was given on how this would be accomplished through
improvements in routes,'consolidation of facilities and equipment, and
other changes in physical operations. Projected merger savings of
$81 million per year were described.1 A figure of $75 million total was
given for the required capital requirements, less disposals of $45
million, leaving a net cost of $30 million. Merger savings, it was stated,
would provide badly needed capital.
The ICC in its opinions basically accepted these arguments. In the
final ICC opinion it was stated:
We believe that with the approval of this merger many problems facing the
applicants will be resolved to a considerable degree. Applicants have shown that
their annual savings from the merger will exceed $80 million after about 8 years
* * *. These large operating savings will go far toward compensating for the
persistently low rates of return, and the increased earnings flowing from the merger
should motivate the unified company to accelerate investments in transportation
property and continually modernize plant and equipment. This in turn should enable the unified company to more fully develop and utilize the inherent advantages
of railroad transportation in the territory served and provide more and better
service, all to the ultimate benefit of the public. (3271.C.C. 475, 501-02)
i This was the figure following a shakedown period of several years during which lesser savings would be
available. An exhibit submitted during the hearings shows the following sums (in millions):


Net savings



Note: The difference between the 2 figures represents costs of joint facilities and employee
protection agreements.

The opinion further stated:
We do not mean to imply that merger is the magic touchstone of success—too
many other elements are essential: research, progressive technology, salesmanship,
alert management willing to face today's problem on a realistic basis, etc. But this
merger will enable the applicants to more effectively handle the external pressures
with which they must daily contend in fulfilling a large part of the requirements of
the public convenience and necessity in transportation. The economies it makes
possible can be converted into the greater return needed by the applicants to
attract investment capital, to maintain and improve service essential in commerce
and industry, to recapture diverted traffic and to avoid further loss of traffic to
other carriers. (3271.C.C. 519)

The position of the two companies has been presented in some detail
in this section because of its disclosure implications. First, it illustrates
management's comprehension of the basic problems facing these
companies and its ability to describe them clearly when it was advantageous to do so. As conditions deteriorated in the postmerger period,
it might be noted, no comparable effort was made. Secondly, the
romised solutions led to high expectations on the part of the public,
'his was reinforced by frequent references in analytical and research
material of the period. What was not made clear, however, was that,
while the problems were understood, the proposed solution had not
been thoroughly examined.



No consideration was given in connection with this merger to the
broad question of realinement of the Eastern roads or whether this was
the best merger for the two roads. They were, in effect, the leftovers,
after other combinations had been individually arranged. Furthermore,
little consideration appears to have been given to the question of
whether this particular merger would work at all. Certainly the combination of two already ailing and financially weak roads raises questions as to feasibility and in this situation the possibility also existed
that the size and complexity of the merged company would preclude
manageability. Although this latter possibility was lightly dismissed
by both Perlman and Symes when raised in the merger hearings, the
intermanagement) squabbling already apparent at that time did not
bode well for the future.
The basic source document used during the merger hearings, which
purportedly reflected the economic justification for the merger, was
a report which became known as the Patchell study. This was never
intended to be used as an actual operating plan but represented a
document assembled rather hastily by the staffs of the two roads for
the specific purpose of having some sort of "plan" to present to the
ICC. It dealt with such matters as which routes should be adopted,
how terminals and other facilities should be consolidated and other
matters of physical coordination and the projected savings related
thereto. The study had a theoretical, rather than a practical, orientation, claiming to show what the merged company would look like,
assuming that the very short past period used as the basis for the
projection accurately reflected the companies as they then existed.
As it developed, however, many of the assumptions on which this
rather simplistic study was based were unrealistic. In a recent assessment of the situation the ICC reported:

The estimates, plans and predictions of railroad executives presented at the
hearings before the Commission in the early 1960's appears to bear little relation
to the savings, costs, investments and operational changes which Penn Central
claims in its reports to have actually realized. We realize that conditions change;
however, there appears so little correlation between the claims and the realities
as to seriously question whether a realistic merger plan ever existed.

The conceptual weaknesses reflected in that report would, of course,
also be present in the origiral decision to merge, which preceded the
submission of the report. It should be noted too that the Patchell
study was a critical document in the ICC's consideration as to the
feasibility and advisability of the merger.
By the time ICC's approval was obtained, two decisions had been
made which many people have suggested sealed the doom of the
company. Neither had been contemplated at the time of the original
reached an accord with
{wroposal. First, in May 1964, the two roadswhereby they, in effect,
abor, the Merger Protective Agreement,
bought the cooperation of the unions, which had been opposing the
merger. The result of this agreement would be to cause the company
to incur costs far above those anticipated in the Patchell report and
thus limit the savings projected. The second factor was the decision
of the ICC to force the New Haven Railroad on the Penn Central,
adding still a third financially and operationally weak road to the
The hearing examiner's initial report recommending approval of
the merger came down in 1965, with the ICC's decision issued on
April 16, 1966. The merger now appeared imminent.
Saunders has described the Penn Central as the most complex
merger in the history of the United States. Thorough planning was
obviously essential. It was reported to the PRR board in late 1965
For us these are uncharted seas and all of these tasks demand a considerable
expenditure of time and forethought in anticipating problems to be encountered
in doing a job which had never been done before on anything approaching this

Yet from the beginning, it appears, this effort was doomed. The
problems faced, most of which have been noted previously, were
overwhelming. The complexity and the dispersed nature of the
two roads made the task of combining their activities difficult under
the best of circumstances. And these were not the best of circumstances. The facilities and equipment of both roads were seriously
rundown. Major irfusions of capital were needed but the cash situation was critical and no such funds were available. And the conflicts
between the officers and staffs of the two companies which had first
surfaced at the highest levels of management were now appearing at
lower levels as well.
Shortly after announcement of the hearing examiner's initial report,
Saunders and Perlman called a top level staff meeting announcing they
had designated themselves as the merger steering committee, and that
all merger plans to date, generally dating back several years, would
be scrapped and a fresh start made. A merger coordinator was named
for each company and intercompany committees were established in
the various functional areas, to work jointly in developing plans. The
theory, as reported to the PRR board, was as follows:
The aim is not to fit one organization into the mold of the other, but to take what
is best of each, or formulate something new so that the merged company will be

superior to either of its components. To this end, the focus has been on the essential
functions performed by each department. Once it is decided just what is to be done,
the organizational structure best suited to the job will be adopted.

However, the sharp personality conflicts and fundamental differences
in philosophy were in many instances seriously interfering with the
planning effort. While the decision had been made to seek the "best
method" in all circumstances, among those with differing philosophies,
who was to decide what was the best method? As long as the two road?
remained independent, one side was not in a position to impose its
decisions on the other and the problem was increased by the fact that
no one knew which "side" would hold various critical management positions after merger and would thus be in a position ultimately to
make the decision. Even as between Saunders and Perlman, the only
two officers named prior to merger, it was unclear at that point how
the postmerger lines of power would operate. All in all, there was no
one able to take effective control and give direction to what was obviously a very difficult situation. Aad so, critical preparatory work
was not done. The later repercussions would be disastrous.
While the planning purportedly went as hoped in some areas, in
others it definitely did not. Among the areas where there were serious
deficiencies were: (1) operations, encompassing the running of the
railroad itself; (2) marketing and sales; and (3) finance, which included accounting, financing and computer operations. Obviously,
these three activities would be at the heart of Penn Central. The
other activities would be peripheral.
Of all the functional departments, only the financial department
refused to cooperate in the overall effort of the merger-planning group.
The chief financial officers at both roads were strong personalities and
the attitude of the two departments was apparently that one side or
the other would survive in the merger and implement its own approach.
Since no one knew who the boss would be until after the merger,
basic problems were left unresolved. Some minimal effort was made
within the financial departments to deal with the most obvious and
immediate merger problems, but there was no genuine planning. The
disagreements between the computer organizations were particularly
In the marketing area the problem was somewhat similar. While
they cooperated in the planning effort, there was a basic conflict in
the marketing philosophy of the two companies, with two rather
extreme positions represented, and the repercussions and uncertainties
related to this situation continued long after the merger was consummated. Before the matter was resolved, almost the entire New York
Central marketing organization had left Penn Central.
The combination of operations of the two railroads was, of course,
the crux of the merger. As indicated earlier, the original Patchell
report was not an adequate base for actually implementing the
merger, and a group was assigned to work out an implementation
plan. One person from each road was put in charge and they had a
large full-time staff working on the combination. After extensive work,
this group prepared a six-volume master operating report, which
they planned to present to Saunders and Perlman at a meeting in
November 1967, shortly before the merger.
The assigned task of the group was to provide for an orderly stepby-step transition from a two-railroad facility into a one-railroad

facility, and their report represented the culmination of 2% years of
effort. However, Perlman, apparently with support from Saunders,
wanted rapid implementation of the merger so that merger savings
might be achieved as rapidly as possible, while the merger-planning
staff favored a somewhat slower approach in order to ease the problems of transition. Instructions were issued in early November to
Tevise the sequence of construction projects contemplated by the
master operating plan to accelerate savings in the first 2 or 3 years.
And a few minutes before the plan was to be submitted at a meeting
on November 28, Perlman ordered all copies marked "Preliminary".
The marked copies were distributed at the meeting, then gathered
up, and apparently permanently laid aside. As one individual closely
involved with the situation assessed it:
We were in the same situation as if we had planned the invasion of Europe
without having General Eisenhower named until D-Day . . . Here we have a
plan which has never been said, "This is it, do it this way." The man who was
going to run the railroad has not said, "This is what we're going to follow."

The future impact of this report can be judged by the fact that
Perlman at the time of his testimony before the SEC staff apparently
did not even recall its existence. Saunders recalled its existence, b u t
claims never to have seen it (although it is clear from the testimony
of others that he did). He indicated that this area was Perlman's
responsibility as chief operating officer and that he knew there was a
plan and assumed Perlman was following it, although he never asked,
even after severe operating difficulties developed in the postmerger
The master operating plan was merely a plan for implementation.
Little actual implementation was carried out in the premerger period,
either in the preparation of physical facilities or in the education of
employees for the changes which would be brought about.
I t was understood before the merger that there would be chaos if
employees were not adequately prepared when M-day arrived, yet
minimal attention was directed to this problem. Some witnesses have
claimed such training prior to merger was impractical; others suggested
that more could have been done if more firm decisions had been made
in the operations area prior to merger, so that there was a clearer idea
of where the road was going and what had to be done.
Five years passed between formal application to the I C C and the
final merger. During this period few of the projects necessary to physically combine the two roads were carried out and thus on merger date
there were still basically two separate roads. To a considerable extent,
the reluctance to invest money in merger projects was understandable,
since the merger was not a certainty. Furthermore, money was scarce.
On the other hand, there is evidence that certain modernization projects, in particular, would have been carried out earlier, on their own
merits, as advantageous even if the merger did not ultimately go
through, if the management of one road had been able to impose its
decisions and philosophies on the other. Thus, even at the end there
were projects in dispute, with the final determination dependent on
who would be "boss" in the combined road.

With the fundamental problems which originally led to the merger
proposal still extant, Penn Central was burdened with a new series of

problems arising out of the merger itself. As suggested in the earlier
discussion, the merger was questionable in theory and poorly planned.
Now it was poorly implemented and when things fell apart operationally, as they almost inevitably would, considering the circumstances,
management proved itself incapable of straightening them out. As a
result, the new company found itself faced with the double-barreled
disaster of substantial losses of business and extra costs.
In attempting to understand the operating situation, the staff took
extensive testimony from Penn Central personnel. The picture that
emerges is one of confusion and chaos. Directly conflicting testimony
was received on virtually every major point, strongly suggesting that
no one really grasped what was going on. The lack of planning and
the hostility personnel from the two roads felt towards each other interfered with the orderlyflowof information, while major officers appeared
to lack the capacity to assess the information that was being received.
The following discussion focuses on two major areas—the problems
which arose in the physical operation of the Penn Central in the period
after merger, and the financial effects and implications of these
During the initial months following the February 1,1968, merger,
things were in a state of confusion at headquarters. Part of the top
management group was located in New York and part in Philadelphia.
Personal relationships were still in a fluid state and responsibilities
were not clearly delineated. There had been serious conflicts between
the two organizations during the premerger planning period and, with
several years to fester, there was no reason to anticipate that the
problems would be suddenly resolved because the companies were now
merged. Many management-level people, who were unhappy at the
decisions being made and the people they would have to work with,
were leaving Penn Central, depleting the executive ranks.
Out in the field, for the first few months, physical integration of the
two roads was limited because necessary connections had not been
made. Thus, physically they were handled as two separate operations,
as before the merger. However, they did operate now under one name,
not retaining their separate identities in relationships with shippers
and other railroads. This caused initial problems and when, in the
summer of 1968, the first large-scale attempt was made to combine the
roads physically, major service problems, far beyond those anticipated
or planned for, developed. Management admits that at least by late
summer the situation had reached alarming proportions, and over the
ensuing months it got worse.
Perhaps the best way to summarize this complex area is to quote
from documents prepared at the time by company personnel. One
officer, in a speech given to a group of shippers in March 1969, described
the situation as follows:2
This period of transition from two railroads to one harmonious system has not
been easy. One of the reasons for our difficulty can be found in the size of the
plant itself. While our lines paralleled each other in a number of areas and we
shared many common points, the Pennsylvania and New York Central systems
were not complementary. Our separate yards did not have the individual capacity
to handle the combined business of the two railroads, and we have had to keep
several yards in operation until combined facilities can be built.8
It should be noted that both this document and the following one were prepared for the
public and thus carefully worded to minimize the unfavorable aspects.
According to the ICC, one major source of difficulty was that traffic from both roads
was in fact directed into one facility, which lacked the capacity to handle both.

Our separate communications systems were not compatible and this complicated
some of the service problems created by the merger. This situation has been
aggravated by confusing routing symbols, particularly from off-line sources. For
example, a car routed Penn Central-Cincinnati that should have gone t o the
former Central yard in Cincinnati often has ended up in the old Pennsylvania
yard and frequently its waybill papers went astray as well. In addition, employees
of the former Pennsylvania were not familiar with the properties and procedures
of the former New York Central, and vice versa. A great deal of cross-pollination
had to take place in the process of finding the most efficient way to handle traffic.

An internal memorandum prepared about the same time and
intended for use by top-level management personnel as a basis for
response to numerous press inquiries about the road's "lousy" freight
service relates the following:
From the beginning of merger discussions it was recognized that it would be
necessary to continue parallel operations over the lines of the two former railroads until terminals could be integrated, connections constructed, and yards
expanded along principal routes. Before the merger was consummated, arrangements were made with our principal connecting carriers that blocking of traffic
and interchange would continue as before merger, with gradual changes to be made
as construction and operational arrangements were completed to permit integration on an orderly basis. For a while following merger, operations were maintained
in accordance with this plan, and deterioration set in only when there was a relaxation in the preclassification and delivery arrangements at major gateways, such
as St. Louis and Chicago. The problem was unintentionally compounded when
shippers began to route their freight " P C " rather than via "PNYC(P)" or
"PNYC(N)" thereby failing to direct their traffic to one or the other of the former
The principal effect of these changes was to create congestion and confusion
at major gateways and to shift the classification functions of those terminals to
internal yards, thus spreading the congestion eastward. This initial disruption
triggered a number of collateral effects: It widened the margin for error by clerical
personnel who were unfamiliar with stations and consignees to which they were
routing traffic; it disrupted the cycling of locomotives and thereby produced
sporadic power shortages; it placed an unmanageable tracing demand upon a data
processing system already beset with the problems in incompatibility; 4 it caused
separation of cars from billing as emergency steps were taken to clear congested
yards; it prompted short-hauling of Penn Central, thereby increasing the switching burden at interchange points with other eastern carriers—and as these adversities snowballed one after another the speed and reliability of our service deteriorated steadily.

As suggested by the paragraphs quoted above, the immediate
problems experienced by Penn Central could be traced in large part
to the inexperience and lack of training of its personnel. When
questioned about this, certain witnesses pointed out that new classification manuals, with revised routing, had been prepared for yard
employees in the premerger period.6 It is clear that little else had been
done to meet problems of this nature. As the situation deteriorated,
efforts were made to step up training and education, but the decline
continued. Eventually, with the passage of time and still more strenuous
educational efforts, some degree of control was obtained over the activities of yard and other field employees. However, internal documents
show that substantial residual effects of these problems remained
well into 1970.
Penn Central was also taking other steps to improve the chaotic
situation. A crash program was instituted to increase compatibility of
the two computer systems, so that the masses of misdirected cars
As noted earlier the computer area was one where there had been strong conflicts in
the premerger period, seriously limiting planning efforts.
However, as one witness put it, if a yard clerk, who for 20 years had relied on his
memory to correctly direct cars, suddenly had to go through a manual for each car that
came along, he would soon have cars backed up all the way from Indianapolis to Kansas

could be located.6 By mid-1969 there was apparently some improvement in this area. A program to engage the assistance of connecting
lines and shippers in directing traffic to the yards which Penn Central
had selected met with only very limited success. Former officers have
indicated to the staff that it was unrealistic for the company to have
expected shippers to uniformly follow their instructions to route
traffic as "PNYC(P)" or 'TNYC(N)." And there is testimony
that some officers questioned, even before the merger, management's
easy assumption that they had enough clout with the connecting lines
to force them to send traffic to the yard which Penn Central had
designated for that class of traffic; even though it might be cheaper or
more convenient for the connecting line to use the other local Penn
Central yard. In addition, just as the confusion and bottlenecks
caused a snowballing effect within Penn Central, these factors may
have also been a contributing factor with the connecting lines whose
employees felt their carelessness would scarcely have an effect on the
massive congestion that already existed in Penn Central's yards.
The problems were not limited to the shortcomings of field personnel.
Despite the complexities involved, Perlman was operating on a very
informal, ad hoc basis in running the railroad and implementing the
merger. The Patchell plan was acknowledged to be unrealistic and
Perlman himself had scuttled the master operating plan. Route and
terminal selections which looked good on paper proved unfeasible in
actual practice. And so something else would be tried, and then something else again, in the search for suitable solutions. Throughout this
chaotic period, the merger acceleration program, which Saunders and
Perlman had favored, continued, yielding new changes before the old
ones had been adequately coped with.
Policy differences remained and the propensity of operating personnel to criticize the practices of those from tne "other road" increased as the situation deteriorated. Perlman and David Smucker,
executive vice president in charge of operations and a former PRR man,
clashed frequently. Ex-Central personnel were strongly critical of the
old PRR facilities, indicating they were completely out of date and
that significant infusions of capital would be necessary if the Penn
Central was ever to become a profitable road. The PRR group on the
other hand claimed that Perlman was more interested in building railroad yards than he was in running a railroad, and there was skepticism
concerning the savings being claimed on some of these projects. One
focal area of dispute was the necessity of a new yard m Columbus,
Ohio. This project was strongly supported by ex-Central employees
while the P K R personnel felt it was unnecessary or extravagant. It
became virtually a sjonbol in the continuing battle between the two
groups and at one point the conflicts reached such a pitch that Basil
Cole, Saunders' assistant, seeking an objective opinion, met to discuss
the plan with an ex-Central operating man who was now with another
road and thus felt to be somewhat removed from the battlelines.
In early 1969 Smucker was replaced as chief operating officer
because of the unsatisfactory service record of the new company. This
was done at Perlman's insistence but with Saunders' agreement. What
Perlman did not know was that Saunders had also decided to replace
Perlman. Smucker testified that during this period Saunders told him:
The computer problem was also linked to inexperienced personnel, which resulted in
•errors in input.

I'll be rid of Perlman within ninety days; he's the worst enemy I've ever had
in my life; he's cost me untold millions of dollars; I didn't want him in the first
place and I'll get rid of him; you can have my word of it; I'll be rid of him in
ninety days.

However, Saunders could not accomplish this task. Perm Central's
condition by this point was well-recognized in the industry and
although he tried, Saunders could not get any suitable railroad executive to take the job as top operating executive.
Management has indicated on several occasions that the service
problems peaked in mid-January 1969 and that there was significant
improvement thereafter. Saunders was apparently getting information
to this effect from his operating and marketing people,7 although it was
of course in their own self-interest to make such claims. As Smucker
put it:
[Perlman] was characterizing the operation as being very poorly handled and
very badly done and at the moment l w a s no longer in charge of it, Mr. Perlman
was characterizing the operation as having been vastly improved and the subject
of compliments instead of complaints and this sort of thing.

Smucker, who was put on Saunders' staff after he was replaced as
operating head, indicated that Saunders would ask him if these
purported improvements were real and that Smucker would point
out that there were still significant problems.
It would appear from the testimony taken that there was perhaps
some success in overcoming the merger-related service problems after
early 1969, although it is unclear how much of this represented real
improvement and how much of it was simply an improvement in
weather conditions.8 At any rate it is clear that the pace of improvement was disappointing. One witness, who is currently a Penn Central
officer, but was with connecting roads in 1968 and 1969, recalled only
poor service throughout. Another officer, also new with the company,
held a series of meetings with large shippers in April 1970, to get their
comments on Penn Central's service. "We got an earful. We really
did/' he reported.
In about January of 1969, Penn Central had undertaken a major
ublic relations program aimed at shippers. The reason was obvious,
'enn Central was losing vast amounts of business from irate customers
who were turning to other modes of transportation whenever possible.
To prevent further diversion, to recapture lost business and to offset
critical articles appearing in the press, Penn Central went on the offensive. This program included a series of press releases, noting improvements in f acilities and equipment, and a number of visits by high level
management with major shippers, in which the officers described what
was being done to improve service and beseeched the customer to give
Penn Central another chance. To some extent management apparently
succeeded in this recapture program, although it was recognized that
henceforth these customers would be very sensitive to inadequacies in
service and, thus, the road's task would be doubly difficult. This
doubtlessly meant increased costs.
Nonetheless, there remained numerous complaints from shippers and
from connecting lines, whose own customers were complaining to
them about Penn Central's inadequate service. When groups of
shippers or traffic men from other roads gathered, the discussions


Actually, according to notes taken in staff meetings he was getting information that
the situation was improving even during the mid-December to mid-January peak.
Winter weather regularly caused service problems.

would turn inevitably to Penn Central's poor service. And the company's complaint files were voluminous—although these files contained
only the written complaints, while most were oral. A number of the
letters were sarcastic. One writer indicated that fifteen years ago his
business had been located on the New Haven line and the service
was terrible. "We all know what happened to that railroad/' 9 he
added. After a change in location to a spot on the Central line, service
had improved but now, with the merger, it was worse than it had ever
been on the New Haven and "I can only say that I hope your railroad
survives." Another shipper suggested that the company put some of
its dispatchers and car handlers into a boxcar headed for the west
coast with just enough food to last the scheduled trip, indicating that
they might well be more sympathetic to the shippers' problems upon
their eventual arrival at the intended destination. Some complaints
were more gentle, but still to the point. How could Penn Central hope
to compete with those providing far superior service? some asked.
One shipper noted that he had been sympathetic toward the road's
problems in the past and often turned the other cheek, but his customers were unfortunately not so understanding and forgiving about
the delays. Would management please consider the enclosed list of
past deficiencies? he asked. Another customer suggested that while
the road had explained his complaints of the prior winter away on the
the basis of winter weather, it was now summer and things were still
Management became quickly aware of the physical aspects of the
service problems. That information did not have to be generated
internally—complaints from the outside told the story. An understanding of economic aspects however developed more slowly. In the
first few months after merger, management had only a weak grasp of
major segments of its cost and revenue situation. There was no prior
history as a combined company to serve as a basis of comparison.
Managers were in some areas unfamiliar with major sections of their
operations, because of the addition of facilities of the other road, and
therefore were not in a position to effectively control costs. Techniques
which had formerly been used on the two roads for estimating revenues
presented difficulties when the two roads were combined, making for
distortions in the figures. While the calculations of actual revenues
were amended in light of these problems, the forecasts were not,
adding to the confusion. Reports from the field were being received
in two formats depending on whether it was former Central or former
PRE. territory. Complaints by high level management about the
unreliability of the profit figures, particularly in 1968, were frequent.
These problems were compounded by disputes between the staffs of
the two roads as to the accounting system, which led to substantial
delays in getting a combined system instituted. The PRR system,
utilizing responsibility accounting, was ultimately adopted, but not
without considerable confusion. One official complained m an October
1968 memorandum:
It is unfortunate that we are enmeshed in all of the problems of unifying the
accounting at the same time as our need for cost control is so great. . . . [A] gap
between the way the railroad is operationally organized and the way it is being
accounted for leaves quite a few holes and quite an opportunity for passing the

It went bankrupt.


Perlman, who at the Central had used another accounting system,
made no attempt to hide his dislike for the system adopted. This led
to complaints by him that he was not being given the information he
needed to do his job effectively, a claim which is disputed by other
officers. He also indicated that he was disturbed and confused by the
' fact that the earnings figures as they were distributed to the public,
did not agree in content with those which he was receiving internally.
About once a month Saunders held budget committee meetings
with his top operating and financial officials to discuss current results.
These were measured against established budgets or more frequently,
as the pressure of events rendered the budgets of limited value, against
a series of relatively short-term forecasts, concerning basically the
current quarter.
One participant described these meetings as consisting principally
of strongly worded exhortations to do better. As the initial postmerger
confusion settled and the situation was clarified, Saunders was highly
unhappy with company results, and demanded to know why. Many
of the problems appeared to lie with lower than anticipated revenues,10
which the marketmg people attributed to poor service, a responsibility
of the operating department. The operating people would respond by
explaining the poor service on the basis of bad weather, lack of money
to maintain equipment, slow orders because of poor track, and so forth,
and so forth.11 One witness summarized these budget committee
You could cut a record, and rather than have these meetings, just play this
record over again, all of which [problemsj were real. The fact of the matter was
that the railroad was in a hell of a mess.

The financial situation continued to deteriorate. It was not merely
a question of profits. The cash situation was critical, and the railroad
losses were a drain. The exhortations grew stronger. The emphasis
was on what had to be done rather than what could be done. Saunders
demanded that operating officers cut costs, generally by a specific
amount or percentage, which he had arbitrarily selected. Often these
orders came very shortly before the end of a quarter, with instructions to cut x dollars, for example, before the end of the quarter.12
High level operating personnel indicated that these instructions
were generally completely unrealistic, especially in light of the
very high ratio of costs which were fixed over the short term 13 and
that in effect no attempt was made to comply with them fully, although
This is a particularly damaging featnre in the railroad industry with its high ratio
of relatively fixed costs, since a high proporton of lost revenues work their way down to
the profit.
The master operating plan had contained projections of ton miles, based on certain
gross assumptions as to rates of growth, specifically growth of 2.9 percent and 2.6 percent from 1966. Instead, Penn Central's figure in 1969 was 8 percent below 1966, according1 to ICC calculations.
The latter two items reflected a perennial lack of adequate maintenance and repair
which had indeed by this point reached very serious proportions.
As will be discussed later, this is part of a broader pattern of last minute attempts
management each quarter to find some way to report respectable earnings.
No one denied the cost figures contained excessive items. The objections lay with the
nature of the crash program being instituted to cut costs. Paul Gorman, who was hired
principally on the basis of his reputation for cost control, indicated that the bulk of
operating costs relate either to the labor factor or to repairs and maintenance. He felt
that there was little room for improvement in the maintenance area, since the equipment
and plant was already in poor condition. In the labor area efficiency was not good and
there were many excess people on the payroll. However, under the labor agreements they
had tenure for life and there was no way of getting rid of them except by buying them off,
delaying the impact of any financial benefit.

some cuts were made. 14 To have made the cuts ordered would have
destroyed service, they stated. 15
Although the instructions to cut costs which were sent by the
operating personnel into the field indicated that they were not to let
such cuts interfere with service, this was more easily said than done.
In November 1969, several memorandums appear in Penn Central's
files indicating that service was deteriorating seriously and that
complaints were increasing. Problems cited included late arrivals of
trains, missed connections, cancellation of regular trains and switching
services, delays in yards, car shortages, shortage of power, yard
congestion, misclassification of cars, and other problems similar to
those which had plagued the company in the immediate postmerger
period. Some regional managers, it was noted in these memorandums,
were publicly attributing the deterioration in service to the severe
budget restrictions which had been ordered. Renewed instructions
were issued that while costs were to be trimmed, the managers were
not to let this interfere with service. There was concern expressed
that inadequate service could lead to further loss of customers, who
could not this time be wooed back.
On December 1, 1969, Paul Gorman became the president of Penn
Central. Unable to find a railroad man to take over operating responsibility in what was obviously a failing situation, Saunders and the
directors finally went outside the industry. Gorman, a cost-control
expert who knew little about the railroad business when he arrived,
was appalled by and completely unprepared for the situation in which
he suddenly found himself.
In the latter part of December and early January there was severe
winter weather which the company blamed for a considerable part of
the very poor first quarter 1970 earnings. Again, the precise impact of
such a factor cannot be gauged. While it perhaps did have some impact,
a road operating in the Northeastern part of the United States which
cannot financially withstand a poor winter is indeed in a precarious
position. Furthermore, it should be noted that unusually bad weather
was also used as an excuse the previous winter and that second quarter
1970 results were relatively no better than first quarter results. 16
Meanwhile, as the financial condition of Penn Central degenerated,
the railroad's capital expenditure program, which, because of financial
limitations, had been inadequate to maintain equipment and facilities
for many years, deteriorated still further. In mid-1969 orders went
out to see what capital programs already under construction could be
halted to conserve cash.17 While a capital expenditure budget for 1970
was prepared, it was not even sent to the Board because of lack of
funds. 18
Gorman related his initiation at his first budget committee meeting, 2 weeks after he
had started with Penn Central. It was mid-December and Saunders was ordering a
$20,000,000 increase in revenues and $10,000,000 reduction in expenses before the end of
the quarter. Gorman, in amazement, asked him to repeat the statement, then announced
it was not realistic, but that he would look into the matter and see what he could do.
A few days later he reported back that he could cut $100,000 or so, but that was all there
would be. In his testimony before the SEC staff, Saunders did not recall making such statements and indicated that such orders would not be realistic, that there was "no way in
the world" that this could be done. However, there are several witnesses who do recall this
and other budget committee incidents clearly.
By this point even some of the directors were expressing concern that the extreme cost
cutting measures being contemplated would damage the road.
The term "relatively" is used since the first quarter is generally the poorest quarter
of 17 year because of seasonal factors.
One immediate target suggested by the PRR people was the Columbus yard, but it was
virtually finished by this time.
This did not of course completely stop the flow of funds into capital projects but
eliminated all but those immediately essential.

The events described in this section are illustrative of the problems
that faced Penn Central. Here was the largest railroad in the United
States, faced with what Saunders described as "the most complex
merger in the history of this country." The company had three principal officers—Saunders, Perlman, and Bevan. Saunders had come
from the N. & W., one of the most profitable railroads in the country, to
head the P E R and later the Penn Central, with its multitudinous
problems. He was a lawyer by profession, not an operating man. His
special assistant characterized his special talent as problem solving
but it is clear that he was unable to solve the biggest problem of them
all, the railroad itself. His expertise did not lie in this area and he was
unable to cope with such problems. His solutions lay with exhortations
and completely unrealistic demands, not of much aid to the fundamental problems lacing this faltering railroad. The second major officer
was Perlman, who was an operating man with a respected reputation.
He had salvaged several faltering roads. However, his ad hoc techniques and the very personal role he took in running the railroad
proved inappropriate for the sprawling complex that was Penn Central,
further contributing to the chaotic situation. Saunders' solution to this
"problem" was to search for a replacement for Perlman. But, with the
company's future so dismal, he could not find a topnotch operating
man who would take the job. The third major officer was David
Bevan, the chief financial officer, who had originally aspired to have
Saunders' role as chairman of the PRE, prior to the merger. He was
bypassed. Bevan had carved out his own little empire, focused on
financing and diversification. His interests apparently lay principally
in diversification, and he was ready to starve the railroad which he
felt was unprofitable and held no promise. In the meantime he was
off on frolics of his own, involving him personally in very questionable
situations. In his areas he kept the information very much to himself,
giving fuel to the claims of Saunders and Perlman that they were being
provided with inadequate financial information.
With these three individuals, all pulling in opposite directions,
it is not surprising that the outcome was chaos. Compounding the
confusion was the imposition in the operating hierarchy of two former
P E E officers in the positions immediately subordinate to Perlman.
Each had no confidence in the ability of the other. Under these circumstances, it was not surprising that Saunders, the consummate
optimist, faced with conflicting stories on the operating situation on
nearly every point, chose to believe the most favorable. Yet, even
Saunders seemed to recognize reality because, when faced by the SEC
staff with blatant examples of his "overoptimism", he denied they
happened, pointing out that the position attributed to him was unreasonable and unrealistic. Yet, it is clear that they did happen and
that the same general attitudes were reflected in information being
disseminated to the public.

The basis for the merger, as indicated earlier, was the promise of
substantial operating savings from the combining of the two roads.
While it was recognized that there would be some offsetting costs
initially, the magnitude of the problems which would develop, and

the accompanying costs, was grossly underestimated. The result was
a sharp plunge in the reported results from railroad operations.

In response to an item on the Merger Performance and Status
Report,19 requiring the company to report to the ICC the net effect
on revenues and net income of actions taken under the merger,
Penn Central reported that it was "difficult to identify and evaluate merger related projects and activities separately from all other
projects and activities of this company.'' Nonetheless they did
make such calculations, showing savings of $22^ million in 1968
and $52 million in 1969. These figures were well above those predicted for the postmerger period in either the Patchell report or the
master operating plan, fueling public statements that the merger
was progressing well. The company did not, of course, purport to be
operating under either of these plans, but under an ad hoc, accelerated
schedule involving substantial extra costs. Furthermore, skepticism
has been expressed as to the accuracy of the figures, since the interpretation of what constitutes a merger saving appears to leave a great
deal of room for discretion and varying interpretation.
While there were certain merger-related charges which did not
impact the income account—e.g., capital expenditures and costs
which Penn Central got permission from the ICC to charge against a
special reserve 20—there were other items which did affect the current
income figures. According to company calculations, these totaled $75
million in 1968 and $15 million in 1969. Calculations of such costs
present the same problems of determination as do the savings figures,
and it is clear that it is not feasible to obtain definitive figures suitable
for public dissemination. Furthermore, it appears that Penn Central
calculated the figures on a different basis in each of the 2 years to show
the results which it desired to show. While it is clear that the effects
of merger-related service problems caused the newly formed company
to incur very substantial costs which had not been anticipated in the
premerger period, only the 1968figuresattempted to take into account
this element. In 1968, Penn Central, seeking to explain away disappointing earnings figures on the basis of allegedly temporary factors,
included in its $75 million figure, $33 million in revenue losses due to
service impairment, $15 million in extra per diem costs 21 due to yard
congestion, and $15 million in overtime labor costs in excess of normal
levels. While the problems continued in 1969, Penn Central's $15
million cost figure included no adjustment for the three service impairment items described above. By year-end 1969, Penn Central
was seeking a bright spot in the seemingly dreary railroad picture and
wanted to show net merger savings, so low cost figures were advantageous and these items were ignored. Thus, in 1968 the calculations
showed net merger costs of $52 million charged to the income statement, while 1969 showed net savings of $36 million. Clearly, there had
been no improvement on that scale.
Penn Central was required to submit such a report to the ICC annually for 5 years
after merger.
See discussion of merger reserve at p. 42.
Per diem costs are charges which one railroad pays for the use of cars of another


In assessing the conditions leading up to the failure of Penn
Central, the staff of the ICC's Bureau of Accounts made a comparative evaluation and study of the income pattern of Penn Central
and other large eastern roads, covering both the premerger and
postmerger period. On the basis of this the Bureau concluded that
the decline in railway operating performance of Penn Central in the
postmerger period was the primary cause of the failure, attributing
this to a rapid decline in both market share and absolute levels of
freight volume, at a time when other comparable roads were showing
increases.22 A deterioration in operating ratios during this period,
it was indicated, probably also in part reflects the decline in business.
This decline, the ICC report stated, was almost certainly merger

Penn Central's quarterly results from railway operations, as reported to the ICC,23 for the last premerger year and the postmerger
period are as follows:24
[In millions]

Operating revenue:
1st quarter
2d quarter
3d quarter
4th quarter
Operating expenses:
1st quarter
2d quarter
3d quarter
4th quarter
Net railway operating income:
1st quarter

2d quarter

3d quarter
4th quarter






430 ..,.



1,652 ....



383 ....



1,414 ....












* Penn Central reported to the shareholders a loss of $9 million.
Note: Losses shown in parentheses.
Source: ICC form R. & E.

These figures, while important as a reflection of the steady deterioration in operating performance, do not reflect the full extent of
railroad losses, since the fixed charges are not included, and these
involve very substantial amounts. An offering circular prepared for a
proposed Pennsylvania Co. debenture offering in April 1970, gave the
following Transportation Co. figures:
*»See exhibit IA-1 at end of section. This chart, taken from the ICC Report, shows
ordinary income, but the net operating income closely parallels it.
83 As discussed later, the figures reported to the ICC and to the public were not always
the same.
Results include New Haven Railroad beginning Jan. 1,1969.

[In millions]

Railway operating revenues
Railway operating expenses
Taxes, equipment, rents and other deductions



Loss before fixed charges
Fixed charges
Loss on railroad operations









Source: Pennco: Preliminary offering circular—Apr. 27,1970.
Note: Losses shown in parentheses.

Figures prepared for internal management purposes and including
only 1968 and 1969, show the following:
[In millions]

Rail losses:
1st quarter
2d quarter
3d quarter
4th quarter








The loss for the first quarter of 1970, calculated on the same basis,
was over $100 million.

It appears that the underlying factor which sent Penn Central
into reorganization was the gigantic losses it had to absorb on railroad operations. These losses reflected problems more deepseated than
simply those brought about by the merger. There is, of course, no way
of knowing whether the PRR and Central would have ultimately
survived if there had been no merger.25 It is clear, however, that in
contrast to the expected benefits of the merger, it had instead the
opposite effect, and that the immediate problems arising therefrom
were a critical factor in the collapse of Penn Central in mid-1970.
Perlman indicated he felt that the Central had the financial capacity to survive, absent
the .merger. Bevan testified that the merger probably accelerated the downfall of the PRR,
although he had reservations about the long term viability of the railroad at any rate.




i I



















As suggested in the last section, by background and experience
Saunders was ill-prepared to handle the fundamental problems facing
the Pennsylvania Railroad and later the Penn Central. Exhortations,
without substance, proved inadequate. Saunders' reaction was to
substitute improvement through accounting devices for the real
improvements which were essential. His policy, he made clear to the
other officers, was that, despite the vast array of problems facing the
company, the earnings picture was to be presented in the best possible
light. Basil Cole, a Penn Central vice president and special assistant
to Saunders in the 1967-70 period, described the situation as follows:
. . . Relating that phrase [income maximization] to my experience working
for Mr. Saunders, I think it means, it reflects, keeping the company on an even
keel during times of adversity. He was not prepared to see the earnings of the
company look any worse than they had to in days of declining business and increasing expenses, and when an opportunity occurred for producing income that
would keep the earnings of Penn Central on as level as possible a basis, he tended
to favor that course of action.

There was, of course, except possibly in 1965-66, nothing but periods
of adversity for Penn Central, with the situation steadily deteriorating
and no real prospect of a turnaround.
Perhaps management had hopes of some future improvement, but
the shareholders and the public were entitled to be provided with
the picture as it existed at the time, minus the impact of the temporary
expedients being utilized to provide the illusion that the company
was on an even keel when it was not.
Just as Saunders was not an operating man, his background was
not in the financial area either. Therefore, while he established and
encouraged the basic policy of maximizing the reported income, he
had to rely on others for ideas, which he would then pursue. It became
a group effort among the top echelons of management. As Cole
Everyone thought it was their job. Certainly in the real estate area—
. . . Sam Hellenbrand would have thought it was his job. Ted Warner certainly
thought it was his job to do what could be done in the tax field.

Warner also, he added, took over responsibility for searching the
company's multitude of subsidiaries for income opportunities for
the parent. William Cook, who was comptroller of Pennsylvania
Railroad and later Penn Central, explained that in recommending
one of his employees, Charles Hill, for a raise, he noted that Hill
was extremely creative and had added millions annually to the
Pennsylvania Railroad's reported net income. This comment was
made because it was recognized that it would have a special appeal
to Saunders. Cook also indicated that many of the accounting devices
which might be used to increase earnings emanated from operating
people who were not meeting the goals which Saunders had established


for them, and would come up with these proposals as a defensive
measure. Saunders would be receptive to any such suggestion.
Various classes of devices fell within the maximization program, all
directed toward improving apparent earnings. 26 In many instances
they reflected the desperation of the circumstances facing Penn Central, and the importance attached to immediate earnings, since the
benefits were clearly short term, with offsetting detriments of equal or
greater scope in the future. One class of activity, sometimes referred to
as "cannibalizing" the company's assets, involved the selling off of
anything salable, both for earnings and for cash flow purposes. While
this type of transaction hardly reflects a healthy situation, it does increase reported earnings, especially if the company limits the transactions to those which can be executed at a profit. Another practice
involved the timing of certain items. Apparent improvements in reported earnings could be brought about by simply accelerating the recording of revenues in a particular quarter, while at the same time delaying the recording of expenses. This could be, and was, done legitimately in some cases where reportable transactions themselves were
rushed through or delayed, but in many other instances such action
simply reflected improper accounting practice. Another device employed by management was to stress the ordinary and recurring nature
of various somewhat unusual income items, while seeking to label
somewhat unusual expenses as nonrecurring. 27 The purpose was, of
course, to show the maximum possible basic or normal earning power.28
In all of these arrangements the imprint of what one witness described
as Saunders' "preoccupation with the appearances of income" is
clearly visible.

I t is clear from the testimony of various witnesses, for example,
Bevan, Cook, and Hill, that the accounting department was under
pressure to do their part to assist management in reporting higher
earnings. Hill, for example, testified as follows:
Question. I got the impression that you were under a mandate to compute
to the greatest extent possible^ is that correctt
Answer. Unquestionably correct.
Question. That mandate came from Saunders directly?
Answer. F r o m Saunders directly.


He later indicated t h a t there was a continuing effort on the part of
top management "to create the most favorable income at all times by
the best favorable transaetions".
The impact of such pressures was predictable. Wherever advantage
could be taken either of some imprecision inherent in the figures or
of some situation not specifically and precisely covered by the accounting literature, the effort was made to do so. In the former
situation, where some imprecision was inherent in the figures, accounting department personnel appear to have pushed things as far as they
** As will be discussed in a later section on disclosure, the actions described here were
part of an overall pattern of masking railroad operating losses.
At times this was reflected in the financial statements themselves and at times in
textual material contained in press releases and other information disseminated to the
Generally, the value of a stock, at least for long-term investment purposes, is dependent on its future earning power, and current basic earnings levels are the starting point
for an assessment of future levels.

dared, although the staff has not attempted to measure the precise
impact. I n the latter situation, where specific accounting precedents
were lacking, several examples will be given below in which technicalities of form were stressed and the substance of the transaction was
ignored. I n effect, concepts established under generally accepted
accounting principles were stretched to justify the treatment desired
to the point where their application under the circumstances of this
case may have been misleading.
Since the bankruptcy, Penn CentraPs prebankruptcy accounting
practices have been widely criticized. Saunders was obviously very
much aware of this and came in to testify with his defense prepared.
Again and again in his testimony he referred to "generally accepted
accounting principles.'' The almost incredible number of times he
used this phrase suggests that this had been his all-consuming standard
while he was running Penn Central, yet Cook suggested that it did
not seem to him that Saunders was overly concerned with such principles. Cook stated that "if the accountants would go along with
overstating it [reported income], that would not bother him [Saunders]
particularly either".
Initially, Saunders in his testimony sought to create the impression
that he was not an accountant and would almost blindly and without
question accept anything accounting personnel proposed. Obviously,
he was not qualified to discuss what was and was not acceptable
under generally accepted accounting principles. However, while
neither the Penn Central accounting staff nor the accounting profession can escape responsibility for their contributions to the events
involved in this situation, it is clear that Saunders was not playing the
passive role he sought to project. Indeed, by the conclusion of his
testimony, Saunders was characterizing Cook as "overly cautious
and highly straitlaced". 29 Cole testified that:
I think he [Saunders] felt many times that they [the accounting department]
were unimaginative and wanted to slavishly follow through on a project for the
sheer joy of making the entries.

Considering the extent to which the accounting department was
willing to go to satisfy Saunders' recognized desires for the maximum
possible reported income, the foregoing comments seem ironic.
However, as indicated earlier, there was a barrage of suggestions from
a variety of sources, and the accounting officers did resist certain of
these. Both Cook and Hill indicated that Saunders sought to make
his influence felt, and, even though they might ultimately prevail,
they were constantly being called upon to defend their actions to him.
Cook added that in these matters it was always helpful to have some
outside support, for example, from the ICC accounting regulations or
professional accounting literature in fending off these demands. As
illustrated in subsequent sections, at times even this was not sufficient
to convince Saunders, who then sought to apply his keen persuasive
powers on representatives of these outside sources. And all this effort
was being exerted to salvage the apparent earnings of a failing
He added that, while he did not mind this in an accounting officer, he did not feel that
Cook's word was gospel or that he could not be questioned.


Typical of the intense pressures to which the accounting department
was subjected in the interest of reporting higher profits are those
described by Bevan in a diary 30
which he kept in 1967 and 1968,
assertedly for his own protection. While Bevan's credibility on some
subjects, as illustrated elsewhere in this report, is open to serious
question and while he may have had his own personal reasons for
Keeping this permanent record of Saunders' improper activities at the
same time that he was concealing so many of his own, the entries are
supported by the testimony of Cook, who was comptroller during
most of the period covered by the diary. The testimony of other
witnesses also support this document, although on occasion they
question the tone (rather than the substance) of some of the entries.
The most serious dispute between Saunders and the Penn Central
accounting staff which 31 reflected in the diary involves a period in
early November 1967. Throughout the last half of 1967 it was
known that there was a significant inventory deficit and increased
requirements for reserves for injuries and for loss and damage. The
accounting staff delayed booking these costs at Saunders' request
that they wait until the fourth quarter when it was anticipated that
earnings would be better. When earnings did not improve and Saunders
then objected to loading everything into the fourth quarter, Bevan
He [Saunders] said some people did not seem to realize we were going to merge
with the New York Central and whether or not we were underaccrued by several
millions of dollars at that time would never be known and would make no
I explained as far as inventory deficit was concerned this shortage basically
represented an understatement of earnings and had to be taken care of this year.
He then jumped on increased requirements for injuries to persons and loss and
damage. He stated these were estimates at best and there was no reason to catch
this up in the 4th quarter. I explained that we closed our books at the end of the
year and that we had to have our reserves as proper as we knew how at that time.
He then lost his temper and said I and nobody else would decide what we are
going to charge in this connection. I remained silent and we moved on to other

While Cook did not attend the meeting in question, one of his associates did and wrote a memorandum to Cook outlining the events of
the meeting. He reported:
Mr. Saunders felt that it was not necessary to go into the merger fully accrued
in these areas and he said that 1967 operating results did not have to reflect these
adjustments unless he said so. He then said they should not.

In his own memorandum, Cook described the next event:
Late in the afternoon of November 7, Basil Cole came down to my office and
stated that in addition to the items discussed at the Budget meeting, Mr. Saunders
wanted to see what could be done to avoid the booking of the $3 million inventory
deficit in the fourth quarter of 1967.1 explained to Mr. Cole that nothing could be
done—that the inventory was taken at the end of June and that the results had
been constantly reviewed by the auditors and other accounting personnel and
that this item would have to be booked in 1967. He took the position that he did
This diary has been reproduced in its entirety as exhibit IB-1. It will be quoted extensively in subsequent parts of this chapter.
The diary ends in mid-1968 after Bevan lost responsibility over the accounting functions in the merged company. Bevan claims that the reason why he was downgraded at
merger was because he would not play along -with Saunders* schemes as described in the
diary. Saunders claims it was because he had a constant problem with Bevan, finding it
difficult to get needed financial information from him and never knowing whether the
information obtained was the truth or only a partial truth.

not see where it would hurt anything to let this go until some time next year after
merger and I explained the position that we certify to in the annual financial
statements and that what he was suggesting was the same type of thing that
occurred at Yale Express and Westec which was a criminal offense and that I
would not be a party to it.

In preparation for a possible battle, he also asked Charles Hill, who
was to later become his successor as Perm Central comptroller, to
prepare for him a memorandum outlining the provisions of the Interstate Commerce Act relating to annual reports. The following provisions were quoted:
(1) The Commission is hereby authorized to require annual, periodic or special
reports from carriers * * * to prescribe the manner and form in which reports
shall be made, and to require from such carriers, specific and full, true, and correct answers to all questions upon which the Commission may deem information
to be necessary. * * *
(2) Said annual reports shall contain all the required information * * * and
shall be made under oath and filed with the Commission. * * *







(7) (b) Any person who shall knowingly and wilfully make, cause to be made, or
participate in the making of any false entry in any annual or other report required
under this section to be filed * * * or shall knowingly or wilfully file with the
Commission any false report or other document, shall be deemed guilty of a
misdemeanor and shall be subject, upon conviction in any court of the United
States of competent jurisdiction, to a fine of not more than five thousand dollars
or imprisonment for not more than two years, or both such fine and imprisonment: * * * (Interstate Commerce Act, Part I—Section 20)

His continuing concern about the criminal implications is obvious
in the final paragraph.
This information apparently proved useful, because Cook reported
that 2 days later Cole was down again:
Cole made some further remarks about Mr. Saunders* desire to improve the
fourth quarter results, particularly in the railroad, despite the fact that he thinks
that revenues will be lower and operating costs higher than previously forecast
and that he, Mr. Saunders, and Cole see nothing particularly wrong with underaccruing various items at this point in time which could conceivably be caught
up some time in the future.

Cook was again forced to point out to Cole that they had to certify
the correctness of the financial statements "and that any deliberate
understatement of expenses in the manner suggested was a criminal
offense." Further emphasizing Cook's great concern are two Wall
Street Journal articles, dated November 9 and November 10, 1967,
which he sent to Bevan. These articles deal with the Westec situation,
then before the civil courts, and the passages marked referred to the
overstatement of that company's earnings. It was obviously clear to
the PRE, accounting department what their own top management
was trying to accomplish!
It was a period of tension within the accounting department. Cook
went to see Bevan, who was his superior at the time, indicating that
he was indignant and outraged and would resign if forced to do what
was being suggested. Bevan indicates that Cook told him that he would
fully support any statement by Bevan that "month after month we
have 32
been subjected to improper and undo [sic] influence as to accounting." Meanwhile, Saunders called Bevan and asked him not to prepare
any letters or memoranda about the accounting questions he had
raised at the November 6 meeting. He said he wanted to sit down with
Cook did not recall this particular discussion, but indicated that it was consistent with
his feelings at the time.

Cook and Bevan to discuss the questions, stressing that everything
possible had to be done to improve fourth-quarter earnings. Bevan
speculated that one of the other officers had warned Saunders after
the November 6 meeting that he was putting himself into an untenable
position, and that, accordingly, Saunders did not want any permanent
record made of this.
Cook and Bevan both agree that the accounting changes which
Saunders was demanding were not carried through. The staff has not
examined the voluminous underlying accounting records in question
and cannot directly take issue with this position. It might be noted,
however, that in connection with the 1968 audit, which was 33 first
audit for the Penn Central (and the Pennsylvania Railroad ), very
substantial retroactive increases were made in these reserve accounts.
It should also be noted that, consistent with Penn Central's everpresent policy of reporting the maximum income possible, these major
increases were offset by direct charges to retained income, rather than
against the current income account.
Saunders claims not to recall any of the incidents in question surrounding the November budget meeting, although he generally denies
the implication of the Bevan diary entry, quoted above, that he was
trying to bury certain expenses until after the merger. Cole denies any
independent recollection of the budget meeting but did seek to interpret
notes that he took there which indicate "STS said, 'Why hit the fourth
quarter with all these catchups. It won't make any difference after we
merge.' " Since Cole was obviously directly involved in the events too,
it is perhaps not surprising that he jumped to Saunders' defense, when
questioned about these items. While it seems clear that what Saunders
was trying to do was to get the accounting department to agree to
"doctor" the books, the core of Cole's position seemed to be simply
that Saunders would not do anything improper or deceptive. Initially
Cole tried to avoid the obvious explanation of Saunders' comment by
suggesting there was something in the merger and combining the books
of the two roads which justified what Saunders was advocating. However, he could not suggest what that was or that he had any basis for
that belief. While he admitted that Bevan's diary and his own notes
were obviously referring to the same event, he claimed they were interpreting it differently. However, he could not explain his own interpretation. He next claimed he knew nothing about accounting,34 although
his own testimony showed he knew more than he was admitting. He
suggested then it might be unnecessary or improper to accrue this item,
even though the accounting department had said it was required. He
even got to the point where he said that while he understood now that,
if such an expense was not charged, income would be higher, he was not
sure that he understood it then. That this very elementary concept
would not be understood by an individual in Cole's position is very
difficult to accept.
With respect to the events following the budget committee meeting,
Saunders did not recall, but could not deny, the call to Bevan asking
him not to reduce to writing the events of the meeting. His position as
to the Cook-Cole meetings suggests that Cole was off on some frolic of
his own, and that Saunders knew nothing about them. Cole on the

Pennsylvania Railroad had not had audited financial statements prior to that time.
Cole is an attorney and is currently Penn Central's vice president—legal administration. During the time under discussion his title was assistant vice president, administration,
and he reported directly to Saunders.

other hand dismisses the Cook meetings lightly, saying he does not
deny they occurred and thinks they probably did, but that the tone is
wrong, that if there had been a serious confrontation of the type described he would recall it. He attributes Cook's memoranda to the fact
that someone (obviously referring to Bevan) had conditioned Cook's
Actually, the events of the November period appear to be the culmination of a year of controversy. On March 22,1967 Cook had written
a memorandum marked "personal and confidential'' to Bevan, objecting to "schemes being discussed to manipulate first-quarter earnings"
and adding that " I think to enter into any of them would be a very
serious mistake and would invite disaster. I do not condone them
nor will I participate in them." The three schemes noted in particular
in that memorandum were—
(1) The reporting of earnings on real estate sales on the basis of
date of agreement rather than date of settlement;
(2) The cutting off of material transactions prior to the normal
cut off period;
(3) The spreading of storm costs throughout the year, rather
than recording them in the period when they occurred.
Cook's memorandum went on to emphasize his point by indicating
that this would invite "disaster from the ICC as well as severe criticism from the analysts and the public accounting fraternity," going
on to document his arguments with provisions from the ICC regulations as well as accounting literature. The constant pressure being exerted by top management is illustrated by the fact that, a few months
later, near the end of the next reporting quarter, Cook again had to
repeat his objections in response to further suggestions that the booking of real estate sales be carried through on an accelerated basis. Cook
was also disturbed by a suggestion made almost simultaneously by
the vice president of coal and oil that the revenues that quarter be
arbitrarily increased by certain amounts then in dispute between the
Pennsylvania Railroad and another road, although there was a strong
possibility they would have to be deleted some time in the future,
stating that "as far as I am concerned this is placing a worthless asset
on the books and creating imaginary income."
An interesting comment was made by Cook in connection with the
March memorandum. He pointed out that the Pennsylvania Railroad
would have in that quarter very significant "credits and other unusual income items," including sales of real estate and securities and
prior year adjustments, and he suggested that the policies being proposed might well place in jeopardy these other items as well. And this
was not the only situation where such a consideration entered into
discussions on the proper accounting treatment for a particular item.
I n effect, management was being warned that if it got too greedy, the
whole house of cards might collapse.

Certain areas proved particularly troublesome to the accounting
department because of the problems they presented in withstanding
top management pressure. These generally involved areas which Hill
described as "spongy." These were accounts where the final definitive
figures would not be available until some time in the future, and thus

involved some element of judgment in recording them currently.
The temptations in times of declining income were obvious and there
were numerous suggestions that the company take advantage of the
imprecision inherent in these figures, pending some improvement in
operating results. Basically, this would be used as an income equalizing
device. Saunders, perhaps sensing this was a toe-hold in his battle
with accounting personnel 35
who would be unable to confront him with
hard facts and absolutes, raised these matters at virtually every
budget meeting. In effect, he was seeking to substitute his judgment,
always on the side of higher earnings, for theirs. Nonetheless, as Hill
put it, while there was some uncertainty inherent in these "spongy"
areas, the flexibility was inherent in the accounting and not in the
executive direction of the company. It was not merely a question of
arbitrary judgment but of fact, and these items were subject to preestablished procedures of calculation. They could not properly be
used to meet the needs of the moment, and there is evidence, both
in the Bevan diary and in testimony, of resistance to Saunders'
One problem area of this nature has already been mentioned—that
surrounding various types of reserves. This was not merely a late-1967
problem but one which recurred again and again, both before and
after merger. One witness noted that the concern of top management
always seemed to be that these accounts reflected overprovision,
thereby understating income, and that equal concern was not directed
to the possibility of underprovision. Saunders7 version, on the other
hand, is that he was involved in "a couple of discussions from time
to time about the size of our reserve for loss and damages and casualties" characterizing them as discussions on the appropriate level of
reserves, whether they were too low or too high. He added, almost
as an aside, that in a number of instances they were too small and had
to be increased.
Another of these "spongy" areas on which Saunders concentrated
involved freight revenues. The final revenue figures were not 36
for several months after the close of an accounting period and
certain elements would be handled temporarily through the clearing
account. As indicated earlier, revenues regularly failed to meet
Saunders' targets. Bevan recorded one incident in late August 1967
when Saunders indicated to him that the third quarter revenue
forecasts were very poor and that an additional $5 million of revenues
had to be found. Bevan reported in his diary that "[although he did
not come out and say so * * * the implication was clear that he
expected me to get this out of the clearing account regardless * * * ."
He also reported that another employee had been approached separately by Saunders on the matter. Bevan's description was as follows:
I asked Sass what that had to do with him since he has nothing to do with
accounting but merely participates in forecasting. He said it was not clear to him.
He did not have a chance to ask any questions as S.T.S. was talking at him but
there seemed to be an implied suggestion that if revenues were not there we
should mortgage our future and put $5 million in anyway.

Cook recalled the Sass incident because, he related, everyone
thought it was hilarious and used to kid Sass about where he was
This had the further advantage of making it more difficult for outsiders (e.g„ the ICC
and the auditors) to uncover and question.
Hill testified that the area of elasticity was perhaps $2 to $3 million and that even
within that range, it was not arbitrary but based on various available data.

going to find $5 million. Cook did agree that what Saunders apparently
had in mind was taking it out of the clearing account and putting it
back by understating future revenues, indicating that this was the
only way to interpret the request.
Hill also testified that Saunders at least quarterly made demands
for additional revenue. When asked how Saunders expected him to
find it, he answered, "I have no idea, frankly. I assume by adjusting
the book." He indicated that Saunders constantly and legitimately
raised the issue with him that he, Hill, could not with absolute certainty
document the revenue within 1, 2, maybe even 5 percent. Hill understood that Saunders by these comments was trying to tell Hill to
increase the revenues. However, Hill testified that the 1 to 2 percent
elasticity inherent in the figures could not be used legitimately to
manipulate revenues within that 1 to 2 percent range.
Saunders describes these conversations as merely reflecting his
concern that all revenues which could legitimately be recorded that
quarter be recorded and that the accounting people went out and made
sure they picked up everything possible. While it is clear that the
types of effort he described were taking place, the situations described
by others appear to extend well beyond Saunders' appraisal of them.
The operating people, who were under fire for performing poorly,
were making their own revenue calculations and coming up with
more favorable figures than those of the accounting people, thus fueling
Saunders' desire for more income. Saunders admitted he recognized
the bias in the operating department figures, indicating that that was
the reason why he inevitably accepted without question the accounting
figures. However, Hill describes one occasion in late 1969 which refutes
this claim. The executive vice president for marketing gave Saunders
a memorandum charging that the financial department figures were
understating revenues by several million dollars:
Answer. Saunders confronted me with the memorandum and requested that I
adjust to that level. We could not adjust to it. We had what we regarded as
factual data. It went beyond the information available to the Vice-President of
Question. Did he [Saunders] tell you that he was going to be the one to make that
decision and not you?
Answer. That substance of words crept into the conversations but without result.
Question. How did you withstand that pressure, then?
Answer. By simply not making the changes in the account.37

This situation is illustrative of the environment in which the accounting department was forced to function.38 Considering the nature and
source of these pressures, it is not unreasonable to believe that such
pressures had a significant impact on the recording of various items,
encouraging the staff to push things as far as they felt they could
hope to get away 39
Per diem charges were another situation where full charges would
not be known for some time and accruals were necessary. Bevan's
diary describes two situations, one in mid-1967 and one in mid-1968,
in which he claims that Saunders advocated deliberately understating
per diem charges to increase income. In the second situation Bevan

Saunders and Cole recall the meeting, but deny it went as far as Hill indicates.
Saunders offered the same incident as an example of how he always followed accounting department policies.
"These are the charges which one railroad must pay for using the cars of another

indicates that, when Hill told Saunders it was probably already underaccrued, Saunders said that did not matter, "[i]t had been underaccrued before and it was not necessary to become a 'Christian' all
at once." While Hill did not recall the incidents, he indicated, however,
that they would be characteristic of the situation. Notes which Gole
took at the budget meeting described also appear to support Bevan's
Per diem costs were very high in 1967-69, a matter which concerned
Saunders greatly. Operating people, in defense of their poor performance, would indicate that they thought per diem charges were
being over-accrued by the accounting department and would come up
with their own supporting figures. Cook testified that Saunders never
directly told him to under-accrue the per diem account but it was
suggested at budget committee meetings and Saunders was a party to
the discussions. And Hill recalled that accounting personnel were
being challenged at virtually every budget meeting that they were
overproviding for per diem costs and being directed by Saunders to
reevaluate the figures. Hill indicated that, indeed, they felt they were
just barely at the correct level with a struggle to keep fully accrued.
Cook characterized it as being a matter of Saunders believing his
operating people (who were offering higher profits) rather than his
accounting people.40 Hill and Cole indicated that Saunders had a
tendency to want to wait on these unfavorable items, until "we have
a better feel" (that is, when operating conditions improved).

Another subject of controversy and pressure involved the merger
reserve. In line with his past proclivities to advocate accounting
treatments which would avoid charges against current income,
Saunders took the position that all types of costs which could be
considered merger-related should be charged off against a reserve
established for that purpose.41 Once again, while this would not result
in any real savings, it would enable Penn Central to report higher
earnings than if it was forced to treat these items as current expenses
as they were incurred. In contrast to costs, merger savings would be
allowed to flow through to increase reported earnings.
Before it could establish the reserve, Penn Central had to obtain
ICC approval. Saunders was told by his staff that an all-inclusive,
broad proposal had no possible chance of getting the required approval
and, accordingly, such a proposal was never submitted. Indeed, Cook
told him that even a much narrower plan the company was preparing
would probably be turned down by the ICC's Bureau of Accounts
and would have to be taken up with the Commission. Indicative of
Saunders' keen interest in income maximization was the fact that
upon being informed of this and before the accounting people dis40
Saunders testified he always accepted his accounting department's judgment without
question and when the staff pointed out that there was testimony from others which
contradicted this, he characterized these incidents as discussions where he sought to
understand what was going on.
Saunders also took the position that the reserve should be established by a direct
charge to retained earnings. While it was ultimately handled as an extraordinary charge
in the 1967 income statement, it would appear that as a practical matter this change is of
little significance.

cussed the matter with the ICC staff, Saunders himself took Cook
down to discuss the matter privately with William Tucker, Chairman
of the ICC.42 No one was present from the Bureau of Accounts,
although Tucker did eventually call in another Commissioner, John
Bush, wh° had an accounting background. After some discussion it
was decided to handle it through a normal presentation to the Bureau
of Accounts. A meeting was held later with Mathew Paolo, Director
of the Bureau, although the Pennsylvania Railroad did not inform
him of their earlier meeting with the ICC chairman. After getting a
staff denial on most of the request, the company then appealed
through regular channels. When Cook came down for the appeal
proceeding, Tucker, who was not one of the three Commissioners
hearing the appeal, asked Cook to stop by afterwards and tell him
how it went. Cook indicated to him that he thought it was favorably
received. He got the impression that Tucker also was sympathetic to
the road's position. Shortly afterwards, Pennsylvania Railroad was
notified it had received virtually full approval of their request at the
Commission level.
Upon approval, a $275 million pool had been created against
which currently incurred expenses could be charged.43 The temptations for misuse this would present to a profit starved company were
recognized by both the ICC staff and by Peat, Marwick, Mitchell &
Co. (Penn CentraPs auditors) at the time the account was established.
It was agreed it would have to be closely audited.44
As anticipated, almost immediately after the merger Saunders began
to make suggestions that the use of the reserves be expanded. Saunders
denies a statement in Bevan's diary of April 22, 1968 that Saunders
*a Saunders did not specifically recall the incident, but agreed that it happened. His
explanation of why Penn Central started at the top, so to speak, is as follows:
"A. This was something new for the Commission mainly as to whether there is any
possibility of getting this done and they submitted papers to the Bureau of Accounts and
if they don't go along, you have got a right to appeal it, that is what they said.
"Q. Why didn't you do that in the first place, why didn't you go right to the Bureau of
Accounts ?
"A. We wanted to find out if we had any chance of getting this thing.
"Q. Couldn't he have told you that, couldn't Mr. Paolo have told you that?
"A. Told us what?
"Q. Whether you had a chance of getting it through or not?
"A. It's just like a court proceeding, you can submit something to the Federal judge or
court of first jurisdiction if you don't like their decision.
"Q. You don't start with the Supreme Court and ask them their views before you go
down to the trial court, do you ?
"A. Well
"Q. That is what you did, isn't it?
"A. No. this is not a court.
"Q. You used the analogy.
"A. But you've got a right to appeal.
"Q. But you don't go to the Chief Justice first.
'"A. Well, it's not uncommon to discuss matters of this sort with the Commissioners.
"Q. You did it on a number of occasions, didn't you ?
"A. Well, on certain occasions, yes."
« The reserve had been established at a level which proved to be far in excess of the amount of charges
authorized under the agreement permitting its establishment. While this is contrary to the pattern exhibited
with the reserves discussed earlier, it should be noted that these earlier charges would have been against
ordinary income, while the one-shot establishment of the merger reserve was treated as an extraordinary
Peat, Marwick, for example, in an internal memorandum dated January, 1968 noted:
"It seems to us that the critical points will be reached in determining the actual amounts to be charged
against the reserve, since the establishment of the reserves has been based on rather broad estimates at
best. Charley Hill recognizes that he will be under pressure to use up whatever reserve is created and,
knowing him, I am sure he will find a way to rationalize many borderline expenditures."
Another memorandum during this period contained a number of guidelines and concluded:
"While the foregoing admitteily are rather stringent, they would serve as the basis for restrained discussion and would bring about the necessary reorientation in thinking to prevent the reserve from being used
as an earnings stabilizer in future years."

had been told at a budget meeting that Penn Central "could not hope
to get away with" charging extra people against the account because
it would be closely audited, and that he had tried to insist that all
that Peat, Marwick and the ICC could do (if they learned of it) was
to criticize the company, which did not bother him. Bevan was sufficiently concerned about the implications of this and other similar
suggestions that in spite of the fact he no longer had accounting responsibility he discussed the matter with Edward Hanley, one of
Penn Central's directors, in the summer of 1968. Hanley then met
with Walter Hanson, senior partner of Peat, Marwick, in New York.
Hanson assured him the account would be watched closely.
When the substance of Bevan's diary entry of April 22 was presented
to Hill and to Cole they objected to the use of the term "get away
with" but recalled that Saunders had on occasion made comments of
similar import. Hill recounted that over the postmerger period, as
earnings worsened, Saunders increasingly focused attention on what
Hill described as an "expanded use concept" of the merger reserve,,
indicating a feeling that "in a general sense, the merger reserve ought
to be a means of sheltering any unusual costs growing out of the
merger." Hill further indicated that Saunders apparently looked
upon the reserve as simply a bookkeeping device, and "at one time
or another would have solicited a charge to the fullest extent of the
reserve provision without regard to the nature of the agreement [with
the ICC]." Saunders was clearly attempting to return to his original
concept which he had been told could not generate ICC approval. In
addition, Hill also stated that Saunders was constantly concerned
that maximum use was not being made of the merger reserve and that
he "was insistent in his own mind that we were not charging adequately to the reserve" so that Hill was constantly having to check,
the reserve to make sure that some legitimate cost was not getting by.
Hill claims that no charges except those permitted under the conditions established by the ICC were made against the merger reserve,,
to the best knowledge of the accounting department. However, there
were two situations where Penn Central returned to the ICC for expansion of authority. In one of these instances again, Saunders was.
directly involved, seeking to make his influence felt to obtain desired
goals. This case involved a group of mail and baggage handlers and a
$4.7 million charge. Initial indications were that both Peat, Marwick.
and the ICC staff were opposed to permitting this charge against the
reserve. After meeting with Saunders, Hanson (of Peat, Marwick)
apparently changed his mind, agreeing to abide by the ICC decision..
And again Penn Central went directly to the ICC chairman. Hill,
who had taken over from Cook as comptroller, and Tucker, who had
left his position as chairman of the ICC to become a Penn Centrals
vice president, met with Mrs. Virginia Mae Brown, the then current
chairman. Once again, Penn Central succeeded in obtaining the

decision it wanted at the Commission level.45 However, the SEC staff
believes that $4.7 million charge did not come within the original
"merger reserve" criteria and should have been reflected as a period
expense during the year ended December 31, 1968. (See further
discussion at page 67.)

Management's attempts to improve railway earnings through exhortation were described previously, as was the unfortunate practice
of skimping on maintenance to save current expenses (and cash). The
suggestions for increasing re venues through use of the suspense account
and for reducing expenses through delays in the booking of per diem
charges, inventory losses, increases in reserves for damages, personal
injuries and the like, has been noted, as has the plan to charge current
costs against a reserve instead of against current operations. All of
these actions were directed toward increasing reported earnings.
The last section was devoted principally to those situations where
the accounting department was under pressure to do things which it
was resisting. However, it agreed to and sometimes initiated schemes
involved in other parts of the earnings management program.
Under railroad accounting, certain facilities are not depreciated
but their costs (less scrap value) are charged to ordinary income when
abandoned. It was up to Saunders to determine when a facility was
considered abandoned, which gave him effective discretion to control
expenses of this nature. He took advantage of this situation. In
September 1969 Saunders issued instructions that, while he had approved the preliminary forms necessary for retirement of certain
properties, none were to be made effective "until accounting authority
is received which will avoid these losses from being charged to ordinary
operations." Plans were underway for a Master Abandonment Program
whereby at some point in the future, ICC authority would be sought
to establish a reserve against which both past and future writeoffs
could be made. In the meantime, the abandonments would pile up.46
« Another example of Saunders* keen interest in keeping every somewhat unusual expense item out of
the calculation of ordinary income and his willingness to take steps personally to bring it about is a 1964
situation involving certain damage to equipment caused by heavy snowstorms that winter. Saunders
wanted to charge it directly to retained earnings. He put a great deal of pressure on the accounting department, and when they resisted, he insisted that they take the matter to the ICC for approval. The Bureau of
Accounts turned them down. Saunders then met with Walter Hanson of Peat, Marwick to seek his support,
but Hanson, after some research, indicated that he was unable to do so. Saunders wrote back to Hanson
stating his basic position:
" I am convinced that the business community benefits from financial reporting practices, which are consistent in principle and which meet broad tests of acceptability. At the same time, it is highly important
that investors and financial people obtain a correct picture of the effectiveness of management in conducting
corporate affairs. It seems to me that the short-term disturbance to earnings produced by such events as the
January snowstorm leads to misjudgment in evaluating our direction. The accounting profession and the
business world would do well to look to a better solution to the problem of reporting period income."
This statement reflects the clearly "even keel" attitude.
A few months later, Saunders was still complaining about the situation asking Bevan "What are we doing
to get the Commission to adopt a more realistic attitude in this regard?" Bevan in a reply memorandum
"Practically every well-known accounting firm in the country is strongly in favor of putting, with very
few exceptions, all charges through the current Income Account. We believe that as time goes on their influence in this respect on the ICC's position will be such that it will become increasingly difficult to get permission to charge various items to Retained Income. Furthermore, each year a greater percentage of the railroads of the country are having their books audited by C.P. A. 's who, in turn, will insist on this approach with
the various railroads involved. Under the circumstances those roads that wish to handle numerous items
through Retained Income are going to find themselves very much in the minority and very much in an
almost untenable position.
"These are the facts of life as we see the situation at the present time."
Cook testified that the P R R did obtain permission to charge these storm-related costs over the full 1964
year and that it was his impression that this was because of Saunders' intervention, but this matter is
One witness testified that from his trips around the system shortly after merger, it appeared that P R R
had a lot of unused track, which it was apparently not taking out of service because it did not want to incur
the service costs.

Also in 1969 Penn Central established a reserve for "Loss on Investment in Long-Haul Passenger Facilities" of $126 million. The ICC
disallowed the item for ICC reporting purposes, but the company
included it in its reports to the public. The basis for ICC disapproval
was that the properties were still in use and had not been abandoned.
The company, on the other hand, claimed that there was a permanent
impairment in value and wrote it off anyway.47 This had the earnings
advantage of lowering depreciation costs now and in future years (most
of this property was depreciable).48 And the reserve, labeled as an
extraordinary item in the 1969 income statement, would be construed as such by the investment community, and thus its effect on
reported income in 1969 would be discounted.
In this last situation, perhaps more disturbing than the transaction
itself is the inconsistency with the prior item. Here, property still in
use was nonetheless written off in order to save on current expenses,
whereas in the last instance, property which was effectively abandoned
was not written off, again to save on current expenses. The influence
of the maximization policy is clear.
In 1969 Penn Central had another problem. It had been forced to
absorb the New Haven Railroad. The New Haven had lost $22 million in 1968 and had a consistent pattern of unprofitable operations,
which Penn Central could ill afford to report considering its own disastrous performance.49 Saunders suggested a reserve for operating
losses be established, but was told that this was clearly impossible
under generally accepted accounting principles. However, a treatment
was found that reduced the earnings impact, at least over the short
term. The state of New Haven's equipment was very poor, it was
claimed, and it had to be rehabilitated. On this basis, a very high proportion of the total maintenance cost attributable to the50
road in 1969
was written off against a liability for rehabilitation cost established
as sort of negative goodwill in connection with the purchase of the
New Haven properties.51 As a result total maintenance costs in 1969
were very significantly lower than they had been in the prior year.
Peat, Marwick, after initial objection to Penn Central's claim, finally
relented and accepted the company's position. On the other hand, for
purposes of reporting to the ICC, the company was forced to treat
$22 million of these charges as ordinary maintenance, not rehabilitation, and charge them against ordinary income. The result was a $22
million difference in the profit figures reported to the ICC and to the
public in 1969.
« The files of Peat, Marwick, discussing 1969 accounting problems, carry the following notation concerning
this item:
"Two conflicting theories of accounting may be advanced with respect to the long-haul passenger service
situation. On the one hand, there is ample precedent for writing down assets to their net realizable value;
on the other hand, an argument can be made that to continue long-haul passenger service carries with it
the obligation that the true costs of providing that service is rendered. We can see merits to both arguments,
and, therefore believe we must respect Penn Central's position."
« The financial statements did carry a footnote reporting the difference between the treatment in the
shareholder report and the ICC report, and the fact that the item had a $4.5 million impact on depreciation
in 49
Hill testified that on the structuring of the New Haven transaction " I know T did a lot of head-scratching, trying to figure out a means to achieve the objectives that seem evident in Interstate Commerce Commission with the least possible burden on the Transportation Co."
Cole's budget meeting minutes indicate that at one meeting the suggestion was thrown out that the
New Haven be assigned to the employees' pension fund! While this was not ultimately done, the idea was
that the equity could be given away, while Penn Central continued to operate the road. This way it would
not have to be included in Penn Central's results.
so It was contemplated that when the $40 million sum thus reserved was exhausted further such expense
might then be capitalized.N
si When Penn Central's comptroller was asked if anyone in Penn Central ever expressed the opinion
that this was nothing more than a reserve for future losses he replied that "there was a great deal of cynicism
among people that did not understand the accounting principle involved * * *"

Another consistently unprofitable railroad property was Lehigh
Valley Railroad Co., a 97.3-percent owned subsidiary of Penn Central.
Losses in 1968 and 1969 were $5-$6 million per year. However, despite
the very high percentage of ownership, Lehigh Valley's results were not
included in the consolidated statements, thereby permitting the parent
to report a higher net income. The justification claimed was a fiction
that the Lehigh Valley was being held only on a temporary basis.52

The emphasis thus far has been on railroad activities. However, in
the quest for income to meet management's earnings goals, nonrailway
areas, particularly those related to real estate and investment activities,
presented even greater opportunities.
The Penn Central complex includes over 170 separate companies. 53
The key entity is Penn Central Transportation Co. which has direct
responsibility for operating the railroad, and also holds securities in
various railroad and nonrailroad subsidiaries. The bulk of the nonrailroad assets are held through the Pennsylvania Co. (Pennco), a
100-percent owned subsidiary of the Transportation Co., which functions principally as a holding company for the various investments it
controls. Both Pennco and the Transportation Co., have numerous
subsidiaries involved in railroading, real estate, and other endeavors.
Above the Transportation Co. on the organization chart is Penn
Central Co., a parent holding company formed on October 1, 1969.54
This company is basically a shell with virtually its sole asset being
100-percent of the stock of the Transportation Co. In requesting shareholder approval of this change in organization management told the
shareholders that the holding company device was being adopted to
simplify the diversification process and to reflect the importance of
nonrailroad operations, getting away from the image of Penn Central
as a railroad company. Basically, what was occurring was that the
railroad's record was so dismal and its future so unappealing that the
company wanted the public to forget it was a railroad. However, as
indicated earlier, the dominant feature in the earnings picture of the
Penn Central system was the very substantial losses being generated
by the railroad system.
In assessing the impact of nonrail activities on Penn Central's
income statements, two sets of figures should be considered. One
consists of consolidated figures, those of Penn Central and its majority
owned subsidiaries. The other represents figures of the principal
operating entity 55 on an unconsolidated basis, hereinafter referred to
as "company-only" or "Transportation Co."
The impact of the drain from railroad activities and the importance
of nonrailway activities to the Penn Central organization is shown by
the following table:
«2 See further discussion on page 64.
« A simplified chart, showing the major companies relevant to the discussions in this report, is included
as exhibit IB-2.
« Up until this date what is now the Transportation Co. was the top entity and carried the name Penn
Central Co.
5 The Transportation Co. and its predecessors.



[In millions]
Company, only:
Earnings (loss) from ordinary operations
Represented by:
Profit (loss) on railway operations
Profit from nonrailway activities
Earnings from ordinary operations
Represented by:
Profit (loss) on railway operations
Profit from nonrailway activities


















Source: Pennco 1970 offering circular.

Some of the income from nonrailway operations 56 represented the
results of routine activities but other portions clearly reflect the results of the maximization policy and Saunders' desire to conceal the
earnings slide.
In the company-only statements, substantial income was derived
from rental properties, principally New York real estate formerly held
by the New York Central, from dividends and interest received from
consolidated subsidiaries, from dividends and interest on other investments, from gains on sales of property and from tax allocation agreements negotiated with subsidiaries who benefited tax-wise from the
railroad's losses. Because Penn Central had the power to control the
timing of gains on sales of investments and properties, and dividends
from controlled companies, these categories offered particularly attractive opportunities for programing reported earnings.
In the consolidated statements the major categories of nonrail income, without elimination of minority interest and without deduction
of interest expense, were as follows:
{In millions]
Pipeline, net—
Real estate rents, net
Real estate sales:
Dividend and interest on investments
Net gain on sale of investments

























Source: Assembled from information in 1970 Pennco offering circular.

In the mid-l^O's PRR, knowing that it was going to be required
bv the ICC to dispose of its very substantial interests in the securities
of the N & W and the Wabash Railroad, and dissatisfied with the
results of its own railroad operations, embarked on a major diversification program. Pursuant to this program by 1965 it had acquired,
through Pennco, controlling interests in Buckeye Pipeline Corp. and
in three real estate development companies, Great Southwest Corp.,
«6 Certain railway-related activities of companies other than the Transportation Co. are included in
the nonrailway figures.

Macco Corp., and Arvida Corp. Great Southwest acquired Macco
from Pennco in 1969. The latter three companies greatly expanded the
scope of Penn Central's real estate activities, as reflected in the consolidated statements. The Great Southwest-Macco operation proved
a particularly useful device in the maximization program.

There was tremendous pressure on those responsible for the company's real estate activities to generate additional income. Whatever
could be done within the Transportation Company and its railroad
related subsidiaries to generate additional income and cash flow from
disposition of property holdings was done. A great variety^ of avenues,
involving a multitude of properties, was explored, although mam^ of
the proposed transactions were never consummated. At any rate,
revenue potential in this area was limited. 57
The real focus, however, came not in the parent but in Great
Southwest-Macco. These operations are examined in considerable
detail in a later portion of this report. Suffice it to say at this point
that there were pressures exerted by Penn Central management
which resulted in changes in the scope and methods of operations of
these subsidiaries and provided a very sharp increase in income in
1967-69. Such changes so overextended Great Southwest that it
nearly collapsed in 1970 and has survived only on the basis of a
massive retrenchment in operations.
A considerable portion of the Great Southwest-Macco earnings was
attributable to a limited number of very large transactions. Two
transactions contributed approximate^ $15.1 million to Penn Central's consolidated net earnings for the fourth quarter of 1968.68 These
purported sales, the Six Flags Over Georgia and Bryant Ranch transactions described in more detail later, involved premature recognitions
of income and little immediate cash benefit to Great Southwest. In
1969 there was another similar transaction, involving the purported
sale of Six Flags Over Texas (also discussed latsr), which resulted in an
increase to Penn Central's consolidated net earnings of approximately
$24.4 million. The following schedale sets forth the estimated incremental effect of these three transactions on the financial statements of
Great Southwest and Penn Central, respectively. I t should be noted
that the effect on Penn Central differs due to: (1) the inclusion of
Great Southwest in the consolidated Federal income tax return of
Penn Central; (2) the absence of taxes payable by Penn Central due to
its tax losses and carryovers and the absence of deferred tax provisions; and (3) the minority interest in Great Southwest. The
$13,401,576 and $18,358,003 figures represented approximately 67 and
53 percent of Great Southwest's reported consolidated net income for
the years ended December 31, 1968 and 1969, respectively:
5 The fact that many of the properties were heavily mortgaged further complicated the situation.
M The company-only statements of the T« asportation Company were not affected, except to the extent
of the increase, if any, in tax allocation agreement payments as a result of these transactions.


I ncrease to net
income (after tax
provision) of GSC
Six Flags Over Georgia
Bryant Ranch (less deferred portion)

Approximate increase to consolidated net
income (no tax
effect) of Penn







Six Flags Over Texas
Bryant Ranch (deferred portion)



As a result of administrative proceedings commenced by the
Commission on December 8, 1971, and as announced by the Commission on June 6, 1972, Great Southwest has agreed to file amendments
to its Form 10-K annual reports for the years ended December 31,1968
and 1969 which will exclude profits from the above three purported
sales, i.e., Six Flags Over Georgia, Bryant Ranch, and Six Flags Over
Texas. In substance, the Six Flags Over Georgia and Six Flags Over
Texas transactions are to be treated as joint ventures with the purported purchasers, and the Bryant Ranch transaction is to be treated
as an incompleted sale where income will be recognized only after all
costs relating thereto have been recovered by Great Southwest.59
A sale in 1969, involving the Rancho California property, resulted
in the booking of a large profit in the third quarter. Unlike the others,
this was a cash sale and has not been challenged from an accounting
standpoint. However, it cannot be considered, either in size or in type,
as a routine Great Southwest transaction, a fact which has disclosure
These real estate transactions, both in Great Southwest and in
other sections of the Penn Central organization, played an important
role in management's attempts to control quarterly earnings. Saunders'
calls to the Great Southwest's management shortly before the end of
each quarter, seeking income for Penn Central, were an integral part
of his operating routine. On transactions within the parent company
itself there were frequent pressures from top management to force
transactions through before the close of a quarter for income statement
purposes. Usually these related to accelerating the closing. However,
on at least one occasion Bevan reported that Saunders had suggested
that a wash sale should be arranged to get the profit if a transaction
could not be pushed through before the end of the quarter.60 In
contrast, the next quarter, when income was again below expectations,
Saunders inquired of the comptroller as to whether there was a way to
avoid recording a loss on the sale of another building in that period.61
Once again, management's propensity to control the earnings being
reported to the public by speeding up the profits and delaying the
losses and costs is clearly apparent.
« See Securities Exchange Act Release No. 9629(1972).
eo Bevan indicated that he had refused, and that at any rate it was never consummated as the potential
buyer was not interested.
« Again he was told no, according to testimony.


The same pattern is prevalent in the investments area. During this
period of time an intensive effort was underway to find additional
sources of cash and profit, and it appears that with a few exceptions
(i.e., the four "diversified companies" acquired in the diversification
program) virtually any company assets offering such benefits were
on the block if a buyer could be found at a reasonable price. Unfortunately, however, the opportunities were limited. The two roads had
been cannabilizing their assets for many years and the most saleable
items were gone. The N&W stock was being sold as rapidly as
possible, pursuant to an ICC order, described later in this section. This
was generating both cash and profits ($10.3 million in 1968 and $13.6
million in 1969) and would continue to do so until 1974 when the
supply would be exhausted. However, there were limitations on the
capacity of the market to absorb the stock and furthermore many of
the shares had been pledged or were for other reasons not readily
available for sale.
As will be discussed in a subsequent section, attempts were made in
the last half of 1969 to dispose of part of Pennco's holdings of Great
Southwest and substantial profits would have been generated thereby,
b u t these plans fell through, largely because of disclosure problems.
Most of the other investments of Pennco and the Transportation Co.
were closely held and lacked marketability, and were often unattractive as well. Efforts were made to dispose of them b u t they were for
the most part unsuccessful. For example, in mid-1969 the sale of one
subsidiary was being considered, but since virtually all of this subsidiary's operations were carried out on behalf of its parent, the
Transportation Co., Peat, Marwick and Penn Central's own accountants vetoed the transaction. Because the subsidiary's basic means of
support was, and would be, the obligation of the parent to use the
subsidiary's equipment, the sale would have resulted in no economic
advantage to the Transportation Co. Thus, management was told,
it would be improper to record a "profit" on such a "sale" transaction.
While Penn Central was stymied in its efforts to sell sufficient assets
to bring income up to the desired standards, the income account was
buoyed by a series of paper transactions which reflected no real change
in the company's position. For example, the subsidiaries were examined closely for possible dividends, and a series of "special dividends"
was ordered by the parent. These were designed to draw into the
parent's income statement any earnings which had been accumulating
over a period of years. Obviously, any such dividends did not accurately reflect current earning power. Several such payments were
arranged in 1969, and dividends from consolidated subsidiaries increased by $25 million. The two largest items of increase were represented by a $14.5 million dividend from New York Central Transport Co. and a $4.8 million dividend from Strick Holding Co. The
Strick transaction was basically noncash in nature. 62 In the case of
New York Central Transport, r e n n Central in effect loaned its subsidiary $12 million to pay the dividend, since the subsidiary lacked the
necessary funds, and after some accounting legerdemain, recorded the
•2 No cash payment was made, but debt owed by the parent to the subsidiary was reduced. And the earnings from which Strick paid the dividend were represented by values assigned to warrants in a newly formed
company which had acquired Strick's major assets.

items as income.63 There were also other similar intercompany dividends. While these transactions would be eliminated upon consolidation, they did help the Transportation Co.'s results, and considering
that entity was where the major problem was buried, Penn Central
apparently considered this better than nothing.
A device used extensively in 1968 to increase income was the repurchase, in the open market at a deep discount, of bonds of various
companies in the rerm Central complex. The difference between the
price paid and the par value was then recorded as a profit. The company recorded a profit of $8.4 million in the Transportation Co. and
$9.8 million in the consolidated entity from this source in 1968, but
found it virtually exhausted64
when suggestions were made in 1969 that
this device be tapped again. These transactions, particularly in light
of Penn Central's need to finance the purchases through additional
borrowing, apparently offered no real benefit to the company except
the generating of paper earnings.
There were also a series of paper transactions involving in essence
substitutions of similar securities which resulted in significant amounts
being added to reported income in 1968 to 1970. Two such transactions
contributed a total of $32.7 million in 1968 to both consolidated and
company-only earnings. The first involved a dividend-in-kind from
Washington Terminal Co.,65 a 50-percent owned subsidiary. This dividend was in the form of the securities of a newly formed company
which Washington Terminal had received when it transferred to the
new company a one-half undivided interest in Union Station in Washington, D.C. Union Station had been Washington TerminaPs principal
asset and an undivided one-half interest therein was the major asset of
the new company as well. Penn Central controlled after receipt of the
dividend, essentially the same underlying asset as it had had prior to
that time, but it recorded income of $11.7 million as a result. The
second transaction was in the form of an exchange of securities with
Madison Square Garden Corp. and contributed $21 million to reported 1968 results.66 The Transportation Co. exchanged its interests
in two assets held jointly with Madison Square Garden Corp., and
\vhich constituted the bulk of that corporation's assets, for shares in
Madison Square Garden Corp. itself. Again, following the consummation of the transaction Penn Central had basically the same interest
as before, packaged in a slightly different form, but took advantage of
the situation to record a large gain.
Other transactions of this nature also occurred.67 In 1964 the ICC
had issued an order requiring PRE, and its affiliates to divest themselves of all of their extensive holdings of N&W stock by 1974.68
In late 1965 PRR and Pennco entered into an agreement with the
N&W, whereby Pennco, which held all of the PRR system's
N&W shares, would exchange about one-third of these shares for
15-year N&W convertible debentures,69 with the exchange to be
« See further discussion of this item on page 60.
•* In 1967 and 1969 the Transportation Co. earned about $500,000 from this source, while consolidated
figures were $700,000 and $1,700,000 respectively.
See furthet discussion on page 62.
See further discussion on page 57.
See also discussion concerning Wabash Railroad Co. stock on page 55.
w The P R R system at that point owned 2.4 million shares of N&W common, representing32 percent of
the total, and a maiority of its voting preferred shares. The reason for allowing a 10-year period was to
permit an orderly disposition and to provide certain tax advantages.
•• Pennco was to receive $104 million in 4^6 percent debentures which were convertible only by holders
other than P R R .

made in 10 installments. A gain of about $80 million was recorded on
P R R ' s consolidated books, 70 but instead of taking the entire amount
into income that year, the company recorded it as deferred income.
The deferred income was then to be recognized on a periodic annual
basis over the life of the contract, 9% years. 71 I t might be noted that,
whereas in the Madison Square Garden and Washington Terminal
transactions it was contemplated that the securities received in
exchange would continue to be held as an investment, the N&W
debentures would, of necessity, be liquidated. Indeed, the securities
received in 1966-68 were sold in 1967 and 1968. There were no sales in
Penn Central took the position that its investment activities were
an integral part of its business and classified all income from this
source as ordinary income. Such a claim apparently lies at the root of
attempted justification of nondisclosure of many of the various transactions noted above. However, not only had the opportunities for
conventional sales become severely restricted, but it would be difficult to
sustain income of the type derived from such items as special dividends,
repurchases of company bonds, and paper transactions like Madison
Square Garden, and Washington Terminal. 72 The contrast between
this and Penn Central's handling of what it considered to be unusual
merger related expenses should be noted. In its presentation to the
ICC on behalf of r e n n Central, Peat, Marwick pointed out that the
use of such a reserve would result in a more fair presentation of the
results of the merged company by removing the impact of certain
unusual expenses on the income statement. Furthermore, as to the
$75 million in merger-related costs which did impact the income
statement in 1968, management took pains to point out to the shareholders that they were temporary in nature. No similar effort was
made to clarify the nature of many of the investment transactions
which were generating reported income.
While Penn Central's search for income potential among its investments was broad-ranging, it exhibited a pronounced reluctance
toward writeoffs of investments. There was substantial evidence by
the end of 1969 of permanent impairment in the value of the investments in Executive Jet Aviation Corp., Madison Square Garden
Corp., and Lehigh Valley Railroad. However, formal recognition of
this fact would require charges against the income statement, charges
which Penn Central could ill afford to report.
Penn Central had invested $22 million in Executive Jet Aviation.
Most of this investment should have been written off in 1968 and 1969.

Because of prior intercompany sales, the profit on Pennco's books was smaller—only $59 million.
While this may appear inconsistent with the Penn Central policy of taking everything into profit
immediately and worrying about the future later, it might be noted that 1966 was an extraordinarily profitable year in the railroad industry, and thus there was not the pressure for additional earnings which was
present in subsequent years. Furthermore, a gain of this size would certainly have been considered nonrecurring and discounted by the public, whereas the smaller amortized gains could perhaps pass unoticed.In this connection it might be noted that while in 1966 P R It made the decision to report the N&W exchange as an ordinary income item, in 1965 when it sold its interest in the Long Island Railroad at a substantial loss, it reported a "Provision for loss on sale of Long Island Railroad" as an extraordinary charge.
Perhaps another indication of management's propensity to use artificial devices to increase income is
this comment in early 1969 by Cole, in discussing plans to establish the holding company:
" I have taken a special interest in this project and have been trying to push it along, because I thought
I foresaw the prospect of being able to generate net income by Railroad or Pennsylvania Company declaring
dividends of low-book value assets which would then be taken in by the Parent at present market values,
as in the case of the Washington Terminal dividend and the Madison Square Garden transaction. Alas, I
have just learned that this is prohibited where the declaring corporation is more than 50 percent owned."
Management never did find any additional transactions similar to the transactions alluded to, and 1969
investment income dropped accordingly.

Unfortunately, disclosure of the fiasco surrounding this situation 78
would have been embarrassing to management, in addition to its detrimental effect on earnings, and so no writedown was taken. The market
value of the Madison Square Garden shares had dropped by more than
50 percent between the time Penn Central's investment in the project
was in effect written up in connection with the previously described
exchange of securities in late 1968, and the close of 1969.7* Again, the
investment was not written down. In the case of Lehigh Valley Railroad, as suggested earlier, that company should have been consolidated and not carried as an investment, but even as an investment, the
earnings and financial history of the company clearly called for a
writedown to realizable values.75

When Gorman came to Penn Central in late 1969, and began to
familiarize himself with the company, he became concerned about an
earnings pattern he discerned. In connection with his testimony he
submitted a table of quarterly earnings results for 1969 and 1968,
which has been attached as exhibit IB-3. This table, prepared by a
Penn Central statistician early in 1970, presents in a readily comprehensible format not only the }
full loss on railroad operations, but also
a chart of "significant items/ including many, although not all of the
items described in previous parts of this section—e.g., New Haven
capitalization, merger reserve charges, the Washington Terminal
dividend, the New York Central Transport dividend, the Madison
Square Garden exchange, the three Great Southwest transactions and
the profit on reacquisition of company bonds.
On the basis of the pattern exhibited, Gorman requested a special
meeting of the finance committee of the board, which met in early
May 1970. The minutes of that meeting record the proceedings as
The President then stated that he was deeply concerned about a number of
management practices, although there was no indication that they were illegal or
had not been approved by outside counsel and outside auditors.
He did state, however, that he was disturbed by certain matters because in his
view an item must not only be right but must look right to outside sources. He
stated that he had followed this code for over 40 years and did not intend to change
at this stage of his career and that he would like to discuss certain matters with
the Committee to determine whether the practices would be continued in the future. He emphasized that his action did not imply criticism of the Chairman of the
Board, the Chairman of the Finance Committee to the Finance Committee, but,
nevertheless, what he was talking about was practices which he believed had
been followed for some time in the past.

While not all the practices related to reported earnings, it was clear
that this was the dominant theme. He specifically mentioned such
matters as the "declaration of dividends by subsidiaries on a hit or
miss basis to satisfy a current underrun", profits on transfers of investments between segments of the Penn Central organization, writeups of investments such as Madison Square Garden with the holdings
then locked in because of subsequent price declines, and unrealistic
budgets. He also questioned certain other practices which he felt did
not reflect a conservative approach to reporting earnings.

w See discussion on page 71.
M It has remained at lower levels since that times
* See discussion on page 64.

Apparently it was in substantial part events in the first quarter of
1970 which alarmed Gorman. As noted earlier, the first quarter was
operationally a disaster, with $100 million in losses from railroad
operations. This was unfortunate because, with a critical cash situation, Penn Central, through Pennco, was about to go into the public
markets for financing. Some way had to be found to improve the apparent earnings picture if the issue was to succeed. Gorman objected
to the two major devices adopted, however, to accomplish the goal.
In connection with the channeling of the proceeds of the proposed
offering from Pennco to the Transportation Co., Pennco was to purchase from the Transportation Co. the stock 76 Clearfield Bituminous
Coal Corp., a 100 percent-owned subsidiary. The transfer was made
at net asset value, and a profit of $16.9 million was recorded on the
Transportation Co. books. Gorman indicated he questioned booking
paper profits such as this, even with full disclosure. He recognized
these intracompany sales would be wiped out in the consolidated statements but asked the question "why do we bother with those kind of
things?" The reason was clear—to dress up the Transportation Co.
That transaction was dwarfed, however, by the other one, which
involved not the Transportation Co. but the consolidated statements.
Pennco owned virtually all of the common shares of Wabash Railroad
Co. and pursuant to an ICC order dated 1964 had agreed with the
N&W to exchange them for N&W shares. The date of the exchange
was established as October 15, 1970. However, when it was recognized the first quarter profits would be very bad, hurried plans were
made to accelerate the exchange to March 31, 1970. As a result,
profits of $51 million were booked as ordinary income in that quarter.77
Gorman, who was in the hospital at the time, knew nothing about it
until after the transaction was consummated and reported. He was
irritated and reported to the finance committee that if he had known
about it he would have dissented. This was a writeup of paper profits,
with aflowthrough to earnings but no cash benefit, he stated, reflecting
to the committee "a general feeling that where there is no cash involved why do you do things. And certainly we were in need of cash."
Furthermore, he was particularly distrubed by the fact that the acceleration had cost Penn Central $1.8 million in Wabash cash dividends,™ which he felt he could certainly have used to repair freight
cars which seriously needed repairing. It might be noted that Penn
Central management had made a number of other expensive concessions to N&W as well, to gain the income acceleration.79
The impact of just these two transactions on reported earnings in
the first quarter of 1970 was as follows:

The carrying value on the Transportation Co. books was only $82,000.
The gain on Pennco's books was $47 million.
w This reflects the difference between the dividends which Pennco received from the N&W shares in
the interim period and those it would have received had it held the Wabash stock.
It appears that under the terms of an escrow agreement in connection with a $50 million debenture
offering of Pennco, debenture holder approval was required before the terms of the exchange agreement
could be amended. Such approval was not obtained.

Company only
Reported loss
Increase loss by eliminating purported profits on:
Sale of Clearfield Bituminous Coal
Exchange of Wabash RR. Stock





Total loss as adjusted (in millions)



It might be noted that there were also other devices discussed by
Saunders and Bevan during the early 1970 period whose effect would
have been to increase reported earnings. The accounting department
suggested an upward revaluation of inventory, although this idea
was dropped on Gorman's objection. The possibility of allocating
part of the overhead and management costs of the Transportation
Company to the holding company and the subsidiaries was brought up.
Gorman said he had no objection but asked why now? Bevan instructed Hill to check with other railroads on amounts being accrued
for 1970 wage increases, stating that it was important not to exceed
what was necessary in this respect. And the old possibilities of expensing off the winter's heavy snow removal cost over the entire year and
increasing use of the merger reserve were raised once again. Saunders
also asked the appropriate people to look at the reserves for injuries,
damages, and so forth, to see if a lower figure could be justified.

The foregoing activities clearly illustrate the course of conduct
being pursued by Penn Central's management. All manner of means
were being employed to make the situation appear better than
underlying circumstances warranted. Very significant portions of the
reported earnings of this cash-starved company were noncash in
nature. Moreover, the figures were replete with income derived not
from routine, on-going investment and real estate activities but from
forced liquidations of assets employed in these activities in order to
meet the earnings and cash needs of the railroad. These assets were
not available in unlimited supply, a fact clear to management long
before Penn Central's final collapse. And the pressures applied by
top management to alter cost and expense figures to meet management's desires in all probability had an impact, of unknown extent,
on the reported figures.
At a minimum, the course of conduct illustrated above called for
clear disclosure of the nature and effect of the policies management
was following in this respect. Thus, under the circumstances of this
case shareholders were entitled to be provided with the information
necessary to permit them to fully and fairly assess the quality of the
earnings being reported. Beyond this, however, it is clear that in a
a number of instances the recording of income or failure to record
deductions from income involved the stretching of generally accepted
accounting principles to the point where the total impression given
may have been highly misleading. A few of the most significant
situations are described in the following section.


Background.—In connection with the construction of the newMadison Square Garden Center over Pennsylvania Station in New
York City the then Pennsylvania Railroad Co. (PRR) acquired a
25 percent stock interest in Madison Square Garden Center, Inc.
(Center). These shares were received as part of the lease arrangements
for air rights over the station and were carried on PRR's books at $1.
The other 75 percent stock interest in Center was owned by Madison
Square Garden Corp. (Garden). Center constructed the facility and
after it was completed in early 1968, all of the revenue-producing
activities and certain related assets of Garden, which had owned
and operated the old facility, were transferred to Center.
As part of, and in connection with the construction of the new
facility, a joint venture was entered into for construction and operation
of a 29-story office building above the easterly third of Pennsylvania
station in New York City. Participation in the venture was as follows:
Pennsylvania Terminal Real Estate Corp. (PTRE) 1
Two Pennsylvania Plaza, Inc.2
Tishman Plaza, Inc



i A corporation 100-percent owned by P R R directly or through one of its wholly owned subsidiaries.
2 A corporation 100-percent owned by Garden.

Under the terms of the joint venture, in exchange for an increased
participation,80 PTRE undertook to loan funds to cover costs of
construction in excess of the construction loan and PRR, which owned
all the stock of PTRE, agreed to furnish funds to PTRE for such
Just prior to December 31, 1968, the equity interests of Garden and
Penn Central in Center and in the joint venture are illustrated by the
following chart:
s° The agreement, as originally structured, provided for a 25 percent interest to the P R R subsidiary and
75 percent to the Garden subsidiary. Because of difficulties in obtaining needed financing, this was later
renegotiated, with P R R receiving an increased participation in return for an agreement to provide financing.

Equity Itoldinss before Exchange of Stockholmin*s
{Madison Square Garden
fN'on-O^cratln/: Entity]!


penn Central Transportation]
Coctpany (Ua i iroad)

Madison Square Careen Center
I Assumed'Revenue Operations of Old Garden]
Two Pennsylvania Plaza, Inc.
11007. owned by M C

Pennsylvania 1 Pvcall
Estate Corporation • 1002 I
[ovned by -Penn

'Joint Venture - 29 :>uory Office
ura" 1
Bldg. "Penn Plazc Ventur


(Tishaen Plaza, Inc.

jOther Wholly owned subsidiaries of
iMadison Square Garden Corporation:
Holiday on Ice Productions, Inc.
[Madison Square Garden Attractions, Inc,
[Madison Square Garden Realty, Inc.
Graham Paige Realty Corp.

Pursuant to an agreement dated December 18, 1968 Garden acquired as of December 31, 1968,81 Penn Central's interests in Center
and PTRE. In addition certain indebtedness owed Penn Central in
connection with the office building project was forgiven. In exchange,
Penn Central received 1,168,664 unregistered shares of Garden's
common stock and 100,000 shares of Garden's participating preferred
stock. Contingent upon approval of Garden's stockholders, it was
agreed that the participatmg preferred would be exchanged for
1,151,000 shares of common. This approval was obtained on April 9,
1969 and the exchange made about 10 days later.82
In connection with the above, on December 18, 1968, Garden and
Perm Central also entered into a stock purchase agreement whereby
Penn Central agreed to purchase shares of Garden's common stock to
furnish the financing necessary to complete the office building. This
related directly to Penn Central's obligation under the joint venture
agreement, as mentioned previously, to furnish funds to PTRE for
that purpose.83
Analysis of Changes in Equity Interest of Penn Central, as a Result
of the Exchange.—Penn Central indicated that the reason for the
transaction was as follows:
The purpose of Penn Central in agreeing to the purchase and proposed purchase
of Securities of the issuer was to concentrate and unify Penn Central's interests in
si This date was selected because of Penn Central's desire that the transaction be closed before the end
of the vear
82 The interim step was necessary because Garden did not have the authority to issue the full 2,300,000
shares in December 1968.
,„ , - A ^
83 P e n n Central agreed t o purchase u p t o 180,638 shares at $11,078 per share. P T R E w o u l d request t h e
a d v a n c e needed. P e n n Central w o u l d t h e n purchase from Garden t h e shares required t o provide that s u m

and Garden would advance the proceeds to PTRE.

the new Madison Square Garden Center and the office building at Two Pennsylvania Plaza through the ownership of a substantial equity interest in Madison
Square which will be the beneficial owner and operator of those facilities. Thus,
Penn Central as owner of the underlying properties will continue to receive fixed
rentals from these facilities and will in addition have a significant single equity
interest in the profit from their operation.84

Penn Central realized no cash from the transaction. It gave up a
controlling 55-percent interest in the Penn Plaza venture, a 25-percent
equity interest in Center and certain interest bearing indebtedness
related to the Penn Plaza project. In return Penn Central received a
23-percent interest in the outstanding stock of Garden, which was
increased soon thereafter to 25 percent through other purchases.85
Garden at this point was essentially a holding company, whose major
assets consisted of its interests in Center and the Penn Plaza venture.
Penn Central retained its 25-percent interest in Center. Its interest in
the office project was reduced from 55 percent to about 20 percent and
it received a 25-percent interest in Garden's lesser subsidiaries,86 which
were all associated with the Garden project. Penn Central was not
relieved of its contractual agreement to advance additional funds for
the completion of the Penn Plaza venture and retained its rights to
receive long-term rentals under the main lease of the air rights to be
paid by Center.
In terms of recorded values on the books, Penn Central was giving
up assets which had a stated value of $4.7 million. It received shares
which had an equity value on the books of Garden at May 31, 1969
of $4.2 million.87
Exchange Arrangement Recorded as Gain by Penn Central.—Penn
Central reported a gain of $20,999,905 on this exchange as ordinary
income in the year 1968. This was computed as follows:88
Received by Penn Central:
Shares of Garden common stock
Shares of Garden common stock which were represented by the
convertible preferred


Multiplied by per share market price of Garden stock
Total market value of shares received
Given up by Penn Central:
225 shares of Center.
100 shares of PTRE
Indebtedness forgiven
Total given up
Net gain on exchange

1,168, 664
1,151, 000
2, 319, 664

$11. 078

25, 697, 238
4, 697, 232
4, 697, 333
_. 20, 999, 905


This was selected as the average market value per share at the time of negotiations and was the figure
agreed to in the stock purchase agreement.
s* Source: Item 4 of Schedule 13D,filedon Apr. 1,1969.
8 This increase was attributable mainly to purchases under the stock purchase agreement entered into
in December 1968, which was previously described.
8 Because of the early stage of operations the contribution to earnings is difficult to assess. However, of
total investments and advances to subsidiaries of $24,800,000 Garden's books, $17,000,000 was invested in
Center, $6,600,000 in the office project, and $1,300,000 in the lesser subsidiaries. The other significant asset
on Garden's books was the old Garden facility which has been cleared and is currently being used as a
parking lot.
8 Thisfigurerepresents a 25-percent interest, rather than a 23-percent interest in these assets.
« As abstracted from accounting workpaper included in thefilesof Peat, Marwick.

The impact on the 1968 financial statements was as follows:
Earnings (loss) from ordinary operations i
Earnings (loss) absent recognition of gain
Per share difference:
As reported
Absent recognition of gain






. 91

i Figures are 1968 figures as restated in the 1969 annual report to shareholders. The 1968 report to shareholders had
reported a profit of $90,300,000 on a consolidated basis and a loss of $2,800,000 for the Transportation Co. only.

This transaction accounted for slightly less than half of the net gain
on sale of investments in the consolidated income statement and 60
percent of the net gain on sale of property and investments in the
company-only statements.
Conclusion.—Serious questions are raised as to the recognition of
gain on this transaction, since, in substance, this transaction reflected
merely the substitution of an investment in one form for essentially
the same investment in another form.

Background.—Prior to the year 1969, as part of a plan to simplify
the corporate structure of Penn Central, it was contemplated that
certain trucking companies would be merged. It was considered at
that time that the New York Central Transport Co., Permtruck Co.,
Inc., and Merchants Trucking Co. would merge into Pennsylvania
Truck Lines Inc. 89
An internal memorandum prepared by Penn Central's tax department proposed that a significant amount of th3 retained earnings of
the nonsurviving corporations be paid out as a dividend prior to
merger. The memorandum stated that the reason for the proposal
was to create an annual savings of some $60,000 in various State income and franchise taxes. As part of the proposal it was suggested
that the amounts representing the dividends paid out be immediately
loaned back to the paying corporations so that no actual transfer of
cash or other assets would be involved. These loans would bear
interest and be subordinated to th( rights cf creditors requiring that
protection. The proposal as set forth by the tax department recommended the proposal subject to the absence of any objections from
the operations and financial sections of management. I t appears,
however, that there were "financial objections" to the proposal as
set forth by the tax department. On March 4, 1969, Cole advised
Our financial people have been shying away from this however, because there
is not sufficient cash to pay the dividend and they say that to execute it as a single
transaction on an intracorporate "bookkeeping'' basis might be regarded as a
manipulation which would be misleading as to actual results. 90 An acceptable
alternative might be to take the dividends on a gradual basis over a period of time.
• New York Central Transport, Pennsylvania Truck Lines, and American Contract Co. were 100 percent own" 1 subsidiaries of the Transportation Company. Penntruck and Merchants Trucking were 100
percent own^d subsidiaries of American Contract.
Ifill tost'fled that some people within Penn Central thought that maybe "you could just make marks
in a bo:>k" fiat would effect the dividend, but that he objected to taking the dividend income "unless
something of value flowed between the parties."

Special Dividend Income Recorded by the Transportation Company
in 1969.—New York Central Transport Co. declared the following
dividends payable to the transportation company: 91
Apr. 15, 1969
July 15, 1969
Dec. 31, 1969

6, 000, 000
2, 500, 000

Also in 1969, Merchants Trucking Co. and Penntruck Co.,
Inc. declared dividends of $300,000 and $1,700,000, respectively, to
American Contract Co. This $2 million in dividends declared to American Contract was the basis for the declaration of a dividend to the
Transportation Company which included this amount.
As to the two $6 million dividends outlined above, the Transportation Company instructed the Manufacturers Hanover Trust Co. to
charge its account and credit the account of New York Central Transport Co., whose account was also carried at that bank. Simultaneously,
New York Central Transport Co. instructed the Manufacturers Hanover Trust Co. to charge its account and credit the account of the
Transportation Company. The instructions were followed. At the time
Penn Central was allegedly loaning funds to New York Central Transport Co., Penn Central did not have the necessary funds in that bank
to cover the amounts transferred.
While advances payable were substituted for equity belonging to
the sole shareholder, the Tend result, in effect did not give the 100percent stockholder entit} anything more than it had before. Indeed,
it was further provided that future dividend potential of the surviving
entity in the tracking company merger was to be reduced by the
amount of interest paid—at the prime rate—on the advances.
The form developed for the manner in which dividends would flow
upstream to the railroad was regarded by management in the first
instance as a manipulation. The interjection of Manufacturers Hanover Trust Co. was a facade designed to provide illusionary evidence
of dividend payments by New York Central Transport of the Transportation Company and did not alter the substance of the transaction.92
Certainly, the situation appears to bear close analogies to the content of Accounting Series Release No. 95, which deals with real estate
In some of the transactions coming before us it appears from the attendant
circumstances that the sale of property is a mere fiction designed to create the
illusion of profit.
Circumstances such as the following tend to raise a question as the propriety of
the current recognition of profit:
6. Simultaneous sale and repurchase by the same or affiliated parties.
7. Concurrent loans to purchasers.

As noted above, the dividends to American Contract by Merchants
Trucking and Penntruck were passed on to the Transportation Co. as
well. The Transportation Co. advanced to the two subsidiaries the
$300,000 and $1,700,000 necessary to pay the dividends to American
Contract. In practical effect the transactions were the same as in the
case of New York Central Transport although the format differed
«i Now York Central Transport Co. reported net income of $2,686.8*4 and $4,202,098 for 1968 and 1969
resDectively. Retained earnings, including 1969 results, amounted to $14,755,632 at December 31,1969 before,
giving effect to the 1969 dividend.
»2 Indeed, Cole has testified that New York Central Transport is currently protesting the transaction
and asking for cancellation of the debt incurred.

Conclusion.—The 1969 "company-only" (railroad) financial statements included the sum of $66,324,000 as dividend and interest
income.93 this amount, $63,838,000 was from dividends of which $14
million discussed herein, or 22 percent, is included. The loss from
ordinary operations of $56,328,000, as shown in the 1969 operating
statement, was understated by this $14 million (25 percent of $56,
In the opinion of the staff the appearance of dividend income in
these transactions is without substance and there is no support under
generally accepted accounting principles to include the results of these
transactions as dividend income on the "parent company only"
financial statements for the year 1969.

Background.—The Transportation Co. reported as dividend income
in the year ended December 31, 1968, the receipt of a dividend-in-kind
from a 50-percent owned company, the Washington Terminal Co.
(WTC). The dividend-in-kind consisted of stock representing 100percent ownership of a newly formed corporation holding an undivided
one-half interest in certain real property and air rights relating to
Union Station, Washington, D.C., and its proposed development into
a National Visitor Center.
The voting control relationships of the respective entities as of
September 13, 1968, just before the declaration of the purported
dividend-in-kind by the Washington Terminal Co., were as follows:
Transportation Company


The Baltimore and Ohio
Railroad Company (B&O)


Philadelphia, Baltimore
and Washington Railroad
Company (PB&W)


Pull ownership of "National Visitor Center Property"


New York Central Transport Co
Merchants Trucking Co..


On September 13, 1968, the board of directors of WTC adopted a
resolution with respect to the transfer of title to the National Visitor
Center property to the owners of WTC. It was the intent to convey
undivided one-half interests in the property to two companies to be
formed by WTC. The dividend-in-kind would then be accomplished
by conveying 100 percent of the common stock of one such company
to B&O and 100 percent of the common stock of the other company to
the Transportation Co.94 This was accomplished on or about September 30, 1968, when 100 percent of the stock of Terminal Realty Penn
Co. was transferred to the Transportation Co. as a dividend.
The deed by which WTC conveyed (to the newly formed corporation) the undivided one-half interest included the following reservation, among numerous others:
Subject to the continued right of use, possession, operation and maintenance»
of the Union Station Building, concourse concession areas and related areas
presently used for commercial operation by The Washington Terminal Co., its
lessees, concessionaires, licensees, passengers, officers, employees, contractors,
invitees, and visitors during the period of alteration and construction of the
Visitor Center parking facility and new passenger station contemplated by
Public Law 90-264 and until the taking of full occupancy by the United States
of America pursuant to a lease covering the property herein described.

The deed may have in form transferred legal title of the undivided
one-half interest to the newly formed corporation. However, the right
to control and use the property remained with WTC.
At the date of the declaration of the WTC dividend-in-kind, it was
anticipated that an agreement would be entered into between the U.S.
Government and the owners of the distributed property for the
development of such property into a National Visitor Center. On
December 18, 1968, such agreement was actually executed. The
December 18, 1968, agreement provided that the National Park
Service would lease the property for 25 years, after the owners had
made significant alterations and improvements, expected to take 2 to
8 years. After the first year of the deferred 25-year-lease term, the
Government had the option to acquire the altered and improved
property for a reducing amount declining to zero at the end of the
25 years.
Accounting Treatment—The Transportation Co. recorded and reflected the dividend-in-kind as dividend income in the amount of
$11.7 million,95 the estimated fair value of its undivided one-half
interest.96 For the year ended December 31, 1968, this represented
approximately 13 percent of Penn Central's consolidated net income,
while elimination would increase the company-only loss from $2.8
million to $14.5 million.
Conclusion.—We question the propriety of the recognition by the
Transportation Co. of income in the amount of $11,700,000 in the
form of a dividend-in-kind from WTC since in substance the position
of the consolidated enterprise was unchanged with respect to the use,
possession, operation, and maintenance of the subject property.
Generally accepted accounting principles do not permit recording a
transaction based on form when its substance is materially different.
The substance of the December 18,1968, agreement was a promise

Under a lease agreement, the Transportation Co. was entitled to all income of PB&W.
The amount was originally recorded as $13.5 million but was adjusted later in the yea**.
96 wTC's net income for the years ended Dec. 31, 1967 and 1968 was approximately $56,810 and
$1,401, respectively



on the part of the U.S. Government to purchase certain property
after significant construction and alternations had been made to transform such property into a National Visitor Center. Recognition of
income under such circumstances was inappropriate until the seller
had substantially performed its obligations.

Background.—Prior to 1962 the then PRR, through subsidiaries,
owned 44.4 percent of the outstanding shares of Lehigh Valley Railroad Co. As a result of an exchange offer, PRR on February 28, 1963,
became the record or beneficial owner of 89.9 percent of the stock and
this was increased to 97.3 percent in 1964.
The Lehigh Valley's position was considered in the PRR-New
York Central merger hearings before the ICC. The hearing examiner
found that the merger could be anticipated to have a detrimental
effect on Lehigh Valley and that specific protective provisions should
be provided. It would either have to find affiliation with the Norfolk
& Western (N&W) or Chesapeake & Ohio/Baltimore & Ohio (C&O/
B&O) systems or be merged into PRR. Until this matter was resolved
PRR would be required to keep Lehigh Valley operational. The
following conditions were imposed by the ICC in its decision dated
April 6, 1966, approving the Penn Central merger:
1. Penn Central was required to propose negotiations and, if the offer were
accepted, to negotiate in good faith and otherwise use its best efforts to obtain a
place for Lehigh Valley in the C&O/B&O system.
2. After October 16, 1969, or upon the issuance of an ICC order denying the
Erie-Lackawanna petition for inclusion in the N&W system, Penn Central was
required to negotiate in good faith with the N&W with respect to the inclusion
of Lehigh Valley within the N&W system.
3. Unless otherwise relieved by the ICC, Penn Central had to retain its holdings
in Lehigh Valley and provide financial support to keep that road going for the
next 10 years. If at the end of that time, it has not been taken into the N&W
or the C&O/B&O systems, the Commission could, as part of the instant proceedings, require inclusion in the Penn Central system.

Neither the N&W nor the C&O/B&O had indicated any interest
in acquiring Penn Central's interest in Lehigh Valley either at that
time or subsequently.
Lehigh Valley was consistently a loss operation with total losses
in 1960-69 of over $40 million. In 1968 the net loss was $6 million,
while the 1969 97
figure was $5.2 million, before an extraordinary charge
of $1.2 million. Meanwhile, Penn Central was required during 1968
and 1969 to advance substantial sums to that company to keep it
operational. Shortly after Penn Central filed for reorganization,
Lehigh Valley followed suit.
Accounting Treatment.—Lehigh Valley was carried as an investment
in Penn Central's consolidated financial statements in 1968 and 1969,
at the following values:

The company has been unable, by a large margin, to even operate within its depreciation.


Unconsolidated subsidiary:
Lehigh Valley Railroad Co.:
Stock, 1,475,579 shares
Bonds, notes and advances
Total (in millions of dollars)







i $27.1




i The figures omit to state $9,400,000 in advances to Lehigh Valley, which in 1968 had been included in the asset category
of "Deferred charges and sundry assets", under the caption "Accounts doubtful of collection." In the 1969 statements
which included comparative 1968 figures this $9,400,000 was reclassified to the investment account.

No dividends were paid in either year.98
Despite Penn Central's 97.3 percent ownership, Lehigh Valley was
not consolidated and accordingly its losses were not reflected in the
consolidated results. The advantage to Penn Central was obvious, and
was consistent with that company's policy of maximizing earnings.
The reports included a footnote explaining the principles of consolidation and noting that Lehigh Valley, "which the Commission has
required to be offered for inclusion in another system", had not been
consolidated. Information as to its net assets and net loss were contained in another footnote.
Analysis,—Penn Central apparently relied on the requirement that
it offer Lehigh Valley to C&O/B&O and then N&W as the basis for
nonconsolidation, drawing its accounting support from the criteria
included in Accounting Research Bulletin No. 51. The pertinent
section of that bulletin reads as follows:
Consolidation policy:
2. The usual condition for a controlling financial interest is ownership of a
majority voting interest, and, therefore, as a general rule ownership by one
company, directly or indirectly, of over 50 percent of the outstanding voting
shares of another company is a condition pointing toward consolidation. However, there are exceptions to this general rule. For example, a subsidiary should
not be consolidated where control is likely to be temporary; or where it does not
rest with the majority owners (as, for instance, where the subsidiary is in legal
reorganization or in bankruptcy).

In this instance, despite the merger conditions, it appears unlikely
that control would be temporary. There were no contacts between
Penn Central and C&O/B&O that related in any way to the acquisition of Lehigh Valley in the period from 1966-1969. It seems safe to
presume that if Penn Central had thought there was any possibility
of interest on the part of C&O/B&O, it would have explored the matter " but C&O/B&O was involved in its own merger plans at the time,
plans which would clearly not have included Lehigh Valley.100 Furthermore, even absent the merger factor, the company was not attractive.
Both the senior vice-president and the chief counsel of C&O/B&O were
emphatic in their testimony: at no time from 1965 to date would Lehigh Valley have had any strategic value to their road. Indeed, the
C&O/B&O would have to be paid to take it, because of the obligations
and liabilities involved. Its attitude toward that road was completely
w No dividends had been paid since 1957.
99 Not only was it required to do so under the terms of the merger, but it would certainly have jumped at
the chance to get rid of this subsidiary.
100 The Erie-Lackawanna Railroad offered in effect the same benefits as the Lehigh Valley, and was
considered more attractive. N&W, which was the potential merger partner of C&O/B&O, absorbed tba
Erie-Lackawanna in early 1968.

In response to a staff inquiry to the N&W regarding its possible
interest in Lehigh Valley, that road's vice president-finance replied:
To my knowledge, Penn Central never approached N&W management about
a possible sale of Penn Central's interest in Lehigh Valley. For its part, N&W
had no occasion to consider acquisition of Lehigh Valley in view of the mandatory
order of the ICC requiring inclusion in N&W of Erie-Lackawanna, which like
Lehigh Valley, affords access to the port of New York through Buffalo. ErieLackawanna was included in the N&W System on April 1, 1968.

Furthermore, Saunders himself testified that they wanted to sell
Lehigh Valley and could find no one to buy it:
Question. What was wrong with Lehigh Valley?
Answer. It was killed by competitors. It was not really a good investment, I
don't think, but I shouldn't pass judgment on that, but Lehigh Valley has never
made any money. It may have way back in the Thirties, but in the last 20 years
Lehigh Valley hasn't made a cent.
Question. Well, why didnH you get rid of Ann Arbor or Lehigh?
Answer. We tried to get rid of Lehigh Valley, we offered it to Norfolk and
Western Railroad and to the C. & O. They wouldn't touch it, nobody would.
Question. Well, wouldn't they take it out of [sic] of book value?
Answer. They wouldn't give you a penny for it, that's my judgment. It's not
worth anything.

Conclusion.—Penn Central knew or should have known that by
the year 1968 it could no longer avoid consolidating Lehigh Valley.
By this point, it was clear that neither the N&W, nor the C&O/
B&O had any interest in acquiring it, and there was no indication of
a feasible alternative. The implications of the ICC conditions with
respect to Lehigh Valley in the Penn Central merger hearings were
clear. The Lehigh Valley would be kept running and if no other
solution were found, Penn Central would have to absorb it. The
company could no longer rely on ARB No. 51 to avoid consolidating
Lehigh Valley.101
Against this background it would appear that the company's
consolidated income statements for 1968 and 1969 were overstated by
the amounts of $5.8 million and $5.1 million ($6.2 million after
extraordinary charges) which represented 97.3 percent of the unaudited losses for Lehigh Valley for those years.
Even if it were deemed that Penn Central had an arguable
position, supported by; persuasive evidence, for not consolidating its
1968 and 1969 financial statements, the evidence clearly indicates
the necessity of a write-down of this investment, at least by
December 31, 1969. In this instance, the negative impact on the
1969 financial statements would be even greater than in the case of
The stock was listed on Penn Central's books at a value of about
$15 per share, whereas the price range in 1969 was $6M-4.102 In
addition, beginning in 1968, Lehigh Valley required significant infusions of capital from Penn Central.103 The operating history of
Lehigh Valley for the decade prior to 1970 clearly indicated that the
Penn Central could not expect repayment of advances 104 and any
benefit from share ownership. All evidence points to a situation fo
permanent impairment in Penn Central's investment.
i It might be noted that the Wabash Railroad Co. was also an unconsolidated, majority owned company
but, as discussed previously, in that case the temporary nature of the control was obvious. See page 55.
102 The market was, of course, limited considering Penn Central's 97 percent ownership. The price might
reflect this factor to some degree.
103 prior to that time, Lehigh Valley had relied largely on proceeds of the sale of capital scrap [largely
second track that they took up] for additional capital.
As noted previously, Penn Central itself initially classified the advances as "accounts doubtful of
collection," although this was later reclassified into the investments category.

The audit workpapers of Peat, Marwick for 1969 illustrate their
awareness of the problem. They stated, "Lehigh Valley—to be written
down or reasons must be supplied."
As a result they obtained a representation letter from Bevan
stating the following:
One of the roads to which the Lehigh Valley must be offered is the C&O
and if the merger with the Norfolk & Western does not go through, the Lehigh
Yalley will have great strategic value to the C&O and we certainly should be
able to come out well on our investment.
There are other alternatives we have in mind if this does not occur but it is
too early and premature to determine to what extent, if any, an impairment
may result in the investment.

As indicated earlier, it was clear by this point that C&O/B&O
had no desire to acquire Lehigh Valley, a fact of which Penn Central
must have been aware. There 105 no evidence of meaningful alis
ternatives available at the time. In late July 1970, Lehigh Valley
entered into reorganization and Penn Central wrote off the unsecured
portion of its investment, amounting to $30.3 million.

Introduction,—The consolidated financial statements included in
Penn CentraFs 1967 annual report to shareholders contain the
following note:
The Penn Central merger results in duplication or obsolescence of certain railroad properties, equipment, materials and supplies, and the requirement to rehire
certain otherwise surplus furloughed employees, all of which are estimated to
represent $275,421,985 in costs and losses. An extraordinary charge for these
items has been provided as a reduction of earnings in 1967. The effect on the
balance sheet, at December 31, 1967 is:
Adjustment of assets:
Obsolescence of materials and supplies
$6, 013, 000
Impairment in value of properties
125, 859, 313
Provisions for Liabilities:
Impairment in value of leased property
Cost to demolish obsolete properties
Cost of recalled employees.._
Liabilities incurred upon merger
Total costs and losses incurred upon merger

131, 872, 313
385, 461
26, 236, 211
116, 928, 000
143, 549, 672
275, 421, 985

In 1968 and 1969, charges of $17,225,000 and $7,216,000, respectively, were made to the provisions other than those for recalled
employees. The charges to the merger loss provisions relating to
recall of surplus furloughed employees totaled $22,459,000 and
$15,250,000 for the 2 years, respectively.
There has been concern as to the propriety of creating a large
"reserve for future losses" by means of an extraordinary charge to
income. There are some circumstances where the creation of such a
reserve is proper accounting and in this case there seems to be justification for its establishment. Under such conditions, the critical
1 5 While shareholders equity was still $67 million at the end of 1969, there is no indication that this figure
had any meaningful relationship to liquidating value. Indeed the figure had been declining from year to
year and was downfromnearly $100 million at the time when PRR acquired control in 1963.

problem is to make sure that all charges against an appropriately
established reserve are reasonable and proper.
Background.—A merger protective agreement dated January l r
1964, entered into between the two railroads and the labor unions
provided that, if the merger ultimately became effective, no one
employed during the period from January 1, 1964, to the effective
date of the merger would be terminated after January 1, 1964. A
subsequent termination did not have to be merger related for the
agreement to apply.
There were two separate classes of employees who were expected to
be made surplus as a result of the merger. The first group numbered
about 7,800 and were to be made surplus as a result of consolidations,
coordinations, elimination of facilities, and so forth. It was made up of
employees who were working as of February 1, 1968, and were to be
subsequently made surplus. All wages relating to such 7,800 employees
were to be charged to current operations—none charged to the
liability reserve. The second group consisted of approximately 5,600
employees, furloughed prior to the merger, but who, due to the merger
protective agreement, had to be recalled to service upon consummation
of the merger and had to be employed and/or paid thereafter until
they left through natural attrition. It was the railroads' position that
the costs associated with the recall from furlough to idle or nonproductive work of these 5,600 employees was solely related to the
The $116,928,000 liability reserve established was to provide only
for wages to be paid to these surplus furloughed employees and only if
they were involved in idle-time or nonproductive assignments. It
should be noted that this group of employees was not made surplus by
any projects conducted after the merger but were already surplus prior
to the consummation of the merger; the obligation to recall them to
service came about solely as a result of the merger protective agreement and not from anything connected with the physical operation
or consolidation of the merged railroads. In other words, if the merger
would not have been consummated, the railroads would have had no
obligation to recall such furloughed employees.
Application to the ICC for Approval of the Charging of Separation
Cost of Mail and Baggage Handlers.—In 1968, as a result of curtailment
of use of Penn Central's services by the U.S. Post Office Department,
Penn Central incurred a cost of $4,672,000 in separation payments to
mail and baggage handlers made surplus by that curtailment. By
letter to the ICC dated January 23, 1969, Penn Central argued that
such costs should be charged to the "merger reserve'' instead of being
reflected as an operating expense for the year ended December 31,
1968. The primary reasons given in the letter were that such costs were
directly the result of the labor agreements incident to merger,106 they
were unproductive of merger savings, and ". . . the reserve was adequate to provide for these charges since a number of employees entitled to reemployment upon merger and for whom reserve provision
was made failed at their own volition to appear on the rolls of the
company." Penn Central did not explain why such costs did not more
closely resemble the type relating to the expected "protection" payments to the 7,800 employees referred to above than they did to those
The separation payments were a way of "buying-out" of the guarantees established under the Merger
Protective Agreement.

which had been provided for in the merger reserve. Hill, who was instrumental in obtaining the necessary ICC approval, claimed that the
separation of mail and baggage handlers had been delayed as a result
of a fire in the related facilities and that otherwise they would have
been separated prior to the merger. However, when asked to provide
documentary evidence of this, he furnished two memoranda, one prepared in December 1968 which does not refer to a fire, and one in
January 1969, which makes only incidental reference to a fire.
The December 1968 memorandum, which was prepared by Hill,
does, however, clearly indicate that in the absence of other authority,
the severance costs would have to be recorded as charges against
income in the year 1968. The memorandum further states that while
it would appear likely that the ICC would grant authority for such a
charge, it was unlikely that Peat, Marwick would accept it:
"The principal reason for rejection by independent accountants is that the
costs arise as a result of decline in business under an agreement which the company
was willing to adopt as a price for doing business on a merged basis. Under such
circumstances, independent accountants would conclude the costs are expenses
of the period and therefore chargeable against income without regard to any
prior period provision of reserves."

Indeed, it is clear that in the railroad industry, contracts giving
extensive protection to labor and entered into to "buy" the cooperation of labor are by no means unique to the merger situation, and
related costs are typically considered as operating expenses.
The period in mid and late January was one of substantial activity
by a Perm Central management bent on avoiding this charge against
operations. On January 22, 1969, Hill and Tucker (a Penn Central
vice president who had a short time earlier served as ICC Chairman)
met with Mrs. Brown, the current ICC Chairman, and Commissioner
Bush to discuss the propriety of the charge. About a week earlier
Saunders had met with Walter Hanson, senior partner of Peat,
Marwick for what he described as a general get-acquainted meeting.
In a memorandum dated January 21, 1969, Cole advised Saunders
that Hill had that day spent a considerable length of time with Peat,
Marwick and that ". . . they didn't understand that Mr. Hanson had
changed his position about the propriety of including mail handlers'
separation pay." The following short memorandum, prepared by
Cole, was given to Hill on the morning of January 22, 1969, the day
of his meeting with the ICC:
Your interpretation of the Saunders-Hanson conversation about separation
pay for mail handlers is correct. That is to say, PMM will not take exception to
the charging of this expense to the Reserve if the ICC will approve that accounting.

By letter dated January 23, 1969, Peat, Marwick expressed its
opinion to Penn Central that the $4,672,000 ". . . costs would not
constitute an appropriate charge against the reserve." However,
Peat, Marwick then went on to state the following (emphasis added):
We understand that you intend to petition the Interstate Commerce Commission to review the facts concerning the separation of the mail and baggage handlers
and to rule on the question of whether such separations are, in fact, merger-related. We have reviewed the letter addressed to the Commission by Mr. Saunders.
Under the circumstance, if the Commission in its judgment deems the separations to be
merger-related and the costs incident thereto chargeable against the reserve, we would
no longer have a basis for objection to a charge against the Merger Reserve for this

Henry Quinn, the writer of the January 23, 1969, Peat, Marwick
letter, testified that he may have been expressing his own personal
opinion in such letter. He explained by saying that the Peat, Marwick
staff had discussed the matter and several felt that the $4,672,000 was
an appropriate charge to the "merger reserve." He stated further that
his opinion was not whether the charge was in accordance with generally accepted accounting principles but was whether the charge was
in accordance with the criteria initially approved by the ICC. Accordingly, it was Peat, Marwick's position that if the ICC said that
the $4,672,000 charge was appropriate then Peat, Marwick would not
By letter dated January 29, 1969, the ICC notified Penn Central of
its decision:
This will advise that a majority of Division 2 107 in conference today voted to
grant the letter request filed January 23, 1969, for authority to charge an amount
of $4,672,000 expended during 1968 in connection with separation of mail and
baggage handlers against the "merger reserve" established in 1967.

It should be noted that the ICC's letter did not address itself to the
question of whether the charge met the criteria originally established;
instead, it merely gave permission to charge the reserve. The decision
was made by Division 2 without the benefit of a written Bureau of
Accounts analysis and recommendation.
Conclusion.—With respect to the special, charge relating to the
termination of mail and baggage handlers, the facts expressed in
Saunders' January 23, 1969 letter to the ICC clearly disclose that the
$4,672,000 charge did not relate to recalled surplus furloughed employees or appropriate substitutes. Such letter clearly indicates that
the $4,672,000 charge related to a curtailment of services after merger
and that such curtailment was not merger related. The additional facts
available to the staff clearly indicate that the curtailment was a nonmerger related reduction in the demand for the railroad's services by
the Post Office Department. The accounting rationale for setting up
the original $116,928,000 liability for the recall of surplus furloughed
employees was that solely as a result of the effectiveness of the merger
a liability had been created and the combined railroads had therefore
suffered an expense (loss), unrelated to future operations, that had to
be recognized. This accounting rationale does not apply to the facts
leading to the $4,672,000 in payments. The operative fact leading to
such payments was the curtailment of services, not the mere fact of
the effectiveness of the merger. The liability, and hence the expense,
did not exist as of December 31, 1967 nor February 1, 1968. Nor was
there a known contingent liability as of such dates.
The $4,672,000 in separation payments incurred during 1968 as a
result of the curtailment in services of mail and baggage handlers
appears not to come within the letter or intent of the original "merger
reserve" criteria. Accordingly, even though the ICC allowed it lor
ICC reporting purposes, such amount should have been reflected as a
period expense during the year ended December 31, 1968 in Penn
Central's annual report to shareholders.
iw Division 2 is the three Commissioner panel responsible for hearing appeals in ICC accounting matters;



Background.—In 1965, as part of its diversification program, PRR,
through a wholly owned subsidiary, American Contract Corp.,
acquired 655,960 shares of class B nonvoting common stock of Executive Jet Aviation, Inc. (EJA) at a cost of $327,980 representing a
58-percent interest in the company's combined class A and class B
shares outstanding. American Contract's largest investment in EJA,
however, was in the form of loans and advances. Between 1964 and
1969, loans totaling $21 million 108 were made by American Contract
with funds provided to it initially by PRR, and later by Pennco.
EJA had been formed in 1964 as an air taxi operation, to furnish
air transportation when and as needed to executives at a fixed rate
per mile under a minimum usage contract. PRR looked upon its
investment primarily as a way of entering the air transport and air
cargo fields. In August 1966, EJA negotiated for the acquisition of
Johnson Flying Service, Inc., whose principal asset was a permanent
certificate as a supplemental air carrier, which it had received from
the Civil Aeronautics Board. Shortly thereafter, EJA committed
itself to purchase four large jet aircraft at a total cost of $26 million.
However, unless and until EJA received the required CAB approval
for acquisition of Johnson Flying Service, EJA had no use for the
aircraft since it lacked the authority to operate them.
In late 1966 EJA applied to the CAB for approval of its acquisition
of Johnson Flying Service. After a lengthy hearing before a CAB trial
examiner a decision to approve of EJA's acquisition was made, with
the condition that PRR divest itself of control of EJA within 6 months.
The divesture was ordered because the examiner found that PRR was
in control of EJA in violation of the provisions of the Federal Aviation
Act, which requires CAB approval before any surface carrier can
acquire control of an air carrier.109 The CAB adopted the examiner's
decision, with certain limited exceptions, in June 1967.
Subsequently, PRR and EJA prepared and submitted for approval
to the CAB a financing and dives ture plan. In this connection, a
preliminary registration statement was filed with the SEC, covering
certain aspects of the proposed financing.110 On December 22, 1967,
the CAB held that the plan, which contemplated considerable continuing investments in EJA by PRR, did not meet the requirements
the CAB had established. It indicated that complete liquidation of
PRR's investment was required.
Meanwhile, the PRR was quietly continuing to advance moneys
to EJA. And EJA itself was still thinking in terms of expansion. In
the last half of 1967, it embarked on a "world operating rights"
program designed to acquire controlling interests in various foreign
supplemental air carriers. At the same time, Penn Central was also
purportedly trying to find a buyer for its interest in EJA, although its
desire to retain some sort of "buy-back" rights was making this more
difficult. In mid-1968 U.S. Steel Corp. and Burlington Industries Inc.

The advances were as follows:
Through 1966



i" P E R had been aware of this problem earlier and taken steps to obscure its effective control,
iw This was later withdrawn.

entered into a memorandum of understanding whereby they would
urchase Penn Central's equity and debt interest in EJA, subject 111
IJA's receiving CAB approval to acquire Johnson Flying Service.
However, Burlington withdrew from the agreement in December 1968
and U.S. Steel followed. Other attempts by Penn Central to dispose
of its interest in EJA proved unsuccessful.
In late 1968 the CAB hearings resumed to consider the steps being
taken toward divestiture. EJA's surreptitious foreign air carrier
acquisitions and the continuing control being exercised by Penn
Central were brought to the attention of the Board by other supplemental air carriers. After the CAB began to inquire into its overseas
activities, EJA, in January 1969, withdrew its application for permission to acquire Johnson Flying Service and filed a request that the
proceeding be terminated. On June 4, 1969, the CAB instituted proceedings to determine whether EJA and Penn Central had violated
provisions of the Federal Aviation Act. Subsequently, in October,
the CAB issued a cease-and-desist order, to which Penn Central and
EJA consented. In addition to levying substantial fines against both,
the order directed EJA to divest itself of control of foreign air carriers
and Penn Central to divest itself of control of EJA.112
EJA's Operating and Financial Condition,—Since starting its
operations in 1965, EJA sustained continuing losses in its domestic 113
and foreign 1U operations. At the same time that these losses were
draining the financial resources, substantial amounts of capital were
required to meet the demands of the company's expansion program.
With the assistance of senior financial officers of Penn Central, arrangements were made for outside financing, but this could be obtained
only under terms requiring that the loans be secured by aircraft
and that Penn Central agree to subordinate its interests in the assets
of EJA. This meant a reduced security position for American Contract.
In addition, Penn Central, despite its own difficult financial situation, was forced to agree to deferral of interest and debt payments
from EJA as they became due. And by the end of 1967, the financial
condition of EJA's foreign subsidiaries was so bad that in order to
meet minimum capital requirements under Swiss law, EJA had to
subordinate its interest in these subsidiaries to that of all other
Early in 1969 Lybrand, Ross Bros. & Montgomery, EJA's auditors,
informed their foreign correspondent, who audited EJA's foreign
subsidiaries, that the subordination agreement might be open to
attack in view of the parent's financial condition. Penn Central
was informed that, because of this, before the foreign auditors would
sign the auditors' report, they were insisting on a statement "that
during the year 1969 the danger of EJA going into liquidation does
not exist" or "that EJA Inc.'s parent [Penn Central] has agreed to
subordination." The statement was to be signed either by EJA's
auditors or by Penn Central or someone with power of attorney to
sign for Penn Central.
The withdrawal of the application to acquire Johnson Flying
Service in early 1969 effectively meant the end of EJA's grandiose


- m If EJA was successful, Penn Central would realize a small profit; if it were liquidated, it would incur
a small loss.
The order directed Penn Central to place all debt and equity interests in EJA into an irrevocable
liquidating trust and to divest all of its interest no later than Mai*. 1,1970.
"3 1P65 loss, $992,000; 1966 loss, $2,214,000; 1967 loss, $869,000; 1968 lof f». $3,830,000; 1969 loss, $4,101,000.
1" ]965 profit, $10,000; 1966 loss, $747,000; 1967 loss, $533,000; 19G8 loss, $489,000; 1969 loss, $266,000.
us The companies had a very substantial equity deficit.


plans and further meant that the company had substantial equipment which it could not operate. EJA was forced to search for purchasers for the large jet aircraft and allied equipment it had acquired.
The company was obviously in extremely serious difficulty, since
this would undoubtedly result in additional severe losses, on top
of the already unsatisfactory results. Indeed, because of this and
other matters, Lybrand wrote to O. F. Lassiter, EJA's chairman
in February 1969, outlining to him four major areas that would have
to be resolved before they could complete their audit for 1968. No
audited financial statements were issued for 1968 or 1969 until after
Penn Central's bankruptcy. 116 that point the auditors disclaimed
an opinion on the statements.
In the summer of 1969, a former EJA officer, John Kunkel, filed
suit alleging mismanagement by EJA's president and naming Penn
Central, American Contract and Bevan, among others, as defendants.
There appears to be considerable evidence that mismanagement and
corporate waste were indeed adding to EJA's substantial operating
losses. Even then, however, Penn Central did not insist on being
provided with audited financial statements for this company in
which it had a major investment.
As indicated earlier, Bevan and other top Penn Central financial
officers had been instrumental in obtaining substantial loans for
EJA, through Penn CentraFs banking connections. The largest loan
was from First National City Bank and by late 1969 their concern
at the situation in EJA was reflected in frequent conversations
between bank officers and Bevan and Jonathan O'Herron, vice
president-finance of Penn Central. One bank employee reported in an
internal bank memorandum dated March 6, 1970 that EJA was
"both insolvent and on the verge of bankruptcy" but that Penn
Central did not want to take a loss that quarter on the investment.
Internal Penn Central management concern during the same period
was evidenced in a memorandum to Saunders, dated March 8, 1970,
in which Cole reported:
But what about now? It should be clear by now that no one is willing to take
our position and Mr. Bevan apparently admitted to you last week the probability
of a loss in EJA some time this year in suggesting the Wabash gains be used
as an offset. Indeed, if the rumors are true, EJA is not meeting its current fuel
bills, one of the big New York banks is calling a $2 million loan within the next
10 days and Lassiter has been diverting funds for some enterprise of his own.

In contrast, Be van's stated position, as reflected in a "comfort
letter" addressed to Peat, Marwick concerning the necessity for a
writedown to be reflected in the 1969 statements, was as follows:
Pursuant to order of the Civil Aeronautics Board, we must dispose of our
investment in Executive Jet Aviation by March 1, 1971. Consequently we are
at this time carrying on negotiations with a number of interested parties with a
view of disposing of our holding just as soon as practicable. It is a complicated
situation and consequently negotiations as between interested parties vary widely.
We anticipate that our holding will be disposed of in the relatively near future
but only at that time will it be possible to evaluate intelligently the consideration
to be received for our investment. It is almost certain that we will receive various
types of securities in exchange for our stock.
lie They stated that although the statements were prepared on a going-concern basis, continuing operations
were contingent on resolution of the following matters:
(1) Realization of assets and liquidation of liabilities connected with discontinued operations;
(2) Stopping of lossas of foreign subsidiaries;
(3) Preventing default actions available to creditors; and
(4) Stopping losses of domestic operations.
It might be noted also that EJA had a reported capital deficit of $13,400,000 as of the end of 1969 and
$9,000,000 at the end of 1968.

This letter was dated March 12, 1970, a few days after the Cole
and First National City Bank memoranda.
During the second quarter of 1970, American Contract finally
wrote down its investment in EJA by $16.2 million because of
impairment in value. This action was taken after the bankruptcy,
when the public impact of such a writedown was minimal.
Conclusion.—It is obvious that American Contract's investment in
EJA was seriously impaired by the continued losses sustained since
its formation. The inabihty of EJA to obtain financing from any
independent source, the CAB's divestiture order, the withdrawal of the
offer of U.S. Steel and Burlington to purchase Penn Central's interest,
and the write-off by EJA of certain costs and equipment related to its
anticipated operations as a supplemental air carrier made realization
by Penn Central of its EJA investment extremely unlikely and
reflected a permanent impairment in value. Based on all available
evidence, it appears that the $16 million writedown recorded in mid1970 should have been recognized in 1968 and 1969.
EJA addendum: The $10 million Liechtenstein account
As part of our review of the Executive Jet Aviation matter, we also
inquired into the transfer of $10 million by the Penn Central Transportation Co. to a Liechtenstein Account.
We encountered great difficulty in exploring the facts in this area.
The key witness, Joseph Rosenbaum, a Washington attorney, declined
to testify, asserting his rights under the fifth amendment. Other key
witnesses are out of our jurisdiction and we were unable to question
them or obtain records from them. Accordingly, the facts we have
were obtained from the company's available documents and discussions
with various persons who either have direct knowledge of the transactions or who have questioned others and have second-hand
knowledge. The facts we have learned indicate the need for additional

In early 1969, the company found it almost impossible to find
domestic sources of funds to be used for the rehabilitation of railroad
equipment. Joseph Rosenbaum, a Washington attorney in practice
with his brother, Francis Rosenbaum, had been involved in obtaining
financing and possible acquisitions for the company since early 1968.
The Rosenbaums had let it be known to the company's top management that they had foreign sources of available funds. One of these
sources was Fidel Goetz, a German financier. A number of transactions resulted from this relationship.
The first effected by the Rosenbaums involved the obtaining of
financing through a . Rosenbaum family partnership, American
Investors Co., for the purchase and lease of automobile racks used by
the company in transporting automobiles. The second transaction involved
a $12 million equipment-rehabilitation loan from the Berliner Bank,.
Berlin, Germany, in mid 1969. Thereafter in August of 1969, the
Rosenbaums again through the Berliner Bank arranged for another
equipment loan of some $10 million to be secured by a conditional sales

agreement between the company and American Contract Co., a
wholly-owned subsidiary of the company. Funds were to be drawn
down as "groups" of the equipment were completed and a schedule
of equipment which had been rehabilitated was submitted to the lender.


(a) The closing
Prior to the completion of the transactions the parties met in Bevan's
office in Philadelphia, Pa. on September 11, 1969. In attendance were,
among others, David Bevan, William Gerstnecker and Robert Loder
from the company, Joseph Rosenbaum and his brother Francis
Rosenbaum, and John Young of the New York law firm of Cravath,
Swaine & Moore. It is not clear who the Rosenbaums represented in
these discussions.
During the morning the various documents were reviewed by the
parties, and corrections made. Right after lunch, there was a meeting
of the officers of American Contract Co. ("ACC"), the company's
subsidiary, at which time the contract and related documents were
ratified. One of the Rosenbaums then took the documents to Germany
for the approval and signatures of the appropriate officials of the
Berliner Bank. Among these documents was a letter signed by the
president of ACC addressed to an entity known as First Financial
Trust ("FFT") a Liechtenstein trust. The letter advised FFT that it
(ACC) had directed the Berliner Bank to transfer the $10 million
proceeds of the loan to FFT's account. The letter instructed FFT to
invest the funds for the benefit of Penn Central Transportation Co.
and requested that the company be protected "insofar as possible
against the possibility of revaluation of the Deutsche mark."
First Financial Trust prior to September 15, 1969, was a Goetz
entity known as Finimobil Anstalt which had been a dormant "Liechtenstein trust." On September 15, 1969, its name was changed to
First Financial Trust and Francis Rosenbaum and Joseph H. Rosenbaum were listed as the only individuals authorized to give instructions to the agents, Dr. Peter Marxer and Adulf Goop. The first act
of First Financial Trust was to open a bank account with the "Bank
in Liechtenstein."
(b) Transfer of the proceeds to the First Financial Trust account
Although the Berliner Bank was directed to transfer the $10 million
to FFT's account with the bank in Liechtenstein, the Berliner Bank
refused to do so because neither the company nor ACC had an account
at the Bank in Liechtenstein.
This prompted the company to issue amended instructions providing for funds to be deposited with the Chemical Bank's correspondent
bank in Germany, the Allgemeine Bankgeselleschaft. At the same
time these instructions were given, the Chemical Bank's correspondent bank was directed to transfer the $10 million to FFT's account
with the Bank in Liechtenstein.
(c) Transfer of $4 million of the loan proceeds to Fidel Goetz
In 1967, Fidel Goetz, a German financier, was introduced to the
top management of the company by Charles Hodge of Glore Forgan,
Wm. R. Staats, Inc., who had also introduced Joseph Rosenbaum
to the company. According to Bevan, when Goetz first met him,

Goetz expressed an interest in loaning money to American companies
and investing funds in foreign airlines. Goetz was apparently aware
of the company's interest in EJA, and of EJA's plan to acquire interests in foreign air carriers.
Goetz claims that during the latter part of 1967 and throughout
1968 he made various investments in foreign air carriers as a result
of which he maintains he sustained losses of over $4 million. It is
further claimed that the interests were acquired by Goetz to assist
EJA in its foreign air carrier program, and that Bevan had promised
that he would be held harmless from any loss sustained in connection
with these transactions. Bevan denies tnat he had any such arrangement with Goetz. Goetz claims that the moneys were due him as a
result of losses he sustained when the company was forced by the
CAB to curtail and divest itself of its overseas foreign air carrier
program of EJA.
David Bevan testified that the suggestion for transferring the
proceeds of the loan to the Goetz entity, FFT, originated with
Gerstnecker, his assistant. Gerstnecker testified that the suggestion
came from Joseph Rosenbaum, and that he advised Bevan of that
fact. Bevan imposed no objection to placing the funds with Goetz
because, according to what Bevan told Gerstnecker, Goetz had
attempted to raise financing for the company and had "been involved
in EJA matters. ,,
On the same day, September 22, 1969, that the $10 million proceeds
were transferred from the company's account in the Chemical Bank
to FFT's account in the bank in Liechtenstein, $4 million was withdrawn, at the direction of the Rosenbaums, and deposited in an
account for Vileda Anstalt, a Goetz entity. Dr. Marxer, a Liechtenstein attorney, and his partner, Adulf Goop, who were agents for FFT
had been directed to so transfer the funds by the Rosenbaums who
had stated in writing to Dr. Marxer that Vileda Anstalt was owed
these moneys by the company. Dr. Marxer did not question this
statement as Francis Rosenbaum had been introduced by Goetz
as an attorney representing Penn Central Transportation Co.
(d) The drawdown oj $6 million from FFT by the company
The conditional sale agreement signed on September 12, 1969,
specified that the rehabilitated equipment was to be completed in
two groups, the first group involving some $6 million and the second
some $4 million.
When the first group was completed on October 21, 1969, the $6
million became available for use to the company's subsidiary, ACC.
At or about that time Joseph Rosenbaum arranged to transfer that
amount to the company's account at the Chemical Bank.

Some time in late 1969, the rehabilitation of the second group of
equipment was completed, and the company would have been entitled to draw down the remaining $4 million at that time. When
inquiry was made of Bevan by other company employees, Bevan
stated that it was not the right time to draw down the funds. It was
indicated that the funds were to remain in Europe so that Goetz
could use them as a compensating balance. These funds have never
been recovered by the company.


This was not the first time that the Rosenbaums were instrumental
in directing the company's funds to the use of Mr. Goetz. In M a y of
1968, the Rosenbaums received $1,125,000 from the company as a
"security deposit'' which was to be "front money" to enable the
Rosenbaums to develop "fresh" sources from which the company
could borrow funds. But, in fact, these funds were transferred to
Goetz' account, Finance Aktiegesellchaft, in the bank in Liechtenstein. These funds were returned to the company on August 6, 1968.
On August 28, 1968, the Rosenbaums were instrumental in transferring $675,000 to an account, Agencier Industrial Corp., in the bank
in Liechtenstein. The funds were not returned to the company until
July 21, 1969.

The discussion of the accounting principles followed by Penn Central inevitably raises questions in regard to the role of Peat, Marwick,
Mitchell & Co., the corporation's independent public accountants.
I n the various individual accounting controversies discussed above, it
appears that a variety of justifications were presented to the auditors
supporting the accounting methods followed. The validity of a n u m ber of these justifications seems doubtful, and the depth of investigation by the auditors of company assertions was perhaps less t h a n
might have been expected under the circumstances.
The problem of distinguishing form from substance is a significant
and difficult one, yet successful discrimination is essential if financial
statements are to be meaningful to investors and creditors. A number
of the specific problems above are of this nature. Independent auditors bear a heavy burden of public responsibility in reviewing transactions with such a distinction in mind. I t is not clear that the auditors
in this case gave sufficient consideration to the reality behind the
various transactions.
I n addition to the analysis of various individual transactions, the
overall impression left by the financial statements is part of the
responsibility of the public accountants. Statements cannot simply
be the accumulation oi data relating to individual transactions viewed
in isolation. Questions can be raised as to whether a reasonable and
dispassionate appraisal of the totality of Penn Central's operations
could lead to the conclusion that the company was profitable in the
year 1969. I t is not apparent that such an appraisal of the total
impression created was fully considered by the auditors.

For a variety of reasons, I have decided it is advisable to keep a
diary regarding certain things.
1. About a month ago, at a Budget Meeting S. T. S. stated he thought
we should deliberately underestimate our per diem charges until
such time as we received a rate increase in order to help out in the
income account. I ignored this statement and changed the subject to
another area. After the meeting Tom Schaekel came up to me very
much disturbed and shocked and asked me if S. T. S. meant this since
I had specifically instructed him after we got out of some trouble when

the per diem was handled in the Operating Department that under no
circumstances was there ever to be any juggling in this account. I
told Schaekel to ignore the entire thing and proceed in accordance
with instructions and accrue per diem as accurately as possible regardless of anyone and I would stand back of him.
2. The same afternoon S. T. S. advised me that he had a talk with
Bill Johnson of the Illinois Central and they might be interested in
purchasing our interest in the Willet Co. and he wanted to push this
sale through to get profit involved before end of quarter, if humanly
possible. He said if this did not work out could we arrange a wash
sale to get the profit anyway. I told him this was not possible but I
would do everything I could to work out a sale if the Illinois Central
was interested—it developed they were not.
August 22, 1967
1. Coming back this morning on the plane from New York, S. T. S.
was reviewing the very poor forecast of earnings for the third quarter.
After covering various expense items that might be involved, he
said that we had to find an additional $5 million of revenues. Although
he did not come out and say so since I have nothing to do with revenue
side of the picture, except from accounting, the implication was clear
that he expected me to get this out of clearing account regardless,
a matter in which he has expressed a great deal of interest.
2. I was informed by W. S. C. at home tonight that Basil Cole had
been down to see him on instructions of S. T. S. to find out if there was
any way we could avoid recording in the third-quarter accounting the
loss on sale of Manor Building in Pittsburgh. W. S. C. replied in the
Wednesday, August 23,1967
Wednesday night, before dinner, at Seaview S. T. S. came up to me
and said that he just wanted me to know that in his opinion the Financial Department was the best department in the Company and best
managed and he greatly valued the warm friendship existing between
us for many years.
Friday, August 25,1967
Just before lunch today, Fred Sass said he had to see me immediately
after lunch on an urgent matter. It develops that on Wednesday morning, before we left for Seaview, S. T. S. called him in and told him we
had to find $5 million of additional revenues in the third quarter.
I asked Sass what that had to do with him since he has nothing to do
with accounting but merely participates in forecasting. He said it was
not clear to him. He did not have a chance to ask any questions as
S. T. S. was talking at him but there seemed to be an implied suggestion that if revenues were not there we should mortgage our future
and put $5 million in anyway.
I told Sass this was not very logical since he had nothing to do with
accounting but he could review our present forecasts all he wanted to,
but under no circumstances was he to come up with a revenue forecast
on any other basis than the best combined judgment of the forecasting
Wednesday, August SO, 1967
This morning at our Budget Meeting I advised S. T. S. that we had
just received information with respect to taking inventory and there

is an indicated deficit in the inventory of $4 million, that we still had
to take inventory at Altoona and this would probably be on the plus
side but not by any substantial amount. I went on to say that this
deficit meant that our inventories were currently overstated by $4
million and that our operating expenses for the year to date were
understated by $4 million through failure to charge out the missing
inventory and, therefore, our profit picture was $4 million worse than
so far reported. This would have to be absorbed before the end of the
S. T. S. replied that we certainly could not afford to have a charge
of this magnitude made against income and he advised D. E. S. to
look into the situation immediately. I have no idea what he can produce other than if the figures mentioned should contain some error or
errors. However, in view of the fact I was not sure whether the figures
were firm or preliminary, I did not press the matter nor did D. E. S.
ask what he was to look into.
Later both our Treasurer and Comptroller came to me disturbed by
the implications involved and said that we just had to charge this out
this year with which I agreed.
Monday, November 6, 1967
This morning we had quite a difficult budget meeting. Included in
charges against the fourth quarter earnings we indicated a $3 million
deficit for inventory shortages and an increase in the requirements for
injuries to persons and loss and damages of $2.1 million.
For some months we have known oi both of these and S. T. S. has
bee a consistently advised these charges would have to be made. In
each instance he has requested they be put off until the fourth quarter
when earnings will be better and we will have the rate increase.
This morning he strenuously objected to what he termed loading
everything against the fourth quarter. He said some people did not
seem to realize we were going to merge with the New York Central
and whether or not we were underaccrued by several millions of dollars
at that time would never be known and would make no difference.
I explained as far as inventory deficit was concerned this shortage
basically represented an understatement of earnings and had to be
taken care of this year.
He then jumped on increased requirements for injuries to persons
and loss and damage. He stated these were estimates at best and there
was no reason to catch this up in the fourth quarter. I explained that
Ave closed our books at the end of the year and that we had to have
our reserves as proper as we knew how at that time. He then lost his
temper and said I and nobody else would decide what we are going to
charge in this connection. I remained silent and we moved on to other
I t is obvious there will be extreme pressure on everyone to cut these
charges as contained in the attached memorandum of November 3
just as far as possible since he insisted at the close of the meeting that
we had to have earnings in the fourth quarter of $13 million and $22
million for the year. We only had $7.5 million for the first 9 months;
it is not clear how we jump from the $20 million to the $22 million
but I raised no question.
S. T. S. also complained bitterly over the fact that profit on sale of
real estate in the third quarter on the U N J R R went to the U N J R R
and could not be included in the account of P R R itself but only in the


consolidated statement and at the same time the capital gains tax had
to be charged to PRE,. He wanted to know who wrote the lease and
wanted to see a copy of it. I t was explained to him the lease was made
over 100 years ago. He also said it was unfair the other stockholders
should get a windfall with P E R paying all the tax. I t was explained
to him that one factor in the annual rental paid by the P E E is the
income tax of U N J E E and that the tax is increased by gains and
decreased by losses and in our consolidated return we get all the
benefit of the gains and that the other stockholders of the U N J E R
get no windfall since they are paid an agreed upon fixed rate of return
out of the rental.
Messrs. Cook and Relyea were out of town and Messrs. Charlie Hill
and Ed Hill substituted. Among those present were Sass, Funkhouser,
Smucker, Large, Chaffee, Cole, and Greenough.
Tuesday, November 7, 1967
This morning W. S. C. came in to see me since he had heard about
yesterday's budget meeting. He told me he would not be willing to sign
any statements that underaccrued personal injuries reserve and as a
matter of fact he said in all probability if we did not do this it would be
picked up by examiners of the ICC who are in at the present time. I
assured him I had no intention of asking him to do anything improper.
I did ask him point blank however that if I ever made a statement t h a t
month after month we have been subject to improper and undo [sic]
influence with respect to accounting whether he would consider this a
correct statement and whether he would confirm it. He replied very
positively in the affirmative.
Thursday, November 9, 1967
Yesterday I had a very unusual call from S. T. S. just before he was
taking off for California.
He said that in his absence he did not want any letters written about
the accounting questions he raised at the Budget Meeting on Monday,
the 6th of November. I told him I did not understand what he meant
about letters as I did not know why or who would be writing letters
dealing with that subject. He then hesitated and said he really meant
memorandums back and forth between officers. I had only written the
attached to him but under the circumstances I said nothing about it
and will not send it.
He said he wanted to sit down with W. S. C. and me on questions he
raised which I said we would be glad to do. He went on to say we had to
do everything possible to improve fourth quarter earnings since he was
afraid revenues were not going to hold up. I said I understood that
situation and shared his fears but the real problem was that the
operating people were failing to meet the budget, particularly in the
Western Region. He concurred in this and said he would talk to A. J. G.
The import of the whole conversation was that I had a feeling that
possibly Funkhouser, although this is pure speculation, had advised
him after the Budget meeting that his comments at the meeting had p u t
him in a very untenable position and he was trying to prevent anything going on the record about it. I really think he had in mind the fact
that the minutes might include some statement about it.
[e. May 1,1968]
At the Budget Meeting on April 22, 1968, S. T. S. suggested t h a t
certain additional people be charged to the reserve account. Messrs.

Grant and McTiernan replied that we "could not hope to get away
with it. This reserve account will be closely audited by our own CPAs
and the I C C . " S. T. S. tried to insist that all they could do in the last
analysis would be to criticize us and this did not bother him. He
dropped the matter for the time being.
On April 30, S.T.S. and I flew to Pittsburgh together. On the way
out, S. T. S. said Mr. Perlman said I had been 100 percent cooperative
with him and Perlman was very pleased. On the way back S. T. S.
advised me he had talked to Dick Mellon, whom he stopped in to
see on the same trip, and told him I was doing a fine job in every way.
Monday, May 20, 1968
I had a call from Charlie Hill advising me that Tom Meehan,
Director, Auditing, was very upset and would probably quit and that
he had a date at 10 a.m. with S. T. S. The news came as no surprise
as I previously had a number of talks with him as he was very upset
by the fact that Walter Grant had made him report to the Budget
Manager, whereas before the merger he reported directly to W. S.
Cook and me. Also, he had been given various warnings about not
being aggressive in his auditing plus a number of other things that
had a very bad cumulative effect on him.
As a result of these various conversations, prior to our board meeting
in April I had a long talk with S. T. S., explained the situation to him,
and told him if we were going to keep Meehan he would have to report
to someone at a higher level and I had never known any place where
the auditor reported at such a low level. This is particularly important
in our case since Meehan has uncovered very substantial areas of
fraud. S. T. S. agreed with me and stated he would have it handled
through one or two of the Directors making a suggestion at board
meeting. I thought it would come up in April or M a y but it never
On Monday, after receiving a call from Hill, I got ahold of Meehan
and tried to calm him down. He said there had never been any problems as long as he had reported to W. S. Cook and me, but things
were unsatisfactory now and he had gone too far to reverse himself
and stay. He thought that by the way he had been deliberately undercut by his new superiors that he had lost his effectiveness and he
thought our Auditing Department was disintegrating very rapidly.
Latex in the day, Basil Cole on S. T. S. staff, advised me that S. T. S.
had been unable to persuade Meehan to stay but had remarked if
he had an opportunity to get into this earlier he was sure he could
have persuaded him to stay.
Tuesday, May 21, 1968—Budget Meeting
As usual S.T.S. complained about the per diem account and how
excessive it was. He then suggested that in order to improve earnings
that we deliberately underaccrue it. When told by Charlie Hill that
he thought it was probably already underaccrued, S. T. S. said that
that did not make any difference. I t had been underaccrued before
and it was not necessary to become a "Christian" all at once.
Wednesday, May 22,1968
Today, while W. R. G. and I were in New York, W. R. G. received
an urgent call from Verlander stating that he had been instructed
by McCrone, Treasurer in' New York, to cancel a lease that the
Financial Department had authorized by the Board of Directors in

volving some racks for piggyback cars. McCrone also said that he
should order some additional racks and pay for them in cash and not
finance. He said these instructions had come from Walter Grant. On
my advice W. R. G. advised Verlander to take no action until he had
an opportunity to investigate what was going on.
Thursday morning Walter Grant denied to W. R. G. that he told
McCrone to have the lease canceled but still insisted that the racks
should be bought for cash by Dispatch Shops, a subsidiary of the
former N.Y.C. W. R. G. pointed out that we had a very serious cash
situation and that these racks were ideal for investment credit financing and that he thought one way or another Dispatch Shops money
should be conserved.
Late Wednesday afternoon I had a meeting with S. T. S. and informed him what had transpired up to that date re interference by
Grant. All he said in reply was work it out yourself.
Recently, when I received rumors that Bruce Relyea, Budget
Manager of the Pennsylvania before the merger and now Assistant
Budget Manager was planning to leave I called him in to talk to him
to see if I could persuade him to stay in any way. He advised me that
morale on the Pennsylvania side was very bad in the accounting budget
area, that although he considered McTiernan, Budget Manager, a
very bright person he thought he was not only lazy but only willing
to take the course of least resistance. He said McTiernan was not
interested in developing true cost throughout the railroad but was
satisfied with something far less than what was potentially possible
and desirable. He thought he would be wasting his time in staying.
He also advised me that certain of the Regional Comptrollers, formerly
of the Pennsylvania, were looking for jobs because they thought we
were going to lapse into the former N.Y.C. bookkeeping approach
rather than a modern scientific accounting approach that had prevailed on the Pennsylvania prior to the merger.



Pennsylvania Co.

Lehigh Volley
Railroad Co.

New York Control
Transport Co.



(6S% by Transportation C o . )

Railroad Co.

Southwest Co»p.


New York Central
Transport Co. Inc.


Arvida Corp.


Co. Inc.

Buckeye Pipe


Line Co.




& Western Railway Co.
n Square Garden Corp.




Majority Interest held by PC Organization-

. . . Minority Mtitsl hcUbyPC Orpniauian

[Dollars in millions]



quarter quarter quarter quarter quarter quarter quarter


Fixed charges


Rail earnings...
Real estate:
Real estate earnings
From subsidiaries:
Tax payments.
Other dividends—Interest
Securities transactions
Financial earnings
Net company earnings
Consolidated earnings

$382.2 $392.1 $372.1 $369.3 $406.0 $417.9 $393.4 $429.7
387.1 388.9
397.6 420.3 431.5 423.9





































.5 .

































Transportation Company, rail:
New Haven losses
Passenger depredation reversal
New Haven capitalization
Per diem time/mileage
Northeast corridor A/C 80 charges
Merger reserve charges
IBM program capitalization.
Transportation Company, nonrail:
Albany Stations, New York
Dover station yard, Boston
Special dividends:
Washington Terminal sale
N.Y.C. Transport
Merchants Despatch Transport
Despatch Shops
Strick Holding...
Manor Real Estate
Sale Madison Square Garden securities
Profit-Company bonds reacquired
Total Transportation Co. significant items.




































.1 .



Great Southwest—Sale:
Bryant Ranch
Atlanta & Irvine Sck
Six Flags Over Texas
P.LE. Pennsylvania capital stock tax refund.
Manis Lke. Sup.—Pft. prop, liquid
Manor Real Estate—Pft. Prop, sales
Pennsylva- ia Co.—Gain on sale of N.&W.








Total subsidiaries' significant items

















Grand total Significant items...

17.5 .
2.0 .

Note: Transportation Company earnings also reflect Subsidiaries .significant items to the extent received as dividendsand
tax payment,
i Included in above results.


The formal bankruptcy of the Penn Central finally occurred in June
1970 after the company was unable to obtain an immediate Government guarantee for a $225 million loan. The company had simply run
out of cash and ways of raising cash. To many reasonably informed
investors this terminal cash crisis came as a surprise because Penn
CentraFs earnings, while becoming progressively worse, had not
seemed to indicate such a critical cash shortage. m The results for the
transportation company only (the company containing the railroad)
were poorer than the consolidated results, but they did not appear to
be terminally critical, particularly considering the size of the
The reported earnings, however bad, did not reflect the truly disastrous performance of the company, particularly with respect to
the critical cash flows. The earnings were inflated by transactions
and accounting practices which produced reported earnings but little
or no cash.118 Additionally, the earnings were presented in a format
which tended to conceal the source and the trend of the losses.119
While the moderately adverse earnings figures were being presented
to the public, a cash drain of staggering proportions was occurring in
Penn Central. The following is a chart of the cash flow at Penn Central,
including the railroad but excluding cash flows within individual
subsidiaries: 12°
ii7 For Penn Central's earnings see following table:

Penn Central
earnings l
January-March 1970.


Penn Central
Co. only i
(which includes

Excluding extraordinary items.
See Income Management section of this report for further explanation.
Management has argued that accounting practices required for reporting to the ICC mandated this presentation. Even if ICC accounting were required for ICC regulation purposes, management was not prevented from supplying additional earnings information to the public.
120 These figures do not include expenditures for equipment which is customarily financed by conditional
sales agreements or equipment trust certificates which require little or no cash outlay by the company.
Under these financings, the loans are directly secured by the equipment being acquired.


[In millions of dollars]
Month's end
cash balance


February, 1968..
March, 1968
April, 1968.
May, 1968
June, 1968
July, 1968...
August, 1968


September, 1968


October, 1968


November, 1968

December, 1968
January, 1969
February, 1969.
March, 1969.
April, 1969
May, 1969
June, 1969
July, 1969.
August, 1969





September, 1969


October, 1969...
November, 1969.
December, 1969
January, 1970.
February, 1970
March, 1970



April, 1970


May, 1970
June, 1970


Month's cash

cash flowi


debt repaymenl


Cash drain met by borrowings; includes debt repayment.

The public was unaware of the magnitude of the cash drain. This
cash drain was particularly important information about the condition
of the company and the direction in which it was headed. The drain
cut through the optimistic statements and the inflated earnings
because it was a reality which could not be denied even by management. The cash drain also indicated at a very early date that Penn
Central was a likely prospect for bankruptcy. Penn Central's ability
to borrow was very limited despite its huge corporate size. It could not
raise money through long-term debt because most of its property was
already encumbered by debt and Penn Central's poor earnings would
assure poor reception for long-term debt in the financial markets.
Penn Central could meet its cash drain only by short-term borrowing
or by a liquidation of assets and these two courses were restricted in
their own right. There were few assets that could be liquidated. The
real estate holdings in New York City, formerly owned by the New
York Central, were heavily mortgaged and would not produce much
cash upon sale. The other likely area for salable assets would be the
Pennsylvania company, but many of these assets were pledged, and
some, like Great Southwest Corp. and Macco Corp., were not what
they appeared to be on the surface.
Faced with these problems and the poor image that would be
created by trying to liquidate, Penn Central decided to use some of
these assets indirectly by pledging them as collateral for short-term
loans. The short-term borrowing had severe limitations, however.
The money market was tight and interest rates were high even for a
large "blue chip" such as Penn Central. Then, too, the pledging of
assets in connection with borrowings, such as the revolving credit,

quickly narrowed any future possibility for financing while the use of
unsecured financing such as the commercial paper put out by the
Transportation Co. exposed the railroad to an immediate runoff if
adverse information about the company became public. Penn Central
very quickly painted itself into a corner from which there was no
escape short of a very dramatic and immediate reversal in the direction
of the railroad earnings. Indeed, such a reversal would be needed
simply to meet the interest charges. As described elsewhere, there
existed fundamental problems in the merger and in management's
ability which precluded such a reversal. The cash drain then, and not
the publicly reported earnings, foretold the destination of the merged
Given the apparent differences between stated losses in the financial
reports and the actual cash losses a question arises about where the
cash went. The following are some of the major areas of cash loss.
These descriptions are merely illustrative of some causes of the cash
drain and of the efforts of management to conceal the true magnitude
and extent of the losses.

The principal cash drain was from the operations of the railroad.
Losses had been experienced in the premerger period. After the merger
these losses turned abruptly worse. The deteriorating condition of the
railroad operations was masked because the financial results included
income, much of it noncash income, from other sources. When the rail
losses are set apart, the deterioration of the rail operations is apparent:
(Loss) on rail operations
January to March 1970_( $101, 600, 000)
(193, 215, 000)
(142, 367, 000)
(85, 747, 000)


2, 559, 000
(548, 000)
(15, 636, 000)

The causes and the course of the deterioration of the railroad are
described elsewhere in this report. It is sufficient to note here that
traffic volume decreased while costs soared, mainly because of enormous and continuing drains brought on by the chaotic operation of
the merged railroad.
It should be noted that most of the cash drain in railroad operations
was a drain from the day-to-day operation of the railroad and not, as
management implied in its public statements, expenses associated with
improving the road's facilities. The growing cash outflow, therefore,
did not principally represent expenditures being incurred for the development of a better railroad in the future; it represented drains

caused by the poor operations of the railroad. In fact, while capital
needs were very great in the postmerger period, the funds available
were limited and expenditures were fairly constant. 121
Management also indicated repeatedly that the railroad's poor
performance was caused by losses on passenger service. While losses
from passenger service were growing m and did contribute to the cash
drain, management cited the passenger losses in ways which tended to
shift attention from the overall losses of the railroad to the losses
from passenger service. This accomplished two management goals.
First, it made the railroad's problems appear to be the fault of the
Government and not the fault of management. Although the Government-mandated passenger service did cause losses, management was
able to deflect criticism awaj- from its own ineptness, which was the
cause of most of Penn Central's losses.123 The second effect of emphasizing passenger losses was to indicate that if and when the railroad
was relieved of that burden by the Government, investors could expect
the railroad to operate at a profit. On more than one occasion, management stated publiclj- that without the passenger service losses, the
railroad would be operating in the black.124 Such statements were
i2i Penn Central Transportation Co. (includes P R R , Central, and N.Y., N . H . & Hartford) capital expenditures for road and equipment 1964-70.
[Thousands of dollars]
Equipment (excluding amount
Equipment (financed)




























122 Passenger results, 1964-1970:
Solely related
New York Central
Pennsylvania Railroad
New Haven
New York Central
Pennsylvania Railroad
New Haven
New York Central
Pennsylvania Railroad
New Haven
New York Central—
Pennsylvania Railroad
New Haven
Penn Central Transportation Co
New Haven
Penn Central Transportation Co
Penn Central Transportation Co

Fully allocated















123 indeed, when questioned by the staff, many of the directors still cited the passenger losses as the
principal cause of Penn Central's financial difficulties. The directors, however, were unable to identify
the magnitude of the losses or their relation to overall losses.
124 A,n example from Dec. 1,1969, letter to shareholders explaining the cancellation of the dividend:
" I n this same period [first 9 months of 1969], our railroad had a passenger deficit of $73,000,000 on the basis
of fully allocated costs or approximately $47,000,000 in direct costs. But for this, the railroad would have been
in the black." [The loss from rail operations exceeded $193,000,000 for all of 1969.]

Management used two devices to achieve its goals in setting forth
passenger service losses. First, it tended to emphasize the "fully
allocated'' losses rather than the lower "solely related" costs or the
"avoidable" costs. The fully allocated costs include costs shared with
freight service. Many of these costs would continue even if passenger
service were abandoned. Solely related costs are the costs assigned
by accounting to running the passenger service. Avoidable costs are
costs which would be avoided by the discontinuance of passenger
service.125 When used in the context of savings that might be achieved
by relief from passenger service, the fully allocated figures conveyed
an inaccurate picture. The second device used by management was
to avoid comparing passenger losses with overall railroad operation
losses.126 Such a comparison would have shown that the direct losses
on passenger service were only a relatively minor portion of the overall operations losses.127 These were losses which would still be incurred
even if Penn Central was relieved of all passenger service and they
were losses largely related to mismanagement and not Government

The Penn Central continued to pay dividends until the fourth
quarter of 1969.128 Prior to the abandonment of the dividend Penn
Central had been paying dividends of $.60 per share each quarter. 129
Although the company had sufficient retained earnings from previous
periods (in excess of $500 million) to support a dividend undei applicable legal standards, the serious cash drain caused by the performance of the railroad was substantially aggravated by the payment
of the cash dividend:
125 Avoidable costs were only computed when Penn Central petitioned for abandonment of a passenger
See pp. 86 and 87 for loss figures.
The rise in passenger service losses themselves was probably caused in part by the same problems afecting freight losses.
« For a description of the decision to abandon the dividend see the section of this report on the role of the
» Dividend record of Penn Central and predecessors:
Penn Central


total 1




i A n n u a l t o t a l s i n t h o u s a n d s of dollars.




total 1





total 1


[Thousands of dollars]
(loss) 12



Co. earnings 12



Loss from
railroad net borrowings,
cash loss



Cash dividend


i Before extraordinary items.
2 The reported earnings are not equivalent to cash earnings. Income maximization section of this report describes a
number of transactions which resulted in reported earnings without producing cash.

Because there had been no inflows of cash to support the dividend
since some time before the merger, money had to be borrowed at the
high interest rates to make the payments. The increases in dividends
leading up to the merger were unwarranted, the continuation of the
high dividend rate after the merger was reckless. At a time when urgently needed road capital items were being denied to those responsible for the operation of the company, money was being borrowed at
high interest rates to pay dividends, including those paid to Saunders
and other officers.
The principal purpose of the continuation of the dividend was the
desire to project an image of optimism and soundness. The image was
deceptive to investors, many of whom held this "blue chip" stock for
its long history of dividend payments. The deception struck most
directly at those who invested in Penn Central for its dividends. These
investors were suddenly faced with no dividend at all and realization
that the company's condition was much worse than they had been led
to believe (with a commensurate decline in the price of the stock).

Interest rates were rising in the post merger period. Of more importance than the rise in rates, however, was the tremendous increase
in borrowings needed to meet the cash drain. On a consolidated basis
the interest on debt was as follows:

$80, 723, 000
86, 229, 000
102, 206, 000
137, 018, 000

The additional borrowing by the Penn Central from merger date
through the end of 1969 (after deducting debt repayment) was
$405 million. The interest costs of these additional borrowings was
in excess of $40 million at an annual rate by the end of 1969.130 These
interest payments were, of course, cash payments. I t can be said
that the additional borrowings were the prime cause of the rise in
the interest burden during the postmerger period, because the borrowings in this period wTere made at interest rates at or above the prime
rate 131 while the interest burden on most of the existing long-term
debt was at fixed lower interest rates from earlier periods130 The company was required to keep compensating balances of between 15 and 20 percent of funds borrowed, thereby effectively increasing the interest rate.
Some investors may have believed that the short-term debt was being increased to avoid rolling over
long-term debt at the prevailing high interest rates. In fact, most of the borrowing was being consumed bv
operations losses.


A principal example of the concealment of the real cash losses of the
company under the camouflage of reported earnings is the performance
of Great Southwest Corp. (GCS) and Macco. These subsidiaries
were the source of profitable diversification according to repeated
statements by management. Management also repeatedly stated
or implied that these companies supplied cash to the railroad. During
the years when the railroad was suffering a staggering decline, Great
Southwest and Macco were reporting the following soaring earnings.132

51, 543, 000

Although the earnings were reported in Penn Central's consolidated
results, with a minor exception none of these earnings were received
by the company in cash.133 Adding further injury, the railroad actually
passed approximately $32 million in cash down to GSC (excluding
the initial investment) from 1966 through 1969. The flow stopped
during 1969134
apparently because the railroad had finally run out of
money itself.
Pennco, the railroad subsidiary which owned Great Southwest and
Macco, however, did pay dividends to the railroad.135 The funds for
these payments came chiefly from Pennco's holdings of Norfolk and
Western stock and Wabash stock and not from the real estate subsidiaries. This source of cash was being diminished however, as the
company sold off these holdings:
[Thousands of dollars]

Norfolk & Western










In general, management misrepresented the role of the real estate
subsidiaries, particularly as to cash contributions. The principal
cash contribution was from the long-standing investments such as
the Wabash and the Norfolk and Western dividends. The muchtouted diversification into real estate was unproductive. Only Buckeye
paid a significant dividend and that dividend of $6 million a year was
Before Federal and State income taxes. GSC paid no Federal taxes because of the railroad's tax loss
shelter. Under a tax allocation agreement GSC was obligated to pay to the Transportation Co. 95 percent
of the Federal taxes which would have been paid without the tax shelter. GSC never paid the Transportation Co. any cash under that agreement.
133 GSC paid Pennco dividends of approximately $1,000,000 in 1968 and $2,900,000 in 1969. However, during
that time substantially greater amounts of cash were being passed down to GSC and a total cash debt exceeding $20,000,000 was "forgiven" in late 1969 through the acceptance of GSC stock. During this time GSC
was itself suffering financing difficulties which made the payment of a dividend a questionable practice (during late 1969 and early 1970 GSC borrowed over $40,000,000 in Swiss francs at high interest rates).
is* For details of the relationship between Penn Central and GSC, see section of this report on Great Southwest Corp.
i3o Pennco dividends to Transportation Co.:

simply a 6 percent return on the initial investment of approximately
$100 million. From the other diversification subsidiaries (Arvida,
Great Southwest and Macco) no significant cash return on the investment was received and, in the case of Macco and Great Southwest,
substantial cash advances were passed down after the initial investment. Worse than the poor performance of the diversification program
was the use of the program to pass inflated earnings to the parent and
the associated touting of the "performance" of the subsidiaries and
the "value" of the holdings of the stock of these subsidiaries in
Penneo's portfolio.
Executive Jet Aviation is another example of a concealed cash
drain that is more significant in its concealment than in the actual
amount lost. Penn Central lost over $31 million in cash from the
initial investment to the end of 1969. This may be only a relatively
small part of the overall corporate cash drain, but as with the real
estate subsidiary investments, the element of deception practiced by
management compounded the injury caused by the actual cash loss.
The initial investments were made to give Penn Central a foothold
in the air cargo business.136 This investment was made with the full
knowledge that Civil Aeronautics Board rulings prohibited rail
carriers from owning air cargo operations. When the CAB discovered
the situation and ordered divestiture, Penn Central continued to
invest money in EJA, much of which was squandered by EJA management.137 Finally, $10 million intended for equipment purchases was
diverted to Liechtenstein to cover up EJA's European activities.138
Penn Central management engaged in deception to keep the EJA
losses confidential, in part to avoid a formal bankruptcy of EJA which
would have affected Penn Central's financial statements. The deception was so diligent that even Paul Gorman, the president of Penn
Central, who had been charged with investigating EJA affairs, did
not realize the extent of the losses until after bankruptcy.
(1) CASH S I T U A T I O N A T T I M E O F M E R G E R ( F E B R U A R Y 1968)

Penn Central's cash crisis was well known to management. Management knew, in fact, that the financial situation was perilous prior to
the merger. In 1968 the situation quickly became critical and by 1969
the company was drawing on its last available credit. The crisis,
however, was concealed from investors. This and the next section
describe the declining financial condition of Penn Central and management's knowledge of that crisis.
Railroads traditionally have operated on narrow cash balances.
This situation had existed at both the Pennsylvania Railroad and the
New York Central Railroad prior to the merger in 1968. At the time
of the merger both railroads were cash short, with the Pennsylvania
Railroad being acutely short of cash. In an early memorandum of
November 10, 1966, to Bevan's immediate subordinate, William
Gerstnecker, John Shaffer, the Pennsylvania Railroad treasurer,
Saunders felt that air cargo service would do to rail freight what air passenger service did to the rail passenger business. Whether Saunders was right or wrong on that point, he could not have done worse than in
selecting EJA as the countermeasure to the presumed threat.
See further discussion at page 71.
See further discussion at page 74.

indicated that the cash loss for 1967 would be $50 million. He stated:
"this preliminary forecast definitely indicates that we will be in a cash
bind by the end of the first quarter of the next year and something
will have to be done to generate cash."
By 1967 the cash situation had further deteriorated. The situation
was complicated by the merger agreement with the New York Central
which had placed a ceiling on additional borrowings. In a September 8,
1967 memorandum to Gerstnecker, Shaffer pointed out that net
working cash at the end of August was at least $57 million less than it
was at the end of August 1966, but that this figure could be viewed as
$88 million if a number of unusual transactions were included.
At the same time, Bevan was alerting Saunders to the deteriorating
state of affairs. In a memorandum to Saunders of September 8, 1967,
Bevan warned: "Because of our present extremely low cash position
it is imperative that we plan carefully for the balance of the year and
for 1968 * * *" The memorandum indicates that even after the
receipt of $18 million from the sale of N. & W. debentures "it is still
estimated that the cash balance at the end of December will be only
$6 million compared with $40 and $45 million which is required for
operations and compensating balances in banks where we have
outstanding loans." The memorandum goes on to discuss necessary
financings and the possible need to obtain New York Central permission again to increase its debt limit under the merger agreement:
As a matter of fact, we cannot get through October and November of 1967
when our cash is reduced by the end of those months to $13 million and $6 million,
respectively. On top of this, based on present estimates and historical results,
we are faced with a decline in cash between the end of this year and the end of the
first quarter of 1968 of $25 million.
Under all the circumstances it is essential for us to raise as early as possible this
fall somewhere between $35 million and $50 million with the hope that this will
carry us through next year until at least the end of May. We do not have any assets
of a substantial nature which can be liquidated to supply our cash needs and,
therefore, we must resort to the issuance and sale of debt and our medium would
probably have to be an issue of debenture bonds by Pennsylvania company * * *
Unless we do the latter, we have no alternative but request the New York
Central to approve an increase in our debt limitation.








I have been postponing this inevitable conclusion with the hope that increased
rates and business would improve our position but our current and prospective
cash position leads me to the conclusion that we cannot delay any longer.

By early November the railroad was considering requesting an increase of $75 million in the debt allowable under the merger agreement
with the New York Central. By mid-November of 1967, however,
when it became apparent that the merger might take place as early
as January 1, 1968, the Pennsylvania Railroad began rethinking its
financing needs since it would have to survive only until January
under the existing debt ceiling. The revised plans called for a "floater
debenture'' on Norfolk & Western stock owned by Pennco to produce
over $8 million; a drawdown under a revolving credit agreement of
approximately $10 million; and a sale to banks of dividends from the
N. & W. stock expected to produce another $10 million after the beginning of 1968.


As described above, the cash situation of the merged railroad at
the time of merger was bleak. In the postmerger period chaotic operations and the resulting deterioration of service quickly put an additional strain on the cash situation. The Penn Central, however, managed to paint an almost flattering picture of its financial posture. In a
news release dated August 7, 1968, the Penn Central reported on the
sales of commercial paper and on its overall financing program. With
reference to the $100 million of commercial paper that had been authorized by the Interstate Commerce Commission on July 29,1968, the
release stated:
"We have been informed by Goldman Sachs & Co., our commercial paper dealer,
that the paper has been well received in the financial market," Mr. Bevan said. He
pointed out that the use of this method of financing is virtually new in the railroad
industry but it can provide great flexibility in meeting short-term requirements.

The release went on to describe the issuance of commercial paper
as the first phase of a three-phase program designed to give Penn
Central "more modern methods of financing." The second phase was
to be $100 million in revolving credit to replace outstanding bank
loans. The third phase involved a long-term blanket mortgage which
was expected to become the major long-term debt vehicle for the Penn
Central :
"Substantial progress has been made on this work/ 7 Mr. Bevan said. "When
this program is completed, we will have all the tools necessary with which to meet
both long- and short-term requirements, as circumstances dictate, with the greatest
possible flexibility."

The picture painted in a memorandum from Bevan to Saunders on
July 25, 1968, a couple of weeks earlier is starkly different from that
presented to the public. Bevan complained about the absence of an
income budget for 1968 and about a recent reduction in the revenue
forecast, both of which made planning difficult. He indicated, however,
that the situation had become "sufficiently critical" to have forced them
to make some estimates. The memorandum indicates that by the end
of the year: (1) the $100 million revolving credit would be exhausted;
(2) the $100 million in commercial paper would be exhausted; and
(3) there would be still a need for $125 million to $150 million of additional financing.139
In an October 9, 1968, memorandum to Saunders & Perlman, labeled
"Personal and Confidential,'' Bevan reported on progress being made
to close the $150 million cash deficit projected for 1968. This included
a reduction of capital expenditures by $22 million and a proposed $50
million Eurodollar loan. The total reduction was $98 million. Bevan

The memorandum reads in part:
"In the absence of an income budget for the year 1968, we have not been able to make a detailed cash
flow estimate for the year. However, with two recent major cuts in revenue forecast and the possibility
of a steel strike, the situation has become sufficiently critical so that we have felt impelled to make the
best estimate possible under the circumstances.
"In connection with the revenue reductions, we are advised of a reduction of $15 million made by the
Revenue Forecast Committee on July 12 and an additional $4 million reduction on July 16. This difficult
situation has been further compounded by the not unexpected request from the New Haven for additional
$5 million on August 1 * * * We are preparing further more detailed estimates based on the information
presently available, but it now appears that at the end of this year we will have exhausted the $100 million
revolving credit and the $100 million commercial paper program and that we will still have a need for somewhere, depending on future circumstances, between $125 million and $150 million. This is without giving
further affect to what would be required in the event of a steel strike. When this is coupled with the fact
that we almost invariably lose cash for the first 8 months of the year, I believe it is necessary for us to take
all possible steps at this time to conserve cash and work toward a very minimum capital budget for 1969."

then made specific attacks on road capital expenditures including
expenditures for yard improvements. He stated:
There are certain other items that cannot definitely be identified specifically as
yard expenditures, but it seems likely that during the balance of the year capital
expenditures for yards alone total about $10 million. On the basis of the sketchy
income budget recently submitted for 1969 it would appear that there is going to
be very little cash available except for commitments already made. It seems highly
improbable that amounts such as $26 million for Columbus yard are going to be
available for some time to come. It therefore raises the question as to whether or
not future expenditures of this type during the remainder of 1968 are justified.
I strongly recommend that the yard program be reviewed at once and that the
balance of the unexpended money for this year also be reviewed in an effort to
bring our cash in line at least up to January 2. From that point on it is quite
inevitable that we are going to have extremely serious problems and that every
effort must be made to establish a positive cash flow quickly as possible.

Despite the addition of the Eurodollar loans, the cash situation did
not sufficiently improve. The Treasurer's report on November 26,
1968, indicates that the projected cash loss for 1968 would be $273
million which would be met by $253 million in borrowings, including
$103 million in bank loans, $100 million in commercial paper and $50
million from the Eurodollar borrowing. The gap remaining was $20
million to which was added the need for $24 million additional cash
in bank balances leaving additional cash required at $44 million
for 1968.

The following year did not promise any relief from the continuing
cash demands. A cash forecast dated January 23, 1969, to Bevan from
Schaffer indicated that the cash figures for 1969 would go from a
$46 million positive balance on December 31, 1968, to a deficit of
$104 million in December of 1969. Schaffer concluded his presentation
of figures with the statement that "Although this forecast is very
tentative at this time, I believe it to be a good indication of the cash
problems facing us in 1969."
By February of 1969 it was clear that major increases in financing
would be necessary simply to keep the company afloat. A memorandum
from Schaffer to Bevan on February 25, 1969, indicated that the company was in a cramped financial position and that there were heavy
needs ahead. The memorandum indicated that the source and application of funds statement showed an anticipated source deficit of
$157 million for 1969.
By the latter part of 1968 and early 1969 it had become unmistakenly apparent to management that the financial problems were
extremely critical. It had been hoped that the merger would lessen
the cash drains which had been experienced on the PRR. Yet, in this
postmerger period, cash was actually flowing out at a much greater rate
and there appeared to be no prospect of a reversal. Financing means
were limited. The market for long-term railroad debt was bleak and
for Penn Central it was nonexistent. Short-term debt was limited by
the likelihood that lenders would discover the cash drain. There were
not many salable assets, or at least not many assets that could be
sold without alarming lenders or shareholders. In addition, many of
the assets were covered by pledges, mortgages or other restrictions.
A particular problem at that time was the limit on bank borrowings
and the problems of the additional restrictions that such borrowings
would impose. Gerstnecker was aware that borrowing limits were
being reached:

Question. Were you involved in discussions to increase the revolving credit to $300
Answer. Yes.
Question. Did you believe at that time it would be possible to borrow any additional
amounts [from] banks of the revolving [credit group] above the $300 million?
Answer. I think the reverse. When I told Mr. Saunders of my reason for leaving,
I [told him] I would not take part in borrowing any more money than that. I
thought we had reached the limit of our credit.

Gerstnecker's concerns were shared by Bevan. Bevan consulted
George Woods, formerly chairman of First Boston Corp. and, at that
time, a recently retired President of the International Bank for Reconstruction and Development. From the testimony of Gerstnecker:
Question. Did Mr. Bevan fully perceive the increased bind the company was getting
into in terms of its borrowings; that is, you were coming to a finite limit, and also the
restrictions and burden of interest were becoming more and more complicated?
Answer. Yes.
Question. Did he express fears [to] you in discussion with you?
Answer. Yes.
Question. Was this [in] any particular context? For instance did you ever have a session where you sat down and discussed this?
Answer. Yes; I had a session with George Woods, who is Chairman of the
World Bank, I guess, or Monetary Fund or something, and who had previously
been the head of First Boston. And Mr. Bevan took me with him, after saying he
had gotten Mr. Saunders' approval to go talk with George Woods, and he told
George Woods of his concerns and wondered if he had any suggestions as to why
it might be—as to what might be done, and my understanding is, and my recollection is, although I'm not positive of it, that as a result of that discussion
George Woods talked to Mr. Saunders and indicated to Mr. Saunders that the
$300 million was the limit and should be the last borrowing that the company
could make unless the cash flow or the operations could be turned around.140

Knowledge of the financing problems at that time was not limited
to top management. From Gerstnecker's testimony:
Question. Was this a common open concern among people in the finance department
what the limit would be?
Answer. Yes.
Question. Was that ever discussed at the budget committee meetings, [attended by
operating officers as well as finance officers] particularly in the context "We're coming
to some limit and we1 re getting blocked in by restrictions," and things of that sort?
Answer. I don't recall there was. There were discussions at the budget committee
where we would have before us one of Mr. Shaffer's forecasts of cash loss in which
it would say "Here is another $40 million loss, and we can't put up with this, we
just can't lose a million dollars a day as we are doing," but there never was a
sophisticated type of discussion that I recall.

On February 10, 1969, Bevan and Gerstnecker met with Patrick
Bowditch141 and another officer of First National City Bank to discuss
increasing the revolving credit from $100 million to $300 million. The
reasons given for the request for the additional loan were that the
merger of the railroad was taking longer than anticipated and that
estimates indicated a cash loss during 1969 with earnings not expected until late 1969 at the earliest. Another reason was the difficulties in issuing the new blanket mortgage. Bowditch suggested that a
meeting of all banks be held in which Penn Central would indicate
detailed lists of debt maturities by year for the years 1969 through
Bevan first spoke with Woods on Jan. 7,1969. Woods advised Bevan on efforts to increase the revolving
credit to $300 million. In May, Bevan sent Woods an unsolicited payment of $25,000. Woods continued in
an informal advisory capacity until the bankruptcy.
A First National vice-president and the officer servicing the Penn Central commercial account.



1975 along with other information. The information was never
On February 28, 1969, William Mapel, Bowditch's superior, wrote a
memorandum describing his understanding with Bevan and Gerstnecker on the increase in the revolving credit to $300 million. Mapel
felt that the loan was on sound footing. He noted in his memo.
With respect to the credit itself it has been upgraded through a tighter amortization schedule, a negative pledge on railroad properties which presently have a
debt capacity of about $200 [mm] and a negative pledge with the right to secure at
our option outstandings through a pledge of Pennsylvania Company's stock. The
latter was volunteered to me by Bevan without the knowledge of Gerstnecker,
who told me to suggest this to Gerstnecker with the full knowledge that he would
approve it. It is very important, however, that the nature of this deal with Bevan
at no time be discussed with anyone else in the company. * * * I feel that we have
negotiated a very satisfactory deal with the company, and I have every confidence
that it will live up to its commitment on balances. Furthermore, it is their firm
intention to sell the blanket bond issue as soon as possible, and at that time they
expect to use the proceeds to repay the banks.142

During this same period Bevan was negotiating for the issuance
of additional commercial paper. On March 19, 1969, the ICC authorized the issuance of an additional $50 million of commercial paper,
bringing the total to $150 million. This paper was quickly marketed.
The Pennsylvania Co. was also being used during this time as a financing vehicle. In July 1969, $35 million of Pennsylvania Co. debentures
were privately placed and an additional $40 million of Pennsylvania
Co. preferred stock was to have been issued. The latter financing was,
however, never effected.
A report prepared by the treasurer's office, dated, May 20, 1969,
showed an anticipated year-end cash deficit of $130 million which,
when measured against a cash balance of $46 million at the yearend
1968, indicated a cash deficit of $167 million for 1969. The treasurer's
report also indicated the uses of the first $100 million to be drawn
down under the $200-million increase in the revolving credit. This
included $35 million for compensating balances, $25 million for
vouchers released and $30 million to pay off temporary loans from
banks, leaving a balance of working cash of $10 million. This, plus the
$35 million to be received from the Pennsylvania Co. would provide
sufficient cash to the end of June. Additional cash would be needed to
meet debts occurring on the first day of July. The $100 million of
revolving credit was drawn down on M a y 27, 1969.
The cash situation contined to deteriorate. As of June 10, 1969, the
treasurer estimated that yearend cash balances would be only $37
million even after inclusion of the additional $100 million drawdown
under the revolving credit, the additional $50 million commercial paper, and the additional $35 million through Pennsylvania Co. preferred
stock. The railroad was reaching a final crisis in its financings. In a
memorandum of June 20, 1969, to Gerstnecker, Schaffer indicated that
even drawing down an additional $50 million under the revolving
credit in August (bringing the total drawdowns to $250 million) and
raising $75 million through Pennco borrowings, the company would
still end the year with a balance of only $37 million. Because of
required bank balances, this meant that an additional $63 million of
It should be noted that our investigation has uncovered no indication of any activity with relation
to the blanket mortgage after some initial activity in the early fall of 1968. The market for such an issue
was poor, formidable legal and mechanical problems existed, and investors would not purchase such bonds
from a company with the negative cashflowbeing experienced by Penn Central.

borrowings would be needed by the end of the year. This program allowed for a strict road capital program not exceeding $50 million for
By this time it had become apparent that the additional financings
themselves were producing serious cash burdens on the railroad. In
addition to the need to keep extensive compensating balances against
the bank loans as required by banking practice, the interest payments
were becoming large. With $250 million of revolving credit and $150
million of commercial paper and with the Pennsylvania Co. borrowings, the interest costs were approaching a rate of $50 million a year.
In September of 1969 Be van met with First National City Bank
officials to obtain their approval of an increase in commercial paper b y
$50 million to a total of $200 million. Under the terms of the revolving credit agreement, the debt of the railroad outside of the revolving credit could not exceed $150 million which was the existing
amount of commercial paper. The railroad had drawn down an additional $25 million on the revolving credit on August 18, 1969, and was
drawing down an additional $25 million on September 3, 1969,
bringing the total to $250 million. Bevan pointed out that he could
draw down the last $50 million of the revolving credit and leave the
commercial paper at $150 million, but that he would prefer to obtain
the last $50 million by commercial paper. He agreed not to draw down
the last $50 million of revolving credit until commercial paper had
been paid off in an amount equal to the final revolving credit drawdown. First National City Bank obtained the approval of other
banks for this change in the agreement. The effect was to decrease the
backup lines for the commercial paper while allowing Penn Central to
increase its borrowings. Prior to this time the $150 million of commercial paper had been backed by a $50 million bank line and the last
$50 million of the revolving credit, providing a 66% percent coverage.
With the commercial paper increased to $200 million the backup was
reduced to only 50 percent. Prior to an attempt to get additional
security in early 1970, it appears that the banks, through their agent
First National City Bank, never seriously doubted the financial
ability of Penn Central to pay off its loans. They continued to rely on
the issuance of a blanket mortgage bond and on the earnings of the
real estate subsidiaries in addition to a hoped-for turnabout in the
performance of the railroad.
On September 8, 1969, Saunders wrote to Bevan asking for a
program to meet capital needs for the next year and for the 2 years
thereafter. Bevan responded with a memorandum to Saunders on
September 10, 1969, in which he pointed out the continuing financing
strains from the operations of the railroad. In light of the cash situation, Bevan observed:
Therefore, in my judgment, extraordinary efforts must be made to preserve
every dollar possible. We will be coming up with additional suggestions in this
regard shortly, but I think an immediate stop must be put on capital expenditures.143
In view of the current cash situation, it seems to me that every project should
be stopped immediately until each one can be analyzed individually to see whether
or not it is absolutely necessary that it be progressed at this time or done at all
this year.
It should be noted that capital expenditures were not greatly larger than they had been in the premerger period. See the descriptions in the earlier portions of this section. Bevan's request reflected the
degree of the cash shortage and not unreasonably large capital expenditures.

I realize that there are problems incident to labor and overhead involved in
stopping these projects but I think that a very complete analysis should be made
immediately so that every possible cent of cash will be saved and I am particularly
interested in what can be saved in the next 30 days. Where we have outside
contractors obviously holding up the work or postponement of the work is easier
than where we are doing it with our own labor.
I requested an intensive program to reduce accounts receivables but because of
the nature of the program I am not optimistic of a material gain this year, although
it could bear some near-term results. I do think, however, that a very drastic cut
in inventories should be instituted immediately even to the extent of selling in the
open market any excess items we may have on hand.

Saunders responded on September 12, 1969, in a letter to Be van in
which Saunders described efforts he had made to convey Bevan's
With regard to your letter of September 10, I enclose a copy of [a] letter which
I have written to Mr. Perlman today with copy to Mr. Flannery. I have also
talked with them personally about this and impressed upon them the necessity of
immediate action.
I have also talked with Malcolm Richards with regard to curtailing at every
possible point and making no further purchases, except where absolutely necessarj^,
until our situation improves.
At the budget meeting this morning, I asked Mr. O'Herron and Mr. Hill to
work with Peat, Marwick on a study of our billing and accounts receivable
situation to the end that recommendations can be brought forward for

On October 29, 1969 the Penn Central received ICC authority to
issue an additional $50 million of commercial paper, bringing the total
to $200 million. At this point the company had effectively exhausted
all loans and all commercial paper possibilities. Most banks were at or
near their legal or practical lending limits and were looking towards a
paydown of these loans rahter than increases. Goldman, Sachs, Penn
Central's commercial paper dealer, was already indicating to management that it was difficult to keep out the $200 million and that any
adverse information might cause a run on the commerical paper.
I t was also in October of 1969 that Penn Central learned that it
would not be possible to market Great Southwest stock (w^hich would
have included a Pennsylvania Co. secondary offering). This offering
would have produced approximately $45 million for the Penn Central
complex. As indicated elsewhere in this report the idea of the Great
Southwest offering apparently originated with the Penn Central management. The cash needs of Great Southwest, however, were enormous
and pressing and Pennsylvania Co. was no longer capable of supplying
it with cash. The desperate financial activities in late 1969 and early
1970 by Great Southwest are detailed elsewhere in this report, including a last minute effort in 1969 to have the three principal officers of
Great Southwest purchase $40 million worth of Great Southwest
stock as a substitute for sales to the public or to private investors.

By October 1969 the prospects for improvement were bleak. A cash
estimate from the financial department on a receipts and disbursements basis dated October 9, 1969, indicated a cash deficit of $338
million for 1970. In November of 1969 Penn Central's commercial
paper dealer began becoming more concerned about the condition of
Penn Central. 144 The desperate condition of the railroad would first

For a detailed treatment of commercial paper sales and the role of Goldman, Sachs, see section III-A.

aifect commercial paper because there was a continuing need to resell
the short-term paper as it became due and because it was an unsecured
financing. Robert T. Wilson, the head of the Goldman, Sachs commercial paper department, spoke with Jonathan O'Herron, who had
replaced Gerstnecker, on November 10,1969, and indicated that a New
York Times article which quoted Penn CentraPs counsel as having
told the ICC that the Penn Central is having a rough time with the
merger could be harmful to the sale of commercial paper. Wilson suggested an additional $50 million of standby bank lines. On December
1, 1969, Wilson called O'Herron to indicate that with $200 million
worth of commercial paper outstanding the adverse information concerning Penn Central would require that $15 million of the $50
million standby bank lines be converted to "swing" lines which could
be drawn down on very short notice in case of difficulties in reselling
the paper as it became due. Wilson again made reference to the level
of backup bank lines. At a meeting on December 9 between George
Van Cleave of Goldman, Sachs and members of the finance department
of Penn Central (not including O'Herron, who was out of town), Van
Cleave pointed out that Goldman, Sachs was currently holding $16
million of Penn Central notes in inventory, the largest position in
Penn Central notes that they ever had. <3oldman, Sachs suggested
additional bank lines on a swing line basis to enable Goldman, Sachs to
reduce its inventor}'. Goldman, Sachs cited "their now being at the
$200 million level, a tight market and adverse publicity" as figuring
in its desire to reduce inventory.
As the bank lines and the commercial paper reached their limits,
the Pennsylvania Co. became the last remaining vehicle for additional
financing. The Pennsylvania Co. made a $35 million private placement of collateral trust bonds in the summer of 1969 and then issued
$50 million in debentures in December 1969 in a public offering.146
The proceeds of both sales were supplied to the Transportation Co.
Each step of additional financing, however, restricted the range of
options to the company. The stock of Pennsylvania Co. had been
pledged to the revolving credit. Both the $35 million trust bonds and
the $50 million debenture offering in December would have precedence
for security purposes over any subsequent financings. This would
make potential additional lenders on Pennco's credit more cautious.
In addition, the principal asset of the Pennsylvania Co., the stock of
the Great Southwest Corp., was very rapidly declining in price. I t
was clear to the Penn Central management that there was little hope
of reversing this decline in the value of Great Southwest stock because the earnings of Great Southwest had been paper earnings and
a Great Southwest stock issuance had already been canceled for fear
of the impact on the market price from the disclosure of adverse
On January 27, 1970 Bevan and O'Herron once again approached
officials of First National Bank for additional funds. Bevan indicated
that Penn Central would have to raise $165 million to coyer capital
expenditures and operating losses and to replenish working capital
in 1970 despite a projected decrease in capital expenditures to $150
These debentures were convertible into Norfolk and Western which gave the issue value aside from
the assets of Penn Central. The sale can be looked on as a liquidating of some of Pemico's most valuable

million from the $350 million for each of the preceding 2 years. 146
Bevan asked the First National City Bank to act as a lead bank on a
$50 million "bridge" loan to the Pennsylvania Co. to be repaid
upon the sale of $100 million of debentures by the Pennsylvania Co.
Bevan also indicated that the company was discussing a $15 million
to $30 million long-term European financing and $20 million to $40
million in commercial paper in European currencies, all of which was
to be debt of the holding company.
Since banks normally have limited control over their outstanding
loans except when the loans are in default or when other restrictive
provisions become activated by circumstances, the First National
City Bank decided to use this request for an additional loan to try
to strengthen the security position of the $300 million revolving
credit. A January 29, 1970 internal bank memorandum by Bowditch
observed that the $165 million additional borrowings for 1970 anticipated a loss in the operations of the railroad of about the same size
as that in 1969. He stated:
It is not possible for us to judge how long this cash drain will continue. Therefore,
it appears necessary that we regularize through security and convenants our
This is a condition precedent to our considering a new $50 million loan (our
share $10 million-Si 5 million) to the Pennsylvania Co. If Bevan is unwilling to do
this, I feel we must decline additional advances and proceed to foreclose on our
EJA equipment.147 Our primary effort, however, should be to improve our present
credit exposure.148

The First National City Bank informed Penn Central that it wanted
a dollar limit on the amount to be borrowed by the Pennsylvania
Co.; a secondary pledge of the Pennsylvania Co. stock on the existing $50 million Eurodollar loan and on a $30,400,000 working capital
loan; a negative pledge with the right to take security on the proposed $50 million bridge loan; and other changes in the credit covenants to restrict Penn Central. This was communicated to an officer
in the Penn Central finance department on February 9, 1970. A
First National memorandum also indicates that Morgan Guaranty
had indicated to First National that it would not participate in the
bridge loan without security. 149
Bevan was not daunted in his efforts to avoid any further restrictions. He turned to the Chemical Bank which agreed to act as the lead
bank in the unsecured $50 million bridge loan to Pennsylvania Co. At
that time, the Chemical Bank had a participation in the $300 million
revolving credit line and thus Chemical deprived itself of additional
security on that loan as well as foregoing security on the additional
loan. Although the First National City Bank shortly learned of the
Chemical loan and although Chemical was aware of the absence of
First National from the $50 million group of banks, neither bank spoke
to the other about this loan or about the loss of the opportunity to
obtain additional security on the revolving credit.
« Bevan's figures on capital expenditures fcr 1968 and 1969 arpoar to be greatly exaggerated even when
equipment financing is included.
"7 EJA had loans from First National City Bank which were in default. It avoided foreclosure, however
upon Bevan's guarantee in the spring of 1970 that the railroad would make good any losses to First National.
The bank was aware that EJA was bankrupt and that foreclosure would require an embarrassing writeoff,
in 14
Penn Central's first quarter.
« First National Bank internal memorandum by Bowditch 1-29-70.
"9 Penn Central directors Perkins and Dorrance were also directors of Morgan Guaranty but both deny
any involvement in relations between Penn Central and Morgan Guaranty.

While Bevan was sidestepping a confrontation with Penn Central's
banks he was beginning to feel increasing concern and pressure from
Goldman, Sachs, its commercial paper dealer. On February 5, 1970,
upon the announcement of the 1969 loss of $56 million for the Transportation Co., Wilson contacted O'Herron. Wilson asked about the
cash picture for the first 6 months of 1970 and O'Herron indicated
that "it is very tight." Wilson told him that it was Goldman, Sachs'
judgment "that this news [the 1969 loss] would have an adverse
effect on their sale of c/p and we may not be able to keep out $200
mm of their notes." 150 Wilson emphasized again the need for an
additional $100 million in standby lines to back up the commercial
paper. O'Herron stated that he did not think it would be possible to get
an additional $100 million in standby lines. Wilson indicated that
procedures would probably have to be set up so that Goldman,
Sachs would not have to inventory the $15 million of notes it was
carrying (thereby diminishing the direct risk to Goldman, Sachs).
On the next day, February 6, 1970, Gustave Levy, Goldman, Sachs'
senior partner, and Wilson met with Bevan, O'Herron and Robert
Loder of Penn Central to review the threats to the commerical paper
situation. Bevan succeeded in explaining away the 1969 performance
and in projecting an optimistic 1970, including having the railroad
break even in the fourth quarter of the year. Goldman, Sachs again
asked for an additional $100 million in backup lines, suggesting the
use of Eurodollar backup lines. They also requested provisions to
make the existing backup lines more readily available, including
availability to reduce Goldman, Sachs' inventory from $15 million
to no more than $5 million. On Feburary 12, 1970, Penn Central
bought back $10 million in notes that were in Goldman, Sachs' inventory. Penn Central never obtained additional backup lines.
As the lines of credit with domestic banks began running out for
the company, it began looking toward Europe. In the fall of 1969,
Penn Central engaged in some equipment financing through a German
bank, with the assistance of Joseph Rosenbaum. At a later time,
portions of this borrowing disappeared, apparently having been
diverted to the European associates of Executive Jet Aviation. 151 Penn
Central was looking for additional foreign financing, particularly
general corporate financing. William Strub of Pressprich & Co.
arranged through Joseph Rosenbaum to have Penn Central officials
meet with officials of the Dresdner Bank of Germany. This meeting
took place on November 19, 1969, in the Penn Central's New York
offices. Bevan was present at this meeting. A subsequent meeting took
place on January 22, 1970, again in Perin Central's New York offices.
This meeting was attended by Bevan, O'Herron, Charles Hodge,
Joseph Rosenbaum, and Strub, among others. A representative of the
Dresdner Bank indicated that German Government restrictions
would make a public deutschmark offering unlikely, but that the bank
would like to do a Eurodollar offering in the amount of about $20
million. This information did not satisfy Penn Central which wanted
quick action and preferred much larger amounts than Dresdner could
supply. After the Dresdner officials left, Strub indicated that he might
be able to arrange a short-term Eurodollar financing of $15 to
$20 million.

Goldman, Sachs internal memorandum by Wilson Feb. 5,1970.
This matter has been previously discussed at p. 74.

Strub was authorized to proceed and he then contacted Ufitec, a
group of European lenders based in Switzerland.152 O'Herron instructed
Strub that the borrowing would be made through the holding company,
which had no debt or restrictions. Ufitec advised Penn Central to set
up a subsidiary in Curacao for tax purposes. On February 2, Ufitec
indicated that it would be able to lend 50 million Swiss francs. On
February 5, Strub called Joseph Rosenbaum from Switzerland to tell
him that Ufitec could raise up to 150 million Swiss francs. He received
word from Rosenbaum that Penn Central would take 120 million
Swiss francs (approximately $30 million) at 10.5 percent. Meanwhile,
Hans Muntinga of the European underwriting firm of Pierson,
Heldring & Pierson called Strub on February 10, 1970, to say that he
wanted to do a Eurodollar financing for Penn Central. Muntinga had
heard of Penn Central's interest in European financing because the
Penn Central International subsidiary in Curacao was being managed
b}r an affiliate of Pierson, Heldring & Pierson. O'Herron met with
Muntinga in mid-Iebruary 1970 and they discussed a $20 million
offering. The offering was to have been done in conjunction with First
Boston Corp. The holding company, Penn Central Co., would have
been the issuer (debt restrictions may have prohibited such borrowings
through the railroad).153
After the first Ufitec offering was completed, Strub was asked by
Ufitec to see if Penn Central would take an additional 35 million
Swiss francs. This loan was completed in early March. On 154
April 22
and 23 an additional 100 million Swiss francs were placed. In all
these financings, Pressprich and Rosenbaum split the finder's fee.
These Swiss loans were first disclosed in the offering circular for the
proposed $100 million Pennco debenture offering. The European
short-term money markets were Penn Central's last resource. Because
it could be done through the holding company it avoided the restrictions under the revolving credit and other agreements. No security
was required (none was available) and the European lenders were
relatively unsophisticated about Penn Central.
After the $50 million Pennco debenture offering, which presented
few investment problems because the debentures were convertible
into Norfolk & Western shares, Penn Central had little or no
financing ability left. The company had found accommodating Swiss
lenders (at high rates) and did manage to play Chemical Bank off
against First National on the bridge loan, but the commercial paper
borrowings were threatening to come apart. The situation was clearly
terminal. The Pennsylvania Co. $100 million debenture offering was
the last hope for even temporary financial survival. The proposed
Pennco offering was fraught with difficulties and doomed from the o,utset. The proposal of such an offering, however, did give management an
opportunity to maneuver a while longer. The difficulties with the
debenture offering and the discoveries being made by counsel for the
Ufitec was already involved in some loans to Great Southwest. In the loans to GSC and Penn Central,
Ufitec apparently felt it was lending to a blue chip company. The loans, however, were made at high interest
Thisfinancingwas seriously considered, but was postponed pending developments with the troublesome $100,000,000 Pennco debenture. Both issues would have been offered publicly and presented disclosure problems.
is* In U.S. dollars, Penn Central International borrowed the following amounts from Ufitec:
Feb. 24,1972

Mar. 12,1972
Apr. 22,1972
Apr. 23,1972


underwriters are very significant. Because of its importance the offering
is treated separately in the next section. The two sections must be
read together, however, for a full description of the financial affairs
of the company during this period.
By April 22, the final phase of the slide to bankruptcy began. On
that day the company announced disastrous first quarter results,
including a $63 million loss in the Transportation Co. The
announcement sealed the fate of the debenture offering and started
a run on the commercial paper. Goldman, Sachs redoubled its sales
efforts but could resell little of the paper coming due. Because most
of Penn Central's paper was of short duration, the runoff was rapid as
sizable amounts of the unsaleable paper matured. Part of the $50
million standby line had already been drawn down to reduce Goldman,
Sachs' inventory. By the end of April, $37 million of the backup line
had been drawn down. A few banks balked on their commitments
and by May 11, 1970, the final drawdown of the $46.5 million available
took place. Now only the last $50 million of the $300 million revolving
credit remained to pay off approximate^ $150 million of commercial
paper which was by then virtually unsaleable.
Under the terms of the credit agreement Bevan could draw down
the last $50 million as the commercial paper was reduced b u t the revolving credit bankers would want some explanations about what was
happening to determine whether the provisions of the agreement had
been met. Also, alerted by O'Herron's warnings that things were worse
than Saunders or Bevan had admitted, Secretary Volpe had arranged
for Saunders to see Treasury Secretary Kennedy over the weekend of
May 9 and 10 at Hot Springs, Va., about emergency Government
assistance. I n public statements Bevan and Saunders continued to
assure the public that the ship w^as still on course.
By May 21, 1970, Penn Central could no longer avoid drawing
down the last $50 million of the revolving credit. Bevan invited First
National City Bank and Chemical Bank to a meeting in his New York
office in the late morning. He told them that the debenture offering had
been abandoned and that Penn Central was drawing down the last $50
million of the revolving credit. He also asked them to join in an additional loan that would be guaranteed by the Government. This was
the first knowledge the banks had that a terminal crisis existed. They
told Bevan that they would hold up further drawdowns until the other
banks could be informed and could indicate their approval because
First National and Chemical feared they might be held liable for letting
a drawdown occur under the circumstances. The bankers left to consult with their lawyers.155
Bevan then summoned the managing underwriters to a late afternoon meeting in his office.156 I t had been pretty well understood that
the offering would not be completed.157 Bevan now told them that the
offering had been terminated but that they should keep this information confidential because of confidential negotiations taking place
with the Government.
On Monday, May 25, management again met in Washington with
Government officials including Secretary Kennedy, Peter Flanigan,
Further detail on matters relating to the banks is given in section II-A dealing with sales of Penn
Central stock by banks who were in the lending group.
w Representatives of Salomon Bros, and Glore, Forgan were present. First Boston was unable to attend
that meeting. It received the information the next morning.
w See section on Public Offerings.

and Arthur Burns. On Tuesday, management met again with First
National and Chemical in New York. The bankers had decided that
a meeting of all the bankers should be held at which time Bevan could
explain the situation and prospects. Invitations were issued to all
creditor banks for a meeting at First National on the morning of
May 28.
On the 27th, management asked the Penn Central directors for what
was, in effect, unlimited authority to pledge assets and to enter into
financing agreements. When a few directors balked, management reluctantly told them what was taking place with the bankers and the
Government. The board gave the requested authority.
The Wall Street Journal on May 27, 1970, contained an article highlighting the commercial paper runoff which was disclosed in a textual
portion of the revised Pennco prospectus dated May 12, 1970. This
appears to be the first revelation in the press of the financial crisis.
Copies of both circulars had been distributed to the press but the format of the prospectus did not highlight the significant problem. A
Wall Street Journal writer had attempted to learn about the commercial paper problem from Penn Central and from Goldman, Sachs on
May 13, before the revised circular with the commercial paper runoff
information was issued. Penn Central and Goldman Sachs had both
refused to comment. 158
At a meeting with the bankers on May 28, Bevan made some explanation of Penn Central's problems and announced the abandonment of the debenture offering. He also asked the banks to join in a
Government-guaranteed loan. After the meeting, a steering group of
banks was formed and representatives of First National City Bank
flew to Washington to talk with Government officials. Early in the
afternoon of May 28, Penn Central issued a release announcing the
"postponement" of the debenture sale and indicating that the company was "working on alternate methods of financing."
Penn Central was now solely dependent on the Government loan.
The success of this undertaking was largely a matter of the negotiation of terms between the bankers and the Government. One of
these terms wTas the removal of Bevan and Saunders. The removal
was accomplished on June 8. A major problem was the priority of
security. The banks wanted to keep their existing security. In negotiations with the Government, flexibility to the extent of some sharing
was possible. However, Congressman Patman, who was not involved
in the negotiations but whose approval of additional lending legislation was needed, wanted the Government to have first priority.
Finally on June 19 the Government withdrew the proposed guarantee
and on June 21, 1970, the Penn Central Transportation Co. filed
a petition for reorganization.

Throughout Penn CentraPs decline, management demonstrated
indifference to its obligations to provide shareholders with adequate
and accurate information about Penn CentraFs affairs and about the
The question of selective disclosure through the prospectus is discussed in the next section on Public

conduct of management. A relatively minor, but clearly delineated,
obligation provides an example of that indifference. I t also demonstrates that Penn Central's financial problems and restrictions
were such that even minor financial demands were more that Penn
Central cared to acknowledge. This particular example is the dilution
of the value of stock of the Norfolk & Western Railway Co. (N. & W.)
into which Pennco preferred stock was convertible. Under the terms
of the preferred stock agreement, Pennco was obligated to increase
the exchange rate whenever a dilution occurred in N . & W. stock.
Penn Central senior management failed to follow the terms of the
agreement, despite repeated warnings from subordinates that management was failing in its obligations. 159
Background.—On July 24, 1964, pursuant to a merger agreement with
Buckeye Pipe Line Co., Pennco, a wholly owned subsidiary of Penn
Central Transportation Co., issued 699,123 shares of preferred stock
convertible into N.&W. stock at any time after July 1, 1967. The
optional redemption price was $137, subject to adjustments if additional shares of N.&W. common stock (other than shares issued for
reasons stated in the agreement) were issued at anytime after February
6, 1964. Pursuant to proceedings relating to the merger of N.&W. and
the New York, Chicago & St. Louis Railroad Co. (the "Nickel Plate"),
the ICC required N . & W. to acquire the Delaware & Hudson Railroad
(D. & H.) and the Erie Lackawanna Railway (ELR). N . & W. organized Dereco under the laws of Delaware as a holding company to
acquire the D . & H. and the E L R . N . &. W issued to Dereco 412,627
shares of its $25 par value common stock to effect the D. & H. acquisition. N . & W. also issued to Dereco a right for it to require the issuance
of not exceeding 821,280 shares of N . & W. common stock to Dereco
in exchange for Dereco preferred stock issued to acquire E L R . The
question whether the issuance of additional N . & W. shares had caused
a dilution which required Pennco to place in escrow more N . & W.
shares to be available in case of conversion by its preferred shareholders was considered at Penn Central with the knowledge that the
Pennco preferred agreement specifically required prompt notice to
shareholders in the event of any dilution. 160
Action by the Pennsylvania Co.:
On December 27, 1968, Hill (Comptroller of Penn Central Co.)
wrote a confidential memo to David Wilson of the legal staff of Penn
Central stating that "[w]c have interpreted the N . & W. issue of stock
rights for Dereco (Erie-Lackawanna) and their issue of common
stock for Dereco (Delaware & Hudson) to cause price adjustment
under our [Pennco] preferred requirements/' He went on to say he
felt the adjustment would result in a reduction in the redemption
price from $137 to $130 per share or a loss to Pennco of over $3,500,000.
Because Pennco's holdings of N. & W. stock were pledged or otherwise
restricted, Pennco would probably have had to purchase the stock on
the open market to satisfy the escrow requirements. Hill asked Wilson
to review the 1964 agreement "to determine if our interpretations are
legally correct, and whether there are loopholes we might beneficially
apply. 7 '
On June 6,1972, the board of directors of Pennco announced that the exchange ratio for the convertible
preferred was being adjusted to reflect the 1968 issuances of N. & W. stock. Their knowledge of the existence
of this problem arose out of inquiries made by the staff in the course of the investigation.
w penn Central officers handled the matter because Pennco did not have its own officers except for puro
poses of formal actions.

On January 6, 1969, Wilson replied to Hill pointing out " t h a t the
terms contemplate that the optional redemption price must 'immediately' be adjusted whenever N . & W. issued any additional shares
of stock other than so-called Excluded shares." " I t is furthermore
required that upon any such required immediate adjustment the
corporation is obligated 'forthwith' to file a formal statement of the
adjustment with the escrow agent and give prompt written notice by
mail to all holders of record of the preferred stock. I t would appear
that Pennsylvania Co. is rather seriously in default in these obligations."
On January 15, 1969, Wilson wrote to David F. Anderson of the
law firm of Potter, Anderson & Corroon of Wilmington, Del., the
general counsel of Pennco, stating that he felt that the optional redemption price should be adjusted and asking Anderson for his
thoughts. On January 20, 1969, Anderson replied to Wilson stating
that he agreed with him, "[hjowever, I do not have an expertise in
interpreting this provision of the merger agreement, and your judgment is as good as mine."
On January 22, 1969, C. L. Rugart, Jr., the secretary-treasurer and
comptroller of Pennco, sent a memorandum to Gerstnecker who at
the time was a financial officer of Penn Central but was neither an
officer nor director of Pennco. The memorandum stated that Chemical
Bank was holding 39 shares for conversion and that other preferred
holders were considering converting. Advice was requested concerning
revision of the conversion ratio. Rugart also cited the provision
which states that if N . & W. takes any action with respect to its
capital stock which is not adequately covered by the express provisions on dilution and which might materially dilute the right of any
holder of preferred stock, the board of directors of Pennco must
appoint a firm of independent certified public accountants to get an
opinion as to the adjustment.
During the latter part of January, Wilson, at the suggestion of
Gerstnecker, forwarded to Robert Rosenman of the law firm of
Cravath, Swaine & Moore, documents relating to the several transactions. Rosenman was asked to form tentative conclusions to be
given informally. Sometime prior to February 18, 1969, Wilson and
Rosenman conversed. On February 18, 1969, Wilson wrote a memorandum to Gerstnecker stating that the preliminary view of the Cravath firm was that the transactions did constitute the events of dilution
requiring an alteration of the conversion ratio and the deposit of
additional N . & W. stock with the escrow agent. The memorandum
stated that Wilson had told Rosenman that Gerstnecker felt no
dilution had occurred. I n response, Rosenman had indicated that a
change in their preliminary opinion would require additional facts,
assuming that such facts existed. The memorandum closed with a
request to Gerstnecker to consider the urgency of the situation.
On April 3, 1969, Wilson wrote separate memorandums to Rugart,
Edward Kaier, general counsel of Penn Central, and Cole, assistant
to Saunders. In the memoranda Wilson indicated that nothing had
been done since his February 18, 1969, memorandum and that while
he realized that Gerstnecker did not agree with his opinion Wilson
felt that very serious consequences could result if the company
continued to be derelict in its duties to the stockholders. Cole testified
that he recalled receiving Wilson's memorandum and having had
some discussions with Wilson on the matter. Cole also stated that he

never discussed the area of dilution with Saunders and that he was not
aware of whether Saunders was familiar with the area of not.
On May 5,1969, Wilson wrote a memorandum to the files concerning
a conversation with Rugart on May 1, 1969, in which Wilson was
informed that Chemical Bank had asked what the reason was for the
delay in converting 39 shares. Wilson told Rugart that he could
approve only two courses of action: either (1) convert and inform
the stockholder that a change in ratio was being worked out; or (2)
convert without giving the shareholder any notice, and send the
additional shares in a week to ten days. Wilson stated that he could
not approve any course of action which complied with the redemption
request on the old basis without any intention to get in touch with
the stockholder in the future or to take any required action to change
the ratio. On May 5, 1969, Wilson was informed that the alternative
adopted was the one he had not approved of. Wilson was involved in
no further communication until after the bankruptcy.
In testimony Gerstnecker stated that he was aware that there
was a question of dilution, and that he and Bevan had conferred about
the matter. He recalled that both Wilson and Taylor had indicated
to him that a dilution had occurred, but that he had felt that the
question was one that should be resolved by the legal department.161
He also stated that he did not attempt to interpret the sections of 1964
agreement or to indicate his views concerning the intent of the agreement but that he was aware that Cravath, Swaine & Moore had
indicated that dilution had occurred and that there was no reason
for him to think that there was not a dilution. He stated that if he or
Bevan had been told of the need for action, some action would have
been taken. Gerstnecker, however, acknowledged having received
and read Wilson's memorandum which emphasized the duty specified
in the agreement to notify shareholders immediately. Despite this
requirement of immediate action, nothing was done during the period
of a year and a half until the bankruptcy. The matter was never
brought to the attention of the Pennco board.
It is clear that Bevan and Gerstnecker knew that dilution had
occurred and knew that Pennco had an obligation immediately
to notify shareholders upon such occurrence. Their failure even to
raise the issue with the board or to take any of the required steps such
as notifying the shareholders resulted from their unwillingness to
have to face the problem of finding N. & W. shares. All of Pennco's
N. & W. stock had been pledged or escrowed or otherwise restricted.
Pennco probably would have been required to purchase the N.&W.
stock in the market for cash and management was unwilling to face
another cash drain in light of the other financial problems being
encountered. Their failure to resolve the problem also contributed to
the inaccuracy of statements concerning Pennco's assets. Although
the amount of money involved was relatively small, management
refused to take even minimal steps to meet its obligations to shareholders.
His recollection differs from that of Taylor. Taylor recalled that he was summoned by Gerstnecker and
Bevan and told that they were of the opinion that no dilution had occurred despite the opinion of Wilson
and others. Taylor stated that with this in mind he looked into the matter and concurred. He did not put
his views in writing and never spoke with Wilson despite his possession of Wilson's memorandums and
despite the fact that Wilson's office was next to his.


The only public offerings by the Penn Central following the merger
of the two railroads were a $50 million Pennco debenture issue in
December 1969 and a $100 million Pennco debenture offering in the
spring of 1970.162163164 The latter offering was never sold. There was
no requirement that the offerings be registered with the Securities
and Exchange Commission because the issuing company, Pennco,
was under the jurisdiction of the Interstate Commerce Commission.
The Interstate Commerce Commission rules require that companies
under its jurisdiction make applications to the ICC for permission to
increase their debt obligations. The purpose is to determine whether
an increase in debt is justified in the public interest. 165 There were no
rules, however, on the use or composition of any selling literature
disseminated to the public.166
Normally, companies under ICC jurisdiction prepare and distribute
an offering circular in the general format of a prospectus for a registered
offering because the civil liability provisions of the Federal securities
laws concerning disclosure apply to selling literature used by these
companies. Despite the absence of a requirement that offerings be
filed with, and subject to review by, the SEC the threat of civil liability forces issuers and underwriters to be cautious in their use of
sales literature.

The $50 million Pennco debenture offering was made on December
16, 1969. The underwriters were First Boston Corp. & Glore, Forgan,
Wm. R. Staats, Inc. The debentures were exchangeable for shares of
the common stock of Norfolk & Western Ry. Co.167 The N. & W.
shares owned by Pennco had been its most valuable asset both in
underlying value and production of cash income. Because of the
exchange feature, these debentures kept their value even after the
bankruptcy of the railroad. The underwriters have cited this exchange
value as one of the reasons why the circular contains no information
about the Transportation Co. or the holding company. The information in the circular is limited to the Pennsylvania Co. and Norfolk
& Western.
162 The Transportation Co. did issue commercial paper which was made available to public investors but
offering circular was used or was required by the ICC.
Both offerings were made for the stated purpose of supplying funds for the Transportation Co.
Pennco made a $35 million private placement of collateral trust bonds in July, 1969. The proceeds were
supplied to the parent company.
W The Penn Central had to seek and obtain ICC approval to increase debt under the revolving credit
agreement and the commercial paper authorization as well as for these public offerings.
tee The Federal securities laws require issuers (except exempted issuers, such as those regulated by the
IC C) to file with the Securities and Exchange Commission a registration statement containing specific types
of information. There are additional rules governing the distribution of selling literature to the public.
W Exchangeable from Nov. 1,1970, to Apr. 15,1979, at the rate of 12.2 shares of N. & W. for each $1,000
debenture (i.e. at a price of $81.97 per share of N. & W.).


Despite the fact that investors have been protected by the exchangeability provision, the circular presents a misleading picture of Pennco,
particularly in connection with Great Southwest. The assets are
described in the introduction as constituting $922 million in market
value on December 10, 1969. Of this $922 million the Great Southwest
stock comprised $435,400,000.168 The market value of Pennco's GSC
holding was as large as it was because of failure to disclose the true
state of affairs at GSC. The overvaluation was known to Glore, Forgan
because it had been the designated underwriter on a GSC offering in
October 1969, which had to be abandoned because of the adverse disclosure that would have been required.169
The circular contained other failures to fully disclose the affairs of
Pennco. The apparent dilution of N. & W. stock which had occurred170
1968 was described at the end of the previous section of this report.
This would require Pennco to free N. & W. stock from pledge or to
purchase more on the open market. No mention of this additional
burden was made in the circular and Pennco never informed the
Pennco preferred shareholders of this apparent dilution.
The circular mentions a proposed sale of 2 million shares of Pennco's GSC stock to three senior officers of GSC for $20 million in
cash and $16 million in notes. This was a frivolous proposal which was
was never completed171 and created a false impression as to the
possible receipt of cash and as to the value of GSC stock. The circular
failed to disclose a simultaneous proposal, which was actually carried
out, to have Pennco accept GSC stock from GSC in exchange for the
cancellation of a debt exceeding $20 million owed by GSC to Pennco,
principally for cash advances which had been made to GSC by
Pennco. Disclosure of the exchange might have alerted investors
to the cash drain from the railroad to the real estate subsidiaries.
ws Almost all of Pennco's assets were stocks and bonds. The following is a list of stocks and bonds owned
by Pennco at Dec. 10,1989: (From the Pennco circular, footnotes omitted, p. 7.)
[Dollar amounts in millions]

Arvida Corp, common stock_
Buckeye Pipe Line Co., common stock
Detroit, Toledo & Ironton Railroad Co., capital stock
Great Southwest Corp., common stock
Great Southwest Corp.:
6 percent cumulative preferred stock, series A
7 percent cumulative preferred stock, series B__
7.6 percent cumulative preferred stock, series C. _
Norfolk & Western Railway Co.:
Common stock
Common stock with exchange rights
Philadelphia, Baltimore & Washington Railroad Co.,
capital stock
Wabash Railroad Co.:
Common stock
4>6 percent preferred stock
!««See page 137 et seq.
< See page 104 et seq.
See page 142 et seq.
"2 See section I-E of this report on Great Southwest for details.





















Penn Central avoided disclosing these and other adverse facts
about the railroad, Pennco, or GSC in the $50 million circular. As
described below, it was not quite so fortunate in the next public

In 1970, the last vehicle that might be used for an attempt at a
major financing was the Pennsylvania Co. The Pennsylvania Co. itself
had inherent drawbacks as a financing vehicle at this time and the
drawbacks were becoming ever more serious. Debt instruments, including that $50 million December 1969 debenture offering, contained
convenants restricting the amount of debt that could be incurred by
the Pennsylvania Co. in relation to the assets.173 The borrowing^ of
Pennco had already increased by $85 million in 1969. At the same time
the market price of Great Southwest shares, Pennco's principal asset
in terms of market price, was steadily declining in late 1969 and
early 1970. Penn Central management realized that the decline would
continue as the deteriorating condition of Great Southwest was gradually being perceived by investors. The Penn Central, however, had
no choice about using Pennco as a financing vehicle because money was
needed and there were no other means of obtaining that money.
On February 2, 1970, O'Herron called N . Gregory Doescher of First
Boston Corp. to inquire about the possibility of a debenture issue for
Pennsylvania Co. which would include warrants for Penn Central Co.
stock and Great Southwest stock owned by Pennsylvania Co. The
fact that this proposal was coming less than 2 months after Pennco had
completed a similar offering was a clear indication of the serious cash
drain and the limited financing possibilities. Despite this warning, the
underwriters began preparations for the offering.

One complication was encountered immediately. Penn Central management had proposed the use of Great Southwest warrants despite the
fact that Great Southwest had been forced to abandon a public offering in late 1969 because of the adverse disclosure which would have
been required in a registration statement. Glore Forgan, which had
been the proposed manager of the abandoned Great Southwest
offering, knew of the reasons for the abandonment. First Boston, the
lead manager on the Pennco offerings, did not know about the abandoned Great Southwest offering.174 Doescher realized, however, that
the GSC warrants and the holding company warrants were needed as
"sweetners" because of the prevailing high interest rate and the fact
that the Pennsylvania Co. debentures would be less than premium
grade. Doescher understood that these factors might have required an
interest rate so high that it would be self-defeating in that investors
would be frightened away by an offering that had to pay such high
Penn Central had hoped to avoid the disclosure problems b y delaying
registration of the warrants until their exercise date on July 1,1971.175
3 The common stock of Pennsylvania Co. itself was pledged as security to the revolving credit.
t-4 First Boston and Glore Forgan were the original comanagers of the $100,000,000 Pennco debenture as
they had been on the $60,000,000 offering. Salomon Bros, was added at the request of Penn Central.
"» A note written by Doescher dated Feb. 12,1970 states: "Concept feasible, delay exercise of warrants
until July 1, 1971; [debenture] circular now; delay registration statements until warrants become

For their own reasons Great Southwest and its outside counsel, George
Davis, were not happy about that approach. Even if registration could
be delayed, Great Southwest would have a commitment to future
registration hanging over it. At that time Great Southwest's affairs
were deteriorating. This made the prospect of even a future registration unattractive. Glore Porgan shared Great Southwest's concerns.
In a February 20, 1970, memorandum of a telephone call between
David Wilson, Penn Central house counsel, and Davis, Wilson wrote:
According to Davis, General Hodge and Jack Harned of Glore Forgan, either
severally or jointly, suggested to Davis that he call me with the proposal that
Davis and I try to sit down with Mr. Bevan at a very early date and persuade him
not to market any part of a GSC common stock offering at this time. In talking
with Davis, I gathered that at least Harned (if not Hodge) was present at the
general meeting in New York on Wednesday, February 18. After some discussion
neither Davis nor I could understand why the Glore Forgan people did not take
that occasion to explain the big problems to Mr. Bevan.

Discussions about the problems involved First Boston and their
counsel as well as Great Southwest, Penn Central and Glore Forgan
officials. First Boston was supplied with a copy of the draft prospecspectus for the abandoned Great Southwest offering.176 Sullivan &
Cromwell, counsel to the underwriters, began having reservations
about whether registration could be legally delayed. In early March,
Sullivan & Cromwell suggested that the underwriters seek a "noaction" letter from the SEC.177 The matter of the registration of the
warrants became secondary in late March as the underwriters became
increasingly alarmed about the debenture offering itself and serious
disclosure problems. Apparently these revelations eliminated the possibility that the sale of the Great Southwest and the holding company
stock would be allowed without registration. The disclosure that
would have been required would have compounded 178 disclosure
difficulties. The warrants were abandoned in early April.

Penn Central had decided to have a simultaneous offering in Europe
of $20 million in debentures of Penn Central International Corp.,
a newly formed subsidiary of Penn Central Co.179 Therefore two
circulars were being prepared simultaneously: the Pennco debenture
circular and the Penn Central International circular. First Boston
and Pierson, Heldring & Pierson of Amsterdam were the underwriters

w From a memorandum of February 24,1970 from Paul A. Downey of First Boston Corp. to Doescher:
"Jack Harned called today to say that lawyers from Great Southwest and the railroad got together with
Jack Arning Monday to discuss the problems of SEC vs. ICC registration. They will meet again on Wednesday and will determine at that time what route is to be taken. Harned sent a copy of the Great Southwest
red herring to N GD, which I have intercepted. The next move is still up to the company and there is nothing
we can do for the immediate future except familiarize ourselves with Great Southwest."
i" Counsel indicated to the staff that statements in Louis Loss' Treatise on the securities laws raised a
question about the legality of offering the warrants without registration.
"8 From a letter cf April 9,1970 to Hans Muntinga, cf Pierson, Heldring & Pierson of Amsterdam, underwriters for the proposed debenture offering of Penn Central International Corp., from William Williams of
Sullivan & Cromwell:
"On Monday afternoon Dave Bevan met with representatives of First Boston, Glore Forgan and Salomon
Bros, and proposed that the Penn Central and Great Southwest warrants be eliminated from the Pennco
$100,000,000 offering. Fred Smith of First Boston believes that one of Bevan's motives was to avoid the disclosures with respect to Penn Central and the Railroad which he knew, from our draft introduction, we
would have required. I think this also enabled Bevan to avoid some rather difficult problems he was encountering with Great Southwest's management and counsel and in getting the Penn Central Common
stock into Pennco's hands on a basis satisfactory to all concerned."
Penn Central International, a Curacao subsidiary of the holding company, had been formed for pur
poses of making short-term Swiss franc borrowings. The holding company and its subsidiaries were used
because the debt restrictions of lending agreements did not apply to it. See page 101 et seq. for details of
efforts to obtain foreign borrowings during this period.

on the International offering. The format of the International offering
circular was focused more on the holding company and the railroad
than was the Pennco circular.
The preparation of the circulars proceeded routinely, except for
the warrant question, until mid-March. At that time, the underwriters began receiving materials, including financial statements,
from Penn Central. The underwriters , counsel had indicated that the
preparation of financial information should take the SEC standards
into consideration even though the circulars would not be filed with
the SEC. Counsel had also asked for cash flow information. The information began to alarm the underwriters and counsel for the
underwriters. They were also concerned about whether the company
was making full disclosure to them. On March 18 Bevan and O'Herron
met with the underwriting group working on the domestic issue.
Bevan stated that budget projections showed break-even results in
third quarter of 1970 and a profit in fourth quarter. The statement
was not based on fact. The railroad had already lost as much as was
projected for all of 1970 and there was no indication of a reversal.
The underwriters knew or should have known that these projections
were not founded on fact because Penn Central did not have established forecasts or budgets. From the testimony of Doescher:
Question. Do you remember exploring the budgets of the Transportation Company
for 1970 and subsequent years in connection with preparing the circular?
Answer. I remember trying to.
Question. You weren't able to do that?
Answer. As I recall, they did not have budgets, much to our surprise.
Question. Is that unusual for a large company like that not to have budgets?
Answer. Yes.
Question. Did they give any explanation for not having them?
Answer. The explanation was that they were in a situation that was simply
impossible to forecast.
Question. What was the factor that created the impossibility to forecast; the factor
or factors, as they explained it?
Answer. The size of the railroad and the lack of financial controls and then I
should say that [at the March 18 meeting] Mr. Bevan went on to give his own
description, his own forecast of the railroad for 1970 which I have testified previously on.
Question. Did he indicate how he was able to make such a forecast if the company
itself could not pull together the necessary information?
Answer. Well, he wasn't necessarily separating himself from the company;
he was saying that, "No, we don't have detailed financial forecasts, but my own
forecast would be along these lines."

Two days later on Friday, March 20, despite the warning signs,
the senior First Boston officials decided the domestic issue did not
present serious problems and that although they were "uncomf or table''
about the international issue, they would go along because of its
small size.
At the same time that the underwriters were being appeased by
Bevan, William Williams, counsel to the underwriters on the international issue, was becoming increasingly concerned about what he
was seeing. He was particularly concerned about the cash situation
a t Penn Central. In light of the excess of current liabilities, debt due
within 5 years and the growing losses, Williams concluded that ''there
was a risk, perhaps a significant risk, that some time within the next

1 or 2 years that the railroad could end up in bankruptcy whether
they obtained $120 million or not." On March 19 Williams spoke
with John Arning, counsel to the underwriters on the domestic
offering,180 and then with the working group members representing
the underwriters on the international offering. He told the working
group members to bring to the attention of the senior underwriting
representatives the adverse information that was being uncovered.
The following day, Williams and other members of the International
offering working group were in Philadelphia for a regular session on
the circular. As a routine question in light of large writeoffs in 1969
the underwriters asked the Penn Central representatives whether
any additional writeoffs were contemplated for 1970. The comptroller,
Hill, stated that a major writeoff of track was being contemplated.
Hill produced a book describing the writeoff plans. He also submitted
a draft of the 1969 annual report to shareholders which was to be
issued shortly and which contained the following statement:
Redesign of System Trackage.—We have launched a project to streamline our
railroad by eliminating 5,800 miles of surplus track from our total of 40,000 miles.
This could bring benefits of $90 million of equivalent capital and save $9 million
annually in operating expenses.
Efficiency of our remaining plant will be enhanced through disposition of these
unneeded freight facilities, seldom-used branch lines, excess yard trackage, and
duplicate lines.

WiUiams indicated that the writeoff against earnings that would
result should be disclosed in the circulars and that a press release
should be issued no later than the issuance of the circular if such
a writeoff was imminent. 181 E. K. Taylor, Penn Central's house counsel
who was working on the offering, then suggested that this be taken
up with Bevan. After Hill had briefed Bevan, the working group
was called to Be van's office. Bevan was annoyed about this question
of disclosure. He stated that much of any writeoff would be covered
by the merger reserve and would not have to be reflected in earnings.
He said the abandonment plan was subject to constant change.
When asked why the abandonment was mentioned in the annual
report he said he did not know of it and considered such reference
to be stupid. 182 He left the room to consult with Saunders and returned
to assure the working group that there were no plans for abandonment
"in the foreseeable future." Williams pressed Bevan on the meaning
of "foreseeable future." Bevan finally indicated that it would not
take place in 1970. Hill agreed with Bevan. Williams was troubled
by the inconsistency of the earlier position of Hill and Bevan's
position. Williams was also troubled by Bevan's evasiveness:
Question. Did you get the impression that Mr. Bevan's answers to your questions
were evasive?
Witness WILLIAMS. Can I let the record speak for itself?
Question. Well, Vm asking you for an impression, or what was your impression,
in your efforts to obtain his answer?
Witness WILLIAMS. My impression was that on the subject he was being evasive
iso Although the international offering and the domestic offering were being coordinated, separate working
groups were working on the offerings. William Williams was counsel to the international group and John
Arning was counsel to the domestic group.
i8i Williams was not taking the position that such a writeoff necessarily would be viewed adversely by
investors, but only that it was something they should know of.
182 This was typical of Penn Central disclosure. The annual report stressed the benefits and their immediacy. Disclosure of any adverse impact on the earnings, however, was ignored.

Question. Did you consider the possibility that perhaps a writeoff had been contemplated by the Transportation Co., but that Mr. Bevan was now taking the position
that it was not contemplated so as to avoid a damaging disclosure in the proposed
offering circular?
Witness WILLIAMS. Yes, I considered that.
Mr. Cooper. You considered thai as a possibility?


Williams was receiving an introduction to the Penn Central standard of disclosure.
Arning was out of the country from March 21 to April 4 during
which time Williams covered the work on both the Pennco and the
International offering. On March 23, Williams informed Arthur Dean,
senior partner of Sullivan & Cromwell, about what he had told the
junior members working on the International offering, including the
possibility of bankruptcy of the railroad. Dean advised him to be sure
the senior underwriting officers were aware of the problem. Williams
then contacted the senior members to say that Sullivan & Cromwell
would not go along with the International offering unless the underwriters were fully aware of the facts.1*3
Doescher of First Boston then reviewed the International circular
and, after speaking with a representative of Pierson, Heldring &
Pierson, decided to recommend postponing the International offering
because the " disclosures are very severe and [the underwriters] did
not want to be in a position of appearing to sell something abroad
which could not be sold at home" according to a note made by Doescher. On the 24th and 26th, further conferences involving the underwriters, counsel, accountants, and officers of Penn Central took
place. At about this time, Dean decided to call a meeting of the top
officers of each of the underwriters to make certain that they understood the facts. The meeting was set for March 31. This was acknowledged to be an extraordinary meeting which resulted in part from
Williams' growing concern that "someday this whole thing would
blow up, and I wanted to make sure that the firm was focusing on it
at the stage where we could do something about it, focusing on it at
the highest levels * * *."
Bevan was growing increasing concerned for his own reasons. Every
probe was uncovering embarrassing information that was contradicting his representations, which he knew were false. On March 27
Dean met with Bevan at Bevan's request. Bevan criticized Williams
and asked that Williams be removed. In response, Dean noted that
Williams belonged to a younger generation and that certain duties
were imposed by a case known as BarChris. (Escott v. BarChris Construction Corp. relates to the liability of parties to a registration
statement when inadequate investigation is done). Dean declined
Bevan's request to remove Williams. Williams was then called into
the meeting.
In response to a question from Williams about income budgets,
Bevan stated again that the company would lose no more in 1970 than
in 1969 although he admitted that first quarter losses were considerably greater than first quarter losses in 1969. Bevan also stated that
there were assets that could be sold. When Williams referred to the
m The International underwriting presented particular problems because its only asset, indirectly, was
the railroad and the offering would require extensive disclosure about the railroad.

negative pledge in the revolving credit agreement, Bevan said he was
negotiating with First National City Bank to get a release of the assets.
In fact, however, First National had been foiled only a short time before in efforts to get additional security on the outstanding loans and
certainly would not be inclined to weaken its secured position.
On March 28, 1970 Williams prepared a memorandum to Dean
outlining some of his concerns about the company. The memorandum
was to be distributed to the underwriters at the March 31 meeting.
Summarized below are a number of observations which Williams made
in this memorandum:
(1) Williams noted that "substantially all Railroad's system lines are mortgaged or otherwise encumbered. A significant portion of its investments is pledged
as security for Railroad's long-term and short-term indebtedness. In particular,
in April 1969 Railroad entered into a Credit Agreement ("Credit Agreement")
pursuant to which it pledged all of Pennco's common stock to First National City
Bank, as Agent for some 48 banks. Indebtedness outstanding under the Credit
Agreement may be accelerated and the pledge may be foreclosed in the event
that, among other things, any obligation of Railroad, Pennco, Penndel Co.
("Penndel"), The Pittsburgh and Lake Erie Railroad Co. ("P & LE") or
the Pittsburgh, Fort Wayne and Chicago Railway Co. ("Fort Wayne") for the
payment of borrowed money, the deferred purchase price of property or the rental,
charter or hire of rolling stock is not paid when due or is declared due and payable
prior to stated maturity by reason of default or violation of the terms thereof.
In addition a ma1*or portion of the properties of Railroad's subsidiaries other than
Pennco is mortgaged or pledged to secure their indebtedness, and Railroad's right
to mortgage or pledge certain of its unencumbered assets and the stock and assets
of certain unencumbered subsidiaries is restricted.
(2) Williams noted that "Pennco has been used as a vehicle to finance Railroad's operations through the issuance of debt and preferred stock, the proceeds of
which are used either to make loans to Railroad or acquire assets from Railroad."








In connection with its financing activities Pennco has pledged a substantial
portion of its investments as security for its long-term indebtedness and is committed to give up a substantial portion of its investments upon exercise of exchange
rights by holders of its long-term indebtedness, and preferred stock. In addition,
Pennco is obligated to deliver a portion of the N & W common stock held by it to
N & W exchange for N & W debt, and Penn Central is committed beginning in
1975 to deliver N & W common stock upon exercise of exchange rights by holders
of the preference stock which Penn Central issued to acquire Southwestern and
Royal. (In fact, the total claims on N & W common stock by way of pledge and
exchange rights exceed the amount of N & W common stock available to Penn
Central without going into the open market.)
(3) If the railroad complied with the SEC line of business disclosure requirements, the losses on railroad operations would be shown as being extremely large.184
(4) Penn Central's earnings prospects were uncertain at best despite Bevan's
(5) On the weekend of March 21-22, Penn Central set out to accelerate an
exchange of Wabash stock for Norfolk and Western stock which would produce a
paper profit of $40 million-45 million in the first quarter.
(6) Penn Central had arranged financings through Francis and Joseph Rosenbaum and Francis was a convicted defrauder of the U.S. Government.

On March 30, at Williams' request, First Boston contacted the
First National City Bank to review the credit position of the company.
First National City Bank informed the underwriters that the railroad
could be in trouble if there was not a turnaround, that First National
had turned down Bevan's request for the $50 million bridge loan
which later was made by a group of banks led by Chemical Bank, and
that Executive Jet Aviation was in default of some obligations to the
"4 Williams also noted that the domestic offering with the warrants "was structured in this way because
Penn Central wished to avoid registration under the Securities Act of 1933 at this time."

bank. First National indicated it knew of no other defaults. The underwriters made no attempt to contact Chemical Bank or the commercial
paper dealer, Goldman, Sachs.
Counsel for the underwriters called a meeting for the purpose of
considering the serious questions being raised about the underwriting.
The meeting took place on March 31,1970, at 2:30 p.m., in the offices of
Sullivan & Cromwell. Attending along with Dean and Williams of
Sullivan & Cromwell were the leaders of the investment firms participating in the underwriting.185 The March 28 memorandum was distributed. Of particular concern was the threat to Penn Central's
The subject of what would happen in the event of a bankruptcy in the railroad
was discussed. We [counsel] read them the relevant provisions of Section 77 of the
Bankruptcy Act.
We were asked whether, as a legal matter, Pennsylvania Co. would withstand
the bankruptcy of the railroad, and we expressed the view that it would.

This danger most directly threatened the international offering and
it was decided that the offering would be postponed. It was next concluded that the underwriters would be willing to state in the prospectus that the warrants for Penn Central Co. stock were worthless.
After further discussion it was agreed that they would proceed with
the underwriting with the understanding that Sullivan & Cromwell
would include any disclosures needed to protect the underwriters
from liability. No consideration was given at this time or any other
time to asking or requiring the company to make any public statement about the seriousness of the problems.
The underwriters were running some risk but they were apparently
unwilling to be known in the financial community as the cause of the
collapse of the Penn Central by any move to withdraw. A minute from
the Salomon underwriting committee meeting of April 2, 1970, reflects
the conclusion of the underwriters:
Pennsylvania Company offering.—John Gutfreund stated that we had a moral
obligation to do the issue if we get adequate opinion of the Company's counsel.
He stated that we will have to be very careful because of the Company's cash
problems and large amounts of pledged assets.

As a result of the March 31 conference Penn Central was called
upon to supply a number of items of information for review for possible
inclusion in the circular. One of the individuals working on the underwriting indicated Penn Central had some difficulty in producing this
information and some information such as cash forecasts was never
produced. It was this individual's view that Penn Central was simply
incapable of producing some of this information although it is almost
unheard of for such information to be unavailable in companies of
that size.
A major hurdle to the offering was encountered on April 22 when
Penn Central released its first-quarter results. The results were
extremely poor and tended to confirm the downward plunge of the
company. The results should have been a further warning to the
underwriters that they were not being told the whole truth by Bevan
Among those participating were: First Boston Corp. (Emil Pattberg, Jr., chairman, Paul L. Miller,
president, Charles C. Glavin, chairman of executive committee, N. Gregory Doescher, vice president);
Glore Forgan, Wm. R. Staats, Inc. (J. Russell Forgan, chairman, John C. Harned, senior vice president);
Salomon Bros. & Hutzler (John H. Gutfreund, partner in charge of syndicate department); Pierson, Hendring & Pierson (Hans Muntinga, the Amsterdam firm's senior representative on this underwriting).

and that the underwriters were contributing to the facade that Penn
Central was trying to maintain. The loss was greater than Bevan had
indicated in the March 18 meeting with the underwriters. From
Doescher's testimony:
The actual loss was somewhat in excess of what he had represented to us.
I recall having been surprised at the amount of the actual loss for the first quarter,
but on the other hand I don't attribute that to any particular motivation on his
part. My recollection of that meeting that we had with Bevan and O'Herron on
the 18th was that they dealt with us just as honestly as they possibly could in
terms of what they knew on the 18th.

In fact, on March 18 Penn Central management knew almost the
precise magnitude of the loss that would be recorded in the first
In the April 22 release, Penn Central management attempted to
play down the losses, which were lessened on the consolidated level
by the $51 million profit on the acceleration of the Wabash exchange
and on the Transportation Company level by the $16,900,000 profit
on the sale of Clearfield Bituminous Coal to Pennco. The sale of
Bituminous was a means of getting cash from Pennco in connection
with proposed debenture offering. The release implied that the losses
were a result of temporary difficulties such as bad weather and strikes.
The release also referred to "railroad" losses of $62,709,000 in the
first quarter. In fact, the railroad's operations, had lost over $100
million.186 The railroad results included nonrailroad items, including
the Bituminous sale.187 Although "railroad" may be used merely as
a term of convenience, it has particular significance in a release of
this kind.
The railroad operations were the heart of the company and seriously
adverse performance directly threatened the survival of the enterprise.188 The significance of the railroad losses was a cause of their
being set out for the first time in the offering circular. They were not
set out in the release, however, even though it was reviewed by counsel
for the underwriters shortly before its issuance. To Doescher the
problem was solved by financial statements attached to the release:
In my very recent testimony I went through my thought processes as far as
this press release was concerned and they were to the effect that, taken alone, I
would have considered this second paragraph misleading [the second paragraph
showed the Transportation Company loss], however, as I have indicated before,
my concern was allayed because the financial statements were attached to the
press release and taken in the context of those financial statements, I don't believe
this second paragraph was misleading. And after all, a net loss is reported by the
accountants as a net loss.

It is the textual information which is used by the news media.
Further, even an informed analyst would not have been able to fix
the loss from rail operations from the statistical information.
On April 24, 1970, the underwriters met with Bevan and O'Herron.
The underwriters had already assumed that the Standard & Poor's
rating would be downgraded from BBB to BB (BBB is the lowest
1 6 The release had a two page statistical presentation attached to the text. A reader could not tell what
the losses were even from this table unless he kn°,w how to rearrange certain of the figures. The text, of
course, was the principal source for news media. Shareholders did not receive quarterly reports from Penn
iw It apoears that this sale, like the Wabash exchange, was entered into with a view toward lessening the
losses in the first quarter.
Howard Butcher III, a former Ponn Central director whose customer accounts represented the largest
block of Penn Central stock, stated that he started selling off Penn Central when he learned from the offering
circular for the first time that the railroad was losing so much money.

rated security of investment grade). The underwriters were attempting to establish a price for the offering. In light of Sevan's objections
to their rating assumption they decided not to set a price. According
to Doescher:
So, it is perfectly natural in that kind of a situation, to avoid the price question.
What you decide is whether or not you're going to go ahead. Mr. Bevan, or the
Penn Central Transportation Co., at that particular point in time was not in a
position to be fussy about price. The question was: Could we sell the issue. And
now let me explain that, what our position was. We weren't virtually certain that
we could sell the issue knowing everything that we knew as of April 24 and particularly taking into consideration the bond market. But this was an old and
valued client, particularly of First Boston and Glore Forgan, and a name of great
reputation. We were dealing with people of high stature in the business community
and finally, it was a matter of cash, it was a pro bono publico matter that we do
everything possible, to see that the railroad obtain its $100 million. And, therefore,
you find yourself in a position where you are not really in a position to say that—
you don't want to be in a position of saying you can't sell the issue, because who
knows. There is a saying in the financial community that anything could be sold
at a price.

On April 27, the application to the ICC for the offering was filed.
On April 28, First Boston, using a standard mailing list, sent approximately 1,300 copies of the circular to members of the selling group,
selected institutions, and certain publications. On April 30 Doescher
conducted a meeting with the sales department of First Boston to
explain the issue. The offering was directed at institutional buyers as
is customary for railroad debentures. The reactions to the offering
were not good. According to Doescher: "[D]uring this period of time,
there was—we were not getting any reaction from the standpoint of
the market. The issue was not taking hold." The institutional market
was effectively eliminated by 189 downgrading of Pennco's rating
from BBB to BB on May 15. Despite the rating Bevan told the
press that "We have every intention of going ahead with the financing
as planned. The precise date of the offering is being determined and
will be announced shortly."
Following the announcement of the first quarter loss a runoff of
commercial paper had begun. This was disclosed in a statement in the
text of a revised circular dated May 12.190 The revised circular had
been made necessary by a change in the terms of the offering.191 The
debentures had been made redeemable at the holder's option in 5
years. The revised circular was sent to those receiving the original
circular and 192 to all members of the National Association of Securialso
ties Dealers. It is unlikely that this additional circulation would be
effective or even cause many brokers to read the circular.193 The
189 Bevan had learned cf Standard & Poor's decision prior to the announcement and had arranged a meeting in an attempt to have the decision reversed.
i«o The circulars were not distributed until May 16.
iw The revised circular was not filed with the ICC. The ICC had no rules relating to offering circulars
or to their amendment.
"2 Copies cf the May 12 circular were sent to 3,375 NASD members whereas the April 27 circular had
gone to 700 brokers.
"3 According to Doescher:
"Q. New would you be able to make any estimate with respect to how many of these broker-dealers [who
received the circulars] actually do attempt to market this type of an offering? * * *
"A. This type of an offering or any offering circular to the whole NASD, it will only be a very small—I
don't think it would be any different than it would be with respect to any offering, I don't think that there
is any difference between this particular offering and any other offering where we circulate to the dealers
who are on the NASD list, and of the 3,300 dealers, that would be a relatively small proportion of the 3,300
who actuallv reacted to the
"Q. In terms of numbers, just a rough estimate, would it be 50 brokers, 500 brokers, do you have any
estimate along that line that might actually make an affirmative effort to sell an underwriting such as this?
"A. Beyond the list of underweriters [the] selling group might consist of 12 or 50 other NASD members."

underwriters learned during this time that Butcher & Sherrerd was
withdrawing from the underwriting.194
On May 15, the terms were set at 10% percent interest with a selling
concession of 1% percent and a closing date of June 2. By this time the
underwriters were able to conclude that the debenture offering would
not be completed. As Doescher explained:
Question. Did you say anything to Mr. Reimer [of First Boston]?
Answer. No. I was beginning to take a rather relaxed attitude about this issue
at this point in time.
Question. For what reason?
Answer. Well, we had floated our price ideas on Friday, the 15th and it did
not appear to have any material effect on increasing the interest in the issue.

In the late afternoon of May 21 the underwriters were invited to
Perm Central's New York office. Representatives of Glore, Forgan,
and Salomon Bros., attended. The underwriters were told that
Pennsylvania Co. had decided not to go forward with the offering.
First fioston was notified the morning of the 22d about the cancellation
of the offering. The three underwriters then met at First Boston's
office on the morning of the 22d: "I [Doescher] recall that at the
meeting, it was a general reaction, it was relief that we were off the
hook, so to speak, as far as the issue was concerned." The underwriters
agreed that their selling effort was to be concluded at that point and
that they were not going to announce the conclusion of the offering
until the company had an alternative plan worked out, probably
involving a Government loan. From Doescher's testimony:
Answer. What we discussed in the meeting of the 22d was that we were going
to conclude our selling effort as at that point in time. And also that we were not
going to officially withdraw the issue until we were notified by the railroad that
the issue would be withdrawn.
Question. What was the reason that you were not going to notify—that you were
not going to publicize the fact that the issue was withdrawn until it was withdrawn
by the company?
Answer. The reason was that it would have caused the company problems as
far as the banks and rest of the financial community was concerned. In (other
words, what the company wanted to do was to be able to say they had the loan
from the Government at the same time that they announced the withdrawal of
our issue. Had we announced the withdrawal of our issue and no other alternative
had been presented, that would have, in itself, collapsed the house of cards.

The announcement of the cancellation was made on May 28 and
appeared on the Dow Jones broad tape at 1:22 p.m.
The handling of the Pennco offering is another example of management's attempts to create a facade to conceal adverse information. Throughout the entire spring and early summer of 1970 it w a s
the Pennco debenture offering which enabled Penn Central to maintain a claim of solvency. In fact it was doubtful that the offering
could be completed. The very fact that the offering was proposed
almost immediately after the completion of a similar offering indicated the accelerating pace of Penn Central's cash drain and the
unavailability of other means of financings. At the same time, Pennco
was deteriorating as a financing vehicle: Its Great Southwest stock
was declining in value; its N. & W. stock was pledged or escrowed;
there were restrictions on selling or encumbering its rail holdings; and
all of Pennco's common stock was pledged to the revolving credit
i»* Butcher & Sherrerd claimed that it had begun selling out selected accounts based in part on information
learned from the circular.

Bevan knew of these problems and of the declining condition of
Penn Central but he was prepared to explain away the problems to
maintain the facade. The underwriters came to realize some of the
fundamental problems. They also knew or should have known that
Bevan could not be relied upon. Their reaction was to avoid a confrontation which would publicly have raised questions about Penn Central
or the statements or actions of its management. They decided to
protect themselves by avoiding direct liability to potential purchasers
of the Pennco bonds although it is likely that they never expected to
have to underwrite the bonds.
While the underwriters and their counsel resisted the distribution
of an offering circular that did not contain what they believed to
be adequate disclosure, the placing of the entire focus of disclosure
on the offering circular does not appear to have been the appropriate
way to make disclosure of the rapidly deteriorating financial condition. A more direct method should have been employed. Moreover,
inclusion of disclosures in the circulars which were distributed to
broker-dealers and institutional investors resulted in their having
advance information concerning the company which in certain instances was used to their advantage and to the detriment of the
uninformed members of the investing public.
An offering circular, particularly one principally of interest only to
institutional investors, does not appear to be the appropriate way to
make disclosure when the circular contains very significant information not previously public. A public statement should be made about
the significant nonpublic information at the time the circular is distributed. No reference to adverse disclosures was contained in the
April 28, 1970, news release announcing the application being filed
with the ICC.
The limitation of the disclosures to the offering circular assisted
Penn Central management in maintaining an appearance of solvency.
Management not only avoided broad disclosure of what the underwriters were learning, but it was even willing to use existence of the
debenture offering as a device to screen Penn Central from inquiries.
In a letter of April 22, 1970, to Saunders, William Lashley, the public
relations officer, made this suggestion:
With reference to n ^ note about the strong possibility of requests for interviews
with you, Mr. Gorman and Mr. Bevan and perhaps other company officials in
the wake of our news release today [on first quarter results], I recommend the
following procedure. My department should tell callers that we cannot arrange
interviews but if we are given direct questions, my department will attempt to
get the answers. If this procedure does not satisfy some of the more insistent requests,
do you have any objection to our saying that we are considered to be "in registration"
at this time and are not free to talk? 195 1 am reluctant to use this because it will lead
to more association of the financial results with the debenture issue.
195 Emphasis added.


Although Great Southwest Corp. (GSC) was only one out of a
number of subsidiaries in the Penn Central complex, it played a
major role in the affairs of Penn Central, including the efforts of
Penn Central management to conceal the railroad debacle. 196
First, Great Southwest was the keystone of the railroad's diversification effort. I t was this diversification which was supposed to make
Penn Central a growth conglomerate. This prospect and the expected
railroad improvements were the principal factors accounting for the
soaring price of Penn Central stock in the premerger and immediate
postmerger period. Second, the soaring earnings of Great Southwest in
1968 and 1969 helped conceal the railroad losses. Third, the market
value of Great Southwest stock was important to the Pennco portfolio
which, in turn, was important to Penn Central because Pennco was
used both as security for railroad loans and as a financing vehicle in
its own right. At one point, the value of Pennco's holdings of Great
Southwest based on the quoted market price of Great Southwest
shares was approximately $1 billion. Even late in 1969 when Pennco
was used as a public financial vehicle, the Great Southwest stock
constituted approximately one-ha]f of Pennco's portfolio market
value. 197 Fourth, the public was given the impression that Great Southwest was contributing cash to the railroad, particularly in light of its
soaring earnings. In reality, no cash except nominal dividends in 1968
and 1969 was coming up and instead substantial cash was being passed
down to Great Southwest. The history of Great Southwest illustrates
particularly well the deceptions practiced by management and the
complex relationships among the different elements in Penn Central.

Great Southwest Corp. was formed in late 1956 by Angus Wynne,
Jr., to develop the Waggoner Ranch, lying between Dallas and Fort
Worth, into an industrial park. Wynne and his uncle, Toddie Lee
Wynne, contributed $4,500,000. New York interests, composed principally of Rockefeller Center, Inc., contributed the same amount. A
group of Dallas investors contributed a lesser amount. Wynne became
the president and chief executive officer. A public offering of Great
Southwest stock was underwritten in 1960 by Glore, Forgan & Co.
Part of the proceeds were used to underwrite the development of an
amusement park within the industrial park. The park, Six Flags Over
Texas, was built for the purpose of generating cash needed to carry
the undeveloped land and to pay development costs. The Pennsylvania
Railroad made its initial modest investment in Great Southwest when
its pension fund purchased an unsold portion of this public offering
from Glore, Forgan upon the urging of Charles Hodge, a Glore, Forgan
1 6 F 0 r convenience, unless otherwise indicated, references to Great Southwest include Macco Corp.,
which was merged into Great Southwest in March 1969.
w As will be seen, the market price was greatly inflated as was known by management.


In 1964 Angus Wynne undertook to head a Texas pavilion at the
New York World's Fair. Wynne's involvement in the Texas pavilion
forced him into personal bankruptcy. The 90,000 shares of GSC stock
he owned had been pledged against loans for the pavilion. When he
was unable to pay these loans his stock was sold. Wynne's return to
Great Southwest was further complicated because he was no longer
on good terms with his uncle who had opposed his involvement in the
Texas pavilion. To resolve disharmony within Great Southwest,
Wynne prevailed on his uncle and the Rockefeller interests to sell their
holdings to a third party. Wynne then asked Hodge to find a buyer.
While this was taking place Pennsylvania Co. was beginning its
diversification efforts, funded to a large extent by moneys received
and to be received from the disposition of Norfolk & Western stock
as required by the ICC. Hodge presented the Great Southwest investment to the Pennsylvania Railroad and both Bevan and Saunders
visited the Great Southwest properties. The railroad, through its
subsidiary, Pennsylvania Co., then acquired over 50 percent of Great
Southwest stock. Wynne agreed to remain with the company as chief
In discussions between Wynne and Bevan, a mutually agreeable
policy of expansion was undertaken. The management of the railroad
wanted further real estate diversification and Wynne wanted to build
a chain of amusement parks and to pursue industrial development in
other parts of the country. In furtherance of this policy, Wynne began
searching for land for development in California through a new Great
Southwest subsidiary, Great Southwest Pacific. While Wynne was
looking for individual parcels of land William R. Staats & Co. (then
being merged into Glore Forgan) brought Macco Corp. to GSC's
attention. Macco had substantial undeveloped real estate holdings and
also had an established business of single-family dwelling construction.
Wynne had a high regard for the management of Macco. On his advice
and following a detailed inspection of the Macco properties by Saunders
and Bevan, the Pennsylvania 199 20 in 1965 purchased all of the
company's stock for $39 million.
The investment in Macco soon proved to be a bane rather than a
boon. Macco experienced a serious cash drain, which 201202
by 1967 required
advances of over $7 million a year from Pennco.
sales were lagging and the idle holdings of undeveloped real estate
resulted in heavy carrying costs.
In mid-1967 Robert C. Baker, who was then general counsel and
secretary of Great Southwest, was selected by Bevan and Wynne to
analyze Macco's problems with a view to his taking charge of Macco.
Although Baker lacked management or real estate development
See section on Penphil for Wynne's involvement at the time in an investment group including Hodge
and Pennsylvania Railroad officers.
i»» Until the merger of Macco and Great Southwest in March 1969, Macco was a 100-percent subsidiary
of 200
For its active part in the evaluation, development, and negotiation of acquisition of Macco, GSC was
given an option to acquire 80 percent of the common stock of Macco from Pennco in exchange for 800,000
shares of GSC. The option was exercisable within 180 days of the date on which Macco repaid the $39,000,000
advanced by Pennco to acquire Macco or redeemed preferred stock held by Pennco in subsitution of the
$39,000,000 indebtedness.
2°i The railroad itself had a pressing need for cash at this time and it looked to Pennco also as a source cf
cash. The drain to Macco and Great Southwest accelerated until the bankruptcy of the railroad although the
railroad was unable to supply funds after 1969.
2°2 The treasurer and comptroller of Macco, Roy C. Fredrickson, reminded the Macco board of the problem:
"In the course of his [financial] report [to the board], Mr. Fredrickson made particular reference to the
efforts that were being made by the management to minimize the extent of borrowings needed from Pennsylvania Co. in order to meet the company's cash requirements" (Macco Realty Board Meeting Feb. 22,1967).

experience,203 he gave indications of being an imaginative and expansive executive. He began sending Wynne memorandums outlining
problems and suggesting ambitious solutions to Macco's problems.
Baker suggested elaborate administrative procedures (which later
were to balloon into extremely costly but largely unproductive
overhead). He also proposed various methods of restructuring Macco's
operations including "* * * deals whereby Macco receives prepaid
interest. This type of transaction can be worked whether it involved
Macco land or not * * *."204 The inventive schemes of Baker were to
prove highly valuable in the short run to Penn Central although the
long-run consequences to Macco and Great Southwest were less
In late 1967 he became vice president of finance of Macco and on
January 1, 1968, president. Baker, in turn, recruited William Ray,
who had been a bank official in California involved in real estate
mortgage matters, as Macco's chief financial officer. During this time
Great Southwest Corp. had begun development of an industrial park
in Atlanta, Ga., imitating the Texas development. These were funded
internally. During this time, Wynne remained the chief executive
officer of both Great Southwest and Macco.205

Prior to Baker's arrival at Macco, the performance of the railroad's
diversification program had been modest at best and Macco, as noted
above, was incurring serious cash losses. Baker's arrival led to a significant change in the "performance" of Macco and later GSC. This
change resulted from the coincidence of three factors. First, Baker
himself was ambitious and was well aware of Bevan's desire for greater
reportable earnings performance. Indeed, it was Baker's understanding that Be van played a role in his being sent to Macco in 1967.206,207
Secondly, at about the same time, the need for greater reportable
earnings from Macco and Great Southwest was increasing as the performance of the Pennsylvania Railroad began deteriorating rapidly.
This trend was to be drastically accelerated a short time later when the
Pennsylvania merged with the New York Central. Thirdly, under an
employment contract which he entered into in 1968, Baker stood to
receive a percentage of profits from transactions he devised.
It was not surprising that the Pennsylvania Railroad was able to
make its desires known to the managements of Macco and Great
Southwest. Before and after Baker was sent to Macco, Be van played
an active role in the companies through which the Pennsylvania had
attempted to diversify. As a father to the diversification efforts, he became deeply involved both inside and outside of the board meetings
in the affairs of Macco and Great Southwest.
203 Baker had been on the legal staff of Great Southwest and had advanced to general counsel and secretary
prior to his Macco assignment.
20* Memo from Baker to Wynne Aug. 5,1967.
205 Upon the acquisition of Macco by GSC in 1969, Baker replaced Wynne as chief executive officer of the
combined companies.
206 From Baker's testimony:
"Q. To your knowledge, did Mr. Bevan have any rcle in your being transferred from Great Southwest to
"A. Macco was, in 1967, not meeting its projections as to either income or cash. I was sent out to Macco at
Mr. Wynne's direction, I assume at Mr. Bevan's request, in order to, as it was put to me, to try to get a
handle on what exactly was going on and what needed to be done."
207 From Bevan's testimony:
"Q. What was the chief quality that Mr. Baker had? That you looked for to help the situation?
"A. He was—he understood legal matters, he was imaginative and creative, he had a great ability to set
up tax-oriented deals which operated in Southern California with the film industry, wealthy people—he
was good on that type of thing."

From Baker's testimony on Macco:
"Question. Did Mr. Bevan take an active role in the reorganization of Macco f
"Answer. I don't quite know how to answer the term 'active role\ He was on the
"board of directors of Macco and was responsible for Macco. Kept himself very
much advised as to what was going on. He didn't actually go out and hire the
people or fire them, as the case may be.
"Question. Did you or to your knowledge did someone else report to him periodically
what was taking place, what changes were being made?
"Answer. Yes.
"Question. Did he ever make any suggestions or changes himself in the plan submitted to himf
'"Answer. He was, you know, active as the one the company ultimately reported
1;© and would take part in reasonably long director meetings where the company's
prospects and plans were rather fuliy laid out and, you know, of course he made
certain contributions to those meetings.
^Question. Were these meetings other than the board meetings, you mean?
Answer. Well, in many cases they were board meetings and in other cases they
were just monthly kind of meetings that would take place, wherever the place he
would designate. The company was a wholly owned subsidiary of the railroad or
the Pennsjdvania Company. So, the company would be rather detailed, not rather
detailed, but completely detailed in terms of its projections and staffing requirements and proposed acquisitions and proposed sales."

Almost every other Penn Central officer in the financial, accounting,
and related departments became involved in the affairs of Macco and
Great Southwest.
From Baker's testimony:
At some point in time it seemed like all the administrative people of the railroad came down to look over and make suggestions as to what was happening in
the subsidiaries. But, principally, we were involved with Mr. Bevan himself, and
Mr. Dermond, William Gerstnecker, William Cook, who was comptroller, and . . .
Charles Hill, who was his assistant and then later became comptroller, various
people on the comptroller's staff, which was a fellow by the name of Dawson and
Mr. Warner was in charge of taxes back there and he had an assistant by the name
of Antoine, and there was a vice president in charge of administration, I think
that was his title and his name was Fox. Then, there were other people such as
Robert Loder, and there may well be others that I have omitted.

The Penn Central accounting department which was responsible for
producing the consolidated figures for the consolidated financial statements, required monthly and quarterly reports from Macco and Great
Southwest.208 The earnings projections were also continuously reviewed and discussed with the management of Macco and Great
Southwest by Penn Central employees. These reviews and discussions
made clear to Great Southwest officials that the railroad needed
greater reportable earnings and that the need was always increasing.
From Baker's testimony:
°8 Peat, Marwick, Mitchell & Co. were the auditors for Macco and Great Southwest as well as for Penn
Central. At times the Philadelphia office of Peat, Marwick became involved in disagreements about booking
profits for Great Southwest, particularly in light of the policies of maximization of reported income practiced
by Penn Central. On the afternoon of July 25,1969, after a morning consultation with Saunders, Charles
Hill, the Penn Central comptroller Henry Quinn, the engagement partner on the Penn Central accountflew to California to consider certain transactions which might result in higher reported earnings for the
first halffinancialstatements. The following is Baker's description of this event:
"In 1969 we had a couple of instances which gave rise to my statement which is rather general, as to the
possibility that the railroad might do something or attempt to do something which would seek treatment of
the transaction more favorable to their specific needs at the time than to the company.
"Thefirstsuch instance arose in 1969 when, after the half-year profits were over or after the half year was
over, Charlie Hill and Mike Quinn made a midnight ride out to Macco to see if there was possibly another
$300,000 of earnings, as T recall the number, and attempted to review rather specifically the various accounting treatments ofthe transactions in order to see if a few more dollars of profit could not be received from
those transactions, and I took great offense to that because we felt like in this case we attempted to arrive
at the best accounting treatment or the proper accounting treatment on the transactions.
"There's always an area of judgment in connection with transactions as to allocation of bases and, you
know, the many and varied other things.
"We didn't feel that kind of pressure on the auditors was proper."
The questionable items were apparently not included as income. Quinn recalled a trip, but said that he
was attempting to resist Great Southwest efforts to record certain transactions as income.

Answer. We made our own projections. Mr. Bevan and the financial staff
worked with us in reviewing those initial projections and they monitored our
performance under the projections. We were encouraged to push the companies
forward as fast as they could reasonably go.
Question. Did this indication by Penn Central as to earnings, profits, goals, become
more intense as time went on, that is, were the goals raised individually [should read
Answer. Your question assumes an answer to the previous question which
wasn't there.
I think I said they never did set our goals for us. They became increasingly
more interested in profits, it seemed to me as time went on. I am trjdng to answer
your question, but they did not set specific goals for the company. From the outset,
Penn Central indicated they wished to maximize their returns on the investment
and I don't recall what percentage number they used.
But, in each case the subsidiary companies would present a pro forma or projections of the coming fiscal year end and that would be gone over by Mr. Bevan
and his staff and there would be various consultations relative to those pro formas
for the coming year, and the Great Southwest was encouraged, as was Macco,
to attempt to increase profits and increase the cash results.
Question. Did you ever discuss these budgets [of Great Southwest] with anyone at
Penn Central before they were presented to the Great Southwest board?
Answer. Yes.
Question. And with whom did you discuss it?
Answer. Primarily with Gerstnecker and Bevan. There was a man in their
department named Earl [Dermond] who had occasion to review the budgets * * *
Question. Did they ever discuss the profit performance?
Answer. Oh, yes.
Question. Was this just in terms of how much it was?
Answer. How much and, "how much can you increase it," yes.
Question. Were the Penn Central officials satisfied with the profit level that was in
the budget that they were given for review?
Answer. Well, I don't know how satisfied they were. They should have been;
but there was always a demand for more—at least a desire for more.
Not necessarily a demand.

Penn Central's interest in the reporting of profits by Great Southwest was more than the simple pursuit of "performance." Penn sought
desperately to conceal the disastrous performance of the railroad. The
profit maximization schemes in Macco and Great Southwest were
counterparts to concealment efforts being made in other parts of the
Penn Central system. Macco and Great Southwest management,
particularly under Baker, knew what Penn Central management
wanted and it acted to meet those wants. It should be noted that the
booming "earnings" performance of Macco in Great Southwest not
only helped conceal the railroad losses in the consolidated financial
reports but it also gave the false impression that the railroad's diversification program was enormously successful in itself. Finally, the
resulting explosion of the value of GSC stock made Pennco's assets
balloon in value which aided the railroad in obtaining financing from
banks (to whom Pennco's stock was pledged) and in making sales of
Pennco securities.
The intensity of Penn Central's desires for more profits from Macco
and Great Southwest increased as the fortunes of the railroad declined
and its losses and financing needs increased. Indeed, after the merger
of the railroads even Saunders, who had little involvement in the
affairs of Macco and Great Southwest, became directly involved in
seeking grearer profits from the subsidiaries. He began calling Wynne
and Baker at the end of each quarterly reporting period asking what
the profits were going to be and demanding that they be increased.

At one point, after the end of the second quarter in 1969, Saunders
sent Hill (the Penn Central comptroller) and Quinn (a Peat, Marwick
partner in Philadelphia) to find additional earnings to be included in
the second quarter report. From Baker's testimony:
Question. Did either Mr. Hill or Mr. Quinn ever indicate that they were making
this examination at the behest of anyone at Penn Central; that is, any member of the
senior management?
Answer. Mr. Saunders was the one that was always calling right at the end of
the quarter and screaming for a few more hundred thousand dollars profit and
Mr. Hill worked for Mr. Saunders.
Mr. Saunders would call and say, "Can't you close this deal or Can't you do
something here? And sometimes we could. Sometimes there was a piece of property
we could sell. 209

Amid this constant interaction between Great Southwest and Penn
Central, one element of the Penn Central organization remained,
at its own choosing, largely uninvolved in the events taking place.
The directors of Penn Central received periodic reports from Bevan
that the earnings were soaring and would continue to soar. Only one
director, Kobert Odell, showed concern. Odell was himself involved
in California real estate. In July 1968 he wrote to Saunders210 warn
him of problems Macco could face and to counsel caution. When
Odell later demanded that the board be furnished with information on
Great Southwest activities, management refused OdelPs demands by
informing the other directors that Odell had a conflict of interest
because his own firm was involved in west coast real estate. Management also obtained an opinion from Dechert, Price and Rhoads, a
Philadelphia law firm, stating that the directors would expose themselves to liability; if they became too involved in Great Southwest's
affairs. This opinion was circulated to the directors.211
At the December 17, 1969, board meeting of the Transportation
Co. management attempted to reassure the directors about Great
Southwest by having Great Southwest officers make a presentation
to the board. This presentation has generally been described by
witnesses as a "slide show" of California and Texas properties. No
209 Wynne also received these quarterly calls:
"Q. Did Mr. Saunders participate in many cf those discussions about the—[budget]?
"A. Yes, every quarter.
"Q. Would this have been in the context of the board meetings?
"A. No.
"Q. In what context would it be?
"A. How much are you going to be able to increase your earnings primarily.
"Q. Was this a personal meeting?
"A. Primarily, a telephone call.
"Q. Would he call you?
"A. Yes."
210 i n a letter of J u l y 3,1968 t o Saunders, Odell wrote:
"DEAR STUART: I am apprehensive about the Macco operations and fear there may be some unpleasant
surprises later on. Unconfirmed rumors concerning Macco are quite unfavorable. Large investments in
undeveloped land are very speculative in any market, and expeciaily under present and forseeable money
conditions. Interest charges and taxes usually double the cost in about 5 years without development and
planning, which is always very costly.
"I am for whatever is good for Penn Central, Pennsylvania Co. and Stuart Saunders.
"However, there is so much chance for bad judgment and manipulation in land development projects, I
feel they should be most carefully watched." (Letter from Odell to Saunders July 3,1968.)
Odell was concerned that Saunders would be caught unaware. Unknown to Odell, Saunders was directly
involved himself in Macco through the extension of his insistence on maximization of reported profits to
Macco management. Saunders nevertheless reassured Odell of Penn Central's review:
"Without overdoing it, I think it is safe to say that there is almost daily communication between officers
of the Penn Central and these companies and finally, which I presume you realize, immediately after we
acquired Macco, Peat, Marwick, Mitchell and Co. were engaged as certified public accountants for them
and we have had audited statements every year thereafter. I might also say that I, of course, follow the
activities of Maccc closely as well as that of all of our other subsidiaries." (Letter from Saunders to Odell,
Aug. 15,1968.)
an Skadden, Arps, Meagher & Flom, a law firm working for the board's conflict of interest committee,
concluded that the directors did have an obligation to become involved, but this view was not made known
to most of the directors.

significant information about Great Southwest's condition or affairs
was presented. This was OdelPs last board meeting. After repeated
attempts to get more information on Great Southwest and to get management changes, including the replacement of Bevan and Saunders,
Qdell resigned. Penn Central directors have stated that they were
unaware of most of the significant events in Great Southwest. After
Odell left the board, the directors ceased further inquiry into the
matter. 212

As early as August 1967, in a memorandum to Wynne analyzing
Maeco's situation, Baker had raised the suggestion that Macco engage
in "bulk" land sales, including prepaid interest arrangements. 213 He
went even further and stated that the prepaid interest transactions
could be effected even without using Macco land. These tax oriented
transactions were to boost the earnings of Great Southwest and Macco
by several hundred percent over the next 2 years. These increases,
in turn, were loudly broadcast to the public as a demonstration of the
miraculous performance of Great Southwest and the great benefits
being received by the railroad from its diversification (while masking
some of the railroad's growing losses). The miracle was made of paper
and the condition of Great Southwest was in fact declining rather than
soaring. The principal transactions contributing to the miracle were
the sales of Bryant Ranch, Six Flags Over Georgia and Six Flags Over
Texas. There were other profit maximization efforts as well.
Bryant Ranch was sold by Macco for $31 million in December 1968.
The sale produced a profit of $9,925,780 for Macco. The syndicated
group of approximately 400 investors (seeking tax shelters) paid
$6,039,000 in cash. Six hundred thousand dollars of this amount was
a down payment on the principal (leaving a balance of $30,400,000).
The rest was prepaid interest (tax deductible by the individual
investors). No principal payments were due until 1984. The only obligation of the investors during the years 1969 to 1983 was a yearly
payment of $1 million in interest payments (which were tax deductible
to the investors). The interest at the 7-percent rate shown on the face
of the note would have been $2,128,000 b u t any excess over $1 million
was not payable until 1984. The investors had no personal obligation
under California law to make any payments after making the initial
cash investment. Macco, however, had an obligation to make recreational improvements estimated to cost $2 million but which eventually
cost $5,500,000. Macco had a further obligation to develop lots for
all 400 investors and to build an access highway at an estimated cost
of $4 million. Macco was further obligated to pay other cost of developing the entire property.
Baker has stated that it was he who first proposed the Bryant Ranch
tax oriented syndication. He was vague, however, about how he first
learned of this kind of real estate transaction. 214 Baker consulted law
212 This matter is more fully treated in the section of this report covering the role of the directors.
3 Memorandum from Baker to Wynne Aug. 5,1967.
2 "0. How did you first become aware of that procedure?
"A. What do you mean?
"Q. About the prepaid interest type of transaction?
"A. I really don't know. I mean, anybody who is in the investment, you know, actively in the real estate
business, you know, becomes aware of the various types of sales that are taking place and the terms. It is
just a part of being involved in the active business community."

firms on the structuring of these tax transactions including a firm
which had a connection with Property Research, an organization that
eventually syndicated Bryant Ranch and the two amusement parks.
Macco at first attempted to syndicate the propert}" through its
own resources. By early 1968 a plan was formulated for the syndications and possible investors were being sought. A prospectus was
prepared in the summer of 1968 m and investors were given tours of
the property. By September it was apparent that Macco would be
unable to obtain a sufficient number of investors on its own and
Property Research was brought into the planning. Wayne Hughes
of Property Research headed the project for that firm. Ify the end of
1968, 15 percent of the syndicated interests remained unsold. The
transaction was clrsed, however, before the end of the year and
Macco deferred accounting for the 15-percent unsold portion until
The two amusement parks owned by Great Southwest Corp. were
sold through tax-oriented syndications in 1968 and 1969 (Six Flags
Over Georgia in December 1968; Six Flags Over Texas in June 1969).
Limited partnerships were syndicated to investors. 216 The limited
partnership contributed the parks to a second limited partnership.
A subsidiary of Great Southwest was the general partner and had
sole and exclusive control of the operation of the parks.
The Georgia park was sold for $22,980,157 with a downpayment of
$1,500,000 and prepaid interest of $1,450,000. Annual interest payments were $1,249,500 through 1974 and $759,500 thereafter until
2004. Principal payments of $700,000 yearly were to begin in 1974 and
continue until 2004. The Texas park was sold for $40 million with a
down payment of $1,500,000 and prepaid interest of $3,932,670.
Interest payments were $1,221,354 }7early and principal payments
were $1,094,331 starting in 1971, and continuing until 2005.
In neither transaction were the investors personally liable for the
remaining obligations of the contract. Ninety percent of park earnings
were obligated to meeting interest and principal payments until 50
percent 01 the Georgia park principal or 33K percent of the Texas park
principal had been paid.217 The amusement parks had been generating
cash and the syndications caused only a minor decrease in cash flow
(the cash was returning through interest and principal payments).
The sale generated profits which were subject to tax but this did not
directly affect Great Southwest because of the tax loss shelter of Penn
Central. Payment obligations were incurred, however, because the
tax allocation agreement with the Transportation Cc. required GSC
to pay Transportation for 95 percent of the tax savings realized from
the shelter.
These s3rndications were not sales of property but, were, rather,
sales of tax and other benefits in exchange for immediate reported
profits and some immediate cash. Even the inflated profits could not
continue, however, since GSC had used the best syndication vehicles
in these initial syndications. 218 These profits were, in turn, repeatedly
and falsely represented to GSC and Penn Central shareholders and to
the investing public as reflecting enormous and sustained growth. The
2 5 This was an intrastate offering and no SEC filing was made.
2 8 These syndications were registered with the Commission.
There are other details of the transactions which tend to indicate that GSC continued to be, in practical
effect, owner and that GSC gave up certain benefits in order to book a profit.
In early 1970 Baker proposed the purchase of property for the purpose of syndicating it at great profit.
Great Southwest management was unable to explain how this could have been achieved and no such sales
could be effected.

price of GSC shares soared 219 and the growth in reported earnings
helped to mask the losses of the railroad. 220 The price rise for Great
Southwest stock was itself an important benefit for Penn Central because Pennco owned approximately 25 million shares of GSC. Each
additional point on the price meant an increase of $25 million in
Pennco's portfolio (at $40 a share, GSC's peak price, the holdings
equalled $1 billion). Pennco was used to borrow $85 million in 1969
and was the vehicle for the abandoned $100 million debenture offering
in 1970. The Pennco common stock was security for the $300 million
revolving credit of the Transportation Co. Be van repeatedly emphasized Pennco's portfolio (of which GSC was the principal asset) to
lenders and to the public.
Penn Central officers and employees were continuously aware of,
and were consulted about these transactions. 221 As stated above, Penn
Central officers continuously reviewed forecasts and discussed those
forecasts with GSC officials. In addition, the cash flow impact of
major transactions was discussed in detail by Penn Central employees
in Philadelphia.
The managements of Great Southwest and Penn Central were not
satisfied with recording profits from the sales of the amusement parks.
After the sale of the $50 million of Pennco debentures in 1969 but before the end of the calendar year, Great Southwest and its accountants
decided on a change in the reporting of the income from the sale of
Six Flags Over Georgia and Six Flags Over Texas. The sale of Six Flags
Over Georgia in 1968 had been carried as extraordinary income.222 The
sale of Six Flags Over Texas in June of 1969 had also been reported as
extraordinary income in interim financial statements. Before the close
of the 1969 year, the reporting was changed to show the sales as ordinary income. The ostensible reason for the change to ordinary income
was that Great Southwest had. changed its business and had become
engaged in the building and selling of amusement parks rather than
in the building and ownership of amusement parks. At this time in
late 1969 Great Southwest had begun construction of an amusement
park in St. Louis to be called Six Hags Over Mid-America. This park
was scheduled to open in the spring of 1971.
No other parks were being built or were in any planning stage There
had earlier been plans to develop a park near San Francisco but that
plan was abandoned early in 1969 when local opposition developed.
When asked to explain how Great Southwest could determine that it
had changed its course of business the company officers made vague
references to their hopes or aspirations. They also referred to "studies"
Tho price of Great Southwest shares increased as follows:
High bids:
— 41>£
220 The amount of disclosure about these transactions varied from detailed recitations in the syndication
prospectuses (which were not given to GSC or PC shareholders) to conscious and explicit misrepresentation
Penn Central officials.
From Baker's testimony:
"Q. Do you recall every describing these prepaid interest transactions with Mr. Bevan or anyone else
at the Penn Central?
"A. We discussed them at great length with the people at Penn Central.
"Q. Who conducted these discussions, yourself principally or were there other people?
"A. Well, there were a variety of people involved in the discussions. I had them with Mr. Bevan and
Mr. Wynne. There were various people on the Penn Central staff that were involved."
The sale of Bryant Ranch also had been carried as extraordinary income in 1968.

that had been done. These studies were done principally by Economic
Research Associates. Booklets supplied by Great Southwest for staff
inspection show only two studies done at the behest of Great Southwest: one for a park in Virginia and the other for one near Toronto.
The Virginia feasibility study was not done until March 1970, and the
study for the park in Toronto was couched in terms of financing the
park for ownership by GSC, not for selling the park. Both studies were
limited to preliminary feasibility studies and in no way indicate any
consideration of going forward with such parks.
Considering the magnitude of the change in the reporting of income
involved in switching from extraordinary to ordinary income it appears
that only superficial consideration was given by the company or its
accountants to the validity of such a change. In 1969 alone, the profit
from Six Flags Over Texas accounted for $27.6 million out of the
$51.5 million profit booked for that year by Great Southwest. As
indicated by the construction program of Six Flags Over Mid-America
no income from the sale of an amusement park could have been booked
in 1970. All of the Great Southwest witnesses were unable to recall
any review by the Peat, Marwick officials of the plans Great Southwest
had for the future development and sale of parks.

The principal surge in the income of Great Southwest in 1968 and
1969 resulted from the syndication sales of assets including Bryant
Ranch, Six Flags Over Texas and Six Flags Over Georgia. Profits were
also being maximized by the acceleration of sales of developed real
estate located in the industrial parks. This activity began in 1968 and,
like the syndications, was linked to Penn Central's desire to be able
to record greater profits from its subsidiaries to mask the severe losses
from the operation of the merged railroads.
In its industrial parks in Texas and Georgia, Great Southwest prepared raw land for use by industrial and commercial firms. A portion
of this land was immediately sold to produce cash for further development. Another portion was leased in order to provide a permanent
flow of income. This was part of a longstanding program at Great
Southwest. 223 ' 224 Following the merger of Macco and Great Southwest
in March of 1969, which elevated Baker and Bay to control, a decisive
change in industrial real estate policy took place. Emphasis was on
selling land rather than on a balanced program. This resulted in a
surge in reported profits, since in earlier periods only a portion of the
developed land was sold. I t also reduced the ratio of leased property
in Great Southwest's portfolio which would have an adverse effect
on long-term prospects. In fact, it was a trade off of long-term benefits
for short-term profits.
223 "But you have to weigh all those reasons, when you make a sale, as to whether you want the profit or
you want to keep that annual income. We had been working for a long time to get our lease income up to
a million dollars a year in Great Southwest Industrial District, Mark I, and we had." (From Wynne's
224 William Dilliard, a Great Southwest officer who had responsibility for all industrial park development
prior to March, 1969 described the policy:
"One thing here was that the goals and objectives of the company were different at the time [a couple of
years prior to March 1969] In other words, they [Great Southwest] were not trying to sell as much land as
they could possibly sell. The idea was to develop land, build buildings, lease the buildings; build up an
investment portfolio that would produce investment income, pay off the mortgages, so down the road the
mortgages were paid off. The revenue would carry the overhead of the company. So you make—when you
take a leasing route, your profits—stated profits are much less than if you take an outright sales route.
"Q. What was the, say, percentage ratio between leasing and sales during that time?
"A. I'd say aboutfifty—Ibelieve aboutfifty-fifty.In the early years, in order to get the property
started, we had to sell land to users and people called investor-builders, to make it attractive and all."

The industrial park profits from land sales increased from approximately $2 million in225
1968 to $3,700,000 in 1969 and the profit goal in
1970 was $4,600,000.226 These increases were attributed to the change
from leasing to sales.
There was also constant pressure on the sales manager of the industrial parks to produce maximum profits by accelerating the sales of
specific projects into an earlier reporting period according to William
Billiard, a Great Southwest official in charge of industrial park
Question. Did you ever learn, say that Penn Central had wanted Great Southwest
to perform better in any particular quarter and that therefore was the cause of . . .
Answer. This was my understanding. I had heard that that was the case.
Question. Now, how did you hear that? Was it just a rumor, or did somebody tell youf
Answer. Well, usually my superior would ask me, could I make more profit or
push it into this thing, and I would imagine that they would say, well, the owners
of the Penn Central, or the boss wants us to do better.
Question. Is that what they would tell yout
Answer. Yes, I believe so. That's the way I recall it.
Question. Can you recall any specific individual . . .
Answer. . . . I would hear through William Ray or Hans Zwyter [an assistant
of Ray] or one of his assistants that if we needed to get pushed up or try to come
in with higher profits for that period of time, could I do it.

An increased rate of sales, of course, is not improper conduct.
Where, however, projects are taken from future dates for the purpose
of boosting profits in a particular quarter, a false impression of increasing activity and profit can be given. It appears that this was the case
with many of GSC's transactions. It is clear that the desires of Penn
Central management for more income were well known at all levels in
Great Southwest and that these syndications and accelerations were
undertaken to book increased profits without full disclosure of the
purpose or long range impact of this conduct.

Among Penn Central's "assets" was an enormous tax loss carryforward. Both the Pennsylvania and the New York Central had
extensive periods of losses and the performance of the merged railroad
added vastly to the losses. Because of this loss carry-forward Penn
Central and its consolidated subsidiaries, including Great Southwest,
paid no Federal taxes.
Prior to the merger of the New York Central and the Pennsylvania
railroads, several of the New York Central's subsidiaries had entered
into tax allocation agreements with that railroad. These tax allocation
agreements sought to obtain for the parent company a portion of the

Total profits from industrial park operations (including Texas and Georgia and including buildings):
1969 (6 months)
226 From Dilliard's testimony:
"Q. Is that difference in the profits primarily from this change to sales?
"A. I would think so, yes.
"Q. You're doing essentially the same developing at the same rate, is that correct?
"A. Yes, that's right. And we began to sell more properties than we sold before. . . .
"Q. But it wasn't because the whole tempo of the development was increasing was it?
"A. No, I think a lot of it had to do with the change in policy."

tax savings enjoyed by the subsidiary because of the tax losses of the
parent. Typically, the agreements required that the subsidiaries pay
the parent a percentage of the tax saving. These agreements were
entered into only with subsidiaries which had minority shareholder
interests because only the minority interest portion of the tax savings
was not recovered by the parent. The cases on such agreements indicate that tax allocation agreements are legal when they fairly adjust
the benefits between the parent and the subsidiary. The question of
fairness is not always easily resolved.
On October 28, 1968, at the insistence of the Penn Central officials
Great Southwest entered into a tax allocation agreement with Penn
Central (the Transportation Company after October 1, 1969) .227 Under
the agreement Great Southwest was obligated to pay to Penn Central
95 percent of the taxes it would pay if it were filing separately. Tax
allocation agreements are not uncommon between subsidiaries and
their parents. The relationship between Great Southwest and Penn
Central was uncommon, however. Great Southwest had undertaken
rapidly to expand reportable earnings for the purpose, to a large extent, of helping to cover Penn Central's railroad losses. Under Penn
Central's tax shelter, the booking of these profits had no adverse tax
consequence. Under the tax allocation agreement, however, Great
Southwest was in approximately the same position it would have been
if it had to pay taxes. In such a situation, Great Southwest would
normally have avoided transactions such as the sales of the amusement parks which created large tax liabilities, at least in accounting
terms. 228 Great Southwest could have deferred taxes or utilized tax
shelters if it were not for Penn Central's need for earnings and "performance" from Great Southwest. 229
As a solution to this problem, Great Southwest almost from the
beginning sought to have Penn Central eliminate the tax allocation
agreement so that Great Southwest would not have to incur large
tax liabilities while pursuing the maximization of reportable profit.
Bevan, however, remained adamant about the continuation of the
agreement. 230 Bevan's interest was not related to any prospect Penn
At the time, Great Southwest was attempting to conclude the syndicated sales of Bryant Eanch and
Six Flags Over Georgia. Penn Central management had participated in evaluating, and was aware of, these
pending transactions.
s [Neither the agreement nor the tax rules require payment of taxes at the time the profit is booked;
payment is made only as the profit is actually received. Great Southwest was required however to make an
ace mnting provision for the total expected liability.
9 From Wynne's testimony:
"Q. Did you ever discuss with Mr. Bevan whether, if it weren't for the interest of Penn Central in
Great South west, that Great Southwest might have done things differently that wouldn't have incurred
as much taxes?
A. Oh, yes.
Q. Do you have that view, yourself? Apparently, it was expressed by a view that Mr. Baker had made.
A. Oh, yes. Certainly. As a matter of fact, if we had been operating without the tax shelter, there are
a number of things that we could have done to obviate taxes that we did not do. And this was pointed
out to him from time to time.
I can't give you a concrete example of what I'm talking about now, but it would have been the sale
and/or lease of real estate rather than sale, and realizing a profit taken over a period of time rather than
all at once.
From Baker's testimony:
A. It seemed unfair to us to have to pay for a tax effect [through the allocation agreement] when we,
meaning the Great Southwest Corp., had no control over its own tax return.
Q. What do you mean by that?
A. Just what I said. We were filing a consolidated return and if we were not to be provided with a
parent tax shelter, then, we should have had the opportunity to create our own to such an extent that
such creation made good business sense.
230 The Transportation Co. (company only) received an additional, if relatively small, boost in income
through the reportable profit maximization efforts of Great Southwest. The profits of Great Southwest
were included in the results of Penn Central (consolidated). Because of the tax allocation agreement, however, the Transportation Co. (company only) was able to record amounts due under the tax agreement as

Central might have had of receiving cash from Great Southwest. I t
is doubtful whether Penn Central ever expected to receive payment
from Great Southwest under the tax allocation agreement. 231 Indeed,
the cash drain at Great Southwest was large and growing larger constantly and Pennco itself was supplying substantial amounts of cash
to meet Great Southwest's needs.
By September 1969, Great Southwest management had decided to
make another attempt to persuade Bevan to cancel the tax allocation
agreement with Great Southwest. Baker worked with Byron Williams,
a Great Southwest lawyer, in preparing a memorandum to be used as a
basis for discussing cancellation of the agreement with Penn Central
officials. The memorandum was written from Baker to Bevan and
dated September 12, 1969. This memorandum was shown to and discussed with Wynne. I t was then used in a meeting a short time later in
Bevan's office. The bulk of the memorandum is in the general form of a
brief on the cases governing tax allocation agreements between parents
and subsidiaries. The principal rule governing such agreements, the
memorandum asserts, is that both parties be treated fairly. A description of benefits to be received by Penn Central shareholders upon
termination of the agreement is discussed in the context of the stated
The memorandum concludes with an indirect threat presented in
the guise of a further discussion of the fairness of the arrangement
between the parent and the subsidiary. The threat also reveals Great
Southwest's true motivation for accelerating the pace of recorded
profits: to make Penn Central look better even at the possible expense
of the interests of minority shareholders of Great Southwest.
Set forth below are the relevant portions of the memorandum. The
memorandum is quoted extensively because it sets forth the entire
matter of the relation of GSC's earnings to Penn Central desires.
T h e next factor bearing upon whether our execution of this agreement is a
reasonable exercise of business judgment, a n d whether same is fair a n d just to t h e
minority shareholders, is again illustrated by a passage from t h e Sullivan &
Cromwell Opinion which directly quotes an observation b y t h e court in t h e
Case suit, noting t h a t a majority "shareholder is required n o t to "u^e its power to
gain u n d u e a d v a n t a g e a t t h e expense of t h e minority * * * a n d to follow a
course of fair dealings toward minority shareholders in t h e way it [manages] t h e
corporation's business." I a m confident t h a t you realize I personally a m not
a b o u t to criticize P e n n Central's management of GSC, vis-a-vis t h e minority
shareholder or otherwise, to accuse it of being unfair to us or them, or to accuse
it of trying to t a k e any undue advantage. However, issues such as these do get
examined in t h e context of assertions t h a t can be made by a disgruntled minority
shareholder, possibly in a shareholder's derivativa action, and, as always in such
situations, with t h e benefit of 20/20 hindsight.
-'3i From Baker's testimony:
Q. What cash impact did the allocation agreement have on Great Southwest?
A. It would have a substantial cash impact, if we had ever made any cash payments under it.
Q. Was this a concern to Great Southwest management?
A. It certainly was.
Q. Was this mentioned or brought up in discussions with the Penn Central officials?
A. Very much so.
Q. What was their response to you concerning this?
A. Well, they said that we will work out something when the time comes.
Q. Do you know what the officers meant when they said, the Penn Central officers, when they said,
we will work something out when the time comes?
A. No. Please let me—I don't mean to make that statement as. you know, this is exactly what they
said in response to our question about what happens when we have to make payments. It was just
something that was pushed off into the future by the Penn Central Company.
The amounts first payable under the agreement were "forgiven" on the last day of 1969 in an exchange of
newly issued Great Southwest stock for debt owed by Great Southwest to Pennco. See page 143 for further
description of the exchange.

Any such litigation would presumably be predicated upon an assertion by such
a shareholder that the alleged 5 percent tax saving afforded GSC by filing consolidated Federal income tax returns with the Penn Central group, and utilizing
the group's tax loss carryovers, is more than offset by the tax liability incurred
by GSC in failing to avail itself of all possible tax savings in an effort to produce
needed profits for its controlling shareholder. In any such suit, I would certainly
testify that I have always been advised by officers of the Penn Central that I
had a duty to avail myself of all tax minimizing devices possible, and that I have
certainly never been coerced to produce profits at the expense of tax savings.
However, and by the same token, I would have to admit under oath that GSC
has always had, and we certainly value, an excellent day-to-day working relationship with our Penn Central parent, take great pride in our contributions to
its earnings, and consistently make every effort possible to increase that contribution. While such evidence should conclusively show that the Penn Central has
never forced GSC, through its majority control, to produce profits against the
best interests of the subsidiary's minority shareholders, I can nevertheless foresee
a judge and/or jury concluding (with that famous 20/20 hindsight) that we, as
officers and directors of GSC, had been guilty of a conflict of interest between our
majority and minority shareholders, to the detriment of the minority. A perfect
example of a transaction which might give rise to such a conclusion is the sale
of the Georgia and Texas amusement parks. Although both sales made excellent
sense, for all the reasons previously advanced to you, and while I have no reservations about their economic validity, a disgruntled minority shareholder could
nevertheless easily argue that GSC, at the direct instance of the Penn Central, sold
two of its substantial and profitable assets solely to produce substantial profits for
its majority shareholders within given financial periods.232 In making the sales, and
as a necessary consideration to the investing syndicates for achievement of such
substantial profits, GSC gave up all depreciation which had theretofore been
available to offset the income from such profitable and productive assets. Therefore, and again with the benefit of 20/20 hindsight a group of minority shareholders could well argue that, not only was GSC's income from such assets reduced, but there was no longer available any depreciation whatsoever to offset
such income; the result being that every dollar of the substantial tax savings that
would otherwise be lost to the Internal Revenue Service by G&C (on a separate
return basis), now amounts to a loss of 95 cents to Penn Central, at least in the
form of an account payable (on a consolidated return basis), as a result of the tax
allocation agreement. (Without even considering the large tax liability generated
by the sales themselves.)

The threat is only thinly veiled and its presentation brought a hostile
response from Bevan. Was Baker prepared to say that these transactions were done by Baker to please Penn Central at the expense of
Great Southwest minority shareholders, Beven inquired. Baker was,
of course, not willing to make such a statement. Bevan's point was
clear: if Penn Central had harmed minority shareholders of GSC, so
had the management of GSC.
Baker also noted in his memorandum that Pennco was only hurting
Great Southwest by burdening it with a debt to Pennco and that, in
any event, Pennco could not reasonably expect to have Great Southwest pay the debt:
As I noted earlier, if called upon immediately to pay its full account payable to
Penn Central, arising from the tax allocation agreement, GSC would be unable to
do so, because it just does not have the cash. By the same token, we are expected
to independently finance our own operations insofar as possible, but, at the same
time, our ability to do so is lessened by the fact that our balance sheet must show
this resulting substantial account payable to our Penn Central parent. Again
theretofore, I personally question whether, in the exercise of reasonable business
judgment this is proper utilization of group financial resources.

Baker concluded the memorandum with the observation that proposed tax law changes would make Great Southwest's position even
more difficult under the tax agreement. One change, a then recent
232 Emphasis added.

change in deduction of prepaid interest, was seen as bearing on Great
Southwest's way of doing business:
While it cannot be termed new tax legislation, the recent change in the I R S
ruling on deduction of prepaid interest has already adversely affected GSC's ability
to make and consummate certain profitable real estate transactions, both as
vendor and vendee.

The " certain profitable real estate transactions" included the large
syndication sales that accounted for most of the spectacular rise in
Great Southwest's earnings. The difficulty in completing further deals
of that sort would not have any relation to the tax agreement but it
would affect Great Southwest's abilty to continue its growth rate in
earnings.233 It appears that the reference to this difficulty appears
principally to inform Bevan that Great Southwest management could
not hope to repeat past performances regardless of the pressure from
Penn Central. Indeed, despite continuing pressure and frantic efforts
by Baker, Great Southwest was not able to find other deals.234
The tax agreement was not cancelled but Great Southwest was
never required to pay any cash. On the last day of 1969, Pennco
accepted GSC stock in exchange for debt arising out of the agreement
and for debt existing from previous cash advances from Pennco to
GSC. The tax agreement did not affect activities because Great
Southwest had already sold its principal assets and the changes in the
tax ruling made these and other schemes more difficult to complete.
At this point Great Southwest was well on its way to generating its
own tax losses.

When Macco was acquired by Pennco, the principal officers were
required to enter into employment contracts providing for their
exclusive employment and for additional compensation when Macco's
earnings exceeded certain amounts.235 The terms for compensation
were based on the performance levels of Macco which were projected
at the time of Pennco's acquisition of the company. No employment
contiacts existed for Great Southwest officers.
By the late spring of 1968, many of the original officers of Macco
had left. They had been replaced by Baker and his appointees. At
the request of Penn Central, Baker, Ray, Wynne, and Caldwell236
executed employment contracts on June 3, 1968. The contracts provided that Wynne would receive as additional compensation over and
above his regular salary, 3 percent of the net income before taxes in
excess of $10 million; Baker would receive 2 percent237 such an amount
and Ray and Caldwell would receive 1 percent.
Based on 1968
results Wynne earned $299,027, in additional compensation; Baker
earned $199,158 and Ray and Caldwell each earned $99,675.238
In the years preceding 1968, there appeared to be little likelihood
that the employment contracts would require any payments. The
results for Macco and Great Southwest even when combined were well
below the $10 million threshold.
In October 1969, GSC had to abandon a proposed public offering because, among other things, it
would have had to disclose that tax changes made it unlikely that its profits could continue.
234 The last such deal was Six Flags Over Texas which was sold at the end of the second quarter in 1969.
This sale coincided with the highest price for Great Southwest stock (40). From that point the value steadily
declined to 16 at year end and to 5 at the bankruptcy of the railroad.
235 Wynne was to receive 3 percent of earnings in excess of $10 million and four other officers would each
receive 1 percent of such earnings. Wynne was an officer of both Macco and Great Southwest.
236 Wynne and Caldwell had previously been Macco employees under contract.
237 The contract period was from Jan. 1,1968, to Dec. 31,1972.

238 T h e s e s u m s w e r e i n a d d i t i o n t o basic compensation of $26,000, $60,000, a n d $55,000, respectively.


1, 918, 974
4, 731, 631
6, 711, 616
25, 426, 215

Baker and Ray have stated that they were reluctant about entering
into these contracts because they disliked the requirement of exclusive
employment for the duration of the contract. However, at the time
they entered into the contract, the idea of syndication was well
developed and much planning had been completed. They would
have known of the benefits they could reap through syndications. I t
appears that Bevan had determined that the bonsues would be worth
the price in the encouragement they would give Baker and Kay to
push for profit maximization.
The size of the remuneration being received by the officers for 1968
alarmed Saunders when he learned of it. He was particularly concerned
by the possible reactions of Penn Central directors if they were to
learn of this generous remuneration. 239 Gerstnecker was assigned the
task of negotiating a new employment contract. New contracts were
entered into on June 4, 1969. In settlement of the previous contracts
Wynne was paid $3 million in cash. Baker was to be paid $2 million
over 10 years and Ray and Caldwell were to receive $1 million each
over 10 years. The new contracts provided additional compensation
for Wynne, Baker and Raj r of 3, 2, and 1 percent of earnings of the
combined Macco and Great Southwest entity in excess of $35 million
in 1969; $40 million in 1970; $45 million in 1971 and $50 million in
1972.240 The contracts were to expire on December 31, 1972. The
additional yearly compensation was limited to $125,000 for Wynne;
$100,000 for Baker and $75,000 for Ray. 241
Disclosure about the agreements was a concern shared by Saunders
and others at Penn Central. Great Southwest itself could look forward
to disclosure in a prospectus for a public offering then being planned.
Gerstnecker informed Bevan that the settlement as worked out would
avoid the more damaging aspects of disclosure:
If approved by the Board of Great Southwest, it fthe termination and new
agreement] will, of course, become an accomplished fact and can and will be
discussed in only general terms in any future prospectus with the settlement
agreements being only a historical fact which will have resulted from the merger
of two companies and the new contracts having a ceiling on compensation to
the extent of no more than twice of their base salary.242

Saunders was also concerned with whether the new agreements
would insure the continued performance of the GSC management:
I understand Mr. Gerstnecker believes, and I gather you also agree, that
the new settlement and agreement will provide sufficient incentive for these
officers to maximize earnings.243

As with many of Penn Central affairs in these years, attempts to
conceal one aspect of the activities created a chain reaction which
itself had to be covered over as best as possible. With the employment
contracts, the initial incentive payments exceeded propriety when
2 9 The Penn Central directors were unaware of the compensation being paid or the amount paid for
renegotiation. Most of the directors admitted to surprise or shock'when informed of the magnitude of the
como?nsation and settlement.
**° Bas*1 salaries were $125,000. $100,000, and $75,000 for Wynne, Bak?r, and Ray respectively.
« Caldwell was to receive a base salary of $55,000 plus compensation of 1 percent of the excess of Macco
earnings only.
« Memorandum from Gerstnecker to Bevan, May 29.1969.
2« Memorandum from Saunders to Bevan, June 2,1969.

Great Southwest and Macco engaged in schemes to maximize reported
earnings. Costly settlements then were entered into to limit the
exorbitant compensation. The terms were described in the April 22,
1970, Great Southwest proxy, but as Gerstnecker observed, Great
Southwest was able to describe it in terms that were historical and
whose impact was unclear to one who did not know of the full circumstances or the true nature of the earnings on which the compensation
was based. In fact, the settlement was made necessary because of the
Macco "earnings" surge which was caused principally by the Bryant
Ranch transaction. 244 Macco never repeated such a sale so it can be
said that Macco paid the principal officers $7 million for producing a
booked profit of $10 million.245 Penn Central shareholders were not
informed of this cost of producing the Macco "profit" and the Penn
Central directors remained ignorant of the matter.

By the late spring of 1969 plans were being made for a public offering
of Great Southwest stock. At the annual shareholders meeting in
Philadelphia on M a y 13, 1969, Bevan told the Penn Central shareholders:
In this connection, and I think this is important, we anticipate in all probability
selling a relatively small portion of our Great Southwest stock this year. This will
allow us to recoup a part of our investment, but what is probably more important,
it will also create a floating supply of Great Southwest common stock and a good
market for that company's stock. At the same time it will enable Great Southwest
to finance its future needs through the use of convertible issues or through the
sale of stock in the market, thereby again enhancing its potential and ability to
grow in the future.

At a board of directors meeting of Great Southwest Corp. on June 4,
1969, the directors approved the preparation of a draft of a registration
statement under the Securities Act of 1933, in connection with a
proposed issuance of 1 million shares of preferred stock and an additional offering by "certain shareholders [in reality Pennco] of shares
of common stock of the corporation held by them."
By October 1969 the offering had taken the form of a sale of 700,000
shares of GSC cumulative preferred stock for $35 million together
with a secondary offering by Pennco of 500,000 shares of Great Southwest stock from its holdings.246 The origin of this proposed offering is
not clear, but it appears to lie with Penn Central management. 247 248
As Bevan told the stockholders, Pennco could recoup part of their
investment and also create a larger market for the stock.249 The offer244
See page 127.
The formula u^ed by Penn Central management was purportedly based on projected increasing profits
through the years of the contract. Penn Central management, however, was aware of the kind of transportation that had produced the "earnings" surge and must have known that there was no hope of continuing
the charade, particularly in light of Great Southwest's critical cash problems.
-;*e it appears that the offering was delayed in part by possible problems under Sec. 16 of the Exchange
Act because of other recent transactions in GSC stock by Pennco.
? Most of the parties to the offering gave vague answers about the origin and demise of the offering despite
the extensive work done and the sudden termination.
248 From Baker's testimony:
A. This was something that the railroad specifically wanted done in terms of this offering. I don't
think anybody at Great Southwest was very much in favor of this kind of offering, because of the difficulties it presented to us management-wise.
Q. Who at Penn Central was the individual or who were the individuals?
A. Mr. Bevan was the only one we reported to.
As Bevan spoke to the shareholders, GSC stock prices (high bids) were touching record levels:
1964—2H; 1965-4J4; 1966—4%; 1967—4%; 1968—13%; Jan. 2, 1969—13.7; May 13, 1969—40.25 (record
high bid); May 19,1969—33.25; Dec. 31,1969—16.
Adjusted to take into account a 10 for 1 split on Apr. 11,1969.

ing of cumulative preferred would, of course, prcduce badly needed
cash for Great Southwest. This motivation would grow greater later
in 1969 when the railroad itself increasingly began to rely on Pennco
to meet the railroad's desperate cash needs. There was one major
obstacle to satisfying the desires of Pennco and Great Southwest:
the offering would have to be made by means of a prospectus which
met the disclosure requirement of the Securities Act.
In light of the way the affairs of the company were being conducted
by the managements of Penn Central and Great Southwest, it was
inevitable that the price of full disclosure would be very great. Indeed, it would appear that from the beginning the price would have
been more than Penn Central or Great Southwest could pay. Full
disclosure about the affairs of Great Southwest would certainly cause
a drop in the market price of Great Southwest stock. Pennco's most
valuable asset in mfd-1969 was its approximately 25 million shares
of Great Southwest stock (when valued at market price). Pennco,
in turn, was about to be used as a financing vehicle for the railroad.
Every drop of one point in the price of Great Southwest decreased
the value of Pennco's portfolio by $25 million and such a market
decline would clearly threaten the ability of the railroad to use Pennco
as its last source of cash.250 251
By the end of September, a draft prospectus was in existence and
was being reviewed by Penn Central counsel. The offering was almost
ready for filing of a registration statement with the Commission.
Wynne told the Great Southwest directors on September 23, 1969,
that the company planned to file the registration statement within
the next 10 days. A draft prospectus bears a proof date of October
13, 1969. This was the last draft that was printed. At this time John
Harned of Glore Forgan, the underwriters for the proposed issuance,
was in Dallas for the final arrangements. Harned, who had been
involved in the initial planning in the summer, was becoming increasingly concerned about the kind of disclosure that would have to
be made. Most of Great Southwest's earnings had come from the
selling off of their principal saleable assets and there was considerable
doubt as to whether this activity could be continued.252253 Harned
was particularly concerned about the impact that disclosure would
have on the market price of Great Southwest stock:
I had analyzed the company in great detail of the Great Southwest, in great
detail, and I had come to the conclusion if the company were to make full disclosures of the business as it was then operated, then, in my judgment the more
sophisticated community would tend to discount the earning power they had
and there would be a serious selloff of the stock in the company.
2 0 The market value of Pennco's portfolio was also important in connection with existing financings. In
connection with certain borrowings the lenders had been assured through debt coverage provisions that
Pennco's assets would not drop below a certain percentage of the outstanding debt. A serious decline in the
market price of Great Southwest stock could create difficulties under these coverage provisions.
25i In the last week of 1969, after GSC stock had been in constant decline, several members of Penphil
(including the two officers in Penn Central's Securities Department) began buying GSC stock. Their
purchases constituted most of the buy side that week and it is possible that this was an effort to hold up
the price of GSC as of the last day of the year against a time when Penn Central might need to cite Pennco's
portfolio market value as of year end. The buyers denied any such effort.
22 The sale of Six Flags Over Texas in June 1969, was the last major sale that GSC was able to make
despite what GSC management admits were feverish efforts to devise further sales of property.
2 3 There were other activities which presented disclosure problems, but the dubious nature of most of
GSC's earnings was a decisive problem of disclosure for GSC.

Harned calculated the consequences to Pennco of a selloff as follows:
Value of
Pennco holding



Loss to Pennco


Harned estimated that there would be a sell-off to between 10 and
15. Thus Pennco faced an asset loss at market value of up to a quarter
of a billion dollars. This would occur at a time when Pennco was
planning a public financing and while all the common stock of Pennco
was pledged on a $300 million revolving credit line.
Harned and other members of the group working on the prospectus
were at the Dallas home of George Davis, GSC's outside counsel,
for an evening work session, when Harned expressed his feeling that
the offering should not be made. After some discussion, Harned then
flew to California to tell Baker of his conclusions. Baker acquiesed.254
Harned then returned to New York where he told O'Herron about the
disclosure problems and the effect this disclosure would have on the
price of the stock. By this time, Harned had obtained the concurrence
of other senior Glore Forgan officials in his recommendation.255 The
offering was dropped and no further information was put forth by
Great Southwest or Penn Central on this sudden demise or the
reasons behind it. Harned's forecast of a sell-off was accurate, although
the period of the sell-off was extended because accurate information
merely seeped into the marketplace. By year end the price was 16;
by the end of March it was 14 and at the end of May it was six. It is
clear that the managements of Great Southwest and Penn Central
realized that the true nature of Great Southwest's earnings, activities,
and prospects were shockingly less than what was being actively
represented to the investing public. For management the registration
statement was the moment of truth. The managements avoided that
moment, and continued a calculated course of deception.
In addition to information concerning the inflated and short-lived
earnings, the prospectus would have contained a considerable amount
of additional adverse information. The draft prospectus disclosed the
extent of the railroad's cash contribution, through Pennco. This cash
was needed to meet the severe cash drain at Great Southwest. Loans
from Pennco to GSC and Macco were:
(9 months)



2 * Davis and members of GSC management tended to be vague on the reasons for the abandonment of
the offering. They indicated that the principal reason was that the offering was "premature."
2 Charles Hodge, a partner of Glore Forgan and a director of GSC, was not available for consultation
during this period.

The company received additional cash through purchase of securities
by the parent:



Since 1966__
July 15,1966

P C T C Pension Fund

Oct. 9,1967


Unsecured note
3,500,000 shares series A 6 percent cumulative preferred.
500,000 shares series A senior Q}4 percent
cumulative preferred.
2,000,000 shares of series A senior 6% percent cumulative preferred.
250,000 shares series A senior 6K percent
cumulative preferred.


PCTC Pension Fund


Buckeye Pipeline Annuity
Penn Central Employees
Mutual Savings



The prospectus hinted that the flow of cash from the railroad might
not continue indefinitely:
To the extent that it has been unable to obtain outside financing, the company
in the past has obtained funds from Pennsylvania Co. and its affiliates. The
company may not be able to obtain similar loans in the future and accordingly,
will be required to obtain all its financing from lenders not affiliated with the company.

The prospectus also indicated that GSC faced $80 million of
scheduled debt payment in 1970 and that 52 percent of GSC's stated
assets were receivables, almost all of which were from bulk land sales.
The prospectus also outlined the option which GSC had to acquire
Macco and the benefits which accrued to Pennco when GSC acquired
Macco in 1969 through negotiation with Pennco and not through the
option.256 Pennco received $274 million worth of GSC securities in
exchange for Macco. If GSC could have exercised its option, it could
have obtained 99 percent of voting control of Macco for $61 million
according to calculations in the draft perspectus. The terms of the
option provided that it could be exercised after Macco repaid to Pennco
the original purchase price ($39 million). The prospectus stated that
the option had not been exercised because (1) GSC or Macco might
not have been able to obtain the financing; (2) that GSC could not
have compelled Macco to repay the Pennco debt; and (3) that Macco
could not have required Pennco to accept repayment (the debt had
been converted to preferred stock.)
In connection with the acquisition of Macco by GSC in 1969, as just
described, Glore Forgan received 641,450 shares of GSC (valued at
$11,500,000 on March 21, 1969 market price). This, too, appears to
have been a favorable adjustment of earlier agreements, according to
the draft prospectus. When Macco was acquired by Pennco, in 1965,
Glore Forgan received 10,000 shares of Macco (10 percent of the outstanding common stock) for $10,000. At the same time, Glore Forgan
gave GSC an option to purchase the 10,000 Macco shares for 100,000
GSC shares after Macco had repaid Pennco the $39 million which had
been advanced to permit the original acquisition. I n the 1969 agreement which joined GSC and Macco it was stated that GSC released its
option to purchase Macco shares from Glore Forgan in exchange for
Glore Forgan voting its Macco stock in favor of the merger. In negotiation, Glore Forgan received 641,450 shares of GSC in exchange for
2 6 The option was granted because GSC had found and evaluated Macco before its acquisition by Pennco.

its Macco warrants. 257 According to the description in the draft prospectus, if GSC had been able to exercise the original option it would
have paid Glore Forgan only 100,000 shares (valued at $1,500,000)
rather that 641,450 shares (valued at $11,500,000). Approximately
600,000 of the shares received by Glore Forgan, were distributed to
Glore Forgan officers.
The prospectus also reveals that after GSC's annual report for 1968
was issued, but prior to filing tax returns, GSC changed its income reporting so that earnings previously reported on the installment basis
were reported as 1968 taxable income. 258 Net earnings for 1968 were
increased $7,036,508 above the previously reported amounts. This information appears as a footnote to the financial statements. I t appears
that this change in reporting was expressly undertaken to permit
higher earnings reports to prospective investors. 259
The draft prospectus also provides some information on individual
development projects. A careful reading informs the reader that GSC
had obligated itself for substantial development costs and that some
land had serious hindrances to development.
The prospectus itself, as it appears in draft form, would not have
disclosed the true condition of GSC, including Penn CentraPs dominant role and the plan of maximizing reportable earnings, but it gives
hints of problems at Great Southwest. 260 GSC and Pennco could not
have afforded to tell even what was in the draft prospectus. GSC and
Pennco failed to disclose the abundance of adverse information known
at that time. The cancellation of the offering is a clear demonstration
of the knowing and willing concealment of adverse information by
Penn Central and Great Southwest.

The forced cancellation of the proposed public offering put pressure
on Great Southwest and Pennco. Great Southwest had an urgent need
for cash and Pennco needed reportable profits. The first alternative
effort was a private placement by Great Southwest. GSC officials
talked with several prospective buyers, including Bethlehem Steel
Corp., but it was unable to find any buyers. Great Southwest's
financial plight worsened.
Pennco still sought desperately to record gains for the sale of some
of its Great Southwest stock. Such a sale was needed to boost the
reported profits of Pennco, which had become the prime financing
vehicle,261 and to boost the profits in the consolidated reports. I t would
also create the illusion for potential GSC investors that Great Southwest stock was desirable. The only avenue that could be found was a
sale to the principal officers of GSC, Wynne, Baker and Ray. These
officers were to purchase 1 million shares from Great Southwest for
7 Glore Forgan's interest in Macco had been converted from shares to warrants in 1967.
» Macco was not covered by the tax allocation agreement in 1968 and did not deduct taxes from earnings
because of the parent's loss carry-forward.
259 Memorandum from Bevan to Saunders, Sept. 11,1969:
With respect to your memorandum of September 10 about the tax elections of Macco:
Messrs. Warner, Hill, Wilson, and myself met this afternoon and are unanimously of the opinion
that we should go along with the Macco management's recommendation. This will add almost
$0.50 a share to the reported earnings for last year, and merely on a basis of 10 times earnings will
add $5 a share to the value of any stock sold, and if it goes to 20 times earnings it would add $10 a
share. Our capital gains [from Pennco's participation in the sale of GSC stock] would be enhanced
by this amount.
260 The prospectus was not filed with or reviewed by the SEC.
26i A proposed sale of GSC stock to GSC officers was mentioned in the Dec. 16, 1969, circular for the
$50,000,000 Pennco debenture offering.

approximately $2u million. A refinement of the proposal called for
the purchase of an additional million shares. Despite much activity,
the scheme was not promising. Neither Baker, Ray nor Wynne had the
resources to make this purchase.262 Even if resources could have been
made available, it is doubtful that Baker and Ray ever would have
committed themselves to such a dubious investment under terms making them personally liable for the purchase price.263
The scheme appears to have been developed by Bevan and Wynne.264
Wynne had helped found GSC and had lost his stock in his personal
bankruptcy in 1964. Since that time he had been making purchases of
the stock. Wynne apparently sought financing from several companies
and individuals of his acquaintance but was unsuccessful.
At Penn Central, approval for the sale had been obtained from the
Pennsylvania Co. board and the Transportation Co. board had been
informed of the proposed sale. A considerable amount of planning for
the transaction had been done by the Penn Central staff and an opinion
letter as to a fair price for this non-arms-length transaction had been
obtained from Salomon Bros. The existence of the proposed sale was
reported in the $50 million Pennco debenture offering circular. The
timing was important because Penn Central wanted the transaction
completed for reporting in 1969's results. O'Herron described the
program on the sale in a memorandum to Bevan on December 24,
3. The irrevocable note must be signed and dated prior to December 31 and the
stock certificates delivered to Messrs. Wynne, Baker, and Ray in exchange for the
note prior to the year end.
4. The note should be paid a few days before the date in January at which
time Penn Central's earnings for the year are released. Therefore, for purposes
of discussion we have set January 20 as the maturity date for the note. Assuming
the note is paid on January 20, the profit and the transaction can be reflected in
1969 earnings.
5. PMM takes the position that in order to reflect the profit in 1969, the stock
certificates must be delivered to Messrs. Wynne, Baker, and Ray without any
strings attached. For example, a profit could not be booked if the profit was
placed in escrow together with the irrevocable note.

THe push for the completion of this scheme, which was never more
than fantasy, reflects the desperation of Penn Central to generate
reportable profits and to salvage seme demonstration that Great
Southwest stock had some value. From a touted "billion dollar"
asset Great Southwest stock had become something that first could
not be sold publicly without making matters worse through disclosure;
that later could not be sold privately; and that, finally, could not be
sold to its own management.
Bevan made one other attempt to utilize Pennco's Great Southwest
stock in financing. The $100 million Pennco debenture offer in 1970
was originally to have warrants attached for the stock of GSC and the
stock of the holding company, Penn Central Co. Bevan attempted to
2«2 From testimony of Wynne:
A. I can't envision myself raising any $20,000,000, and I know that the other two people didn't have
any money so that seems like a rather far-fetched idea to me.
263 From testimony of Bay:
Q. Would you have been willing to buy this stock, aside from any direct or indirect pressures that
might have been put on you, if financing could have been obtained?
A. No, I thought it was goofy.
Q. Do you know whether Mr. Baker or Mr. Wynne shared your views on this?
A. I think Mr. Baker did.
2 Wynne testified that he had difl&culty even recalling whether such a proposal had been made even
after being shown a memorandum of a telephone conversation on the subject naming him as one of the
participants in the conversation. Bevan testified that it was Wynne's idea.

use the GSC stock in this way based on the assumption that no registration with the Securities Exchange Commission would be required
at the time of issuance, since the warrants would not be exercisable
for 2 years. This plan shortly ran into difficulties. The initial difficulties were presented by counsel for the underwriters and by George
Davis, the outside counsel for Great Southwest Corp. Davis was of
the opinion that the issuance of these warrants would require immediate registration.265 Davis spoke with David Wilson, Penn Central's in-house securities counsel on February 20, 1970, and asked
Wilson to intercede with Bevan to explain the problems of the issuance of these warrants to Bevan. At that time Davis raised the
same problems that he had when the October 1969 issue was abandoned; namely, the disclosures about the condition and activities
of Great Southwest Corp. In a memorandum of the February 20, 1970,
telephone conversation, Wilson stated: m
According to Davis, General Hodge and Jack Harned of Glore, Forgan, either
severally or jointly, suggested to Davis that he call me with the proposal that
Davis and I try to sit down with Mr. Bevan at a very early date and persuade
him not to market any part of a GSC common stock offering, at this time. I then
proceeded to carry out the request of O'Herron and asked Davis what he planned
to advise the board and management of GSC about the advisability of full disclosure of that company's affairs at this time. He replied very briefly that he would
advise them to the same effect as he did last year when he persuaded them to
abandon then current plans to register a GSC common stock offering. Among the
reasons for his negative advice were (1) the current absence of any real cash earnings by GSC, (2) the tentative, conditional and rather silly nature of a lot of pending GSC transactions which would not have to be so described after 1 or 2 years
from now, (3) some fairly questionable features about inside interests in GSC, its
mergers, and so forth, which might not have to be explained in the future, (4) the
inevitably depressing effect of these disclosures on GSC stock prices, and (5) considerations of a similar nature.

In subsequent meetings with the underwriters, principally First
Boston Coip., the need for immediate registration was not agreed
with by all parties. Davis testified that at one point he stated he would
seek an injunction to prevent Pennsylvania Co. from issuing the warrants without registration. The underwriters were becoming gradually
concerned about this and other disclosure problems and were considering the possibility of seeking a "no action" letter from Securities and
Exchange Commission about the need to register these warrants.
Finally it became understood among the parties that registration would
be required. The plan for having warrants was then abandoned.267

By December 1969, Great Southwest's debt to Pennco arising out of
cash advances and obligations under the tax allocation was $25,210,977.
This presented several problems to Penn Central and Great Southwest.
GSC did not have the cash needed to pay the debt and, indeed, had a
desperate need for additional cash. Not only was GSC unable to pay
the debt, but its own financing efforts might be hurt by having this
debt obligation on its balance sheet. For Pennco, the matter could be
265 Asidefromthe interpretation of the legal provision, Davis was aware of the serious disclosure problems
and was concerned about having a fixed commitment to register even at a future date.
266 Davis testified that he was unable to recall discussions with Wilson on this matter. Wilson's memorandum appears to be an accurate presentation, however based on the circumstances and other testimony.
267 F o r further information on the warrants and other disclosure problems with the Pennco offering see
the section of this report on public offerings.


embarrassing because it reflected the cash drain to GSC and GSC'a
inability to pay. An exchange of the debt for newly issued GSC stock
was effected on December 31, 1969, after hectic preparations. The exchange price was $18 per share for 1,400,609 shares. The sales price
exceeded the market price on December 31, 1969.
At the time the exchange occurred, Pennco had warrants to purchase
2,102,110 shares of stock for $2.17 per share. Management was unable
to explain why these warrants were not exercised before the purchase
of shares for $18. I t appears that the sole purpose of the exchange was
to conceal the cash losses of Great Southwest.
I n a January 21, 1970, release by the Penn Central the exchange was
pictured as a result of an orderly growth plan. The release quotes.
Be van as saying:
. . . the projection of future growth for Great Southwest justified an increase
in that company's total capital and the exchange of debt for stock was the first
phase of a long term financing program.

The release failed to disclose that Pennco had been trying without
success to sell Great Southwest stock to third parties for cash. Also r
Great Southwest did not have an established long term financing
program. I t had begun borrowing very large amounts of unsecured
short term funds from European lenders at high interest rates and had
discussed the possibility of long term European loans. These loans,
however, depended upon the continued appearance of sound financial
health of Penn Central to whom the lenders looked for security. The
transaction and release are misleading because they convey the impression that the exchange was motivated by positive factors whereas
it really resulted from the inability of GSC to repay the moneys
advanced to meet its continuous and serious cash drain.

As Penn Central's cash problems grew more critical in 1969, it became less able to continue supplying cash to Great Southwest. At the
same time, Great Southwest's needs were increasing rapidly. The
corporate overhead had ballooned; carrying and development costs
were increasing; debt was coming due; and some planned acquisitions
required cash. Great Southwest's "earnings" boom of 1968 and 1969
did not produce cash equivalent to the magnitude of the reported
Great Southwest could not easily obtain money. Ray had limited
financing experience and the banks where GSC traditionally had
entree had reached the limit of their lending authority. Great Southwest's traditional bankers would not accede to Ray's demands that
they free assets by changing the loans to an unsecured basis.268 This
was part of a master plan of Ray's to have one subsidiary of GSC
borrow money on an unsecured basis for the purpose of supplying all
2 8 With Wynne along, Ray approached First National Bank of Dallas and Republic National Bank in
Fort Worth. Both had an officer on GSC's board and had provided the principal bank lines. Ray wanted
the banks to release the collateral. His demands created increasing hostility between GSC and its bankers.

the financing needs of other subsidiaries. It also reflects the scarcity of
pledgeable assets. Some had counseled Ray to develop a secured line
of credit with a group of banks.
The requirement of security presented problems to Ray, however,
and when he was unable to come up with immediate financing, he
turned to Provident Bank in Philadelphia.
Provident was more closely linked to Penn Central and its management than any other bank in the country.269 By December 1969,
GSC had already borrowed $3 million from Provident. At that time,
Ray obtained an additional $5 million for 90 days by personally contacting William Gerstnecker (formerly Bevan's assistant), at that
time, head of a Provident subsidiary and still a GSC director. Ray
found that this kind of banking was not complicated as negotiation
with banks where GSC's entree was more limited.
From Ray's testimony:
I t was certainly not time-consuming. They were very accommodating about the
whole thing. There was a call from New York and I went over there and effected
the transaction in a very short period of time.

The Provident loan was only a stopgap measure. Ray was also
talking with other Penn Central bankers. According to Ray, Chase
Manhattan Bank agreed to provide a line of credit from which it
retreated when Penn CentraFs problems started becoming evident to
the bankers. In any event, Chase's foreign department provided Ray
with introductions in Europe and Ray hired a Chase employee,
James Himoff, to help raise money. Ray had no experience in foreign
GSC's foreign borrowing actually did not come from contacts
supplied by the New York banks. Ray had met Albert Gareh through
a promoter in San Diego who had walked in the door at GSC. Gareh
headed a New York firm, Pan American Credit Corp., which acted
as a broker for foreign lenders. Ray called Gareh in Paris to ask for
his help. Ray then flew to Switzerland and, through Gareh, met
officials of UFITEC, a group of Swiss lenders, including Messrs. Vander
Muhl, Swek, and Zilka. On December 19, 1969, GSC borrowed
$2,676,295 in Swiss francs from UFITEC on a 1-year unsecured note as
introductory borrowing. GSC then established a foreign subsidiary,
Great Southwest Overseas Financial Corp., in Curacao for tax purposes to handle additional borrowings. Most of the loans from UFITEC
had maturities of 1 year. In April, GSC began borrowing from another
company with European sources, Merban Corp. These negotiations
were handled principally by Himoff and the maturities were 6 months
at IK percent above the Eurodollar rate. In all, GSC borrowed over
$43 million in approximately 5 months before news of Penn CentraFs
problems halted the flow of funds.270 None of the loans were secured.
269 Bevan and other Penn Central officers were on Provident's board and its loans to PC and related
entities of $20,023,479 on Feb. 1,1970, exceeded the bank's legal lending limit of $9,200,000. The bank maintains that the limit applies to each subsidiary separately. In any event, the loans to PC exceeded 20 percent
of the bank's net assets.
270 See table on p. 146.

It appears that these borrowings had been made in a desperate
effort to meet GSC's tremendous cash needs.271 The company was
unable to expand U.S. bank lines because of antagonism between Ray
and the bankers and because the company had few assets free for
pledging. The cost for running the complex set up by Baker and Ray
was soaring and development costs under contracts had to be met.
Ray was even considering an attempt to raise cash in Asian money
Ray has maintained that he had tentative commitments for
medium- and long-term foreign borrowings from reputable lenders to
replace the short-term borrowing. It is unclear whether these loans
could ever have been completed. It seems clear, however, that the
loans could only be made under the umbrella of a healthy Perm Central
because the lenders looked to Penn Central to back up the loans.
From Ray's testimony:
Question. Did anyone from the Bank of Brussels or any of the other banks indicate
that they thought the association with Penn Central would make it easier for them to
place the Great Southwest notes in Europe?
Answer. Not specifically with the Banque de Brussels. But that conversation
did come up on a number of occasions, initially, during my first efforts there.
Actually, the European banking community at that time, less so today, but at
that time were extremely name-conscious, and they were very impressed by the
size of the railroad and by the fact it was a company that had been in existence
for a long time, even though there was no direct liability or direct connection with
respect to the borrowing by the railroad. And I initially saw it and to take advantage of that, because it was helpful to the company in terms of its identification,
arid I did so myself without the knowledge that the railroad was about to run into
some tough railroading times, and I had it somewhat backfire later on, in that I
mean it would have had the same result anyhow, I am sure, but, basically, the
only thing I did in that regard, I took copies of the Penn Central statements and
I put those in a package of material that I gave out and on the first trip when
I particularly gave out nothing, I would simply lay a copy of the railroad annual
report on the table and a copy of the Great Southwest annual report on the table,
and I didn't leave anything or didn't ask for anything.

Great Southwest was clearly borrowing on Penn Central's reputation
in Europe as a blue-chip investment.272
The borrowings were authorized by the GSC board. At the December 2, 1969 board meeting, Ray obtained approval to borrow $20
Footnote 270—Continued

Date of loan Borrower

Dec. 19,1969
Dec. 19,1969
Jan. 15,1970
Feb. 19,1970
Feb. 19,1970
Mar. 4,1970
Mar. 4,1970
May 4,1970
May 12,1970
May 21,1970


amount of





11,000,000 S.F.
2,000,000 S.F.
51,000,000 S.F.
11,000,000 S.F.
7,000,000 S.F.
7,000,000 S.F.
3,000,000 S.F.

Due date
Dec. 17,1970
Jan. 8,1971
Feb. 15,1971
Aug. 18,1970
Mar. 2,1971
Sept. 4,1970
Oct. 14,1970
Nov. 4,1970

27i Some of the money was used to repay the banks which were growing hostile to Bay; some was used
for acquisitions, including a bankrupt computer company; the rest disappeared into the company's general
272 Ironically, Penn Central itself had turned to this market of last resort for the company and had placed
approximately $50 million in short-term notes with U F I T E C . American investors knew little of the true
crisis at Penn Central in the spring of 1970; foreign investors knew less. Great Southwest was also in critical
condition but it is unlikely that foreign investors even considered GSC's condition.

million from foreign lenders. At the next meeting, on February 26,,
1970, the authorization was increased to $50 million and at the
following meeting on April 29, 1970, the authorization was increased
to $200 million. I t appears, however, that few people at GSC or Penn
Central realized what R a y was doing.273 One GSC director who wasasked about his knowledge of the sums borrowed stated that he was
unaware that any loans had been made under the authorization. A t
one point Hodge indicated that some restriction should be put on the
terms of the loans which were authorized b u t such restrictions were
not adopted by the board. The board did require, however, the approval of the executive committee on loans under the final $150
million authorization.
Great Southwest was caught in a financial squeeze which had become
critical after the abandonment of the public offering. The cash drain
which had always existed became even worse. Baker's activities had
produced an impressively large operation to support soaring earnings,
b u t the cost in terms of cash was enormous. At the same time Penn
Central's inevitable financial crisis was shutting off the faucet at that
source. Great Southwest was blocked from domestic borrowing because
GSC could not produce security. After drawing on Penn Central's
domestic bank of last resort, Provident Bank, R a y had turned to
Europe. There his inexperience was matched by the Europeans' lack
of knowledge of the condition of Penn Central or Great Southwest.
Nowhere was even a hint of this financial crisis given to GSC investors.
Instead the investors were fed a steady diet of puffing. In a report to
shareholders in early 1970 GSC boasted, almost wryly, of its financing
The primary task of the finance division is to provide financing for the various
divisions. Because of this unique approach to finance, the division has been able
to develop a staff of specialists in the areas GSC is involved in. This expertise
allows the finance division to take advantage of unique opportunities in the
ever-changing financial community.

The proposed public offering had been abandoned partly because of
Harned's concern that investors would ask what GSC could do for an
encore. Many investors had undoubtedly gotten the impression that
the earnings boom in 1968 and 1969 represented a trend. I n fact,
GSC had sold off its principal saleable assets.274 Baker was faced with
an impossible task. He knew that Penn Central wanted more reportable earnings, not less. Baker obliged. At a presentation to the
Transportation Co. board meeting on December 17, 1969, Baker predicted earnings for 1970 of $63 million.275
Baker was faced with several problems, however, since GSC had
syndicated its only two amusement parks, which were the easiest
syndication vehicles. Of equal difficulty were the tax changes and the
growing concern of the accounting profession. The Internal Revenue
Bevan and PCfinancialsources knew of the borrowings partly because they were borrowing from the
same source.
274 Investors were additionally misled into believing the earnings represented cash income. Actually, a
cash drain was occurring in the company.
275 The presentation was PC management's response to Odell's objections that PC board members were
not being adequately informed of GSC activities.

Service was shortening the period which could be covered by prepaid
interest. At the same time, the accounting profession was increasingly
coming under attack for allowing earnings from sales of real estate to
be taken in the first year where there is only a small downpayment and
some question about the purchaser's willingness and ability to make
full payment. Baker struggled to prevent tightening of the accounting
On December 23, 1969, Penn Central's comptroller Charles Hill,
sent Baker a memorandum on proposed guidelines for accounting
treatment for real estate transactions. The memorandum had been
prepared by Peat, Marwick for discussion with Penn Central. The
threat to GSC because of tighter was apparent to Hill:
The guidelines, if ultimately adopted, will represent the basis for recognizing
income among the companies affiliated with Penn Central. Therefore they warrant
searching consideration by you and your accounting staff. We expect to respond
to Peat, Marwick with comments and suggestions on their guidelines by midJanuary. With this target, we would appreciate your evaluation of the Peat,
Marwick proposals and your suggestions for making them wholly acceptable
from your point of view.

The Peat, Marwick memorandum noted that the American Institute of Certified Public Accounts had not addressed itself directly to
real estate transactions but it cited APB Opinion No. 10:
Profit is deemed to be realized when a sale in the ordinary course of business is
effected, unless the circumstances are such that the collection of the sale price is
not reasonably assured.

The memorandum further noted that:
The Securities and Exchange Commission, on the other hand, has shown
a somewhat greater concern with respect to income recognition and in 1962
issued ASR No. 95, entitled "Accounting for Real Estate Transactions Where
Circumstances Indicate That Profits Were Not Earned at the Time the Transactions Were Recorded." 276

In the case of raw land sales, the memorandum concluded that where
there is no effective recourse against nonpayment (for example,
because of insufficient assets of buyer or State law—as in California)
a downpayment of at least 10 percent and certain substantial payments in the first 5 years must be made.
A meeting among Penn Central and GSC officers was held at GSC
in early February 1970.277 Baker's views are contained in a memoran276

The memorandum went on to quote from the SEC release:
With respect to when it would be inappropriate to recognize profits on real estate sale the release
states that:
Circumstances such as the following tend to raise a question as to the propriety of current recognition of profit:
1. Evidence offinancialweakness of the purchaser.
2. Substantial uncertainty as to amount of costs and expenses to be incurred.
3. Substantial uncertainty as to amount of proceeds to be realized because of form of consideration
or method of settlement, for example, nonrecourse notes, noninterest bearing notes, purchaser's
stock, and notes with optional settlement provisions, all of indeterminable value.
4. Retention of effective control of the property by the seller.
5. Limitations and restrictions on the purchaser's profits and on the development or disposition
of the property.
6. Simultaneous sale and repurchase by the same or affiliated interests.
7. Concurrent loans to purchasers.
8. Small or no downpayment.
9. Simultaneous sale and leaseback of property.
Any such circumstances, taken alone, might not preclude the recognition of profit in appropriate
amount. However, the degree of uncertainty may be accentuated by the presence of a combination
of the foregoing factors.
Attended by Bevan, O'Herron, Hill, Wynne, and Baker. The meeting dealt with Baker's concerns
about the involvement of PC accountants and Peat, Marwick's Philadelphia officers in GSC's affairs as
well as with the real estate guidelines.

<dum he prepared for that meeting.278 Baker 279 concerned about the
impact on GSC of a tightening of the rules:
An example of this [the importance of proposed accounting changes] is a lead
article appearing in the February 2, 1970, issue of Barron's entitled "Castles of
Sand." An expert questions the accounting practices of land development companies. Great Southwest is listed by the article as a major land development
company, thereby purporting to place us in the group practicing the "questionable
accounting practices." Yet, the entire thrust of the article is an attack on the
development companies engaged in the sale of recreational lots to the public.
However, the article is an example of the confused manner in which the accounting profession and the SEC may be focusing on the problems of real estate accounting practices. For the most part, such focus fails to take into account the
variety of business and transactions which make up the field of real estate. In
order to properly focus on real estate accounting practices, the real estate business
must be looked at by accountants who have the necessary business knowledge of
real estate or who have received sufficient input so as to know whereof they speak.

For longer range matters Baker proposed an aggressive posture to cut
off SEC or AICPA rules which might curtail GSC activities.280 Later,281
Baker and GSC and Penn Central officers met with several Peat,
Marwick officials at GSC's Cote de Coza resort in California to discuss
the guidelines. As described by Baker, the meeting was an attempt to
aid Peat, Marwick in considering problems and did not involve discussions of specific transactions. It was, Baker stated, a "scholarly"
sort of discussion.
Aside from the accounting problems, Baker was having difficulty in
setting up sufficient deals to even approach his earnings projections.
He stated that he was so busy trying to arrange deals that he did not
have adequate time to oversee the company's operations. Baker informed the GSC board that he had a number of transactions under
way. They included syndications of various properties including the
Movieland Wax Museum, Starr Ranch, and jRiver Lakes Ranch. Of
these properties only the River Lakes Ranch was then owned by Great
Southwest Corp. Baker planned to do a syndication for a sales price of
$12 million and a pretax profit of $7 million. Property Research was to
be the underwriter and Great Southwest was to develop the properties in order to "generate sufficient cash flow to pay the promissory
notes received upon the sale."
Great Southwest intended to purchase the Starr Ranch and then
syndicate it in an intrastate offering. According to GSC's projections,
the sales price would have been $28 million and pretax profit would
have been $13 million. Neither the Movieland Wax Museum nor the
Starr Ranch was purchased. Apparently Great Southwest was changing its activities. It was going beyond the mere syndication of properties already owned and developed, and was, instead, planning to
move into the area of acting as broker in syndicating property. None
of the company's officials could explain how GSC had been expecting
"8 From Baker to Bevan and Wynne, Feb. 3,1970.
29 He also felt GSC and the real estate industry was misunderstood:
We cannot permit P.M. & M., in the absence of rulings by the profession as a whole or the SEC, to
attempt anticipated changes in accounting practice to our detriment or to retroactively apply its
newly formulated guidelines to the transactions which have already been consummated in 1970.
Nor can we afford to delay our sales, marketing and syndication efforts in 1970 while we wait for
P.M. & M. to formulate its guidelines for 1970. Therefore, we are faced with two problems. They are:
(a) The immediate problem of the 1970 transactions; and (b) the new rules and guidelines which may
be established by the accounting profession and the SEC.
28° Baker apparently felt that unscrupulous real estate companies were bringing a crackdown on "reputable" companies such as GSC.
*» Apparently on March 20 and 21,1970.

to make such enormous profits from this real estate brokerage business.
None of these transactions was ever completed. They do, however,
mark the last gasps of the attempts to inflate reported earnings.
Baker was not going to produce an encore to the sale of Bryant
Ranch and the two amusement parks. For Penn Central, there would
be no paper profits to conceal the railroad losses. Even allowing for
fluctuations in real estate company earnings, a quote from the GSO
minutes of April 29, 1970, tells the story:
The next order of business to come before the meeting was a discussion of the
corporation's anticipated pretax profit for the year for 1970. In this connection,
Mr. Bevan asked what the profit was anticipated to be as of June 30, 1970. Mr.
Baker replied that the anticipated pretax profit was somewhere between $2 million and $28 million depending upon whether or not certain large transactions were
closed by June 30.

By mid-1969 the reality of GSC's enormous problems were evident.
Enormous and growing cash losses were coupled with the loss of PC
as a supplier of funds and the inability to produce even paper profits
on transactions. Yet investors were never given a cautionary note
(the prospectus for the abandoned offering would have helped). Indeed, the inflated claims about GSC's prospects in the spring of 1970
continued to mislead investors. The February 27, 1970, news release
on 1969 earnings is headed " Great Southwest Corporation Announces
Record 1969 Earnings ,, and begins:
Great Southwest Corp., a national land and environment developer, announced
record earnings for 1969 reflecting the company's continued success since Macco
Corp. merged with GSC in March last year.

The release was approved by the board of directors. A report to
shareholders in 1970 begins:
For Great Southwest Corp. 1969 was a year of merger and expansion. The
company established itself as one of the most profitable real estate developers in
the Nation. And our merger with Macco Corp. in March provided a solid foundation for company growth and increased profits in the years ahead. (GSC progress
report 1969.)


In light of the critically adverse developments, the lack of adequate
disclosure and the dubious conduct of senior management as described
in the other sections of this report, a question arises as to the role of
the directors. It should first be noted that it is generally agreed that
directors are not responsible for directing the day-to-day operations
of the company and they are not insurers of the performance of management. It should also be noted that outside directors are undoubtedly
at some disadvantage in terms of monitoring and appropriately directing a company and its management. Most directors have other
demanding full-time jobs so that the time and energy that can be
devoted to a company's affairs is limited. Directors often must rely
on the company staff officers for information and evaluation. Directors
rarely have their own staffs to assist them and they usually receive
only relatively modest stipends for being on the board.
Outside directors are, however, ultimately responsible to the shareholders of the company for the proper monitoring of a company's
affairs. Among the roles of directors are the selection of competent
management and review of the performance and integrity of management including compliance with laws applicable to the corporation.
As a practical matter, shareholders can rely only on the outside
directors to oversee management and to take corrective action when
management abuses its authority. The role of directors in the scheme
of corporate affairs is reflected in some of the general legal principles
relating to the liabilities of directors:
Selection of officers.—There is no question but that the directors
may be personally liable where their appointee is untrustworthy or
and the directors were negligent in making the
Oversight oj officers.—All the courts doubtless agree that the
responsibility of a board of directors, or of an individual director,
does not end with the appointment of honest and capable men to
be executive officers, and that ordinary care on the part of
directors requires reasonable oversight and supervision.283
In other words, a director cannot escape liability merely by
picking out able and apparently trustworthy men to act as
president, general manager, and then paying no attention to
the acts of such executive officer or officers or to the corporate
Being put on notice.—Of course, if a director acquires knowledge which tends to raise a suspicion against executive officers
or agents, in connection with their positions, he must follow it
up or inform the other directors.285
283 Fletcher, Cyclopedia of the Law of Private Corporations; 1985 revised volume; vol. 3, p . 688 (§ 1079).
283 Id. p . 674 (§1070).
28* Td. p . 685 (§1072).
285 Id. p . 687 (§1078).


Of course, if negligent or wrongful acts of officers are merely
isolated acts then it might well be that the directors would not
be chargeable with notice thereof, but if the wrongful acts are
part of a system which has long been practiced by the wrongdoer,
the presumption is that the directors, ordinarily, would have
discovered the wrongdoing if they had been reasonably diligent.286
The Penn Central outside directors maintain that they did not
violate their 287
obligations, including their obligations under the securities laws. They maintain that they were faced with a difficult
situation caused to a large extent by forces outside of the control of
management or the board. They cite specifically inadequate tariffs,
passenger service losses, inability to abandon lines, and the overemployment of labor. The directors claim that they took what
measures that they reasonably could under difficult circumstances.
They also emphasize that they received no personal gain from any
nondisclosure and that some directors suffered significant losses on
their Penn Central holdings. They further maintain that they had n<>
knowing participation and they did not aid or abet any nondisclosure
of material facts. It was their belief that all of the company's difficulties were repeatedly made known to the public through statements
to Congress, the ICC, and the public.
It appears, however, based on the information in this and other
sections that the Penn Central board failed in its obligations. In
particular, it failed to see to the integrity of management and it
failed to see to the compliance by management with the laws governing
the company, including the provisions of the Federal securities laws.
The failure of the Penn Central board to effectively monitor management arose from several circumstances. One circumstance was the
change in the complexity of corporate matters as a result of the merger
and the diversification efforts. The directors of the Pennsylvania
Railroad in particular had served on a company with a long and conservative financial and operating history. The railroad performed
basic functions in a largely unchanging way.288 In such a situation,
a board seat was more a matter of business honor than an active
business responsibility. On the New York Central, generally a more
dynamic railroad, the majority of directors were overshadowed by
the active ownership interest of Robert Young and Allen and Fred
Kirby 289 and the active management of Alfred Perlman. Under these
conditions, the boards tended to miss the management and financial
complexity of the proposed merger. Even after the merger, the directors only slowly awakened to what was happening.
Another circumstance limiting the effectiveness of the board was
the limited amount of information it sought or received. In the
merged company, directors were furnished only with (1) a volumnious
286 I d . p . 684 (§ 1072).

In the course of its investigation, the staff took the testimony of almost every director who was on the
board at anytime during the period from the merger to the reorganization. The experience of every director
was not identical, of course. For purposes of clarity, however, this portion of the report will describe many
of the activities of directors in the context of the board as a whole. Some reference is made to individual
directors where such reference is necessary to explain particular developments.
288 For example, until the merger, almost the sole financing vehicle was an uncomplicated and conservative
conditional sales agreement for equipment. After the merger, commercial paper and Swiss francs were used.
Alleghany Corp. acquired control of the New York Central in 1954. Robert Young was chairman and
Allen Kirby was president of Alleghany. Young died in 1968 and Kirby became chairman of Alleghany •
From 1961 to 1963 the Murchison brothers struggled with Kirby for control of Alleghany. Kirby, who finally
retained control, retired in 1967. His son, Fred Kirby, replaced him. Alleghany's control was diluted in 1966*
through an exchange offer of its New York Central stock for Alleghany Corp. stock.

docket of routine capital expenditure authorizations for numerous
individual transactions, (2) a treasurer's report giving the current
cash balances, and (3) a sheet listing revenues and expenses for the
railroad for the period between the board meetings. 290 291 The directors
had no cash or income forecasts or budgets; they had no guideUnes to
measure performance; they had no capital budgets; they had no
information describing the earnings or cash performance of the
subsidiaries. For all this vital information, they were forced to rely
on oral presentations by management.
The board meetings were largely formal affairs 292 which were not
conducive to discussion or interrogation of management. Some of the
directors had little opportunity to consult with other directors outside
of the environment of the board meetings. 293 In extreme cases, directors
were isolated from the company or other directors. Otto Frenzel,
located in Indianapolis, spoke with other directors only at board
meetings, which, as indicated, allowed only limited communication.
Seymour Knox, who was in Latin America and in North Carolina
much of the time from September 1969 to M a y 1970, attended only
one board meeting during this extremely critical period.
The board failed in two principal ways. I t failed to establish procedures, including a flow of adequate financial information, to permit
the board to understand what was happening and to enable it to
exercise some control over the conduct of the senior officers. Secondly,
the board failed to respond to specific warnings about the true condition of the company and about the questionable conduct of the most
important officers. As a result, the investors were deprived of adequate
and accurate information about the condition of the company.

The staff's investigation principally covered the period between the
merger and the reorganization because in this period the decline in the
affairs of the company was most significant and disclosure was most
critical. Nevertheless, an examination of developments leading up to
the merger is appropriate, particularly in connection with th3 role of
the directors. During the period from 1963 to July 1968, the price of
Penn Central stock rose from around 20 to a high of 84.294 The principal cause of the rise was the prospects for the merged company. Numerous financial analysts were repeating the projections of management: the merger would vastly improve the performance of tiie
railroads and the real estate diversification of the Pennsylvania
Railroad would provide a bountiful growth factor. Neither prospect
was founded on fact. This would have been revealed by a more intensive review of the prospects for the merger. 295
M i n late 1969 and early 1970, as directors became more concerned, the flow of information increased
slightly but events had so vastly changed that the information was equally useless.
292 Even the finance committee received no additional written information.
2» The board of the merged company had 25 directors. These were joined at board meetings by numerous
officers. Some directors testifi ed that the size and the arrangement of the meetings effectively limited discussion between management and the directors.
^Directors associated with Alleghany Corp. did have a common connection. Kirby, Taylor, Rabe,
Hunt, and Routh were all Alleghany directors. The Alleghany directors still on the board in the Spring of
1970 resigned following an ICC ruling on Alleghany's acquisition of Jones Motor Co.
Adjusted for the premerger period.
295 The directors state that the planning of that merger and its implementation were the responsibility
of management. The directors also noted that the merger proposal was reviewed by the ICC and was litigated in the courts over several years. Governmental approval was obtained, however, on representations
made by the railroads. In addition, management tended to encourage investor optimism and to minimize
the very serious risks which they knew existed.

As described in the beginning of this report, the proposal of a merger
between the P R R and the Central was dropped after the death of
Robert Young in 1957. Later, following mergers among the other
Eastern roads, Perlman became concerned that the Central would be
isolated. When this concern arose in late 1961, the idea of merger
between the P R R and the Central was revived and negotiating committees of the boards of both railroads were formed. Isaac Grainger
chaired the Central committee consisting of himself, Seymour Knox,
and R. Walter Graham, Jr. The P R R committee was chaired b y
Richard K. Mellon and consisted of Mellon, Jared Ingersoll, and
Phillip R. Clark. The responsibility of the committee was limited to
setting the general terms of the merger including the exchange rate,
the composition of the board, and the staffing of th^ several top
management positions.
The negotiating committees began their work in November 1961.
I t was necessary for the railroads to complete an arangement within
several months because other mergers were before the ICC and the
Central had to determine its position before the hearings began. The
committees each selected an investment banking house to set the
exchange rate. The Central selected Morgan Stanley & Co. and the
P R R chose First Boston Corp. These two selected the third, Glore,
Forgan & Co. The principal problem facing the negotiating committees
was the selection of the top officers. The Central directors felt strongly
that Perlman should have responsibility for the operations in light of
his performance on the Central. James Symes, chairman of the P R R ,
wanted to be chief executive officer despite his planned retirement in
August 1962. Greenough of the P R R was expected to be Symes*
replacement and so the P R R directors wanted Greenough as well as
Symes to have a high position in the merged company. An impasse
developed. On December 27, 1961, Grainger, Symes, and Perlman
met to consider the selection of top management. Upon being pressed
about problems in the selection of management S}Tmes said that
frankly the P R R directors were having difficulty accepting Perlman.
The Central directors, however, were desirous of having Perlman as
chief operating officer because of his performance on the Central. A
caustic discussion followed during which Symes and Perlman bluntly
stated their dissatisfaction with the other's management of his road.
To resolve the basic dispute, it was finally proposed that Symes and
Perlman would become inactive vice chairmen of the board and t h a t
the P R R would name a chief executive officer and the Central would
name a president. The merger agreement was signed, and the merger
began its course through the ICC and the courts.
The road to final approval was not wholly harmonious between the
two railroads, and Perlman occasionally expressed the belief that the
negotiating committee had given away too much and that perhaps
an alternative merger was possible. Meanwhile Sounders had replaced
Symes as chairman of the P R R on October 1, 1963. Saunders was
formerly head of the N . & W. and was named chairman of the P R R
when the railroad was unable to choose one of its own officers (including Greenough and Bevan) for the position. While discussing merger
matters with Saunders in March 1965, Grainger broached the suggestion that the merger agreement be changed so that Perlman could be
made president. Saunders, who was not an operating officer himself,

The negotiating committees became inactive after the signing of the
agreement in 1962 and, except for isolated instances, neither that
committee nor the board was directly involved in any other matters
relating to the merger. The only information about the progress of
the merger which the board received was oral reports from management at board meetings. Other than what was given in the oral
presentations, the board did not review the savings or costs which
were being forecast and they never reviewed the kind of planning
being done.
As explained elsewhere in this repoit, the merger planning was inadequate and fundamentally flawed. The Patchell report which was
presented to the ICC was not a plan for the merger nor was it intended
to be. It had not attempted to set out savings or costs that would
result from the actual operations of the merged railroad. Instead it
was a vehicle for presenting some cost and savings figures to gain
approval of the merger. The planning for some of the departments,
other than the operations department was valueless. The departments
of the respective roads did not cooperate and a lot of the planning
did not take place until the department heads were named at the time
of the merger. In the area of rail operations, where a detailed plan
was formulated, the plan was ignored. Apparently no detailed plan
was in effect on merger day. Little or no training was given yard
crews or connecting lines and shippers.
None of the directors who testified was aware of these problems.
The directors were under the impression that all necessary planning
had been done and that the merger was being carried out pursuant to
this planning. Most of the directors never did learn of the lack of
meaningful planning or the relation of poor planning to the chaos
which occurred upon the merger of the railroads. They were also
unaware that the cost and savings forecasts were not accurate. The
directors have emphasized that governmental bodies reviewed the
merger and that only management could be expected to be familiar
with the details of the planning. It would seem reasonable, however,
for the directors to have informed themselves about the underlying
theories and the actual planning. According to the testimony of directors, however, no director expressed any concern or reservations
about the merger during the premerger period and the board never
attempted to verify the representations of management about planning
progress or expected savings and costs. Neither board had a committee
established for the purpose of reviewing or monitoring the feasibility
of, or planning for, the merger.296 The merger of the Central and the
PRR was probably one of the most complex and difficult mergers in
corporate history and yet it appears that the directors did not make
significant efforts to analyze it or evaluate it.
A committee of the board did review one merger related item. Under the terms of the merger agreement,
the Central and the PRR were limited to $100 million in additional debt. In March of 1966, the NYC board
considered a PRR request to increase their indebtedness above the ceiling. The PRR explained that the
debt increase arose out of the acquisition of Great Southwest, Macco, Buckeye, and Arvida. The Central
board formed a committee consisting of Grainger, Graham, and Odell to examine the request. Upon the
recommendation of the committee, the board approved the increase. The approval recommendation, however, contained some reservations about the real estate investment (these had been raised by Odell):
Independent opinions were exceedingly favorable for the Buckeye property and for the most part
favorable for the real estate acquisitions. However, questions were raised over short-term prospects
for the Arvida properties, and there were negative views expressed in connection with the California
properties. Therefore, the committee cannot give a definitive appraisal of the overall diversification
program of the PRR. While there is a feeling that real estate investments at this time would not be the
committee's choice, nevertheless, it has confidence in the judgment of its partner in the merger. (Memorandum from Graham, Odell, and Grainger to Central board May 2,1966).


The merger got off to a bad start.297 For the first 6 months the
directors generally were unaware of the existence of fundamental
problems. They were aware, of course, that mergers do not always
proceed with complete smoothness but the directors assumed that
all requisite planning and preparations had been done and that the
merger was being successfully implemented.
By the summer of 1968 management was admitting to the directors
that merger difficulties were bemg encountered. Computer difficulties
were cited as a principal cause of operating problems. At this time the
directors were relying solely on the oral presentations of management
and reports from the news media. They had no written income budget
information which would enable them to judge the progress of the merger or to judge the effectiveness of management. They had no written
cash flow budgets to see the rate of the cash drain. Some of the directors, however, did begin getting some independent reports on the disastrous performance of the merged railroad. They began getting complaints from shippers, including complaints from their own shipping
departments. Many of the complaints were sharply worded and described extremely poor service.298 The directors, however, continued
to accept the assurances of management that the company was under
^ Some of the directors, like management, cited the short notice they had of the final governmental
approval as a major cause of difficulty. They indicated that the roads could not commit themselves to capital expenditures until they were certain that a merger would occur. The Central's management apparently
had begun at least some capital items prior to the merger. The PRR, as noted in the section on finance,
was desperately short of cash and could not have afforded capital items even if they were willing to commit
themselves. Neither the directors nor management considered entering into a mere formal corporate merger
before making any attempt to combine the operations of the two roads so that the necessary training, organization and capital investment for the orderly functioning of the merged road could be made. Saunders
did emphasize the need to obtain immediate savings through an immediate operational merger. It would
seem, however, that merging slowly and well would produce more savings than merging quickly and poorly.
If the short notice of final approval threatened any difficulties, the merger could have been delayed until
the operating preconditions had been satisfied.
2« Illustrative of the complaints being received orally and in writing by directors are the following complants received by a director located in the western region of the railroad:
(a) "We are getting more complaints on our service to Indianapolis at this time from various customers,
brokers and our own sales people than I can ever remember. Most of it is traceable to our inability to
get cars and to get delivery of the cars to the customers after they are loaded. It has reached the point
where I dread to see any of our sales people as I know they are immediately going to start complaining
to me what lousy service they are getting from our master warehouse. Frankly, we would like very much
to materially increase our rail shipments and would certainly do so if the car or service problem could
be solved . . . I do not think we would look with favor on any location served exclusively by the
Penn Central . . . We are big rail shippers and could very easily be much, much bigger. But frankly
we don't know where to t u r n . . . . " (Letter of Nov. 12,1968, from an Executive Vice President of a
major food processing company.)
(b) "Apparently, neither company has been successful in promptly getting cars in or out of Indianapolis under the Penn Central operation. Along these same lines, numerous meetings have been held with
area sales representatives and other Penn Central personnel relating to fantastic demurrage and
detention bills resulting from improper placement of cars on the siding, lack of written notice of constructive placement, poor communication and problematical service. (Feb. 27, 1969 letter.) We sincerely
appreciate your interest in this problem and your willingness as our banker and a Director of Penn
Central to see that this information is brought to the attention of the right people at Penn Central for
"As I explained, customers of ours, such as Morton Foods, Campbell Soup, Kraft, etc., ship products
for storage and distribution to our subsidiary. . . . These are long hauls for the railroad and represent
considerable volume. We are in danger of losing many of these important customers because they find
it almost impossible to get good service from Penn Central in shipping to our plant in Indianapolis.
This poor service is jeopardizing new business for the same reasons. Morton, for example, complains that
it is taking them from 14 to 17 days to ship by rail from their manufacturing plant in Virginia to Indianapolis. Naturally, they cannot stand this situation." (Feb. 27,1969, follow-up letter to above.)
(c) "I dislike very much to find it necessary to bring a matter of this type to your attention, but it
does seem to me that unless I go higher than the local people there is no prospect of getting these industries serviced by rail. I am also willing to go on record that our dealings with Penn Central have been
poor for sometime, but they are much worse since the merger, and I do not feel that Penn Central can
service its shipping customers and that there is a total breakdown in the management responsibilities
on a local level." (Apr. 7,1969, letter.)

As the operational problems persisted and associated costs rose,
the strain on the railroad's finances grew worse. By the fall of 1968 it
was apparent to management that the cash drain caused by the
operations debacle could not be absorbed for long. The drains were
enormous and Penn Central had only limited access to cash. The
directors have testified that while they were aware of some difficulties
they were unaware of the extreme seriousness of the operational and
cash problems at that time. It appears, however, that a more critical
examination of management's statements would have uncovered the
enormity of the problems and the urgent need for corrective action.
Even if corrective action would have been difficult or impossible
(perhaps because of fundamental weakness of the merger) the investors
could have been warned of the magnitude of the misadventure.299
Instead they continued to receive optimistic projections.

The seriousness of Penn Central's plight should have been evident
since the board was required to authorize the revolving credit and
commercial paper borrowings. The use of commercial paper in particular should have caused alarm 300
because the use of such paper was
almost unheard of in railroading. The directois have stated that
these borrowings appeared reasonable to them because of the prevailing high interest rates. The use of short-term debt as a substitute
for long-term debt may be justified as a temporary measure when it
is decided not to roll over long-term debt at high rates or where longterm capital investments are being made. In Penn Central's case,
however, the enormous amounts of short-term, high interest, borrowings were going principally to meet current operating losses. The
significance of borrowing to meet staggering operating losses is that
no company can long survive such a condition, regardless of the level
of prevailing interest rates.
Most directors did not begin becoming concerned about the conditions of the company or its finances until the spring of 1969 when
management sought and obtained authority from the directors to
further increase the revolving credit and commercial paper.801 By
mid-1969 the directors had approved an increase of approximately
$500 million in short-term debt since the merger. Most of this was
needed to meet operating losses and dividends.
During this time Penn Central routinely continued to pay dividends
at the premerger rate. According to the testimony of the directors, no
director expressed any reservation about paying the dividends prior
to the events described below. During this time the company had to
2> In the summer of 1968 the price of Penn Central stock had reached a record high level and numerous
officers were selling stock acquired under option prices, which at that time were only one-fourth of the
market price prevailing at that time. Under these option stock sales some officers individually made hundreds of thousands of dollars.
300 The Chesapeake and Ohio, through a financial affiliate, had been the only other railroad to ever sell
commercial paper. Commercial paper is usually used by companies with seasonal cash needs or by companies which routinely have sizable short-term borrowings. Railroads, however, usually have large cash
flows and are more likely to have need of long-term borrowings.
°i One director presciently noted at this time that management's request for more locomotives indicated
some fundamental problems because one of the major premises of the merger was that it would require fewer,
not more, items of equipment.

borrow at high interest rates to pay the dividends. At the June 24,
1969 meeting the directors were faced with approving, as customary
in prior years, a dividend for the third quarter. The board customarily
did not meet in July and August when the dividend for the third
quarter would otherwise come up for consideration. Saimders realized
that there might be reluctance m this year to declare a dividend so
far in advance. He inquired of the legal department about the disclosure that would have to be made if the dividend decision were
postponed until a special August meeting. He was told that the postponement of the decision would have to be disclosed. This would have
an adverse impact on the investing public, and he dropped the idea.
At the June meeting, several of the directors began questioning the
payments of a dividend so far in advance of the third quarter results.
The same problem of disclosure that had troubled Saunders earlier
arose again. From the testimony of one director, Franklin Lunding:
Question. Was this discussed at all at the June [board] meeting, the consequences
that might happen if you delayed the decision [on the declaration of the dividend] until
Answer. It had been customary to declare the dividend at this meeting. If you
didn't declare it at this meeting, then all kinds of questions would arise, I would
Question. Well, can you recall whether this problem was discussed at the June meeting, that if the decision were formally delayed until August, that this would raise
questions in the financial community.
Answer. I am not sure, but my impression is yes, this was raised by either
Bevan or Saunders.

The objections of the few directors were answered by having the
board declare a dividend payable September 26, 1969 with the understanding that a special August meeting would be held so that the
matter could be reconsidered if necessary. According to Stewart
Rauch, a director:
It was June that the third quarter [dividend was declared] payable in September.
It [the question of whether a dividend should be paid] was under discussion and it
was concluded that further consideration should be given to it, so that the board
was called in August for that purpose.

The dividend was then declared at the June meeting and was reported in the press. At the August meeting no objection was raised to
the payment of the dividend even though Bevan indicated at that
time that the cash drain for the year would be $295 million and that
he had no idea where the $300 million needed for next year would
come from. The dividend was finally dropped at the November 26,
1969 board meeting when the fourth quarter dividend came up.

The August 26, 1969 board meeting became an important meeting
for reasons other than dividend policy. At that meeting it was disclosed that a suit had been brought by a shareholder and former officer
of Executive Jet Aviation, John Kunkel.302 The suit named EJA,
Penn Central, American Contract Co., Glore, Forgan & Co., O. F.
Lassiter (president of EJA), Charles Hodge, and David Bevan as
defendants. Kunkel alleged, among other things, that Penn Central
82 There were no public shareholders of EJA. Several insiders held stock and Penn Central had by far
the largest investment.

dominated EJA through Bevan and Hodge;303 that under the influence of Bevan, EJA was acquiring foreign airline interests and
advancing funds to one Fidel Goetz among others;304 that Penphil
(whose shareholders include Bevan and H^dge) had improper arrangements with EJA through Holiday International Tours which caused
a waste of EJA funds;305 that operational losses were in excess of
$9,500,000 and that indebtedness to Penn Central exceeded
$19,500,000. The complaint also alleged a waste of corporate funds
on the personal pleasures of Lassiter and others. Kunkel was in a
position to know of these matters. He was formerly the treasurer and
the chief financial officer of EJA.306
The directors had not been successful in insuring the competency
of management or the company's compliance with laws. Now they were
confronted with a direct challenge to the integrity of the company's
chief financial officer. The allegations made by Kunkel were basically
true. The directors had ample reason to be sensitive to any allegations of impropriety in connection with the affairs of EJA. The directors had been aware for some time that the Civil Aeronautics
Board considered Penn Central's involvement in EJA to be illegal.307
They also knew that sizeable amounts of money had been advanced
to EJA and the Penn Central had received no return on the money.
Up to this point they had relied on Bevan for information about
EJA. The fact that Bevan was being sued was of such significance
in light of all the circumstances that an independent inquiry by the
board was certainly called for.
303 From Kunkel complaint:
"6. Continuously u p to the filing of this action defendant Penn-Central Railroad, dominated and
controlled the election of the board of directors and officers and the management and business policies
of EJA, Inc. through the American Contract Co., Glore Forgan, Wm. R. Staats, Inc., Charles J. Hodge,
and David C. Bevan. Disregarding the corporate well-being of EJA, Inc. and the rights of the minority
shareholders the defendants entered into an illegal conspiracy to enable the Penn-Central Railroad to
dominate the world air transportation market."
304 From Kunkel complaint:
"He (Lassiter) directed EJA, Inc. on a course of action designed to gain control of and acquire foreign
air carriers with funds supplied through various means of financial subterfuge by the Penn-Central
Railroad and Glore Forgan, Wm. R. Staats, Inc. in violation of the rules and regulations of the Civil
Aeronautics Board and the laws of the United States . . . This agreement (on European operations)
was consummated without the approval or concurrence of the board of directors, the management, or
the shareholders of EJA except the coconspirators named herein. Financial reports later obtained by
the treasurer of EJA showed a loss of approximately $72,000 for Transavia in the first 3 months of 1968
and accumulated losses of nearly $600,000 as of May 31,1968. To finance this and other similar conspiratorial transactions the Penn-Central Railroad caused $500,000 to be made available to EJA, to be placed
in the bank (sic) of America and had one Fidel Goetz loan EJA $650,000 for which Mr. Goetz received
interest and a warrant for 40,000 shares of EJA. Mr. Goetz is a German textile magnate and the controlling stockholder in Sudwestflug, a German supplemental carrier.
"Subsequent to the agreement of February 1968 EJA leased a Boeing 707 to Transavia and is presently
owed in excess of $1 million by Transavia for the use of this airplane and attempts to collect this bill
or to have the airplane returned to EJA have not been successful."
305 From Kunkel complaint:
"During the month of February 1968 the coconspirators embarked upon a plan whereby EJA would
control and operate International Air Bahamas and absorb all losses therefrom while the conspirators
would personally benefit from a wholesale tour agency known as Holiday International Tours which
had been hired as general sales agent for International Air Bahamas. Holiday International Tours
was financed and controlled by an investment company called Penphil which had a list of stockbrokers
including O. F . Lassiter, Charles J. Hodge, and David C. Bevan, in fact half of Penphil's shareholders
are either present or retired employees of the Penn Central Railroad or Glore Forgan, Wm. R. Staats,
Inc. The conspirators charged EJA, Inc. with large sums of money for plush and elaborate entertainment expenses and ballyhoo far beyond any reasonable corporate expenditures for promotional purposes.
International Air Bahamas is presently indebted (sic) to EJA, Inc. in excess of $1,500,000 in back lease
payments, maintenance costs and air crews for Boeing 707 furnished by EJA, Inc. and every attempt
by the former treasurer of EJA, Inc. to (collect) this account was hampered and stopped by O. F .
Iiassiter for reasons unknown. This indebtedness grows monthly while EJA, Inc. goes further in debt
to Penn-Central Railroad to finance this operation."
306 The directors were not furnished with copies of the complaint. Apparently no director asked for a copy.
307 The directors also admitted their growing concern about Bevan's inability to sell EJA as required by
the CAB. Bevan had repeatedly assured the board that EJA would shortly be sold. At the time of this
meeting previously reported efforts to sell to U.S. Steel and Burlington Industries had failed. Penn Central
was also being fined $65,000 by the CAB for its continuing involvement with EJA.
The directors state that they had relied in good faith on the opinion of counsel that the investment was


The directors in fact realized the significance of the matter. During
an executive session which was called to discuss Bevan's appointment
to the board, Stewart Rauch questioned whether Bevan's appointment should be delayed until an inquiry of the EJA matter could be
made. The directors finally decided to proceed with the appointment
of Bevan to the board, but to authorize an investigation into the
charges. Although Rauch wanted a wholly outside group to conduct
the investigation it was decided, apparently at the suggestion of
Thomas Perkins, who was a member of the conflicts committee, that
the conflicts committee of the board would conduct the investigation.
Bevan was out of the board room when this discussion took place.
After the meeting adjourned, Saunders informed Bevan of the
board's decision on the investigation. Bevan became angered. He
stated that he would consider an investigation to be a vote of no
confidence and that he would resign. This alaimed Saunders and the
directors who learned of it. Edward Hanley, the chairman of the conflicts committee and a friend of Bevan308 decided that the resignation
of Bevan would be extremely harmful to Penn Central because of the
financial crisis being experienced by the company. Penn Central could
not afford to lose its chief financial officer, expecially one who seemed
so adroit at raising cash. Despite Saunders' general animosity toward
Bevan, he was aware of Bevan's importance at that critical time.
Saunders called John Seabrook to warn about Bevan's threatened
Question. Did Mr. Saunders indicate that he wanted to keep Bevan?
Answer. He sure did. He surely did.
Question. Had you understood that there was any animosity between Mr. Bevan
and Mr. Saunders?
Answer. Yes. I didn't think they were fond of each other at all.
Question. Well did you see any reason why this was not a good time for Mr. Saunders to accept Mr. Bevan1 s resignation?
Answer. Well, keep in mind that timing, August was 2 months before we passed
the cash dividend and he regarded Bevan as a wizard at raising cash and so I think
he didn't want to lose his services at the time.

Rauch was prevailed upon by Saunders to call Bevan and mollify
him. Rauch called Bevan on September 3. It was an awkward call because Rauch had raised the question of what was happening in EJA
and it was Rauch who had suggested postponing a salary increase for
Bevan until the EJA matter could be examined. Sevan rebuked Rauch
and emphasized that the company was in serious financial difficulties,
with the implication that he was indispensible. Rauch's notes reflect
that Bevan spoke of:
Cash drain of $295 [million through 1970] 5 minutes on that.
Near miracle to save company next year $200-$300 million in equipment no
where to come from.

Rauch concluded:
Dave must stay—what action can rectify appt. comti [appointment on August
27th of committee to investigate EJA and Bevan].
*•* Hanley was chairman of the board of Alleghany Ludlum and had caused Bevan to be named to the
Alleghany Ludlum board in 1967.

Hanley conducted a telephone poll of most of the directors 310 309
explained Bevan's position on the matter of the investigation. The
directors agreed that they could not afford to let Bevan go at that
critical time. Hanley worked out a compromise. First, reference to
the authorization of the investigation would be deleted from the
minutes. Second, Bevan would prepare a statement explaining the
EJA and Penphil matters and this statement would be presented to
the board. Such a statement was prepared by Bevan and reviewed by
Hanley. At the next board meeting on September 24, 1969, the
statement was read by O'Herron.311 The statement dealt with the
foreign investments of EJA and made them appear to be minor and to
be a result of a misunderstanding. The report mentioned Penphil
briefly and identified only Bevan as a shareholder.312 The report did
not discuss the other allegations of the complaints, including the
wasting of corporate assets. The statement was so innocuous that the
directors could not recall the mention of Penphil in the report. If the
board had not abandoned its intention of conducting an investigation
or if the directors had merely read the complaint the unacceptable
conduct of Bevan would have been apparent.
The directors explain that the reason for abandoning the inquiry was
their concern because of Bevan's importance and the lack of a suitable
replacement that he could not be permitted to resign.313 It was an admission that the directors realized Penn Central's financial condition
was critical. The public did not know this. Indeed the directors had
avoided the dividend issue at the very meeting at which the suit was
brought up. The shareholders were disserved doubly: (1) Bevan's
activities were not uncovered and he was not removed; and (2) the
financial debacle was kept from investors for a further period.
» Principally the Philadelphia area directors.
«• Q. Was this matter (of the Kunkel allegation) taken under advisement by the Conflict of Interest
Committee, at that time?
A. No, it was not. My recollection of what happened was that Tom Perkins said that he thought an investigation should be made of Executive Jet and Bevan took this to be a vote of no confidence.
Q. What happened?
A. Well, I think that Dave submitted a resignation.
Q. To the board?
A. To Saunders.
Q. How did you learn of that?
A. I think I learned about it from Bevan.
Q. Did anyone else know of this, to your knowledge? That is, did any of the other directors indicate that
they had knowledge of the resignation?
A. Well, if they didn't then they did subsequently because I didn't think we should permit Bevan to
resign from his job at Penn Central at that time, for sure.
Q. And was this discussed before the board, as a whole, then as to how they came to know it?
A. Well, I did a lot of telephoning on it.
Q. Did you talk to everybody on the board?
A. I don't think I talked to everybody, but I talked to most everybody. I know I talked to all of the people
on the board who were from the Pennsylvania Railroad, so I know I talked to a lot of them. And, I talked
to others. I know I talked to Del Marting, who was recently on the board. Finally, I wound up talking to
Stewart Rauch.
Q. Would it be fair to say that the main reason for your not going ahead with the investigation of EJA at
this period—sometime between August and September of 1969—was the fact that the financial condition or
thefinancingstatus of Penn Central was in such a condition that the resignation of its chief financial officer
would have made its financial condition or status even more precarious than it was?
A. I think so. We were getting into this. We weren't full-scale bankrupt at that moment, but were headed
that way awful fast.
an Bevan was not present at the meeting.
312 The complaint identifies Lassiter, Hodge, and Bevan as Penphil shareholders and states: "in fact half
of Penphil's shareholders are either present or retired employees of Penn Central RR. or Glore Forgan,
Wm. R. Staats, Inc."
313 The directors stress the dilemma they faced. They believed that Bevan could not be replaced at that
time without serious harm to the company and yet they were troubled by the charges concerning EJA.
It should be noted, however, that the board did not attempt to place any constraints on Bevan and he was
only replaced in June 1970 at the insistence of banks and the Government.

An immediate consequence to the directors' backing down under
Bevan's threats was that Bevan could continue wasting corporate
assets in the EJA activities and could continue to conceal the need
to write off Penn Central's entire investment in EJA in light of the
effective bankruptcy of the company.314 Bevan had arranged for
Fidel Goetz, a European investor mentioned in the Kunkel suit, to
financially support EJA's "world operating rights program" in Europe.
When EJA was forced to withdraw its application to acquire Johnson
Flying Service, a supplemental carrier which was to be Penn Central's
avenue to the air cargo business, the European plan collapsed. Goetz
had advanced funds for this project and demanded compensation.
In August of 1969 the Transportation Co., through American Contract
Co., a subsidiary, was obtaining a $10 million equipment rehabilitation loan from Berliner Bank in Germany. As part of a scheme to
reimburse Goetz foi his EJA losses and for other reasons, Bevan
arranged to have the $10 million transferred to First Financial Trust,
an account set up in Liechtenstein by Goetz and Francis Rosenbaum.816
On September 18, 1969, when the $10 million arrived in Liechtenstein,
$4 million was immediately transferred to another account, Vilede
Anstalt, controlled solely by Goetz. The $4 million was never recovered. This diversion of funds, which occurred just as the directors
were backing away from their investigation, was not mentioned by
Bevan in his memorandum to the board of September 24, 1969.3X6
The consequences of Bevan's successful intimidation of the board
and the board's knowing and willing refusal to examine direct and
accurate challenges to his integrity were far more serious than the
continuation of the EJA scandal. Bevan was the sole representative
of Penn Central in dealing with lenders. He had responsibility for
billions of dollars of financings. He was actively involved in laising
several hundred million additional dollars during the period after
August 1969. While engaged in this activity he made misleading
statements to lenders.317 These are set forth in greater detail in other
sections.318 In connection with keeping out $200 million of commercial
«** The history of this and related EJA matters is discussed at page 71.
*u Rosenbaum is currently serving a prison sentence for defrauding the U.S. Government.
«• The loss was not discovered until after the bankruptcy. The board apparently had continuing aversion
to facing reality. When the EJA problem was again raised by a lawyer in Florida in early 1970, the conflicts
committee referred the matter to Gorman for investigation (partly because there appeared to be a possible
conflict on the part of the committee's counsel, Skadden, Arps, which represented Pan American, an intervenor in the EJA action before the CAB). Gorman's investigation was carried out under the supervision
of Dechert, Price & Rhoades. As in other matters which that firm handled for Penn Central, its conclusions
did not challenge company practices. It appears that Dechert did not talk to Bevan, Gerstnecker or EJA
officers, and did not know of the diversion of $4 million to Goetz even though they specifically did conclude
that the company's officers did know they were violating the law through the foreign investments. Gorman
then reported to Hanley by letter on May 28,1970:








"During the course of the investigation, there was concern, of couse, over the recitals in the CAB's
consent order of possible knowing violations of aviation law by company officers. These related to
EJA's dealing with foreign interests. Nothing brought out by this investigation persuades me that our
people knew that EJA was doing more than having preliminary negotiations subject to CAB approval.








"The important thing now is to devote the company's efforts to salvaging as much of the investment
as possible under present circumstances. [EJA was in fact effectively bankrupt and should have been
written off Penn Central's books] * * *."
In fact, no independent investigation of EJA was ever made by the directors. Even a superficial investigation would have uncovered the conduct, the deception and the wasting of assets involving among others,
the 7chief financial officer of Penn Central.
« Bevan asserted that he was doing what he could to keep the company going. While his motivation may
be unclear (he had bailed out on much of his stock holdings in early 1969 when he could see the crisis which
the company was in), he must have realized that his departure would expose him to liability for the activities
which his successor might uncover, including EJA and Penphil.
sis See in particular, Finance, Underwriting, Great Southwest.

paper, Bevan repeatedly made misstatements to the commercial paper
dealer. Purchasers were continually buying this unsecured debt until
May of 1970.319 Bevan also made misleading statements to bankers
to induce them to lend an additional $50 million to Pennco. Bevan
attempted to have an underwriter's lawyer who was becoming suspicious removed from an underwriting. 320 The board never asked
about his dealings and they had not established any procedures for
limiting Sevan's power or for monitoring his activities and

As reflected in their deference to Bevan following the August 1969
board meeting, the directors were aware by the fall of 1969 of the
serious financial condition of the company. They were also generally
aware that the railroad operations were experiencing continuing and
serious difficulties which were causing large losses. They were unaware
of the precise extent or cause of the financial or operational problems
because that information was not being supplied to the board. The
directors hoped for some kind of turnaround and cited the employment
of Paul Gorman, which the board approved at the August meeting.
Gorman.—None of the directors could comment authoritatively on
Gorman's hiring because the directors were not kept informed of the
search. Saunders conducted the search and negotiated with Gorman
on his own. The directors were not consulted during the search and
no directors' committee was formed. Gorman was first approached
about the job by Charles Hodge who knew of Gorman as a member
of a country club of which Hodge was also a member. 321 Bevan and
Saunders then discussed the position with Gorman. 322
The hiring of Gorman was not a solution to Penn Central's problems.
Without challenging Gorman's reputation as a cost controller, it can be
said that in light of all the circumstances his hiring was an indication
of Penn Central's dire condition. Gorman was Saunders' choice only
after he had tried and failed to get any major railroad executive to
take the job. 323 Despite the staggering crisis at Penn Central, Gorman's
employment was not to begin until December 1, 1969, more than 3
months after he was hired. Although he had no railroad experience
he made no effort, aside from reading some annual reports, to inform
himself about the railroad industry or about Penn Central. When he
arrived he received some surprises. He had assumed that he would
•*• Commercial paper purchasers lost $83 million. Despite misrepresentations b y B e v a n , the commercial
paper dealers had ample warning of P e n n Central's problems and should have taken appropriate action.
See the section of this report on the sale of commercial paper.
820 gee section on Public Offerings.
321 T h e directors cite the arrival of Gorman as an example of the efforts to secure competent management
after they discovered the problems plaguing the railroad. T h e directors, however, played virtually no role
i n selecting Gorman or even in deciding whether a n e w president was needed. Saunders presented the whole
matter as an accomplished fact.
322 i n fact, Hodge first approached Gorman at the country club. Hodge was not a director of P e n n Central
but he was influential; he was involved in the diversification efforts (particularly with G S C and Macco);
he was a member of Penphil; he was involved in E JA. T h e directors knew nothing of Hodge's role in the
hiring of Gorman.
323 T h e directors ackowledge that they k n e w this to be the case. T h e y still felt that Gorman would be the
right man. This view would appear to be a result of wishful thinking and lack of an understanding of the
fundamental problems.
324 One month was spent on vacation.

have control of accounting, but he found that Bevan had been given
responsibility for accounting. Control over accounting would seem to
be of particular significance to cost cutting activities. He also shortly
learned that Saunders' management approach tended to be arbitrary
and unrelated to reality. He also began learning of dubious accounting
practices. This led to his calling a finance committee meeting on May 5,
1970 (described elsewhere), at which he confided his growing concerns
about management and accounting practices at Penn Central.
Gengras,—During the time Saunders was involved in a search for a
new president he acquired a new director, Clayton Gengras, again
with the aid of Charles Hodge.325 Gengras was the chief officer of the
Security Insurance Co. of Hartford. The insurance company had begun
making moderate purchases of Penn Centra] stock in 1965. In the early
summer of 1969 Gengras learned through investment counsel to
Secuiity that Hodge was trying to interest a number of investors in
Penn Central with a view to reorganizing the company.326 At Hodge's
invitation Gengras met with Hodge, Saunders, and Bevan in Hodge's
office in New York. Hodge made a presentation in which he outlined
a plan to have the soon-to-be-formed holding company controlled
by new, more active directors than those on the railroad board.
Saunders supported Hodge's presentation.327 The insurance company
then purchased 200,400 shares between August and December 1969
through Hodge's firm, Glore, Forgan & Co.328 Gengras was then
nominated to the holding company^ board by Saunders. Gengras was
later added to the Transportation Company board aftsr one of the
directors remarked to Saunders about the peculiarity of having
Gengras on only the holding company board. None of the other
directors knew anything about the circumstances of Gengras' acquisition of stock. They testified that they assumed Saunders was naming
him to the board because he happened to own a large block of stock.
Information.—In the fall of 1969, some of the directors were becoming concerned about the lack of information. At the same time, Eobert
Odell began raising questions about GSC openly in the board meetings.
Under this growing restlessness Saunders asked the directors for
suggestions on the presentation of information to the board. Louis
Cabot and William Day responded in writing.
Cabot was a new member who had attended his first meeting in
May 1969. His freshness to Penn Central as well as his experience
with boards of his own companies may have assisted him in cataloging
with some precision the information that had long been missing:
I believe directors should not be the managers of a business, but they should
insure the excellency of its management by appraising the management's performance. To do this they have to measure that performance against agreed upon
So my first suggestion is that it would be most useful to the directors to have
management tell us in quantitative terms what it is trying to accomplish. For
Penn Central this is, of course, a complicated combination of a number of things.
Even if you yourself have a clear picture of these objectives, it is most difficult
for your directors to have one unless a careful job is done of painting a clear one
*» The other directors knew nothing of the role of Hodge in Gengras' coming to the board.
827 Gengras himself had a reputation for gaming control of and reorganizing companies.
This description is based on Gengras' recollection. Hodge refused to testify onfifth amendment grounds.
Bevan and Saunders were vague. Saunders admits to the meeting with Gengras in Hodge's office, but he
denies having initiated a program of obtaining new directors.
3 8 The stock, which was purchased for $8,127,207.71, was held by Security through the bankruptcy of the

for us. The more complicated it is, the more valuable it can be to help the directors
separate the important from the unimportant; and the more surely they should
not get involved in details.
My second suggestion is that the directors be given, perhaps annually, an
opportunity to review objectives with the management, and endorse them. I
refer to both long-term direction type objectives and short-term targets. This is
the only way we can give any input at all as directors without being in the position
of second guessing after the facts. Furthermore, it can give management some
assurance that the board supports what it is trying to do.
My third suggestion is that the directors be told periodically how actual results
are working out as against the short term targets. Where are their shortfalls?
What were the reasons? Were they some things not foreseen and beyond our control,
or were they Penn Central shortcomings that need more attention.
To take a specific example, how does the $40 million we have lost in transportation so far this year compare with what it should have been? Did the directors
know what anyone thought we would earn or lose? And on the basis of that
expectation did they agree with what management was planning to do; that is,
capital investment, cost cutting, services added or abandoned, organization
changes? Why did we miss? It's not very helpful to be told the railroad business
is terrible. What didn't work the way we could have expected? The economy?
Unusually high strike activity? An unexpected action by the ICC? Furthermore,
if these kinds of losses are unacceptable, which I presume is the case, what shall
we do different to reverse them? How and when can we tell whether the changes
are working?
I do not think directors should know about every real estate deal, but I do
think they should know what we are trying to accomplish. Are we trying to use
up tax credits, or make large capital gains, or add to current earnings by a steady
stream of profitable small trades, or whatr How are we doing? How much capital
should we devote to real estate? And what do we think lies ahead?
I am more concerned about our overall finances. How much longer are we going
to invest vastly more than our cash flow? Are we trying to borrow all the money we
possibly can or is there a prudent limit? If so, what is it? Are our plans consistent
with it?
I think I can defend myself as having been diligent as a director if I have the
opportunity to participate in and vote on such issues as I have fisted. If not, I
don't think I can. I certainly cannot merely by listening to a long list of railroad
capital expenditures once a month. (Cabot letter to Saunders Oct. 28, 1969).

In reply, Saunders assured Cabot that his letter would receive careful
consideration but he went on to give his opinion that much that
Cabot saw as necessary was already being supplied in the reports given
by Bevan, Perlman, and himself. The information, in fact, was not
supplied and was not requested by anyone other than Cabot, and, to
some extent, by Odell.
William Day also wrote to Saunders but his views were more toward
the picture being presented to the Government and the public who
were responsible, according to Day, for the railroad's problems:
The other evening I sat beside Harold Geneen of I.T.T. and had an interesting
talk with him about the outlook for conglomerates and his general philosophy
regarding the course of American business. He said he thought that Penn Central
was making a great mistake in not "exposing the railroad in all its nakedness to
the public" so that the public and, in particular, legislators would realize what a
poor performance, under present ratemaking practices, the railroads are experiencing.329 I mentioned Hal's comments to Jack Seabrook before the meeting and
I think this is what prompted his comment.
It seems to me there is a great deal of merit in this suggestion. I realize that we
must present the consolidated picture to Penn Central stockholders but we have
been tending to cover up the poor results from the railroad operation rather
than exposing them.330 As was indicated in the meeting, presenting the railroad
Penn Central's problems were much deeper than ratemaking; in fact Penn Central had difficulty in
getting other roads to apply for the rate increases of the size wanted by Penn Central.
330 The disclosure of the losses from the rail operations was never made public until the counsel for the
underwriters put it in the $100 million Pennco debenture offering circular in April 1970.

operation by itself would require a number of adjustments but I really feel this
should be done. We just cannot go on forever having the profits of other operations
almost completely absorbed by losses in railroad operations.331 (Day letter to
Saunders Dec. 1, 1969.)

With this reply, Saunders attached the published third-quarter
income statement which, he stated, showed the separate railroad losses.
Unless the reader knew how the figures were assembled, and could
thus rearrange the figures, the statements did not show the losses on
railroad operations. Saunders, however, did touch on the real reason
for not providing full disclosure:
I recognize that there is merit in "exposing the railroad in all its nakedness
to the public." On the other hand, if we go much further than other railroads go
in this regard, our figures are not comparable.832 Moreover, I think our picture
is bleak enough to achieve most of the results that we need from the point of
view of legislation and regulatory agencies. If we go too far in this regard, we also
get ourselves in greater trouble so far as our financing is concerned. I am, however,
in complete accord with you that the Board should have all these facts.

Perm Central had already overextended itself on financing and
Saunders was aware that full disclosuie would shut off further financing
and probably begin a run on commercial paper. It probably also
would have led to the removal of senior management.
Each of these letters reflects the views of two different types of
Penn Central directors. Cabot was a new director concerned about
what he was learning and what information he needed to function as
a director. Day was a director of long standing from the Philadelphia
area. He tended to view a director's responsibility to be solely that of
backing management rather than representing the interests of shareholders; consequently his letter reflects problems he felt management
was having with the government rather than his concern about disclosure to shareholders. Directors with Day's outlook far outnumbered
directors with Cabot's outlook.

The unwillingness of the diiectois to see to adequate disclosure or
to the integrity of management is 333
demonstrated again in issues raised
by Robert Odell in late fall 1969. Odell had expressed reservations
about the real estate subsidiaries when the matter came up before
the New York Central board in 1966 in connection with the increase
in Pennsylvania Railroad's debt ceiling. As described in the section
of this report on Great Southwest, Odell had also written to Saunders
in 1968 about his concern. He was right in his earlier expressions of
concern and he was right in late 1969 when he voiced his concerns at
several board meetings. At the October boaid meeting an executive
session (excluding officers who were not also directors) was held at
Odell's request. At that session he expressed his concerns about the
real estate subsidiaries.
The Perm Central management sought to undermine his position
by emphasizing that Odell had a conflict because he had a California
real estate company of his own. Many of the directors, principally

Day was apparently unaware that much of the nonrailroad earnings were paper earnings.
If any comparability problem existed, an alternative presentation, with appropriate clarification, could
have been supplied along with the standard format.
Odell had not been able to attend the August and September board meetings and never learned of the
proposed investigation of EJA and Bevan.

those in the Philadelphia area, accepted this argument and even
cited it to the staff during its investigation. The directors apparently
ignored the fact that OdelFs knowledge of real estate development,
particularly in California, might lend credence to his concerns.334 The
directors also ignored the simple solution to any conflict problem of
conducting an inquiry into the affairs of the real estate subsidiaries
in such a way that Odell would be excluded from access to inside
I t is important to note that at the time Odell was pressing his
concerns before the board the directors were unaware of the enormous
problems in Great Southwest. The directors had been puzzled about
the Six Flags Over Georgia amusement park sale in 1968 and Saunders
had sent a reassuring, if misleading, letter to the directors. The
directors admitted that even after they read the letter they were
still unable to understand the transaction. In addition, by the fall
of 1969 the price of Great Southwest stock, about which Bevan had
earlier boasted, was plunging. Further, despite the supposed enormous
"earnings" contribution of Great Southwest, the Pennco board in
December 1969 approved a "forgiveness" of a $25,000,000 debt
owed Pennco by Great Southwest through the exchange of Great
Southwest stock for the debt. The debt represented cash advances from
the railroad to GSC to meet the continuing cash losses in the subsidiaries.335
Many of Great Southwest's problems were of vital interest to the
parent company. These interests included the earnings (which appeared in the parent's consolidated results), the cash flow from the
parent down to the subsidiaries, and the value of Great Southwest
stock in Pennco's portfolio. Further, the Penn Central management
dominated the affairs of Great Southwest. This raised the question of
the obligation of the directors of the parent to see that the dominance
was not adverse to the interest of the minority shareholders. The
directors failed to make even minimal inquiries into Great Southwest
when the matter was forcefully and repeatedly brought to their attention by Odell and by circumstances. 336
When Odell encountered opposition from management at the board
meetings he decided to invite the nonmanagement directors to a dinner
meeting on November 25, 1969, the evening preceding the scheduled
board meeting. The invitation prompted communication between
Saunders and several directors and among several directors, principally
those living in the Philadelphia area.337 Saunders and the directors
who rejected the invitation deny that they were attempting to prevent
Odell from having such a meeting, b u t it appears from the pattern of
communication and the pattern of rejections that an effort was made
by management and directors favorable to management to prevent
A director who was asked whether he had attempted to learn from Odell what information he had about
the real estate subsidiaries stated that such an inquiry would be meaningless because of O dell's possible conflict of interest.
w See page 139.
*» During testimony, many of the directors even in hindsight viewed Odell as an annoyance. One director,
when asked what was done about the questions raised by Odell after he left the board replied that the problems ceased. When further questioned about how he knew the problems had ceased, he replied that Odell had
left the board. It became apparent that the problems as seen by the director was not GSC but rather Odell
aw The Alleghany contingent and some others, principally those not living in the Philadelphia area, were
inclined to accept the invitation but Odell canceled the meeting when he learned of the number of rejections.

OdelFs meeting from taking place. At the board meeting on November 26, Odell read a prepared statement and then moved to have
Saunders and Beven effectively removed from control and to have
Perlman placed in control. The motion was not seconded.
On December 17, 1969, a Pennco board meeting was called by Saunders to obtain board approval for the exchange of GSC stock for debt
owed by GSC to Pennco and to approve a sale of 2 million 339
shares of
stock to the three principal officers of Great Southwest.338 At the
Transportation Company board meeting on December 17,1969, Great
Southwest officers made a presentation to the board, apparently as
part of an attempt by management to undercut Odell. The presentation consisted principally of slide photographs of the Great Southwest
real estate. No solid information on Great Southwest conditions or
problems was presented. No detailed information about the properties
was supplied, nor was information on cash flows or costs presented.
Directors favorable to management testified that they were satisfied
by the presentation of the Great Southwest officials. Others characterized it as a "slide show" and a "dog and pony show." Odell asked
for more infoimation.340 Bevan told the board that Great Southwest
had an independent board. He neglected to say, however, that Penn
Central management dominated Great Southwest. Saunders then
assured Odell that procedures for reviewing the activities of the subsidiaries would be recommended to the board.
On Jannary 8, 1970, Odell wrote to the Pennco board about a recent
newspaper report that Great Southwest had acquired I.C. Deal Co. for
approximately 1 million shares of GSC stock. Odell stated that this
was yet another demonstration of Great Southwest activities taking
place without Penn Central knowledge. He stated that the Pennco
board should consider and investigate transactions of this magnitude
before they were entered into by GSC. Apparently management saw
this letter as an opportunity to undermine Odell. They could try to
say that Odell was not interested in investigating Great Southwest and
its transactions but that he really wanted Pennco to operate Great
Southwest. Penn Cential management then met with members of the
law 341 of Dechert, Price & Rhoads, frequently used by Penn Cenfirm
tral. Management indicated that problems they were having with
Odell and indicated that he was something of a "troublemakei".
Odell's long-standing objections were that Pennco should take a
closer look at Great Southwest's activities including its management
and its major transactions. Penn Central management knew that such
examination would prove extremely embarrassing. Some of Great
Southwest's earnings, which contributed to Penn Central's results,
were inflated earnings which did not present an accurate picture of
the performance of Great Southwest. They al^o knew that in terms of
cash the railroad was supporting Great Southwest, contrary to the
understanding of the public and the Pennco directors. There were a
number of other embarrassing facts about Great Southwest including
239 These proposed transactions are discussed in the section on Great Southwest Corp.
Gorman had refused Saunders' invitation to join the Pennco board at that time because he had doubts
about the reasons behind, and the propriety of, these proposed transactions and did not want to have to
pass on them.
30 odell had shortly before requested information on specific matters by letter.
3« Dechert was at that time involved in other matters relating to Great Southwest. They were supplying
legal advice to the Pennco board on the proposed sale of 2 million Great Southwest shares to Great Southwest
omcers and on the exchange of stock for debt. The Dechertfirmlater prepared the bankruptcy petition in
June 1970.

the payment of $7 million to four Great Southwest employees to
renegotiate their employment contracts. Penn Central management
and Dechert, however, decided to treat OdelPs request as though he
wanted the Pennco board to operate Great Southwest. Where Odell
in his January 8, 1970 letter spoke of investigation and consideration
of major transactions of the size of the I.C. Deal Co. acquisition,342
Dechert's opinion referred to a question of prior review of "all material
transactions" and of "formal action" to be taken by the Pennco
board on all of such transactions.343
The Dechert opinion went beyond the issue of "formal action"
on "all material transactions," however, and referred to the role of
Great Southwest's "independent board and the independent management to establish policies and manage its business" and to the dangers
of violating Federal securities laws in having344
Great Southwest furnish
"inside" information to the Pennco board. In fact, Penn Central
already dominated Great Southwest.345 Further, Penn Central already
possessed an abundance of vital adverse "inside information" which
neither it nor Great Southwest had shared with minority shareholders.
Dechert's opinion did not go unchallenged. Hanley told Leslie
Arps346 in mid-January that Saunders had said that the Dechert
firm would give an opinion that OdelFs request would violate the
securities laws because Great Southwest would be giving Pennco
inside information. Arps spoke with Carroll Wetzel, the Dechert
partner who wrote the opinion, and stated his opinion that Pennco had
an obligation to be informed of Great Southwest's affairs, particularly
since Great Southwest's earnings were consolidated with Penn
CentraPs. Arps stated that the securities laws do not prohibit a
majority shareholder from having inside information but only from
abusing it. Arps also responded to Dechert's warning that if rennco
got involved in Great Southwest affairs the board would be held liable
a2 Prom OdelPs letter of January 8,1970 to the Pennco board:
SAN FRANCISCO, CAMP., January 8,1970.
Again I am distressed to learn from newspaper reports that Great Southwest Corporation has apparently
made a commitment valued at between $17 million and $26 million without prior approval of the parent
In my opinion this is absolutely wrong in every respect and places all Directors of the Pennsylvania Co.
in jeopardy.
Over and above legal aspects, transactions of this size should have careful prior consideration and investigation by the directors before any commitment is made.
Prior to consideration, back-up information should be furnished to each director embracing complete
financial statements, independent appraisals and forecasts from a recognized firm of management consultants
with complete detail concerning ownership and management of the company proposed to be acquired.
3*8 From the Dechert opinion of January 21,1970 addressed to the Pennco directors:
' 'We have been asked whether in our opinion it would be proper for Pennsylvania Co. to attempt to require
Great Southwest Corp. to advise Pennsylvania Co. of all material transactions contemplated by Great
Southwest before commitments are made so that prior consideration and investigation of the transactions
might be undertaken by Pennsylvania Co.'s board and formal action taken with respect thereto by the
"Pennsylvania Co. owns more than 90 percent of the voting shares of Great Southwest and the remaining
shares are publicly held. A majority of the directors of Great Southwest have no affiliation with Pennsylvania Co. other than in their capacity as Great Southwest directors.
"The procedure described above is not required by the laws of any applicable jurisdiction and in our opinion
would not be proper, except with respect to transactions required by law to be approved by the shareholders
of Great Southwest or with respect to which Great Southwest deems it desirable to have shareholder approval/'
a** "The role of Pennsylvania Co. as a shareholder of Great Southwest is to seek the election to the board of
Great Southwest of qualified persons who will prudently direct its affairs and elect competent officers to
operate its business. Its role is not to interject itself in the business affairs of Great Southwest. Great Southwest is a publicly-owned corporation with an independent board and independent management to establish
policies and manage its business. Diverse ownership imposes on Great Southwest the duty under the federal
securities laws not to disclose so-called "inside information" which is not available to the public generally.
Moreover an attempt by the board of Pennsylvania Co. to exercise a management role as to Great Southwest
might well result in imposing liability on Pennsylvania Co. for Great Southwest obligations. (Dechert
opinion letter Jan. 21,1970.)"
See section of this report on Great Southwest.
3« of the Skadden, Arps, Meagher & Flom law firm, counsel to the conflicts committee.

for Great Southwest's obligations because of the existing relationship
between the companies. Neither firm, apparently, knew of the state of
affairs of Great Southwest or of the true relation between Great
Southwest and Penn Central but Arps' position was certainly closer to
reality. Dechert apparently had written an opinion tailored to the
tactics of Penn Central management and had made no inquiry into
the facts. Saunders knew of both opinions but communicated only the
Dechert opinion to the directors. The other directors paid little attention to the whole matter, particularly because Odell was "solving"
the problem for them by leaving.347

If the directors had demanded adequate information, they would
have known from the beginning that Penn Central was suffering serious
operational and financial problems. It is probable that they would
also have discovered the devices by which management sought to
conceal the facts from shareholders and the public. Through late 1968
and early 1969, the problems became sufficiently critical that the
directors were forced to note their existence although the directors
were still able to avoid a confrontation with management. In the
summer and fall of 1969 the situation deteriorated further. The
directors were aware of the seriousness of the situation as is indicated
by their reaction to Bevan's threatened resignation.
By the winter of 1969-70 and early spring of 1970 the directors
knew that the situation was grave. Ironically, they were less informed
about current developments than they had been earlier because the
pace of events was accelerating even faster and the web of deception
was becoming exceedingly intricate.348 Some directors still nourished
the ephemeral hope that a revival would occur under Goiman, but
Gorman himself was learning some rude lessons about the company's
affairs.349 Some directors indicated that the bad weather in late December and early January made things look worse than they were at that
time. This appears to be a thin thread of explanation because even
though the bad weather increased the difficulties for a brief period,
the decline quickly resumed its normal worsening rate after the bad
weather passed.
During this time the management, the directors, and the company
began to disintegrate. Some directors talked privately with manage34r in a letter to Bevan on Feb. 5,1970, copies of which were circulated to all directors along with his resignation letter, Odell expressed his views on the origin of the Dechert opinion:
I thoroughly disagree with the opinion of Dechert, Price & Rhoads, which is obviously "tailor-made,"
and the attitude of the Pennsylvania Co.'s board of directors and management in respect to the Great
Southwest Corp., as expressed in your letter of Jan. 22.
Any time a company or an individual has an investment of over 80 percent in a company or a venture,
they are entitled to know and should know in detail the policies that are being pursued and should have
an intimate knowledge of the company's operations and investments. This does not imply that the
directors should act as the management but that they should always be in a position to guide the management if they so desire.
Great Southwest Corp. and Arvida Corp. are highly speculative and are exposed to possible large
As a stockholder, I will be pleasantly surprised by these operations not becoming a disaster and
further that the Penn Central and its subsidiaries under present management does not end up in
*« One director described this period as "The Valley of Frenzied Finance."
w» Because of his growing concern about what he was learning, he called a meeting of the finance committee
which eventually met on May 5,1970. Among other things he told the committee was that an analysis of
earnings of the past 2 years showed that earnings suspiciously ballooned at the ending month of each quarter.
According to testimony given by the directors this was the first time they had heard of the practice of inflating earnings or of possible improper accounting activities. Most of the directors who were not at this
meeting testified that they were never aware of any questioning of the company's accounting practices.

ment about individual concerns or suggested solutions. No organized
activity occurred. Management continued to hide the worst developments from the shareholders, although there was a decrease in the
public expressions of optimism. Bevan continued to deal with bankers,
the commercial paper dealer, the underwriters, and foreign lenders
while concealing Penn Central's desperate condition. The directors
were unaware of, and made no inquiries about, Bevan's dealings. They
made no effort to inquire about what he was telling lenders but simply
gave blanket approval to his activities. The directors did not know
of the concern being expressed by the commercial paper dealer about
First National City Bank's attempt to get more security on the
revolving credit agreement or about the disclosure problems being
uncovered by the counsel for the underwriters.
The directors were aware of some of the earlier discussions with the
ICC and the Department of Transportation on passenger losses and
equipment financing. Gengras, in fact, assisted Penn Central management in bringing Perm Central's request for assistance to the attention,
of Secretary Volpe. The first meeting was on March 12, 1970, in Secretary Volpe's office. Perm Central asked the DOT for help on (1)
passenger service, (2) track abandonment, (3) State taxes, (4) permission to diversify into other modes of transportation, and (5) freight
rate increases. At a second meeting on April 30, 1970, Penn Central
supplied some 1970 forecasts. The company pointed out that even
though it had been skimping on equipment and road capital, it had
reached its borrowing capacity. Saunders suggested legislation which
would provide loan assistance on equipment. The DOT, however,
suggested that this might jeopaidize pending passenger assistance
legislation. The DOT asked for information about the company's cash
The discussion still had not gotten to the question of an immediate
crisis even though Perm Central knew at the time of the April 30
meeting that there was a runoff of commercial paper and that the
prospects for selling the $100 million Pennco debenture were practically nonexistent. O'Herron was more of a realist than his superiors and
he persuaded them to send a memorandum to Volpe explaining the
true crisis. Consistent with then form, Bevan and Saunders substantially diluted the memorandum but O'Herron got permission to carry
it to Secretary Volpe in Washington. O'Herron made the trip on
Friday, May 8 and located Volpe at his home. O'Heiron warned
Secietary Volpe that the condition of Penn Central was more critical
than Saunders was admitting and that the debentuie offering would
probably never be sold. Secietary Volpe called Secretary of the Treasury Kennedy and arranged for a weekend meeting between Kennedy
and Saunders at Hot Springs, Va., where a business conference was
taking place. On May 19 Saunders, Bevan, O'Herron and Randolph
Guthrie met Secretary Kennedy for discussions about an emergency
loan. On May 21, 1970, Bevan officially informed the managing underwriters that the debenture offering had been abandoned. He conveyed
the same information to First National City Bank and Chemical
Bank on that day. On May 25 the Penn Central officials met with
Secretary Kennedy.
The regularly scheduled board meeting was held on May 27. None
of the directors knew about the May meetings with Government
officials, and, consistent with their form, Bevan and Saunders sought

approval of the board to pledge all the company's assets after telling
the directors only that the debenture issue had been canceled. Several
directors were not willing to go quite this far without some explanation.
Saunders and Bevan finally relented and stated that they had been in
contact with Government officials about a guaranteed loan and that
Penn Central was facing a terminal crisis. The board then gave its
approval. Extensive negotiations with bankers and the Government
followed. Finally, on June 8, 1970, under pressure from the banks and
the Government, the directors removed Saunders and Bevan.
Throughout the entire Penn Central debacle, including the loss of
many hundreds of millions of dollars by shareholders, the board had
done nothing. It gave the management, principally Bevan and Saunders, almost unlimited freedom to do as they wished. The board repeatedly failed to act despite direct and clear warnings. It is not
necessary to say whether the bankruptcy of the Penn Central was
caused by mismanagement and malfeasance. We can say, however,
that during the decline of Penn Central its management acted improperly and engaged in conduct designed to deceive shareholders,
and that the directors apparently made no effort to uncover or control
this misconduct.


The fact that Penn Central was experiencing difficulties did not
come as a surprise to shareholders b u t the severity of the difficulties
did. There had been problems in the railroad industry for years and it
was recognized b y most knowledgeable persons that the problems
were more severe among eastern roads than among some other classes.
Financial results and operational trends were there to be seen, despite
management attempts to cover them up. However, these trends had
been present for many years and there was no particular signal that
Penn Central was now reaching the end of the road. Certainly, nothing
the company and its officials said in their public statements would
indicate it. Indeed, steps were being taken which were clearly designed
to conceal from the public just how desperate the situation was.
The adequacy of disclosure depends principally on the fairness of
the overall picture being presented to shareholders. Shortly after
bankruptcy, one of the trustees noted in testimony before a Senate
committee, " I don't mean to be pious b u t if you think of it in terms
of technical accuracy of what is said, that is one thing. If you think
in terms of what was reasonably conveyed, that is another. On the
basis of the second, I think there is a real question about the accuracy
of the picture that was conveyed." 360 I t is clearly the latter standard
which is the one applicable under the antifraud provisions of the
Federal securities laws. I n this connection, the size and complexity
of the Penn Central organization, which was compounded by the
widely varying nature of the different segments of its business, should
be considered. The fact that relevant information is buried somewhere
in the data and statements made to the public is not sufficient. I t must
be presented in a manner designed to reasonably inform the average
shareholder of the significant events, figures and trends. See, for
example, Robinson v. Penn Central Co., (CCH Fed. Sec. L. Rep.
f 93,334 E D Pa. 1971) where the court makes it clear that this is the
standard to be applied, further noting that significant facts and possible consequences must be highlighted and "conclusory statements
and bare facts without a disclosure of the key issues" needed for intelligent decision are not sufficient. Furthermore, the concern is not
with what the sophisticated analyst could ultimately discern from reported information b u t what is understood by the reasonable


The merger of the Pennsylvania and New York Central railroads
was repeatedly held out, both before and after the merger, as a stronglypositive factor for the future, despite internal misgivings. The position was publicly held b y Penn Central until the end, in mid-1970.
35° Hearings on S. 4011, S. 4014, and S. 4016 before the Committee on Commerce, 91st Cong., second sess..


Certainly the industry had basic problems, b u t public attention was
distracted from these by the expectations the merger had bred.
Statements made by management in the early months of 1968 were
highly optimistic, although the company indicated that railroad earnings were down sharply in 1967 due to industrywide problems. 361 The
letter to shareholders included in the 1967 annual report began:
"Consummation of the Penn Central merger on February 1, 1968,
began an exciting chapter in the annals of American business." After
other remarks, the letter continued:
As a transportation system, we are modernizing our properties and making
technological advances which will improve our service and efficiency.
Although we are just getting started, the transition and progress of our merger
has been smoother and more rapid than we had anticipated. Sound and comprehensive planning while we awaited consummation enabled us to evolve a close
working relationship between the two companies.
A remarkable spirit of cooperation and enthusiasm is manifest throughout our
new organization. We are confident that we have a talented, experienced, and
well-qualified management team for the years ahead, and we consider this a very
important asset.
One of the great strengths of Penn Central lies in the fact that we are uncommitted to traditional approaches. We are adopting the best practices and procedures of each of the former companies.
We start with a foundation of solid achievement on which to build. Since 1961,
Penn Central has had the largest capital expenditure program in the railroad
industry for acquiring new freight cars and locomotives and upgrading facilities.
Penn Central is in the forefront of the rail industry in adapting computer
technology to virtually every phase of the railroad business. We will stress innovation in transportation techniques, marketing concepts, and scientific research.

I t is clear with hindsight that the optimistic picture being painted
in the paragraphs quoted above was not justified. Management could
not be, and obviously was not, unaware of the very severe personnel
problems extending through the top levels of management and the
compromises this had occasioned. While perhaps hopeful of an eventual resolution of these problems, it was improper to make assertions
as to a "remarkable spirit of cooperation and enthusiasm." The
departure of key personnel in the "talented, experienced, and wellqualified management team" had already been announced, while
claims of selecting the best practices and procedures, uncommitted
to traditional approaches should be considered in the context of the
prior discussion on premerger planning. Likewise the extent of "sound
and comprehensive planning" should also be assessed in light of that
Virtually every sentence of the paragraphs quoted was misleading.
The statements as to modernization, technological progress and the
capital expenditure program since 1961, suggest an up-to-date modern
plant which clearly did not exist, a fact which management had been
swift to point out in the I C C merger hearings, where the witnesses
bemoaned the sorry state of the road's capital plant and equipment.
Their state at merger date has been characterized as only "fair" or
"poor" by witnesses in a position to know.352 I n light of the problems
which developed subsequently with computer operations, and the lack
of premerger consensus in that area, the reference to computer tech3«i Penn Central never completely eliminated mention of industry problems. Such factors were already
known to the public anyway and furthermore, did not reflect on the ability of management. In addition they
were necessary to explain to shareholders the reasons for any earnings decline which did show up on the
financial statements.
32 Several former Central employees testified that upon visiting former PER properties right after merger
they were appalled-that they knew it was bad but had not expected it to be this bad.

nology appears absurd. It is only in the statement that "the transition
and progress of our merger has been smoother and more rapid than
we had anticipated/' that is is conceivable that management may
have been merely myopic. It was very early and the ensuing problems,
although predictable, had apparently not fully developed by that
point. However, management might have noted for the benefit of
shareholders that no significant attempt had yet been made to integrate the operations of the two roads and that the "sound and comprehensive planning" for this event had been scuttled in favor of an accelerated, ad hoc approach.
The letter to shareholders was dated March 15, 1968. Basically
the same position was taken by management at the annual shareholders meeting held in May and similar claims were set forth in
various speeches made by management during this period.353 Claims
were made on several occasions that the improved earnings in the first
quarter of 1968 were an indication of the company's progress in
realizing the projected merger efficiencies and economies,354 although
the staff found no evidence on which to predicate such a position. Indeed, as noted earlier, internal confusion within Penn Central at this
point in time was such that it seems apparent that no one was in a
position to assess much of anything.355
These generally optimistic statements on the part of management,
as reflected in public speeches and press releases, continued throughout
the summer.356 For example, in a speech given to the New York
Security Analysts' group in September 1968, Saunders made very
optimistic statements as to merger benefits. They would be a great
deal larger than projected and would be realized sooner than anticipated, he indicated. Implementation of the merger was ahead of
schedule, with excellent progress in completing connections and
consolidation of facilities, it was claimed, and the company was
attaining faster schedules, more efficient yarding and operational
savings through use of optimum routes. Without attempting to directly refute these claims, it is clear that at best they presented only
part of the story. Regardless of what the future might eventually
bring (and this was highly problematical), Penn Central was at this
moment faced with severe operating problems, the very real results
of its attempts at merger acceleration. The high hopes were mentioned,
the immediate problems were not.
Saunders' speech also reiterated the party line that the thorough
premerger planning would yield handsome returns, that there was a
fine esprit de corps with no major personnel problems, and the presentation included strong praise of the equipment fleets of the two roads.
353 On some of these occasions overall industry problems were mentioned and on other occasions they were
not, but the overall picture presented was decidedly one of optimism.
354 According to reports filed with the ICC the net railway operating deficit for the combined road showed
small increase between thefirstquarter of 1967 and 1965. The improvement came in other areas.
355 Actually, since merger implementation was not really started until the third quarter, this appears to
be one of many instances where management was jumping the gun, and reporting things as it wished them to
be rather than as they actually were.
8 In a speech to the Investment Analysts Society and the Transportation Securities Club in Chicago on
April 16,1968, Bevan painted a somewhat less optimistic picture of Penn Central's outlook, reflecting the low
rates of return on railroad assets and the fact that merger benefits would not come immediately. The low
working capital and cash position was also alluded to.
In a memorandum to Bevan dated April 19,1968 Saunders indicated that in speeches and interviews with
security analysts all officers should "adhere to a common theme" in discussing the merger and its prospects,
as well as earnings and any related matters. Henceforth, Saunders stated, all officers must obtain his approval
of the text of major speeches on this subject.
On May 29,1968 Bevan made a presentation before the Pittsburgh Society of Financial Analysts. It was
much more optimistic than his previous speech. He testified that that speech was scheduled before he received the memorandum from Saunders and therefore he went through with it, but that he made no more
speeches thereafter except at the annual meetings, because he would not comply with Saunders' directive.


This was while Perlman was fighting for additional capital expenditures to improve what he was indicating was the highly unsatisfactory
condition of the facilities, track and equipment. Saunders, in his
speech also commented on the tremendous savings available in per
diem costs, although at the end of that year he attributed $15 million
in extra per diem costs to the merger service problems which had alalready developed and the record in this area remained poor through
1969. In the passenger area, it was stated that losses on these operations were a deplorable drain on earnings but presented a "great
opportunity in improving earnings and this could be a real asset ovei
a long period of time. ,, Since the passenger loss area was the one
which the company most persistently pointed to as a source of problems, this may well have been one of the occasions where Penn
Central officers were commenting among themselves on Saunders'
rose-colored glasses.
In a yearend statement, released to the public, management
presented the railroad situation as follows:
It will take several more years to integrate our railroad system completely and
benefits in terms of savings, service and growth will accumulate as this work
progresses. We expect in 1969 to reap greater benefits of merger than we did in
During the 11 months of 1968 in which we have been a newly merged company,
Penn Central has made great progress in the formidable task of physically combining properties and molding two formerly separate managements into a single
cohesive organization.
In physically integrating our railroad system, we are ahead of schedule with
our program of consolidating yards and terminals, interchange and connecting
points, and shops and maintenance facilities. . . .
These and other projects encourage us to anticipate a gain in income from rail
operations in 1969. We are aiming for an increase in freight revenues reflecting
strong trends in the national economy. . . .
We will continue to make capital improvements during 1969 in order to provide
better service and more efficient operations.

The tone was changing subtly, the enthusiasm moderating somewhat.
However, no mention was made of the service problems which, according to later management claims, peaked at about this time, costing
the company $65 million in lost revenue, overtime and extra per diem
costs in 1968.
Actually, by the time of the year-end statement it was well recognized that there were severe operating problems on the Penn Central,
this being perhaps the dominant subject of conversation in the railroad
industry. Considerable management attention was directed, somewhat
unsuccessfully, to diverting the press from writing about these difficulties. In mid-January, 1969, Perlman acknowledged the problems
in a speech to the Atlantic States Shippers Advisory Board, admitting,
in something of an understatement, "Quite candidly, our service is not
as efficient as we desired it to be at this point of merged operations."
He then went on to discuss in some detail various steps Penn Central
was taking to improve the situation. In a speech to the New York
Traffic Club on February 20, and included in a company press release,
Saunders stated "We are eliminating much of the confusion and misrouting which occurred in recent months. Our operating department
now has a much firmer grip on these problems and I believe that our
service difficulties have bottomed out. Yes, I am satisfied, we have
turned the corner and this has become more evident to us in terms of

the marked upturn in our business in recent weeks." 357 He also
indicated that "the earning potential of our railroad system has turned
the corner and is heading for a much better showing." While management purportedly took months to recognize the service problem, or
rather to admit it recognized it, it recognized the purported improvement almost immediately! Management was unable to show the staff
any reasonable justification for these "turning the corner" claims, in
light of the uncertainty of the conditions at the time and the very
short time period on which the claimed improvement was based.358
As noted in the section on operations, certainly the accuracy of its
prior predictions had given management no basis for confidence in its
ability to predict accurately in this area and subsequent experience
also bore this out. I t is clear that, at best, management did not have
a sufficiently accurate picture of what was going on in the company
to be making any positive predictions for public consumption. I t s
statements have to be classified as merely wishful thinking, not an
adequate basis for the statements made.
I n a release in January 1969, announcing preliminary 1968 results,
management failed to mention directly the existence of the merger
related service problems. However, the problems were specifically
alluded to in the shareholder letter contained in the 1968 annual
report. "We have encountered a number of operating problems in
combining road operations and consolidating facilities. Some of
these problems are still unresolved b u t we have turned the corner
and the worst is behind us." However, statements concerning the
favorable progress in 1968 in implementing the merger which came
immediately before the quoted statement, and optimistic statements
at the close of the letter as to future prospects for improved service
and savings were obviously designed to downgrade the impact of
such disclosures.369
The same generally optimistic theme was played again throughout
the ensuing months. Heavy merger start-up costs were continuing but,
it was claimed, the company was now realizing significant benefits
and giving better service than before the merger. The company was
regaining business lost because of service problems and this would
continue. Even if this were technically true, and that is open to
serious question, it gave an impression of overall strength and potential
in railroad operations not justified by the record. Any improvement
was minimal when contrasted with the overwhelming problems
faced. No mention was being made of the arbitrary budget cuts being
imposed on the operating departments, which it could be foreseen
would adversely affect service even further.
At a staff luncheon on December 1, 1969, Saunders spoke of the
need to revitalize the company. He stated:
We are at a critical point in the history of our company. We face an urgent
need to produce merger benefits of increasing quantity and quality. We must
make money on this railroad, and in the process improve our service, lower our
costs, and enlarge our volume of profitable traffic.
It is entirely possible that the next 6 months will be the most critical in the
history of our railroad. Frankly, our customers are apprehensive about whether
Cole in his testimony characterized Saunders as "the most optimistic man I've ever
One security analyst, in a report dated January 2, 1969, indicated that management
had told him in October that while they recognized that service had been atrocious, by virtue
of educational efforts and heavy capital expenditures for improvements, service had already
at that early point begun to improve.
3 9 At the shareholders meeting in May 1969, the operating problems were mentioned almost as an aside
in the midst of an extremely favorable picture of merger progress and potential.

or not Penn Central can meet the test of adequate service during the winter
months. If we do not, it is certain that we will have wholesale diversion of business
which we could probably never regain.380
As you know, we are being given a second chance by a number of shippers who
were extremely dissatisfied with our service last winter. If we fail them again we
cannot expect to get another chance.

No indication of this and of the recurrence of service problems on the
railroad was mentioned in public releases at that time.
Subsequent to the filing for reorganization, when asked why Penn
Central had not pointed out its problems sooner, Saunders pointed to
testimony he gave in connection with passenger aid legislation (which
eventually led to Amtrak) being discussed before Congress in November 1969. He stated then that "our problem cannot wait another year
or even another few months. The house is on fire and we cannot sit
around and talk about the best way to put it out while it burns completely down." 361 This comment, taken in isolation, might indeed
appear to be an indication of impending collapse. However, taken in
the context of other circumstances, it is merely illustrative of one side
of a dichotomy facing management. Management fully understood
the immediate desperation of the circumstances. It could not survive
without outside help. They sought it on one hand by telling the
Government how critical the situation was. But they also needed help
from the financial community and could not afford to alarm this
Penn Central was forced to walk a tightrope. Congress was told
the situation was bleak, but management stressed the problem as
industrywide without focusing on Penn Central.363 Furthermore, it
was recognized that the presentation was being made from an advocate's point of view, further minimizing the impact. And this was
nothing new. Saunders in his testimony quoted from an ICC study
made 10 years earlier in which it was concluded that the financial loss
on passenger business was large and growing, and that it endangered
the welfare of the industry. And at the 1969 shareholders meeting, in
response to a question from the floor as to whether Penn Central
could continue to absorb the passenger loss, or indeed the overall
railroad problem, Saunders brushed this off by saying that the same
situation existed in each of the last 10 years except 1966. "This is
nothing—people act as though this had never happened before."
Three weeks before his Congressional testimony, Saunders had
told a group of security analysts:
I believe too many people have a negative attitude toward the railroads.
They are ready to write us off. They claim that we are much more interested in
diversifying ourselves out of the railroad industry than in making it a success.
Such notions are, in my opinion, untrue and give a distorted picture of our potentialities.
No one can doubt that our industry, and this includes Penn Central, is faced
with innumerable problems. I am not prepared to believe, however, that they are
insoluble. On the contrary I think that they are soluble, but not today or tomorrow.
It will take time, perhaps several years, but it could take place much sooner with
cooperation from the Government authorities and the railway labor leaders. And
there are already signs of real improvement in both areas. This, in fact, is one of the
most encouraging developments in our industry.
aw Perlman had taken a similar position many months earlier on the necessity to get service problems
resolved promptly.
a»i House Committee on Interstate & Foreign Commerce, November 12,1969. [S. 3151.
382 Saunders' reaction to this situation, in response to a suggestion from Day that disclosure be more open,
has been described previously. See page 165.
** Actually, while Penn Central had significant losses on passenger business, this was not the area of
greatest deterioration in the postmerger period.

In an article on Saunders appearing in Nation's Business in January
1970, William Lashley, Penn Central's vice president of public relations, pointed out that American railroads, largely because of mergers,
were in far better financial condition than in many years. Five months
later, after extended efforts to stave off bankruptcy, Penn Central
filed for reorganization. And despite the months and years of optimistic
statements emanating from Saunders' office, he now began to characterize the prebankruptcy situation as basically unmanageable.

The steps being pursued to minimize apparent earnings problems
and the necessity of full disclosure of the course of conduct adopted
have been described previously in the section on income management.
Yet disclosure both as to the overall picture and as to the material
individual items incorporated in the course of conduct was negligible.
As with the operational situation just discussed, the picture was
one of deliberate overoptimism. The pattern was reflected not only
in an overstatement of earnings, but in deficiencies in other disclosures
as well. These deficiencies encompassed the manner of presentation,
as well as the content and emphasis, of information which was provided, and the omission of significant information required to adequately inform the investing public. Indeed, the situation was such,
according to testimony from the former Penn Central comptroller,
that there were some quarterly earnings releases to which he would
not have put his name.

Since the focus of Penn Central's earnings problems lay in the railroad area, it was essential that results in this area be made clear to
shareholders, investors, and the public. Instead, the manner in which
operating results were presented served to conceal the problem. Railroad operations were clearly deemphasized, and never presented in a
form in which their full impact was shown. Consolidated results were
emphasized and for a period, over the objection of the press, analysts,
etc., were the only figures presented. Even Transportation Co. results,
on an unconsolidated basis, contained very substantial amounts of
nonrailroad income and expenses, which greatly improved the company's apparent results. This factor was further confused by the
company's practice of referring to Transportation Co. results by such
descriptions as "railroad system" or "parent railroad company" in
quarterly earnings releases and similar situations.
The figures showing the full loss in the Transportation Co.'s rail
operations were available for internal management purposes. Rail
industry security analysts also make a practice of computing such
figures, further emphasizing their significance in assessing company
results. Saunders' testimony indicates that he fully recognized the
dominant importance that professional analysts attached to the railroad-only aspects of the total earnings picture. Furthermore, the
underwriters in preparing the offering circular for the $100 million
Penn co debenture offering insisted on recasting the reported figures
to focus on the unsatisfactory status of the rail activities. This form of
presentation was particularly critical, they felt, in light of the rapidly

deteriorating trend in this area.364 The suggestion by Day to Saunders
in December 1969 that "we have been tending to cover up poor results
from railroad operation rather than exposing them * * * presenting
the railroad operation by itself would require a number of adjustments
but I really feel this should be done/' reflected his concern that the
Government, rather than the shareholders, be made aware of the
existing situation.365 Nonetheless, it illustrates once more the critical
nature of this information.
The reported income figures over the postmerger period have been
included in exhibit IG-1, which indicates consolidated figures, Transportation Company figures, net railway operating income figures, and
the full loss on railway operations. The emphasis in press releases was
on the consolidated figures. In no instance was the loss on railway operations clearly labeled, although in some cases the net railway operating
income, which did not include such factors as fixed charges, was given.
The "loss on railway operations" figures were not given to the public
until 1970, when they were included in the Pennco offering circular.
However, they have been included herein for comparative purposes.
It is suggested that the reader review the annual reports of 1967, 1968,
and 1969 in light of the results from railroad operations given in the
While not indicating the full extent of the drain from railroad
activities, management did attribute the somewhat lower reported
earnings in 1968 and 1969 to poor rail results. However, they took
pains to suggest that future results would be better. "We regard our
railroad as the asset which has the greatest potential," Saunders
stated in late 1969. Predictions as to earnings, even those for the next
quarter, were consistently overoptimistic. The merger savings potential was constantly alluded to. Even where problems were admitted,
they were couched in optimism. The situation was particularly misleading during the later periods where, while citing the potential for
longer term improvements, the company's immediate solvency was
at stake. Future improvements were hardly relevant if the company
could not survive that long.

Concealment of the full impact of railroad losses was aided by the
policies pursued in the nonrailroad area. As noted, the railroad losses
and total reported earnings, whether on a company-only or a consolidated basis, were two very different figures. Helped along by the
various investment and real estste transactions described previously,
Penn Central thus managed to show profits, or at least reduced losses,
despite the rapid deterioration in the railroad. If these represented
regular cash earnings which could be maintained over subsequent
years to offset the inevitable rail losses, it was one thing. But, to
paraphrase a remark attributed to Saunders as early as 1967, the
attitude seemed to be that if no other avenue was available, the
« Under current SEC rules, adopted in 1970, there is a requirement that total sales and revenues together
with income or loss before taxes and extraordinary items be reported for each line of business which provides
10 percent or more of either the revenues or the income reported. This rule was proposed and published for
comment in September, 1969.
*•» See further discussion on page 165.
3 See exhibit IG-1 at end of this section. It should be noted that the calculation of railroad-only earnings,
at least on a rough basis, was not difficult since it involved merely a rearrangement offiguresalready provided in the company-only statement. However, the reader had first to recognize the relevancy of the figures and what to base the calculations on.

company should mortgage its future, and take the income now.367 This
is clearly what was happening in many instances in Penn Central in
1968 and 1969, as earnings were manufactured under the needs and
circumstances of the moment. To make the situation still more serious,
despite Penn Central's voracious appetite for cash, many of these
transactions generated paper, not cash, earnings.
Such factors, if brought to the shareholders' attention, would
certainly raise concern. The question becomes whether this was in
fact done, an issue which involves not only what information was and
was not provided, but whether the information which was given was
sufficient. The complexity of the Penn Central operation is relevant
in this context. Illustrative of the problems entailed is a comment
contained in a letter from one of Perm Central's directors to Saunders
in late 1969, complaining about the quality of the information being
provided to that body:368
Even if you yourself have a clear picture of these objectives, it is most difficult
for your directors to have one unless a careful job is done of painting a clear one
for us.

Cole, noting that the writer seemed to have put his finger on the
problem, commented to Saunders:
This is a valuable reminder. Being immersed in these matters, it is easy to forget
that people outside of management may not understand where the various items
covered in the reports fit into the overall picture.

However, considering the overall pattern of conduct by the management group, as illustrated throughout this report, it is clear that
management did not "forget" the complexity involved, it "used" it.
And obviously the shareholders were in a far poorer position to demand
information than were the directors.
Some information was provided; e.g. the financial statements
themselves and limited descriptive data related thereto. However, it
was left up to the investor to attempt to figure out from the melange
of information given, just what these earnings consisted of. This was
difficult to do. Even the limited information which was provided was
scattered throughout the reports in such a way that it was a real
challenge, even for the expert, to put it together. Under these circumstances, and with management continually extolling to shareholders the benefits of diversification, it is easy to see that investors
would be misled. Indeed, considering the complexities of the situation,
even a complete list of all the questionable items entering into the
earnings picture would not constitute full disclosure unless the
presentation was structured in such a way as to make the pattern
evident. And in the actual situation, not only was the overall picture
not drawn by management for the investor or shareholder, but he
was not even given many of the pieces. The following discussion of
the various releases and statements concerning earnings will focus
principally on these individual pieces.

The improvement in earnings in the first quarter of 1968 which
was attributed by Penn Central to merger benefits has already been
mentioned. A 17-percent increase in consolidated income and a 15367 See p . 40.

ws See further discussion on p. 164:

percent increase in earnings for the "railroad system" was reported.
The first full quarter after the merger was the second quarter of
1968. Penn Central reported a 15-percent increase over the earlier
period. This reflected, it was stated, the continuing benefits of the
diversification program with a 57-percent increase in net income from
sources other than railroad operations. "The true index of Penn Central's profitability is in the consolidated figure and not those of the
railroad alone," and thus in the future, only consolidated earnings
would be reported, the company indicated in its press release. For
this period, however, earnings of the "railroad system" were still reported. The figure given was profit of $2.1 million. It was not disclosed
that the railroad had lost $20 million and the difference was derived
from real estate and investment activities of the Transportation
Co.369 The release closes with the statement that Penn Central anticipated that earnings for the rest of 1968 would surpass 1967 results, a
reference apparently to rail results, although this is somewhat unclear.
When third quarter results were announced, they did show an increase over the 1967 period, an increase of 48.6 percent. Keported
earnings were $15.2 million, compared with $10.2 million reported for
the prior year. Once again it was noted that this reflected the continuing advantages of the diversification program. Actually, however, it
reflected the one-shot advantage of the Washington Terminal dividend.
While the release did disclose that the earnings figure included a "nonrecurring dividend of $13.5 million from a company in which Penn
Central has a half-interest," shareholders were assured that there
were substantial nonrecurring items of net income in practically every
quarter. An alert shareholder would have perhaps discerned that
Penn Central had very little profit except for that dividend, although
there was nothing from which he could deduce its noncash nature.
And as indicated earlier, there is a real question as to whether this
was properly booked as income.
True to its word, Penn Central did not report railroad earnings for
the third quarter, although a reference to the fact that results of the
railroad system had been adversely affected by several factors would
give some indication of possible problems. In fact, net railway operating income was down sharply and the loss on rail operations, including fixed charges, was over $40 million. Saunders, while not giving
these figures, did indicate that he felt the third quarter marked the
low point in railroad business for the year.
The company's decision not to release company-only results had
repercussions. A memorandum from the public relations department
to Saunders on November 4, 1968, noted the following:
Attached is the only newspaper account we have seen to date on our figures
reported to the ICC. I understand that many brokerage firms, however, get Xerox
copies of our R&E and IBS statements from a service in Washington which gathers
this information as soon as it is filed with the ICC.
In view of this, I suggest that we reappraise our decision not to report railroad
system earnings when we report our consolidated earnings quarterly. Not reporting
them has irritated both newsmen and security analysts. Their reaction is to probe
deeper into railroad figures than they would ordinarily if we give them highlights of
the railroad picture along with our consolidated earnings.
If you decided to reinstate giving railroad earnings, it could be announced at our
November 21 meeting. I am sure that this announcement would be greeted with
great enthusiasm.
«» The term "Transportation Co." is being applied to the Company-only operations of Penn Central
throughout the postmerger period, although the name was not adopted until late in the period.

And the policy was thereafter reversed. It had been a failure.
Rather than deemphasizing railroad losses, as management desired, it
had merely served to emphasize them.
On January 30, 1969, Penn Central reported consolidated earnings
of $90 million for the full year 1968, a 27-percent increase over 1967,
and fourth quarter earnings of $38 million, up 32 percent. The release
indicated that the growth came through the diversified holdings and
from certain nonrailroad transactions, mentioning in particular Madison Square Garden and Washington Terminal. No indication, however,
was given as to the size and type of these two transactions. The Bryant
Ranch and Six Flags Over Georgia transactions of Great Southwest
were not mentioned.
Analyzing first the fourth quarter figures, if the effect of the $36.1
million in paper profits recorded on the Madison Square Garden and
Great Southwest transactions were eliminated, the profit would be
virtually wiped out, and, for reasons stated earlier, the staff believes
that these were improperly booked as income. Likewise, elimination of
the Madison Square Garden profit would have turned a $2 million loss of
the Transportation Co. in that quarter into a $23 million loss. Furthermore, had it not been for a $5 million profit on the reacquisition of
company bonds the Transportation Co. loss would have been larger.
A $12^ million profit of Pennco's disposition of N. & W. securities
further improved results that quarter, although this item, unlike the
others, was in part a cash transaction. Nonetheless, considering the
nature, size and impact of these transactions, disclosure was called for,
although none was made.
From the foregoing discussion, it is clear that Penn Central on a
consolidated basis earned virtually nothing in the second half of 1968
and on an unconsolidated basis had a large loss. A profit had been recorded in the first half of the year, and on a full year basis, after elimination of improper items, some profit, although only a fraction of
the original amount, still existed. However, in appraising these earnings, the various items described previously in the discussion relating
to Penn Central's course of conduct should be considered. This includes in particular the charging of the mail handlers to the merger
reserve, the failure to write off Executive Jet or consolidate Lehigh
Valley, and the $10 million in profits generated from repurchase of
company bonds.
The 1968 Penn Central report to shareholders, mailed in late March
1969, contained basically370 the same earnings figures as did the
January release, and with the same limitations. The letter to shareholders included in that report stressed the positive, beginning with an
announcement of the 27-percent increase in consolidated earnings,
which "underscores the importance of our diversification program.''
Saunders and Perlman, who signed the letter, further stated:
We hope this Annual Report will help our stockholders to understand more
thoroughly the diversified nature of the new Penn Central. Our company has
grown from traditional railroad operations, which utilize about half of our total
assets, into a broadly based organization with increased earning power.

They further went on to note that the four companies involved in
the diversification program of the mid-1960,s had doubled their contribution to Penn Central's net income, from $22 million in 1967 to
3 0 There was a small difference in the company-only figures.

$44 million in 1968,371 and that a holding company would be formed
during 1969 to facilitate further diversification. An extensive section
on the system's real estate activities, later in the report, gave an
impression of dynamism and sharp growth in this area.
The report to shareholders, unlike the preliminary release, contained
complete financial statements and related textual material as well.
While disclosure will not cure improper accounting practices, there was
no mention of many of the major transactions which had impacted
reported income. The sale of N. & W. shares by Pennco at a profit of
$10.3 million was noted, although no mention was made of the profit
on repurchase of company bonds. Shareholders were told of the N. & W.
stock-for-debenture exchange and the Madison Square Garden exchange but no indication was given that large profits had been recorded thereon, and obviously the bare acknowledgement of the existence of these transactions, without more, is of little assistance to the
shareholder who is attempting to understand the situation. The Washington Terminal dividend was not even mentioned.372 While fantastic
rates of earnings growth were cited for Macco and Great Southwest,
the increasing risk reflected in that growth was not alluded to. Neither
were the substantial profits claimed to have been generated on the
Bryant Ranch and Six Flags Over Georgia transactions described,
although these two transactions accounted for much of the reported
growth in 1968. Clearly, the ability of these two companies to sustain
this rate of growth (140 percent in one year), or indeed this level of
earnings was open to serious question in light of the source of the earnings and the nature of the transactions. Even independent of the question of the acceptability of such practices under generally accepted
accounting principles, in all fairness the shareholders should have been
apprised of the quality of the earnings and the risks involved. Instead,
management merely extolled to them the benefits of diversification.
There were other deficiencies in disclosure. Information as to the
losses being incurred by373
Lehigh Valley was included in a footnote to
the financial statement
but there was not reference anywhere in
the report to the EJA problems, although by this time the application
to acquire Johnson Flying Service had been withdrawn. The charges
37i Penn Central on Feb. 13,1969 had issued a special press release outlining the results of these four companies, further indicating the emphasis the company was putting on this aspect of its operations.
3 7 2 As noted earlier, B. & O. and Penn Central each owned 50 percent of WTC and received similar dividends. Compare the extent of disclosures in the two companies.
B. & 0.—The following language was included as a note to the financial statements in B. & O.'s 1968
annual report to shareholders:
During 1968 the company received a dividend in property from a 50-percent owned affiliate, the
Washington Terminal Co. The dividend has been recorded at $3.1 million which is considered to be
fair value after allowance for contingencies which exist as to the proposed development and lease of
the property as a visitor center under an agreement with the U.S. Government for a period of 25 years
with an option to purchase. The approximate present value of the net cash flow that would be realized
upon the completion of the proposed development (after consideration of interest and income taxes at
current rates but before any allowance for contingencies) is $5 million at December 31,1968.
Substantially the same language was included as a note to the 1968 financial statements of the Chesapeake
& Ohio Railway Co., owner of approximately 93 percent of B. & O. at the end of 1968.
Penn Central—The following language was included in Penn Central's 1968 annual report to shareholders:
An agreement was signed with the U.S. Department of the Interior to convert Washington Union
Station into a National Visitors Center within the next 3 years. This property was held by Washington
Terminal Co., a 50-percent owned subsidiary. A new modern railroad passenger station will be built
beneath a 4,000-car garage adjacent to the Center.
The above language does not indicate that any income was recognized upon signing the agreement nor does
it mention the WTC dividend-in-kind. It might be noted that Penn Central recorded the dividend at
$11.7 million.
373 Footnotes to the December 31,1968 financial statements disclose:
Principles of Consolidation.—The consolidated financial statements include the accounts of the company
and its majority-owned subsidiaries, except the Wabash Railroad Co., the divestment of which is arranged
as ordered by the Interstate Commerce Commission, and the Lehigh Valley Railroad Co., which the Commission has required to be offered for inclusion in another railroad system.
Lehigh Valley.—Based on unaudited financial statements, the equity in the net assets of Lehigh Valley
at December 31,1968 was $73,232,000. Lehigh Valley reported a net loss for the year 1968 of $5,969,000 and no
dividends were paid.

against the merger reserve were referred to in another footnote to
the financial statements, but the company was silent on other elements
pertaining to the course of conduct being pursued to maximize income.
Thus far the focus of discussion on 1968 results has been on certain
nonrailroad items. However, Penn Central lost $140 million on railroad
operations in 1968 after fixed charges. Of this, $54 million was in the
final quarter and $100 million in the last half. These figures were not
given. Instead, in its 1968 annual report Penn Central emphasized
the loss of $2.8 million from the "parent railroad company/' without
noting the impact of nonrailroad items on this figure.
While the full extent of the loss was not made clear, it was indicated
in the 1968 annual report that railroad earnings were down. Various
reasons were cited, most of them the industry wide problems which
had been listed in the prior year's report as well. Only the mergerrelated costs were new. The shareholder letter in the 1968 report
stated that Penn Central had been burdened with $75 million ($3.25
per share) in merger start-up costs and losses, many nonrecurring, and
that without these "unusual expenses" railroad results for 1968 were
better than for 1967.374 In the release announcing the preliminary earnings figures, no merger start-up cost figure had been given but it was
admitted there were "heavy nonrecurring expenses incurred in the
initial phase of unifying the two separate railroads." These expenses
would, however, it was indicated, help produce increased efficiencies
and earnings as merger implementation progressed.
These claims are misleading in several respects. First, as indicated
earlier, the merger-related cost figure could not be quantified with
sufficient accuracy to justify its public dissemination. Furthermore,
the company's own schedule indicated that calculated expenses of
$75 million were offset by purported savings of $22 million, so that
the comparison of 1967 and 1968 results was inaccurate, 375 In addition
the suggestion that these merger related expenses would help produce
increased efficiency and earnings is not justified, considering the
nature of the majority of the expenses which consisted of costs under
the labor protection agreements 376 and lost business, overtime and
per diem costs related to the service problems. Finally, there was no
mention of the fact that a very large proportion of this $75 million
figure was attributable not to anything inherent in the "carefully
planned" merger, alluded to in the shareholder letter, but to costs
associated with the unanticipated merger-related service disruption
(i.e., management misjudgment). Indeed, the frequent references
in company releases and speeches by Penn Central executives to the
smooth progress of the merger and the fact that physical integration
was well ahead of schedule leave the opposite impression.

Following the events of the last half of 1968 which greatly overstated
income, management was hard pressed to come up with an encore
when rail earnings remained depressed in 1969. I t was only partially
3 7 4 Saunders also cited this factor when a shareholder, attending the 1969 annual meeting, expressed concern about the level of 1968 railroad earnings.
Saunders gave the $75 million figure at the annual shareholders meeting but at that time he did indicate
that there were offsetting savings.
3 « At the 1969 shareholders meeting Saunders alluded to a $35,000,000 figure for severance pay, moving
expenses, etc. This was mentioned in conjunction with the $75,000,000 figure, although the bulk of these
labor related expenses had been charged off against the reserve and did not appear in the $75,000,000 figure.
This again illustrates management's inclination to use ambiguous comparisons to suit its purposes.

As noted earlier, even before the 1968 report to shareholders had
been distributed, management was indicating that the earning
potential of the railroad had turned the corner and was heading for
a much better showing. The press release announcing the mailing of
the 1968 report to shareholders began, "A bright outlook for Penn
Central and its railroad operations was forecast for 1969 in the
company's annual report." The same generally optimistic theme was
played again a few days later in the release announcing first quarter
1969 earnings. Consolidated earnings were down from $13.4 million
to $4.6 million, although the company hastened to add that the New
Haven, which was included377 1969 figures but not 1968 figures,
had lost $6.5 million in 1968.
At this point Penn Central began to include the railway operating
income figures in its quarterly results, which represented improved disclosure but still did not reflect full losses after fixed charges. A first
quarter loss of $10 million was reported, while the full loss was $42
million. In reporting this loss, management mentioned the same
problems as it had indicated impacted 1968 earnings but left a clear
impression of confidence in the future via merger savings, regained
business, and so forth. The company, it was stated, had elected *to
absorb heavy nonrecurring initial costs to more quickly achieve the
recurring benefits of merger. One analyst examined first quarter results
shortly after they were announced, labeling them "in typical Penn
Central style quite incomplete and lacking in necessary detail," but
noting a further deterioration in net railway operating income after
fixed charges. His prediction of a $200 million loss for 1969 in this
category was indeed close to the final figure of $193 million reported
for the year. This was $50 million poorer than in 1968.
On top of the improvement in railroad earnings that management
wfts projecting for the rest of 1969, the April release noted that the
Arvida-Great Southwest-Macco-Buckeye group was still going strong,
with a 92% increase in first quarter earnings over the like 1968 period.
A new format was introduced for the consolidated statements, "designed to portray more accurately the diversified nature of the Company." The revenues and costs were each broken down into three major
categories-transportation, real estate and financial operations. This
helped, since before that time the quarterly releases had not included
the financial statements but only selected figures. Now all the investor
had to do was to figure out what was going on within the various
categories, but the data to do this was not provided.
It may be noted that this quarter, the first in 1969, was a relatively
"clean" quarter, as far as unusual transactions were concerned. On the
other hand, without the benefit of profits of this nature, the company
was able to record only a nominal profit on the consolidated statements. The company-only income statement, which showed a loss of
$12.8 million (compared to a $1 million profit in 1969), was helped
along in this quarter by the first of the two $6 million "special dividends" from New York Central Transport.
Memoranda in thefilesof outside counsel reflect a suggestion by house counsel for Penn Central that
shareholders be told in connection with the $6.5 million figure that:
"* * * comparisons between operations of the New Haven by the trustees [and current year results]
are impractical because the purchase resulted in a new basis of accounting.'*
In the final version this was watered down to:
"The New Haven reported a loss of $6,500,000 as it was then structured and operated in bankruptcy."
The memoranda reflect that outside counsel "did not think that this was fully adequate" but that Peat,
Marwick people felt that it was. The final memorandum ends with the words, "Everyone realized there is
some risk here."

Consolidated earnings of $21.9 million for the second quarter of
1969 were down only slightly from those of a year earlier. All of this
profit was accounted for by the sale of Six Flags Over Texas which
had been improperly reported as income. Thus, for the fourth straight
quarter, if reporting on a proper basis, Penn Central would have had
little or no consolidated income.378
In its second quarter earnings release, Penn Central reported the
profit of $21.9 million. It was stated that the Arvida-Great SouthwestMacco-Buckeye group had contributed $29.1 million to earnings, an
increase of $20.8 milKon over the like 1968 period and that the parent
railroad company had lost $8.2 million, down from a 1968 profit of
$2 million. Management disclosed that the $29.1 million from the
diversified subsidiaries included the sale of Six Flags Over Texas, but
no amount was given, either in the text or in the attached income statement.379 And again, Penn Central sought to downplay the small decline in consolidated earnings by suggesting that the New Haven had
lost $5 million in 1968 so the results were not strictly comparable.
Management did not make a similar effort to point out other relevant items that quarter. It was not disclosed that the $8.2 million
Transportation Co. loss would have been larger were it not for another
parent-financed $6 million special dividend from New York Central
Transport. And, while the attached financial statements of the Transportation Co. showed a net railway operating loss of $7.5 million, the
full railroad loss of $44.2 million was never mentioned. Possible investor
concern was further alleviated by the statement that heavy costs were
still being undertaken to expedite unification, combined with the assurance that the merged system was now realizing benefits from
merger projects and that service was better than it had been premerger.
Internally, the financial situation was critical and the dividend in
doubt, a factor which management was consciously concealing from
the public.380
By the third quarter, Penn Central could hold off consolidated
losses no longer. The reported loss for the quarter was $8.9 million,
although the company was quick to point out that there was a $17.6
million profit for the 9-month period. The third quarter figure reflected
a $24 million decline in profit from the year earlier period. While it
would be possible for the investor to calculate the figure himself from
the data provided,381 the company certainly did not point out this
The emphasis in the third quarter earnings release was on railroad
operations, which had been poor. The usual list of factors, plus a $5
million impact from "unusual occurrences," were cited as the reasons.
However, "much better results" were predicted for the fourth quarter.
The relevant figures given included a $19.2 million loss for the "parent
railroad company" and a net railway operating loss of $14.8 million.
The full loss on rail operations, after fixed charges, was almost $60
million, but this was not stated. Neither did the company point out
that the results for the parent railroad company were inflated by nearly
$12 million in "special dividends" drawn up from subsidiaries.
s7* It might be noted that the Board continued to declare dividends throughout this period.
3 » The transaction was reported as ordinary income in Penn Central's statement although it was treated
as880 extraordinary item in GSC statements.
See discussion on page If 8.
38i The Washington Terminal dividend had entered into the 1968 results.

I n the release, Penn Central devoted little attention to nonrailroad
subsidiaries, although Saunders' "good news behind the bad news''
speech to the Baltimore Security Analysts, 382 which was summarized
in an attachment to the release, did push the diversification program
in optimistic terms. And in the release itself, although giving no
earnings figures for the subsidiaries, Saunders did note that fixed
charges had risen in the Arvida-GSC (Macco)-Buckeye group, because
of the financing of facilities, which would, however, in the future
produce higher earnings. I t was also stated that real estate revenues,
which had increased sharply, included the sale of Rancho California,
and the reader could perhaps surmise that the transaction was being
mentioned because of its size. However, no sales or profit figures were
given, 383 and the reference by itself was certainly not very informative.
As suggested earlier, this was not the routine, everyday type of
transaction and disclosure to that effect was called for.
B y this period, it should be recalled, Perm Central's interest in its
diversified subsidiaries had become concentrated on the immediate
earnings they could be made to produce. And within Penn Central,
management was engaged in an almost desperate search for income and
cash. None of this comes through in the sterile statements being furnished to the public concerning earnings.
By the close of the fourth quarter it was clear that the battle to
sustain 1969 earnings had been lost. The consolidated profits for the
year had evaporated, with a $13.2 million loss in the fourth quarter.
This represented a $50 million decline over the fourth quarter of
1968, although this was not emphasized in the body of the earnings
release where management had always been quick to point to favorable
earnings progress. The various devices which had been used to increase
earnings in late 1968 were now apparently catching up with management in the form of unfavorable earnings comparisons. There were
no substitutes available for the 1969 period.
The fourth quarter earnings figures issued to the public on February
4, 1970, showed a net railway operating loss of $9 million for the
quarter. This compared with a $35 million loss reported to the ICC.
The shareholders were not told of this difference, which was based
primarily on the capitalization of the New Haven repair costs and
the depreciation savings on the long-haul passenger facility write off.
Neither was it pointed out to them that $35 million in fixed charges
should be added to the loss figures given, to get an accurate picture
of the full railway losses that quarter. On the other hand they were
told such things as the fact that quarterly results had been adversely
affected by a $6 million extra charge in accruals for loss and damage
claims and by abnormally high snow removal costs. The suggestion
was that these were nonrecurring.
Penn Central did manage to show a nominal $4.4 million profit
on a consolidated basis for the year 1969, down sharply from 1968
but hardly a harbinger of the impending disaster. The "principal
railroad subsidiary" reported a net loss of $56 million, compared
with a much smaller loss in 1968. A loss of this size is obviously not
a plus factor, b u t a $56 million loss certainly sounds better tnan a
$193 million loss. The latter was the full loss on the Transportation
Company's railroad activities. And even that was understated if the
*•* gee page 178.
** GSC had reported the sales figure earlier in the quarter, however.

I C C approach to the New Haven repair costs and the long haul
writeoff was adopted. While these two items were noted in the footnotes to the 1969 JBnancial statements, no effort was made to clarify for
shareholders the complete loss on rail operations. This was true even
though by the time the report to shareholders was issued, the company
was on the verge of collapse because of still further deterioration in this
factor in the first quarter of 1970.
I t might also be noted that any one of a number of factors could
have turned Penn Central's meager 1969 consolidated profits into a
loss. Elimination of the Six Flags Over Texas transaction, for example,
would have resulted in a sharp loss. Reclassification of the gain
reported on Penn Central's N . & W. investment as extraordinary
income would have had a similar impact. Consideration should also
be given to what the effect would have been of the consolidation or
write-down of Lehigh Valley, the write down of Executive Jet or
Madison Square Garden, the expensing of the New Haven repair costs,
or the effects of a multitude of other possibilities discussed in an earlier
part of this report whereby management took the route of maximizing
income. No hint that such a policy was being followed was given to
shareholders who were expected to blindly accept what was being
handed to them by management.
Actually, while the figures given in the February 1970 release dealing with 1969 earnings were poor, the text itself was remarkably
optimistic, or at least very bland, considering the problems then
extant. The 1969 annual report sent out a few weeks later was somewhat more realistic. By this point of course the dividend had been
eliminated, so the chairman's opening statement in the shareholder's
letter accompanying the 1969 annual report could have come as a
surprise to no one, "The year 1969 was a very difficult one for Penn
Central. Our problems were principally centered in the transportation
company and some of them were beyond our control." I t might be
noted that by this point management knew the first quarter 1970
results were a disaster.
Obviously, no shareholder would be overjoyed by the 1969 decline
in earnings, especially after elimination of the dividend. Some explanation was clearly required. Saunders, in the letter to shareholders,
went on to list and describe seven problems—inflation, delays in
securing rate increases, economic slowdown, passenger deficits, merger
startup costs, abnormal weather conditions, and strikes, although he
admitted that even under optimum conditions, the company might
not have been able to overcome the effect of these problems. He then
outlined steps management was taking to improve the situation. The
picture thus painted was one of a management aggressively moving
to deal with a series of problems, most of which had been listed as
excuses for poor 1967 and 1968 earnings as well. While management
was in all likelihood attempting to improve the situation, no indication
was given of the desperateness of the circumstances.
The discussion thus far has dealt principally with railroad operations. However, management in its statements regarding 1969 earnings
results pointed out that the Great Southwest-Arvida-Buckeye group
had increased its contribution to consolidated earnings to $53 million,
21 percent over the 1968 level. A very careful reading of the report to
shareholders would further show that the growth came entirely in
Great Southwest. As described earlier, this company's ability to sustain

that rate of growth was in serious question in light of the nature of
the earnings being reported and the efforts being made to generate
immediate earnings at the expense of future operations. Thethenrecent
action in calling off Great Southwest's proposed public issue because of
the feared effect of forced disclosure of such factors certainly brings
into clear focus their critical importance. Instead of warning the
shareholders about this, Saunders, in his annual letter told them:
The impressive performance of our real estate subsidiaries is described in this
report. Income of $137 million—derived from real estate operations, investments,
and tax payments from subsidiaries was used to support our railroad operations
during the past year.
These assets have proved invaluable to us and we are confident of their continued
success. Their health and strength will enable us to use them in our financing
program for 1970.

While "renewed emphasis was given to diversification through
growth of [Great Southwest] in order to broaden the company's
base of earnings/' no information was given whereby the investor
could judge the quality of that subsidiary's overstated earnings.384

Announcement of earnings for the first quarter of 1970 came on
April 22, 1970, amidst preparation for the $100 million debenture
offering. While the disclosure requirements on the part of the company
were not increased because there was an impending offer, it seems
apparent that the liabilities that could arise from the offering, affecting
not only the company but others involved in the underwriting process,
Jiad an impact on the degree of disclosure made.
The Wabash exchange involving a $51 million profit and the
Clearfield Bituminous Coal intercompany profit of $17.2 million
were both of such a size and impact on the disastrous first quarter
results that they could not safely be ignored. While in the initial
drafts of the release announcing tfie earnings for the period disclosure
as to the items was buried near the end of the release, it was eventually
pushed up to the front at the insistence of attorneys for the company
and the underwriters. However, disclosure as to the Wabash exchange
did not extend so far as to indicate the manufactured nature of that
$51 million gain, involving as it did acceleration of a transaction
which was to have occurred later in 1970, nor did it encompass information as to the very significant benefits Penn Central had given up
to enable it to thus paint the first quarter earnings picture. likewise,
the disclosure that the Transportation Co. statements included an
intercorporate profit of $17 million represented improved disclosure.
However, that improvement did not extend so far as to indicate that
the loss on railway operations was $100 million that quarter, although
In contrast, at the underwriters* insistence, the following was included in the offering circular for the
$100 million debenture offering:
"Great Southwest records sales of land and buildings in the year of sale and generally takes the full sales
price into income even though in many instances a substantial portion of the sales price is payable over
an extended period of time and may not include personal liability of the purchaser so that the collection of
the total purchase price may be dependent upon successful development of the property. A substantial
portion of Great Southwest's real estate sales in 1968 and 1969 are in this category and were made to a limited
number of individuals. The Tax Reform Act of 1969 and other recent tax rulings have made investments
in properties of this type less attractive to individuals. For this and other reasons, including general economic
conditions and the difficulty in obtaining mortgage financing, there can be no assurance that such sales
will continue.
"In the past Great Southwest has been able to make substantial real estate sales by accepting the prepayment of several years' interest. However, by reason of a November 1968 release of the Internal Revenue
Service limiting the deductibility of prepaid interest, the number of prepaid interest transactions may
decrease substantially, and Great Southwest's sales may be adversely affected thereby."

this class of figure was, at the underwriters insistence, being included
in the offering circular then under preparation. Obviously, a $62
million figure, the net Transportation Co. result, was bad enough—
$100 million would suggest that the entire amount Pennco was then
trying to borrow for the railroad's use could be wiped out in just one

Penn Central's voracious appetite for cash was described in an
earlier section. As noted therein, this necessitated huge amounts of
external financing. When the company's ability to borrow ran out,
it was forced into bankruptcy. Neither of these two elements, the
current cash drain combined with the reasons for it, and the company's ability to continue to finance these drains, was presented to
the shareholders in any meaningful way, although by this point it
must have been clear to management that these were perhaps the
most immediately critical factors for investor consideration.
Realistically, shareholder reliance on management to warn them
of impending financial disaster in a situation such as that confronting
Penn Central is necessarily great. There are many intangibles involved,
and management's knowledge and ability to put the pieces together
obviously far surpasses that of the average investor. Financial statements alone cannot be counted on to do the job, and most certainly
not the financial statements containing the limitations present in this
case. Thus, the public was clearly dependent on the willingness of
Penn Central officers to provide them with a realistic appraisal of the
situation, and management was not "willing." The issue here, however,
involves not merely good will or free choice on the part of management,
but involves obligations imposed under the Federal securities laws.
During the merger hearings of the early 1960's, Bevan, Symes, and
others had discussed in considerable detail the difficult financial situation facing the two roads. Railroad operations, they pointed out, were
consuming huge amounts of cash. On the other hand, because of the
poor earnings record, the securities of most railroads had a very poor
reputation and it was difficult to find sources of financing. As a consequence they had often been forced to rely on types inappropriate to
their needs—for example, short-term sources to meet long-term needs.
Bevan decried the weakened working capital position, which he suggested, reflected a reduced ability to withstand bankruptcy. Symes
described some of the repercussions of the earnings and cash situation
including deferral of necessary capital expenditures and maintenance,
liquidation of assets, and shrinkage of plant and equipment.
The merger finally came in 1968 and, with it, glowing public statements about plans for financing devices which would be employed. At
the 1968 annual meeting Bevan reported, "We on the financial side
are taking such steps as we deem necessary to meet the challenge of a
new and dynamic company by revamping its corporate structure to
provide management with the most modern tools available to meet
future capital requirements, which we know are going to be large."
Thus, the public was conditioned to view with favor, rather than
alarm, the very substantial financing which it was recognized the
future would bring. Bevan noted plans for the issuance of debentures,
preferred stock, and some time in the future the possibility of a blanket
mortgage. Suddenly, the avenues for financing seemed very broad, in


contrast to the bleak picture painted in the merger hearings. Yet
realistically, the possibilities of implementing such grandiose plans,
although mentioned throughout the 1968 period, were remote.
The most specific plans alluded to involved the revolving credit and
commercial paper. These programs, in fact served as the major postmerger financing devices. Purported advantages in the use of these
devices were pointed out. At the 1968 annual meeting Bevan noted
that "they should provide the flexibility with which to meet suddenly
arising problems quickly." An August 1968 press release referred to
the flexibility of commercial paper and the lower interest costs it
offered in the present market. No mention was made of the risks involved in using short-term capital to meet what were essentially, at
best, long-term needs. 386
In his speech to the New York Society of Security Analysts on
September 5, 1968, Saunders presented basically the same favorable
picture concerning the financing outlook. Yet, just a week earlier
Bevan had written him a memorandum describing the critical cash
situation at the time of the merger, and saying that the difficulties in
overcoming this problem had been compounded by a $48 million deficit
on railroad operations in the first 6 months of 1968,886 and a cash loss
of $131 million in the first 8 months of the year. "This drastic cash
drain is going to have a very serious effect, not only this year, but certainly through 1969." The entire commercial paper and revolving
credit lines would be absorbed and Penn Central would require
another $125 to $150 million before the end of 1968, Bevan had
The first words in the 1968 annual report to shareholders were:
"The cover sculpture symbolizes Penn Central as a strong and dynamic company, supported by the many different elements t h a t
comprise its diverse interests." No mention of financing, positive or
negative, was made.
At the 1969 shareholders meeting, Bevan was again assigned to
make the financial presentation. He boasted of the company's ability
to raise substantial amounts of money required by the merger, $450
million to date, despite a difficult financial market. Commercial paper
outstanding had reached $150 million—market acceptance was "uniformly good" and the company had no difficulty in disposing of the
paper, he reported. The company had just asked the ICC to approve
an increase from $100 million to $300 million in the revolving credit
plan. The use of short-term maturities was "extremely advantageous"
because they could be refinanced later on a long-term basis at lower
rates than available in the present market. He expressed publicly the
company's "appreciation and deep gratitude" to its banks for their
vote of confidence and cooperation at a time when the market for
money was very tight. He also noted that Penn Central was now
going into the Eurodollar market for the first time, speaking also of
this in glowing terms. This was mid-May and, internally, the financial
problems were a matter of great concern. Yet the public was left with
3 5 In a discussion with a railroad analyst in June 1968, Bevan suggested the blanket mortgage as an offset
to the short-term debt currently being floated, because of the danger of overextending in short-term securities. This danger was not, however, expressed to the public. Actually, the short-term/long-term distinction is generallv drawn between funds put into such items as inventories or accounts receivable, which will be
liquidated within a short period, and those invested in plant or equipment where the funds for repayment
are generated over a long period of time. The situation here, where the money is going to dividends and
operating losses, which themselves will never generate a return, obviously presents a particular problem.
3« This was an instance where, for internal purposes, management was using the full railroad loss, rather
than the far more favorable figures being given to the public.

the impression that banks and the institutions which bought commercial paper thought very highly of Penn Central. The poor reputation noted in the merger hearings seems to have evaporated. The
deception being practiced on these lenders who purportedly looked
with favor on the company, and the huge amounts of the borrowed
funds going into nonproductive uses were decidedly not items which
management was endeavoring to point out to its shareholders.
The 1969 annual report was sent to the shareholders in March
1970. Perhaps reflecting an attitude that if you can't say something
good, don't say anything, there was no reference in the textual material
to the financing situation.
By the shareholders meeting in M a y 1970, Bevan's enthusiasm
had blunted somewhat. He noted t h a t the cash position was tight, 387
basically because of the capital needs of the merger, 388 he suggested,
and the company was reviewing all expenditures very carefully. However, the arranging of $935 million in financing over the past 2 years
was an "outstanding accomplishment" considering the tight state of
the money market. 389 Again he thanked the commercial and investment bankers for their cooperation. 390
Bevan admitted that the big increase in debt had increased base
and fixed charges markedly:
On the other hand, a substantial proportion of this debt is short or medium
term in nature. Therefore, when market conditions change . . . we should be in
a position to lengthen our maturities and reduce our fixed charges accordingly.
We will not be locked into high cost debt for a long period of time for this portion
of our indebtedness.

He did not indicate that by this point the runoff of short-term commercial paper, which immediately preceded and contributed to the
final collapse, was in full swing.391 He did mention, however, that,
after the sale of the $100 million Pennco bond issue expected in a few
days, 392 the major portion of the 1970 estimated financing requirements
would be met. A shareholder present at the meeting commented that
some Wall Street houses were saying that Penn Central would need
another $100 million after that and wondered whether the company
had the borrowing power. Saunders indicated that he did not think
anyone could answer at this time the question of whether Penn Central
would need more money. There was no mention that approaches had
already been made to the Federal Government for emergency
The foregoing statement was clearly misleading with respect to the
developing financial crisis. Investors were also given very little other
information to direct their attention to this situation. Bevan had
earlier stressed the importance of working capital 3 9 3 as an indicator
of financial health. He had also stated in the merger hearings:
In the case of the railroads debt due within one year is not included in current
liabilities, although it is now reported as a separate item in ICC reports. This is
This was a perennial complaint, but he gave no indication that financing had been stretched to the
8 This was very clearly not the major cause of the drain.
3?» $245 million in debt had been paid off during the same period.
39° He neglected to mention the difficulties the Penn Central organization had faced recently in obtaining
financing, the exhaustion of the borrowing capacity of the Transportation Co. and the necessity to now
finance indirectly through such subsidiaries as Pennco and Penn Central International, operations which
would obviously also have their borrowing limits.
3 1 The revised offering circular, dated the same clay, did make such a disclosure. The underwriters were
writing the one presentation; Bevan was writing the other.
2 By this point (May 12) it was problematical whether the issue could be marketed. It was only 9 days
later that Bevan met with the bankers to tell them the issue could not be floated.
3 3 Working capital equals current assets less current liabilities.

contrary to standard accounting procedure and the practice in other industries,
and in my judgment gives a completely false picture, since obviously there is no
difference between one type of liability and another if both have to be paid in the
same period of time.

However, in the annual report to shareholders Perm Central
continued to classify it as long-term debt,394 rather than as a current
liability,395 thereby improving reported working capital.
Perhaps even more important than the working capital situation
was the rapid exhaustion of the sources of credit available to Penn
Central. The public statements previously described definitely showed
the positive side, with no indication the limit was fast approaching,
although this matter was obviously of concern internally. Each annual
report included, in a graphic form, a statement of source and application of funds for the year, but the information contained therein was
so general as to be virtually useless.396 For example, no indication
was given as the the level of noncash earnings. Considering the admitted importance of the maturity schedule, and the heavy reliance on
relatively short-term debt in situations where long-term fin arcing
was called for, an item in the source and application of funds labelled
"financing" is not very informative, and this is doubly true in a
company like Penn Central where such diverse activities as railroad
operations and real estate development and sales are being combined.
Actually the company did provide more meaningful figures for its own
internal purposes, although these were not available to the general
Other financial statements were scarcely more useful than the
source and application of funds. As noted earlier, lenders had turned
money over to Penn Central, without much inquiry into the company's
ability to repay, because of the very great assets and equity of the
firm. How was the average investor to measure such factors? While the
accountants' report generally indicates the CPA firm's opinion as to
whether the balance sheets and related statements of earnings and retained earnings "present fairly" the information contained therein,
such statements do not reflect current economic values of the assets involved nor do they attempt to do so. Thus, at least insofar as the
balance sheet is concerned, it appears to be of very limited value to the
average investor in gauging the value of Penn Central as a going concern.398 Further, if the investor is not knowledgeable about accounting
practices he might even be misled by the information contained
therein. This is particularly a danger in a railroad company where
fixed assets loom large in the balance sheet.
The management of Penn Central clearly recognized the limitations
in such figures, as reflected in their frequent complaints about the
highly unsatisfactory rate of return being earned on railroad assets.
Low rates of return mean low economic values on those assets. In
aw Perm Central broke this category down into long-term debt due within 1 year and long-term debt due
after 1 year.
»* In the case of commercial paper, totaling nearly $200 million by yearend 1969, even Goldman Sachs
had to ask where that item appeared in the balance sheet. The answer was that roughly half was included
in current liabilities and the remainder in long-term debt due in more than 1 year, although all was in feet
due within 1 year.
aw See exhibit IG-2 at end of this section.
aw At the present time, the SEC requires detailed statements of source and application of funds under
article 11A of Regulation S-X in registration statements and reports filed pursuant to the 1933 Act and the
1934 Act. Further, through the proxy rules (Rule 14a-3(b)(2) of the 1934 Act), the SEC also requires such
information to be included in annual reports (Section 14A of the 1934 Act and Rule 14a-3(b) (2) thereunder,)
to shareholders.
30* At December 31, 1969, Penn Central's balance sheet showed shareholders' equity of $2,800 million,
while the market value of the outstanding stock was only $700 million. At present prices, market value
is $120 million.

light of this, Saunders' suggestion at the 1969 shareholders meeting
that, in the railroad, Perm Central held an asset which could not be
replaced for less than $15-$20 billion (book value was perhaps $3-$3}4
billion) was unconscionable.399 This is an example of the situation
described at the beginning of this section where the distinction was
drawn between technical accuracy and what was reasonably conveyed.
While it may perhaps be true that the asset could not be replaced
for less than $15-$20 billion, the property clearly was not worth
anything remotely resembling that figure and based on economic
factors no one would replace it at such a cost.
Another difficulty which reflected on the financing area was that
the company's assets were already heavily pledged. It is true that
the company did indicate in the notes to the balance sheet in the
1969 annual report that:
Substantially all investments and properties included in the consolidated
sheet and substantially all the properties of the transportation company, together
with certain of its investments, principally Pennsylvania Co. . . . have been
pledged as a security for loans or are otherwise restricted under indentures and
loan agreements. 400

This represented a marked deterioration in position over the prior
jeary although that was not stated.401 Furthermore, the burying of
this information in footnote 7 to the financial statements does not
meet the requirements of a company which is on the verge of collapse,
because of the inability to market further long-term debt, to fully
disclose the imminent danger to its shareholders.
Considering Penn Central's financial predicament, it was misleading for management to continue to make dividend payments.402
When the practice was finally stopped, although it was long overdue,
management, in a letter to shareholders dated December 1, 1969,
explaining the reasons, cited "the necessity to conserve cash in keeping
with responsible management." The possibility of renewed dividend
payments in 1970 was held out as a favorable trend in operating
results. Thus, although dividends were stopped, the true nature of
the crisis was still concealed. "Responsible management" was merely
taking prudent and timely steps to conserve cash, it was suggested.
No indication was given that the action was long overdue and the
situation was critical.403
That letter also pointed out that Penn Central had spent nearly
$600 million for "merger connected capital projects" since the merger.
Reports filed with the ICC show that merger related capital expenditures were $43 million in 1968 and $54 million in 1969, far short of the
figure given above. This illustrated another difficulty the investor
faced in assessing the financing situation. Huge sums were borrowed,
it is true, but the investor had been led to expect this—he had been
warned that capital expenditures would be abnormally high in the
postmerger period, because of merger-related projects. These expenditures of course were to be temporary in nature. This theme was reinforced by postmerger statements about the very rapid progress being
3 He repeated it however in his speech before the Financial Analysts Federation in October 1969.
Generally accepted accounting prinoiples clearly require such a disclosure, so the company was not
going out of its way to make full disclosure in light of the perilous condition of the company. See also the
Commission's Regulation S-X, Rule 3-19
The prior year's report did indicate that "substantial portions" of both categories of assets were restricted. Apparently, however, thefinallimit had not yet been reached.
402 Dividends far exceeded income of the Transportation Co. for both 1968 and 1969.
*<B The letter was rife with what had to be deliberate overoptimism. It is included in its entirety as Exhibit
IG-3. This letter should be contrasted to the tone in other events occurring the same day—Day's letter to
Saunders (p. 165) and Saunders' luncheon meeting with the staff (p. 177).

made in physically implementing the merger. To state that mergerrelated capital expenditures were $600 million was definitely misleading. This figure apparently included all capital expenditures, the
bulk of which would be recurring in the future and were not temporary
in nature. Many were nonrailroad. Further, the rate of capital expenditures in the postmerger period was in fine with the expenditures
in the immediate premerger period. And the statement in a special
press release put out for year-end editions and dated December 19,
1969, to the effect that capital expenditures in 1970 would be substantially less than in 1969 and suggesting that this was because of a decline in merger costs and plans to improve equipment utilization is
misleading. I t is obvious that the real reason was simply lack of
The favorable picture painted throughout the entire postmerger
period of the state of the road's track, facilities, and equipment must
also be considered misleading in tending to divert attention from
financing problems. 404 If the truth were told, the condition of the plant
and equipment was highly inadequate, causing serious service problems, and this was because the company could not provide the
financing to do better.
Further indications of financial strength were also present. On
January 21,1970, Pennco announced it was acquiring additional shares
of stock for the $25 million owed to it by Great Southwest. This
forgiveness of indebtedness would hardly appear to be the action of a
company whose parent was deeply concerned about where it could
obtain additional cash to keep operating.

I t is very clear that the average shareholder could not be expected
to make sense out of the information selectively provided to him by
management. This is further emphasized by the fact that, as noted
earlier, apparently the directors of the company, who had access to
considerably more information than did the public, were unable themselves to piece together the then existing situation.
As indicated, the problem was apparently in part inadequate information and in part the complexity of the situation. While the professional analyst should not be the standard to which disclosure is
directed, examination of what the professional is able to discern, and
how, is enlightening. The fact that some astute analysts were able,
using information from a variety of sources and reflecting an awareness that very significant information seemed to be lacking, to obtain a
fairly reasonable assessment of the situation, militates against charges
made by some persons that criticism levelled toward Perm Central
involves an unjustifiable use of hindsight.
I t is clear that over the postmerger period Penn Central developed a
large "credibility gap" among significant members of the investment
community. I t is equally clear that management recognized the problem. On occasion it went on the offensive. For example, in late 1969
some deterioration was showing up in the company's earnings and
4 4 This tendency appears to have been exacerbated by Penn Central's desires to convince the shipping
public, through press releases, that its service was improving.
However, even before that time, on Sept. 5,1968, Saunders told the New York Society of Security Analysts
"one of our greatest accomplishments in preparation for our merger was the remarkable transformation of
the equipmentfleetsof both railroads," indicating that $1.1 billion had been expanded on equipment by the
two roads since merger proceedings were instituted.

operational figures, and rumors were spreading about Penn Central's
Saunders, appearing before the Financial Analyst's Federation 1969
fall conference in October, opened his prepared speech as follows:
I don't know whether I should ask you to give me a medal for bravery or folly
in appearing before this very influential group today. At least you should be grateful that our merger has provided you so much to write about in the past year and a
half. Penn Central is enjoying the dubious honor of being probably the most talked
about company in the railroad industry, if not the business world.
One phenomenal thing that our merger has achieved is that it has produced a
host of experts on Penn Central many of whom seem to know far more about our
business than anyone on our payroll.

He then moved on to discuss again the industry:
Speaking to a group of financial analysts at this time is a particularly challenging assignment for any railroad inasmuch as it seems obvious that members of
your profession are not overly optimistic about our industry. But if I may say so, I
fear that some of us in our concentration on figures and statistics sometimes tend
to overlook and underestimate many good things which are taking place in outindustry.

After some discussion, he went on to treat Penn Central individually,
stressing the positive steps the company was taking to improve service,
lower costs and increase profits. An article to the same effect, based on
an interview with Saunders, entitled "Penn Central Sees a Light in the
Tunnel," appeared in Business Week on November 22, 1969. He was
quoted as saying that Penn Central's problems had been exaggerated
out of all proportion on Wall Street and in the press, and that unfounded rumors were generating pressure on the stock. Four days after
appearance of the article the directors voted to omit the payment of
the fourth quarter dividend.
The credibility gap was very obvious by this point. However,
investment community dismay at the situation had begun as early as
September 1968 when Saunders gave a talk before the New York
Society of Security Analysts. One analyst characterized the speech in
a report as follows: "Management's recent presentation at the NYSSA
was generally disappointing. While many of the known profit potentials were discussed, there was an abundance of vague, unsure and
contradictory answers." Forbes magazine, indicating that the group
was looking for answers for the sharp decline in the stock's price in
the past 2 months, labelled Saunders' performance as a "letdown" in
an article entitled "Weak Script" appearing in its October 1, 1968,
issue. Other examples of analyst concern can also be cited. Rumors
were circulating widely by the summer of 1969 about a likely elimination of the dividend, and by September even Equity Research Associates, which had distributed a favorable report on Penn Central in
January 405 and continued to recommend the company through the
year, indicated that "ERA hates to give up on this one but we have
to for now. The 'explosive' potential we spoke of as recently as last
week is still there and will one day be realized, but before that day
°s Management, hearing the report was underway and fearing an adverse report, had been working very
closely with the analyst involved. An interesting incident took place in this connection. David Wilson,
in-house counsel for Penn Central, called Dechert, Price and Rhoads, outside counsel, on January 3, the
day after the report was issued and 3 days after the Madison Square Garden transaction was consummated
to inquire as to whether Penn Central would have to make any statement about the profit recorded in MS G.
A memorandum indicates that:
"Dave and I agree it has no duty to its own shareholders to do so, despite the magnitude of the transaction
because of the accuracy of the ERA statement against the background of the rather optimistic release by
Mr. Saunders" [probably his year-end statement issued on December 26,1968].
Apparently, Penn Central felt that if they gave the information to one analyst, they had met their disclosure obligation.

dawns we now believe the dividend will be cut or eliminated." An
analyst from Spencer Trask in early August pointed to the substantial
and increasing cash drain from operations as the most significant
single indication of the company's progress, suggesting that "reported
earnings are a meaningless guide to the position of the company."
Continuing deterioration in passenger and freight operations and the
continued dividend payments were making necessary sales of prime
real estate, extraordinary dividends and debt financing, he reported.
It is clear that if Penn Central management had been meeting its
responsibilities to shareholders, it would have been alerting shareholders to these same factors.
Other professionals were also evidencing awareness of critical
problems which were not being stressed to shareholders. After a visit
with Perlman in August 1969, Morgan Guaranty Bank analysts came
to the following conclusion:406
(1) Our earlier expectations of a rebound in rail operations by the second
quarter failed to occur because of continuing merger costs. (2) We are increasingly
concerned about the weak consolidated financial position in view of the fact that
approximately 30 percent-40 percent of reported earnings are estimated to be
of a noncash nature, resulting in a situation whereby the payment of common
stock dividends might well be from bank lines or short-term commercial paper
borrowings. (3) Our 1969 estimate of $4.75 per share now implies that management might resort to additional nonrailroad sources to meet this objective and
to raise additional working capital—in this regard management could well decide
to sell more nonrailroad investments, that is, Great Southwest Corp., Norfolk
and Western common stock, or a variety of other low cost assets. While such
an occurrence would have been indicated to us early in the year, we feel the
quality of these earnings will be substantially lessened, and more importantly
such an occurrence would mark the second straight year of railroad deficits in
excess of $122 million. (4) The apparent lack of harmony in top and middle
management is gradually being resolved, though we feel this is still somewhat
of an inhibiting factor in achieving operational improvement and also in obtaining a successor to Mr. Perlman who will retire in October 1970. (5) Management in general continues to divulge little in the way of analytical information,
thus leading to investor confusion as to the extent of Penn Centra? s overall
problem and resources.

The contrasts between these impressions and the official company
position, described earlier, should be noted.
Over the ensuing months, the analysts at Chase Manhattan Bank
continued to view Penn Central with suspicion. A check with certain
shippers in late 1969 indicated that there was still much dissatisfaction
with service. After reviewing operating results for the fourth quarter
of 1969, these analysts wrote that the credibility gap between management and the investment community seemed to be widening and
contrasted the poor results with recent statements by management.
They further commented on the "lack of meaningful published information and the reticence on the part of management to thoroughly
discuss the now-sensitive area of railroad operations/' indicating that
this further complicated attempts to assess near term prospects and
the status of certain recognized variables, such as business lost because
of poor service, high per diem costs and merger costs and savings.
In like vein, another analyst, this one from Black & Co., wrote in
early 1970: "with the credibility gap existing in this railroad and,
keeping in mind the many unique adjustments which this railroad has
made and can continue to make, it is evident that the course of their
earnings over the next several years cannot be accurately determined."
« These were the negative conclusions; there were some'positive ones as well.

In another development at about the same time, an executive of
Alleghany Corp., a large Penn Central shareholder, expressed concern
about the trend he had discerned:
It is obvious that there is a timetable beyond which the situation can no longer
continue, that is, railroad operating losses aggregating in excess of $10 to $15
million per month can only be sustained for a short period of time before insolvency inevitably results. It is for this reason that I wished to speak to Mr.
Bevan concerning what unhocked assets or resources, if you will, are left to Penn
Central to use as a source of funds to support inevitable continuing railroad
deficit operations in 1970.

He further noted in the memorandum, which was addressed to
Alleghany Corp.'s chief executive, a member of Penn Central's board,
that it would be unfair and possibly dangerous from a director's
point of view for Penn Central not to make full and clear disclosure
of the railroad losses and its overall financial position in the 1969
annual report.
While the average shareholder would have neither the ability to put
the information together nor the ready access to certain types of
information relating to the company which could be gathered from
various sources,407 shareholders could often benefit from work done
by the professionals, particularly if they were active customers or
otherwise in a situation to command this knowledge. Thus, one, a
well-known attendee at the meetings of various corporations, asked
at the Penn Central annual meeting held 6 weeks before the company
filed for reorganization:
It would be very reassuring to your stockholders, Mr. Chairman, in view also,
of the comments of some Wall Street observers, if you would comment on the
solvency of the Pennsylvania Railroad in light of the heavy deficit with which it is
presently afflicted.

Saunders' response was analogous to that he gave at the September
1969 analysts' convention noted earlier in this section. He pointed to
the company's large assets and equity. He admitted Penn Central
could not continue to lose money as it had in 1969 for an indefinite
period but added:
I do not want to make you think it is going to be easy. It is not. It is going to be
a very difficult task, there are terrific challenges here; there are terrific potentialities; there are terrific assets; and it is certainly the intention of management not
only to keep this company solvent, as you say, but to make it grow and prosper.

He then went on to point out that while there were bleak aspects,
there were bright aspects also, which he proceeded to describe in some
considerable detail.
The shareholder, apparently unconvinced, tried again:
Perhaps it would be helpful at this time if I asked the question in a slightly
different way and that is: Can we keep out of bankruptcy without another
freight increase?

She went on to suggest, as others had done earlier, a policy of full
disclosure in order to gain more Government assistance—that the ICC
should be told just how much the company needed the then pending
rate increase. Saunders said he felt that he had already answered her
concern, and he did not feel it was necessary to go as far as she was
suggesting with the ICC since they were cognizant of the industry's
«* For example, reportsfiledwith the ICC and the American Association of Railroads, industry statistics,
contacts with other professionals, with Penn Central management, with officials of other railroads, with
shippers, and so forth.

problems and anxious to keep it strong and viable. The critical
financial condition was never clearly revealed.

It is doubtful that any knowledgeable investor bought stock in
Penn Central or its predecessors in recent decades without recognizing
that there was some risk involved that the company could go bankrupt
at some future date.408 The risk such investors should not have been
expected to take, however, was the risk that they would not be given
relevant information available to management to enable them to assess
the fact that that day was fast approaching and finally was imminent.
Even less should they have had to accept the risk that management
was actively taking steps to conceal that information. Hope springs
eternal, perhaps, and suggestions that there eventually might be a
turnaround in industry problems, based largely on hoped for Government action, might ring a responsive chord in the investor, but if
there was a significant danger that the company could not survive
that long, the shareholder had the right to be so apprised. The feeling
that, if the truth were know, investors or creditors could not be
expected to furnish additional needed capital, is scarcely a valid excuse
for such deception, although it409
appeared to be a major factor propelling
management's lack of candor. Neither can management be excused
by the fact that their attempts at deception were partially recognized
by a disbelieving corps of professionals and that to some extent this
filtered through the market, as reflected in substantial declines in the
price of the stock.
It is clear from the preceding discussion that, throughout the entire
period from February 1, 1968, until June 1970, when top management
and Penn Central parted company, the public was being fed misleading
information on a virtually continuous basis. Disclosure was made only
to the extent it was not feasible to do otherwise, because it could not
be hidden. The tone presented to the public throughout 1968 was one of
great optimism with respect to all aspects of the business—financing,
earnings, operations, etc., an optimism clearly not justified by the
facts. This picture was altered only when facts about the service problems became known anyway. The company then admitted the existence of these merger-related problems and their related earnings
impact, but indicated repeatedly that the situation had turned the
corner and things were definitely on the upswing. The rest of the
picture was rosy. The diversification program was a success, and there
was no indication given of any significant problems in the financing
area. The policies in reporting earnings assured that the full impact of
railroad losses would be hard to detect.
It was not until early 1970, when the end was near, that the rosiness
was tempered. There was no mention yet of financing problems or the
course of conduct being pursued in the earnings area. The company
did give increased indication of problems in the critical railroad
segment of the business, although management rejected internal
suggestions that it might be in the economic interest of the company
to lay these problems bare in their entirety. Losses were only partially
disclosed and considerable emphasis was being put on steps being taken
*w There were unsophisticated investors, however, who apparently viewed the company as a real blue
chip, which had paid dividends for many years and was completely sound.
400 Another major reason was probably the personal interest of management in keeping their jobs.

to remedy the situation—steps which could not realistically be
expected to yield results in time to prevent disaster.
By this point, in early 1970, some people in the Penn Central
organization were becoming concerned about potential liability if
disclosure was not made. The focus was clearly not on what they
should disclose to the public to fairly apprise them of the situation,
but on what they were forced to disclose because the dangers of
nondisclosure were just too great. Indeed, the fact that some disclosures, which should have been made many months before, were
now finally being made, is a good indication of just how desperate
the situation was, as people scrambled for some degree of protection
for themselves. Collapse of the company would certainly bring this
information out and require explanations for prior concealment.
Nonetheless, it was still difficult to convince top management of
the necessity, and there was constant conflict. O'Herron objected
strongly to the initial draft of the 1969 annual report, indicating that
it "essentially duplicates the same bland and relatively optimistic
tone that was featured in previous years' reports," and that it did
not convey the true character of 1969 results. "Let's tell the real
story without all the nuances and details and establish a credibility
which will be useful when things really do get better." Wilson, the
legal department's SEC expert, raised cries of anguish at the two
initial drafts of the report and announced he refused to take any
responsibility for the material contained therein, further indicating
that the courts had made it clear that material in an annual report
could be viewed as evidence of a practice or intention on the part of
management to mislead investors in violation of the antifraud provisions of the Federal securities laws.410 He was also disturbed by
certain disclosures concerning Great Southwest to be made in the
Pennco offering circular, stating:
"If everything turns out OK for GSW and none of the plans and programs on
which its earnings have been reported comes to grief, all this worrying does not
matter. But management should recognize that they are taking a substantial
business risk in attempting to shortcut disclosure in connection with operations
such as GSW."

He again referred to court decisions dealing with such matters.
Other instances in this period of management's propensity not to
disclose and contra-pressures to provide better disclosure could
also be given. A First Boston representative, describing their experience in connection with the underwriting, testified as follows:
"And because the Penn Central needed this financing once we had established
that we were going to obtain the necessary disclosures, we were in a position of
some strength as far as negotiations over exactly what would be disclosed would
be concerned. They sparred with us for awhile and finally we established the position that we were going to have an offering circular that we were satisfied with.
"The basis of the problem was that Penn Central was concerned that we
would produce an offering circular that would not make a good selling document.
They were concerned about producing a document that was a selling document
and at this point we were beginning to be more interested in producing a document
that was a disclosure document.
"So there was a basic difference of objective at this point in time. And consequently, information was not being volunteered. We would have to ask specific
questions. We had to make sure we were asking the right questions."

The information contained in the 1970 debenture offering circular
did represent a considerable improvement in disclosure. And, it
«• in another memorandum prepared at about the same time he warned that certain information could
seriously mislead the unsophisticated investor, even if the professional would catch the nuances, and that
it should accordingly be adjusted.

might be noted, like the earlier aborted Great Southwest offering,
when the truth was known, the issue would not sell.






COMMN CHART ( « p . U l . W . )

GORMAN CHART (aaaaMldtea)

$ 4.6

w (10.1)


(19 2)

railway operating income (35.4)


m CHART (Mf.Ui.kW)
GORMAN CHART <aa»oHl.a.a)





COMFANr • Finuu froa Farm Central

GORMAN CHART . J J j g f c . ^ ^ . p * ,


OFFERING CIRCULAR . Fifnea from offerine circular pre.
pared (or Peenco $100 Billion debentuv.


Fifures from reports filed •
(Transportation Company •




Earnings from Operations $ 90

Depreciation, Amortization and Depletion

$ 55 Dividends

280 Reduction of Long-Term Debt


Additions to Property

'Sales of Capital Assets and Other Sources (net)

128 New Haven Assets Acquired

Working Capital Decrease
(excluding debt due within one year)

TOTAL $769

EXHIBIT IG-2—Continued

Penn Central Consolidated Source & Application of Funds /Year 1969 (in millions)
Earnings from Ordinary Operations





Depreciation, Amortization and Depletion









635 j ^ ^ i f


Reduction of Long-Term Debt

2 5 7

Addi,ions b


° P e r a ' l n 9 Property

Investments-Securities and Properties (Net)
Charges to Reserves and Other Items (Net)






Working Capital Increase
(Excluding Debt Due in One Year)




December 1> 1969.
DEAR STOCKHOLDER: I am writing you regarding the action taken by the Board
of Directors on dividends at its November 26 meeting, and to report to you on the
current status of the Company, particularly our railroad operations.
The Board decided that the total dividend for 1969 would be the $1.80 per share
already paid, and to omit a payment for the fourth quarter. It will, however, give
consideration during 1970 to dividend payments, either in cash or in stock or both.
This action was prompted by the necessity to conserve cash, in keeping with responsible management. Current indications are that railroad operating losses will
show a favorable trend in the fourth quarter, but obviously the railroad strike
which might occur this month would have an adverse impact on earnings for this
The following summary shows how your 1969 dividend compares with annual
payments in recent years:
$1. 25
$2. 40 1964
. 50
2. 40 1963
. 25
2. 30 1962
. 25
2. 00 1961-58
On a conslidated basis, Penn Central earned $17.6 million, or 73 cents a share
for the first 9 months of this year.
In this same period, our railroad had a passenger deficit of $73 million on the
basis of fully allocated costs, or approximately $47 million in direct costs. But
for this, the railroad would have been in the black. Other important factors in
our railroad deficit were exceptionally high costs (most of which are nonrecurring),
of implementing the consolidation of the former Pennsylvania, New York Central,
and New Haven Railroads into a single system, higher operating expenses incidental to the startup of the merger and inclusion (since January 1, 1969) of the
New Haven, the impact of inflated costs of wages and supplies and the sharp
increase in interest rates.
No compensating increases in freight rates were granted this year until November 18, when a 6 percent increase became effective. Penn Central will gain about
$7.5 million during this quarter from the increase, and about $80 million on an
annual basis, but we also face further inflationary wage demands for 1970. I t
will be necessary for the railroad industry to request an additional rate increase
during the year.
Penn Central is making a determined effort to reduce costs and we are showing
progress in this respect. Our executive payroll is the lowest of any major railroad
as a percentage of total compensation.
With regard to total labor force, wa now have approximately 7,500 less employees than we did at the highest level since our marger and inclusion of the New
Haven. We are accelerating our early r e t i r e s at program and have retired 541

officers and supervisory employees since the merger. We will retire 143 more by
the end of the year, and every department is being asked to submit a list of
candidates who will be eligible in the near future.
In the fourth quarter, we expect to cut our per diem payments (to other railroads for their freight cars on our lines) by about $6.5 million, and we estimate
that these costs will run some $9 million less than for the last half of 1968.
In addition, a recent Supreme Court decision upholding a time-mileage formula
for per diem payments is expected to become effective in the near future and should
produce additional savings of $16 million in 1970.
As you are aware, Penn Central is burdened with a far greater passenger service
deficit than any other railroad, since we now operate more than a third of all the
Nation's rail passenger service. We are continuing to develop public assistance
plans for improving commuter service and cutting operating deficits in the Philadelphia, New York, New Jersey, and Boston areas.
Under terms of an agreement executed on November 25, Penn Central will sell
for $11.1 million its equipment and part of its right-of-way and will receive approximately $4 million in annual rentals from the States of New York and Connecticut for its commuter line between New York City and New Haven. The two
States and the Federal Government will spend $80 million to acquire new equipment and modernize facilities.
Our railroad's new Metroliner trains are producing a 14-percent gain in overall
passenger traffic between New York and Washington.
Penn Central has spent nearly $600 million for merger-connected capital
projects since the merger of the Pennsylvania and New York Central railroads in
February 1968. The biggest single new facility for 1969, a $26-million electronic
classification yard at Columbus, Ohio, will be opened in December. Several other
key yards have been expanded to accommodate heavier traffic.
The largest and most costly of our merger projects are now behind us. We have
combined 32 major terminals and have made virtually all important rail connections. These new facilities are tools with which we can improve our efficiency and
productivity in the years ahead.
Our new president, Paul A. Gorman, took office today. He was formerly president of Western Electric Company, an organization larger than Penn Central,
and an executive vice president of American Telephone & Telegraph Company.
Mr. Gorman, I am sure, will give fresh impetus to cost control and management
efficiency programs. He is recognized as a leading expert in corporation management and we are fortunate to get him.
Our diversification program has been extremely successful since the former
Pennsylvania Railroad initiated it in 1963. We have branched out in two directions—(1) development of our own railroad-related property and (2) acquisition
of real estate properties in California, Texas, Florida, and Georgia, and a pipeline
system in the Northeast.
We are expanding our wholly owned subsidiary, Buckeye Pipe Line Company,
which now operates a 7,800-mile distribution network. Buckeye, together with
our two real estate subsidiaries, Great Southwest Corporation and Arvida Corporation, contributed more than $50 million to our consolidated income during
the first 9 months of this year.
We are in the process of acquiring three companies which will add more than
$100 million to our revenues next year. Southwest Oil & Refining Company
operates a 50,000-barrel-per-day refinery and Royal Petroleum Corporation
wholesales fuel oil and operates a deepwater marine terminal in the New York
City area.
Richardson Homes Corporation of Indiana, which is being acquired through
Great Southwest, a Penn Central subsidiary, has built mobile homes for more than
25 years. Its 1969 sales volume will reach $25 million. Richardson has plants in
Indiana, North Carolina, Texas, and Florida, and is now planning to enter the
modular home field, for the manufacture and distribution of prefabricated housing.
I would like to call your attention to legislation pending in Congress which will
provide Federal aid for passenger-carrying railroads. We are seeking Federal
assistance to cover deficits incurred in operating passenger trains which cannot
pay their own way and to finance acquisition of modern passenger equipment.
Penn Central's best hope for real progress in curtailing its passenger deficit lies
in this legislation. Propects for its enactment are better than they have ever been.
I urge you to write immediately to the Members of Congress whom you know or
represent you asking them to approve this vitally essential measure. Favorable
action by the 91st Congress will be in the public interest as well as your own.




During the optimistic period before and shortly after the merger,
Penn Central stock was favored by many institutional investors
including mutual funds and banks. As Penn Central's fortunes declined, most of these institutions sold their holdings. A number of
these institutions had possible means of obtaining confidential
To explore the possibility of sales based on inside information, the
staff sought the identity of these institutions through questionnaires
sent to brokers, through reports to the Commission from registered
investment companies, and through various other means. Where a
pattern or relationship raised some question, further information was
sought. Over 100 institutions were subpenaed for the production of
documents. This information was analyzed to determine whether
trading on inside information had occurred.
The analysis of possible insider trading was made difficult by the
existence of some public adverse information throughout the period.
Although there was significant adverse information that was nonpublic, sellers were able to cite the public information as a reason for
selling. The staff, therefore, paid particular attention to trading at
significant times or where there was a significant relationship between
the company and the seller. Affidavits or testimony were sought
where unresolved questions existed.
As a result of the analysis, the inquiry focused on five institutions
which sold stock at a critical period (late M a y and early June 1970)
and which had, or may have had, a relationship to Penn Central:
Chase Manhattan Bank, Morgan Guaranty Trust Co., Continental
Illinois National Bank & Trust Co., Investors Mutual Fund and
Alleghany Corp. The staff's findings on these institutions are described separately in this section. 1 Testimony was taken from officers
and employees of these institutions. The witnesses denied that inside
information was used in any way in the decision to sell Penn Central
stock. In each case they cited public information or particular internal
circumstances as the reason for the sales. I t is clear, however, that the
sales of the banks point up inherent conflicts of interest. As a lender
to corporations, a bank is obviously entitled to nonpublic information.
As a manager of trust accounts, a bank seeks out information to
advance the interest of these accounts. I t is clear, however, that no
i Investors Mutual Fund and Alleghany are described together because of common control of Alleghany
and Investors Diversified Services, Inc. (management company for Investors Mutual) and because of relationships in the timing of the sales.


confidential information gathered in a commercial banking capacity
may be used to benefit the trust accounts. Banks have an affirmative
duty to see that appropriate procedures are estabhshed to prevent
any transmittal of information. In the case of these banks, Chase
described certain procedures it had instituted to separate the functions, whereas Morgan, on the other hand, had no such meaningful
procedures. Officers from both units routinely attended joint meetings, and, until almost the hour of Morgan's sales, one analyst served
both the commercial and trust departments.
There is also a question of confidential information passing by
way of interlocking directors. Stuart Saunders was a common director
of Perm Central and Chase. Thomas Perkins and John Dorrance were
common directors of Penn Central and Morgan. Although any conveyance of confidential information by this route was denied, on at
least the Morgan board and its trust committee a common director
spoke on Penn Central's affairs in the presence of trust officers. Interlocking directors should not be put in the position where they might
disclose confidential information to bank trust officers.
Although at this point serious questions exist about whether sales
were made on inside information, it should be noted that proof of
insider trading is always difficult. The difficulty is increased where,
as here, there is some public adverse information which might explain the trade. Unless direct testimony or documents can be obtained
on the use of inside information it is difficult to sustain a charge of
misuse of information.2


Chase Manhattan Bank, N.A., as one of the largest commercial
banks in the United States, had extensive relationships with Penn
Central, including among others, participation in various term loans
to Penn Central by banking syndicates and an interlocking directorship in that Stuart Saunders, chairman of the board of Penn Central,
was a member of the board of directors of Chase.
During the period of May 1-June 21, 1970, Chase sold 7,618
shares for its personal trust 3 accounts and 3,597 shares for its investment advisory4 accounts. 5During the period May 6-June 621, 1970,
Chase sold 543,500 shares from its pension trust accounts.
The activity in these various accounts at Chase may be illustrated
by the following table:

Mar. 26,1970
June 23,1970

Pension Personal Trust







Both of the commercial lending departments of Morgan and Continental had inside information at the
time the trust department was selling Penn Central stock, but the parties to the decision to sell deny under
oath that the trust department had access to the information.
3 In personal trust accounts Chase usually did not have discretionary authority but rather was limited by
the terms of the trust instrument and by the control exercised by the co-trustee(s).
* In investment advisory accounts Chase merely furnished advice with no authority to purchase or sell
securities for the account.
5 From figures made public by Chase. It should be noted that a staff review of the confirmation sheets
submitted by Chase indicates a lesser total. However, we will assume that public statistics are correct.
In almost all pension trust accounts, Chase acted as Manager, i.e., it had full discretionary authority to
purchase or sell securities held by the Trust as it deemed appropriate.

Thus, holdings of Penn Central stock decreased by 529,318 shares or 78
percent.7 The foregoing figures should be compared with the following
table II, which indicates Chase's holdings at various dates prior to this

Pension Personal Trust

Mar. 21,1968
Mar. 4,1969
June 12,1969
Nov. 19,1970







Moreover, it should be noted that Chase as a bank subject to
regulation by the Federal Reserve Board and subject to the restrictions
of the Glass-Steagall Act did not own or trade any Penn Central
stock for its own account.
As the foregoing statistics indicate, the overwhelmingly majority
of sales by Chase of Penn Central stock were made for its pension
accounts. The following table indicates also that these sales were
clustered during the period May 6-June 10, 1970.




Number of
shares sold Date:
9, 900
May 29
1, 000
June 1
8, 000
June 2
7, 000
June 3
June 4
57, 100
June 10
31, 850
39, 700
38, 800

Number of
shares sold
63, 700
27, 000
50, 000
45, 700
30, 600
7, 800

Thus, during the period from May 22 to June 4, 1970, Chase sold from
its managed pension accounts a total of 509,850 shares or approximately 94 percent of the total Penn Central sales made by Chase in the
period May 1-June 21, 1970.
In order to examine the reasons why these transactions occurred,
four employees of Chase were deposed. They were Paul T. Walker,
Vice President, U.S. Department (commercial division of Chase);
James M. Lane, executive vice president, Fiduciary Investment Department (trust division of Chase); Paul P. Lehr, financial analyst,
Fiduciary Investment Department; and James S. Martin, vice president, Fiduciary Investment Department.
Walker was a vice president in the commercial division of Chase
who had responsibility for the commercial and correspondent bank
business in certain mid-Atlantic States. One of his accounts was the
Penn Central complex.
Chase was a participant in various term loans and revolving credits
made to Penn Central and was also a depositary bank for Penn Central.
However, Chase did not directly loan funds to Penn Central as Stuart
Saunders was a member of the board of directors of Chase, and
apparently a direct loan would constitute a conflict of interest.
7 However, it should be noted that the apparent discrepancy between the amount held at Mar. 26,1970,
and the amount held at June 23,1970, may be attributable to a number of factors, including purchases of
Penn Central stock, and transfer of accounts holding Penn Central to or from Chase.

Walker normally represented Chase in its dealing with other banks
relative to loans to Penn Central. Walker did not attend nor was he
aware of the content of the May 21, 1970, meeting between David
Bevan and First National City and Chemical banks, wherein Bevan
discussed Penn CentraFs current financial condition, the postponement
of the Pennsylvania Company's $100 million debenture offering and
Penn CentraFs intent to seek a $225 million Government guaranteed
loan.8 Walker did attend the May 28, 1970, meeting of the banks
regarding Penn Central.
Walker maintained that the only persons he ever talked with at
Chase about Penn Central financial matters were other officers of the
commercial department. Walker specifically denied talking with Mr.
Lehr or Mr. Martin of the Fiduciary Investment Department of Chase
about Penn Central. Moreover, although Chase was represented at
the May 28, 1970, meeting and although it did receive the "Confidential Memorandum" dated May 22, 1970, regarding the financial
condition of Penn Central, it was claimed such information was not
given to the Fiduciary Investment Department.9 Walker made reference to Chase's internal policy regarding communication between the
commercial and trust divisions oi Chase. This policy was stated by
David Rockefeller in testimony to Congress as follows:
By executive letter, last revised under date of November 4, 1968, which was
issued by the chairman of the board and the president of the bank, all personnel
were instructed that there is to be no flow or incidental communication of inside
information from the commercial departments or divisions of the bank to the
investment department or the pension or personal trust divisions of the trust

Ciiase has erected a "Chinese wall" between its commercial and trust
divisions with the intent that neither act with or for the other, and
that although, organizationally, they are divisions of the same bank,
they should be functionally independent.
Lane, as executive vice president, was in charge of the Fiduciary
Investment Department of Chase. Lane was chairman of the investment policy committee which had the responsibility for determining
broad investment policy and strategy. Lane was also chairman of the
trust investment committees, which were four committees, one each
for pension, personal trust, corporate trust, and discretionary investment management accounts.
The investment policy committee in addition to setting broad policy
has final authority to accept or reject the specific market ratings of
the Fiduciary Investment Department's research group. Thus the
investment policy committee in setting broad investment guidelines
and approving specific ratings of particular securities determines the
parameters within which the individual portfolio managers may act,
subject to any applicable restrictions in a trust instrument. However,
8 Walker did receive a telephone call from Jonathan O'Herron at his home on Saturday night, May 23.
O'Herron apologized to Walker about Penn Central's not having kept the banks adequately informed.
Walker considered this to be an extraordinary call,
In a letter dated Mar. 3,1971, addressed to William Kuehnle, Roy C. Haberkern, Jr., Counsel to Chase
"After investigation, we have determined that the "confidential" memorandum dated May 22, 1970,
concerning Penn Central Transportation Co. was received by one or both of two officers in the Commercial department of the Chase Manhattan Bank (National Association), Paul T. Walker and Peter E.
Lengyel, both vice-presidents. It is their recollection that said memorandum was received from representatives of First National City Bank at a meeting held at First National City Bank on May 28,1970, or shortly
thereafter. We are further advised by Messrs. Walker and Lengyel that neither of them had any conversations
with any officer or employee of the Fiduciary Investment Department of Chase with respect to said memorandum or with respect to any other subject involving either Penn Central Co. or any of its affiliates.
As you know, the memorandum was not contained in thefilesof the Fiduciary Investment Department."

the immediate responsibility for managing the account is that of the
portfolio managers. The other members of the investment policy
committee are the senior officers of the various Fiduciary Investment
Department divisions.
Lane discussed the various aspects of the internal Chase system for
rating specific securities. Lane noted that the investment policy committee must approve a change in rating of a specific security before
the change is made. With respect to the rating of Penn Central
common stock, Lane stated that the research department submitted
a proposed change in rating for Perm Central to the investment policy
committee on May 22, 1970. The proposed change was to reduce the
rating of Penn Central from " D 3 " to " D 4 " , which in terms of the
Chase rating system would be a reduction from a permissible sell toa recommended sell. The proposed change of rating consisted of a
two-page memorandum which detailed the analyst's reasons for recommending the change.
This recommendation would be received by members of the investment policy committee and certain senior officers but not by all the
portfolio managers.
The investment policy committee met on May 26, 1970, according
to their usual schedule and approved the downgrading of the Perm
Central rating. This change oi rating and the analyst's detailed dissection of the Penn Central situation was, in accordance with customary procedure, then disseminated to all investment department
Lane noted that the effect of a change from a " D 3 " to a " D 4 "
rating was that:
If the account manager does not sell, he has got to answer for his decision not
to sell, in terms of the policy guidelines that have been given to him . . , He
not only has the delegated authority to sell a 4, if he doesn't sell, he has a lot of
explaining to do.

These investment policy guidelines applied to all accounts held bj"
Chase, including nondiscretionary accounts. Also, this guideline would
apply to Chase's investment advisory service.
Thus, as of M a y 26, 1970, by virtue of the action of the investment
policy committee, Chase's Fiduciary Investment Department personnel were strongly advised to sell any Penn Central stock held by
accounts they managed or advised.
In order to determine the evolution of this change of rating, the
staff deposed the financial analyst who recommended the change and
provided the reasoning therefor.
Paul P. Lehr was a financial analyst in the Fiduciary Investment
Department of Chase. After approximately 1 year's experience in
finaiicial analysis and management training, he was assigned in April
1970 as the analyst for the surface transportation industries with
which he had no previous experience. Lehr stated that he had:
. . . full investment responsibility. . . . I have the full scope of responsibility
for my particular securities.

Lehr noted that he was prohibited by Chase's internal policy from
talking with the commercial department of the bank. Lehr could
speak to the technical research department which serviced both the
trust and commercial departments. However, the technical research
department was prohibited from discussing specific companies and
was responsible solely for economic studies of an industry as a whole.

In executing his investment responsibilities with respect to railroads, Lehr utilized as his principal sources of information, brokerage
research reports, Moody's Manuals, reports of the Interstate Commerce
Commission, and reports of the American Association of Railroads, as
well as any annual and quarterly reports maintained in Chase's research files. Additionally, Lehr would review any documents, e.g.,
prospectuses, relative to a public financing.
Lehr would receive a monthly computer printout of holdings of various Chase accounts of a particular security which would indicate any
changes from the previous month's holdings.
In the ordinary course of his duties, Lehr was expected to prepare
and disseminate to the Fiduciary Investment Department personnel an
informal document known as a flash report which would inform them
of any current information about a specific company which he deemed
significant. These flash reports, and also information memoranda
{merely a longer version of a flash report), would not be submitted to
•or approved by the investment policy committee, but merely by the
director of research.
If a change in rating were to be made, an analyst such as Lehr would
initiate the process. The next step would be a review by the research
review committee.
However, Lehr stated that it was his normal procedure that before
this rating review and change process was initiated and/or completed
he would speak with the portfolio managers regarding a specific
security. Lehr stated:
I try to talk to portfolio managers who I know have a large interest, whether it
be in a number of shares or the importance within a single account.

With respect to Penn Central in particular, Lehr's first written
document was a flash report dated May 13, 1970. Lehr, in describing
the circumstances surrounding this flash report, stated that the
predecessor surface transportation analyst had received a call from
James Reynolds, an institutional salesman for Butcher & Sherrerd.
Reynolds told the analyst that Butcher & Sherrerd was recommending
a switch which Lehr interpreted as a change from a buy recommendation to a permissibe sale recommendation.
After this call, Lehr was instructed to call the research director for
Butcher & Sherrerd, a Ted Bromley, to find out what the main points
were that he thought made Penn Central a switch in recommendation.
According to Lehr, this conversation took place on May 12 or May
13, 1970. Lehr stated that:
. . . everything Mr. Bromley discussed was either information available in the
annual report of Penn Central [or] was just knowledge you gain by experience.

It is important to note that although this conversation took place on
May 12 or 13 and although Bromley discussed the April 27 prospectus,
the revised prospectus of May 12 was not discussed by Bromley and
Lehr was unaware of it. In fact, according to Lehr the earliest he was
aware of the May 12 revised prospectus would have been May 22,
After this conversation with Bromley, Lehr decided to make an
extensive analysis of Penn Central. He spoke with Chase's research
director and received his approval to make the analysis his first
priority. He then proceeded to make an extensive analysis of data

provided by Moody's Transportation Manual and the April 27, 1970,
prospectus for the $100 million Pennsylvania Co. debenture offering.
Lehr had been aware of the first quarter loss of Penn Central but
had not been alarmed, partially due to the fact that a loss was expected and due to his experience in the area. Consequently, he had
not done anything more than note the loss and informally discuss it
with his predecessor who shared his lack of alarm.
The flash report of May 13, 1970, was essentially a report of the
conversation with Bromley, the fact that Butcher & Sherrerd was
recommending a change and certain financial data which Lehr had
obtained from various public sources. Lehr noted in the flash report
that Butcher and Sherrerd was a firm which knew Penn Central welL
Lehr stated the importance of this was that:
I was putting this out to the portfolio managers in order to give them an idea
that this isn't only Paul Lehr with 1 month's experience informing them that the
situation deserves a scrutiny, but that here was a firm that knew Penn Central
supposedly well as witnessed by their being bullish on the stock and writing thi&
bullish r e p o r t . . . here was a firm going out saying we are no longer recommending

After distributing the flash report, Lehr arranged to see Jonathan
O'Herron, vice president of Penn Central, to try to obtain further information such as the sources and uses of funds. However, the meeting
which took place on May 15, 1970, was aborted by O'Herron without
any substantial discussion.
Lehr then resumed preparing his detailed analysis of Penn Central's
financial condition. He tried to reach O'Herron by telephone repeatedly
but was unsuccessful.
By May 22, Lehr's recommendation for a change in rating of Penn
Central stock had been prepared. Lehr also spoke with portfolio
managers, including James Martin, about Penn Central during the
week of May 18-22, 1970. Lehr discussed Penn Central's financial
situation, both present and projected, and his proposed change in rating.
Lehr spoke with portfolio managers in the pension, personal trust, and
investment advisory areas.
Although the portfolio managers did not receive Lehr's memorandum of May 22, he had orally conveyed the substance of same to a large
number of them prior to May 22.
Lehr did not recall whether the research review group approved the
change in rating on Friday, May 22, or Monday, May 25, but in any
event the investment policy committee did in fact approve the change
in rating on Tuesday, May 26. The information regarding the change
in rating would have been disseminated to all Fiduciary Investment
Department personnel by Wednesday, May 27, However, the portfolio
managers had begun selling during the week of May 18-22.
Lehr stated that he and Louis J. Kleinrock of the research group met
with Burt Habgood, vice president in charge of the Pension Trust Department. Lehr spoke with Habgood and with Martin, who was also
present at the meeting, about the substance of the May 22 memorandum regarding Penn Central.
However, Lehr could not recall exactly when the meeting occurred
but felt that it probably was the week of May 25 or later. This fixing of
the time of the meeting was due to the fact that Lehr recalled that
Martin stated that he had sold out most of his position in Penn Central, which according to Lehr would have May 26 at the earliest.

Lehr stated that purpose of the meeting was to provide Habgood
and his department with the analyst's latest information and judgment
about Penn Central and to inquire whether holdings of Penn Central
had been reduced to an extent commensurate with the risk.
Lehr spoke with Don Berry, vice president in charge of the Personal
Trust and Investment Advisory Departments the day following his
meeting with Habgood. Essentially, this conversation covered the
same points Lehr had previously discussed with Habgood.
Lehr's conversation with Berry occurred at the request of Kleinrock
who felt that both areas of the Fiduciary Investment Department
should be equally informed.
After this meeting and conversation, Lehr issued a flash report
dated May 29, 1970, which essentially announced the cancellation of
the $100 million debenture offering.
After these events and prior to the reorganization, Lehr did not
issue any other written reports about Penn Central and his involvement, if any, would have been limited to discussions with the portfolio
managers about Penn Central.
Martin had four portfolio managers reporting directly to him as
well as personally managing certain pension accounts. Martin was
one of two officers who had responsibility for supervision of the pension
trust portfolio managers, subject to the supervision of the head of the
Pension Trust Department, Habgood.
Martin stated that his:
. . . primary responsibility is the accounts which are directly assigned to me,
which are 13 in number. Secondarily, I have responsibility for the administration
of the division of which I am head.

Additionally, Martin was a member of the pension trust investment
Martin recalled that he had met with Lehr, Kleinrock, and Habgood
regarding Penn Central, but he could not remember the date of the
meeting. However, he did indicate that it probably was prior to M a y
26 when the change in rating of Penn Central was officially made.
Martin stated that at the meeting they discussed:
What course of action we should be taking with respect to Penn Central stock
t h a t we held, and we really debated as to whether or not the stock should be
«old and should be sold across the board within the pension department.

Martin noted that the information discussed at the meeting was
based upon the first quarter report of Penn Central and the first
offering circular for the $100 million debenture offering.
Martin recalled that they did discuss at the meeting that Lehr was
recommending a change in the rating of Penn Central stock.
Although Martin could not recall the precise date of the meeting
he was certain that it occurred before he began selling Penn Central
:stock on May 22. His recollection differs from Lehr on this point.
Martin's memory appears more accurate since Lehr remembers being
told to convey information to the head of the personal trust department after the meeting with Martin. T h a t sequence appears more
consistent with conveying information than with checking on the
progress of sales.
Martin noted further that he did not see the revised offering circular until after he had begun to sell Penn Central stock.
In discussing the management of his accounts, Martin noted t h a t
he had in the spring of 1969 sold substantially all of the shares of

Penn Central in these accounts at above $50 a share and then in
November or December 1969 he bought approximately 250,000 shares
at about $25 a share.
With respect to the sales of Penn Central stock commencing on
May 22, 1970, Martin stated that his order to his trading desk was
at a "level indication", which he explained as sales within a reasonable
range of a specific price but not a limit price. Martin stated that he
gave the trading desk:
An amount of shares to work with at the outset rather than specific orders with
respect to specific amounts. . . . As I recall when the orders were first entered the
stock was in the 12 area and we used that as a level. The implication there is
roughly within half a point of that in that kind of situation.

According to Martin all sales made for his accounts were within the
range of 11% to 13. These sales occurred during the period May 22June 1 and during this entire period Martin had an outstanding order
to sell.
Martin stated that "6 or 7" of the 13 accounts he managed held
Penn Central stock in May, 1970, and that he placed oral orders with
his trading desk to sell 100,000 shares beginning on May 22, 1970.
At the time of placing his initial order to sell on Ma}^ 22, Martin
indicated to the trading desk the approximate amount of his holdings
of Penn Central but did not tell them that he wanted to sell all his
holdings. Martin stated that:
I would have indicated to them the 100,000 shares and that there possibly was
another hundred behind it. The decision I made at that time was not one to sell
all the stock I had as far as I could sell it. It was to begin moving out of the stock,
particularly in those accounts where it represented significant exposure. There
was at that time the possibility that some of the stock would have been retained

Martin stated that he would not have sold all his holdings on May
22 if such a sale were possible:
I didn't feel at that time that it was that critical a matter to move all the stock
as fast as I could. I felt that if it was a stock I wanted to be out of I was willing
to take a period of time to do it. I didn't think I was in any imminent danger of
losing all my money. There was a great deal of interest in the stock at the time.
By moving more slowly and without putting undue pressure on the market it was
likely I could get a better price overall.

The trading desk was able to unload a major part of this 100,000share order on May 22. Martin continued to give orders for the sale
of Penn Central until June 1 when bis accounts were sold out.
Martin stated that he did not know at the time he placed the order
whether the trades would be made that day or for which specific
accounts he would be selling. At the time Martin placed the initial
order to sell he had a specific order of his accounts that he wished to
sell out first. Martin listed the specific accounts he sold out first and
reiterated his reasons for selling out these specific accounts. Martin
stated that his:
. . . interest was to allocate to those accounts in whom-in which it represented a
material position, which were, in my view, at least more conservative in terms of
their investment approach.

Further Martin noted that:
The allocation was made to those accounts first which I felt either had the
greatest exposure in the stock in terms of percentage holding or to those accounts
which I felt could assume the least risk by their nature.

Normally the allocation would have been made on a pro rata basis
for all accounts selling Penn Central by the trading desk on the basis
of order tickets submitted by the portfolio managers.
Martin noted that his decision to sell Penn Central was known by
his fellow portfolio managers and also that the Penn Central situation
had been extensively discussed by them. He also noted that only one
other individual portfolio manager in his division held Penn Central
stock. This was a Michael Hoben, whose account which held approximately 7,500 shares was sold by him on May 19 and May 21.
Although Martin was unaware of the reasons why Hoben sold,
Chase has represented that Hoben sold on the 10
basis of the May 13
"flash report" and his conversations with Lehr.
Chase had a possible avenue for the transmission of inside information aside from the commercial lending department. James O'Brien,
who was a partner at Salomon Brothers and who was involved in the
Pennco debenture offering that was aborted on May 28,1970, attended
the May 21, 1970, meeting in Bevan's office. At that meeting, the
underwriters were told the offering was being abandoned and that a
government loan was being sought. O'Brien was formerly head of the
Chase trust department. He knew all the individuals involved in the
decision to sell renn Central stock and in the normal course of business
spoke with them about transactions in which Salomon was acting as
broker. O'Brien testified that he did not recall the information disclosed at the May 21 meeting but that he is certain he never discussed Penn Central or its securities with Chase officers.

It would appear that the commercial department of Chase would
and did as a customary part of its loan arrangements have certain
inside information about the financial condition of the borrower,
Penn Central. However, Chase has claimed that, pursuant to its
written internal policy, such confidential information was not communicated to its trust department and that the sales of Penn Central
stock by Chase Manhattan Bank in May and June of 1970 were not
occasioned by the receipt and use of inside information but rather
were caused by an internal analysis of Penn Central which resulted
in a downgrading of its rating to a point where it became an almost
mandatory "sell" situation.

Morgan Guaranty Trust Company of New York (MGT), a whollyowned subsidiary of J. P. Morgan & Co., Inc., was the largest single
shareholder of Penn Central (PC) at the end of 1968 with 849,275
shares held in nominee name for its trust accounts. This represented
3.4 percent of the total PC shares outstanding. By December 31,
1969, MGT had increased its holdings to 1,173,078 shares of PC stock.
In 1970, prior to May 28, 1970, MGT sold 208,287 shares of PC stock,
but continued to hold 847,308 shares in pension trusts administered
by the trust department. But between May 29, 1970, and the filing
for bankruptcy by PC on June 21, 1970, MGT sold 371,000 shares
held for the pension accounts. The basis for these sales in May-June,
*° Letter of Howard A. Scribner, Jr., vice-president, Chase Manhattan Bank, N.A., dated May 5,1972.

1970 was a trust department decision to sell PC held in all pension
MGT also provided a significant amount of banking services for PC
with $35 million in various commercial debt obligations, and it also
was part of a consortium of banks meeting at the end of May, 1970
to seek methods for additional financing for PC. Furthermore, MGT
was the sole issuing agent u of PC commercial paper and two of
MGT's directors were also directors of PC.
. Taken as a whole these factors raise questions on possible use of
inside information obtained as the basis for the trust department's
sales of PC stock just prior to PC's bankruptcy.

There were two interlocking directorships between MGT and PC.
John T. Dorrance, Jr., a director of both Penn Central Co. and Penn
Central Transportation Co., was a director of both J. P. Morgan &
Co., Inc. and MGT in early 1970. He also was chairman of the board
of the Campbell Soup Co. and served on the boards of John
Wanamaker (Philadelphia) and the Penn Mutual life Insurance Co.
The other interlock, Thomas L. Perkins, an attorney with the New
York law firm of Perkins, Daniels and McCormack, served also on
the boards of American Cyanamid, Duke Power, Discount Corp. of
New York and General Motors Corp.
Dorrance was the senior MGT director, having joined the board of
Guaranty Trust Co. in the mid-1950's, but not until about 10 years
later, after the PC merger, did he become a PC director at the invitation of Stuart Saunders. Several companies Dorrance was affiliated with
had investment accounts managed by MGT, but none of the accounts
had any transactions in PC securities. Although Dorrance Was aware
of MGT's participation in First National City Bank's (FNCB)
$300 million revolving credit arrangement with PC, he testified
that he was not aware of the MGT holdings of PC securities, of the
FNCB meeting, of the decision to sell PC stock on May 29, or of
the sales by MGT in May or June 1970. Dorrance attended the
May 27 PC board meeting when the PC directors were informed that
the debenture offering was to be postponed, and the June 8, 1970,
meeting when certain PC officers were replaced.
Perkins, who served on the finance committee of the PC board, was
quite familiar with PC's financial condition. Like Dorrance, Perkins
had served as a MGT director before becoming a director of New
York Central prior to the merger with the Pennsylvania Railroad.
Perkins was aware of the significant PC holdings by MGT in early
1969 when, as a director of Discount Corp. of New York, he learned
that MGT had purchased PC for Discount's pension plan. Upon
inquiring, he learned that MGT's trust department was optimistic
about PC's future, and he informed the trust department that he didn't
care how they felt about PC, he didn't want any more PC purchased
for the Discount pension fund. However, Perkins stated that he was
not aware of the sales by MGT of PC in May or June and did not talk
to anyone at MGT during May or June about PC, except for his
discussions with John M. Meyer, chairman of the board of MGT,
u The issuing agent processes the physical issuance of the notes and receives and disburses the cash involved. The issuing agent is to be distinguished from the commercial paper dealer, Goldman, Sachs in this
case, who has responsibility for marketing the paper.

about Perkins' resignation from the PC board of directors. Perkins
testified that it was the practice for MGT directors to periodically
attend trust committee meetings at MGT to discuss other companies
which they also served as directors, although no information of a confidential nature was given the trust committee. In a May 3, 1972,
letter, MGT's counsel stated:
With respect to meetings of the full Trust Committee, we are advised that it
was not the practice at any of these meetings to discuss affairs of a particular
company of which one of the members of the Trust Committee was a director,
but rather the general industry being presented for review.
More specifically with respect to Mr. Perkins we are advised that he did not
attend any meeting of Morgan Guaranty's Trust Committee during the period
of May 1, 1970, through the bankruptcy of Penn Central. We are further advised
that there was no discussion of Penn Central or the railroad industry in any
meeting of the full Trust Committee held during this period.

Kenneth E. MacWilliams, vice president of MGT, assumed client
responsibility for Penn Central in April of 1970. MacWilliams reported
that his duties regarding a particular client were to be aware of the
client's financial needs and to participate in the extension of credit
when it is necessary. Before credit is extended by MGT two members
of the credit policy committee must approve any loan involving $5
million or more, or any loan with a maturity date of over 1 year.
Any officer can commit the bank up to these limits without committee
In February 1970, MGT declined to participate in a $50 million
bridge loan to the Pennsylvania Co. for additional cash needs.12
The loan was to have been unsecured, and was to have been repaid
out of the proposed $100 million Pennco debenture offering.
On May 6, 1970, Jonathan O'Herron, vice president of finance of
Penn Central, met with representatives of the MGT's banking division
to discuss Penn Central's financial condition and to make a preliminary inquiry as to MGT's potential participation in a 60-day bridge
loan of $20 million. Apparently MGT declined to participate in this
loan for the same reasons it declined participation in the $50 million
loan in February.
The major loan to Penn Central by MGT was a $25 million participation in the $300 million revolving credit loan which was secured by
Pennsylvania Co. stock. At the beginning of May 1970, MGT had
extended $20,833,333 out of its $25 million participation; $4,166,667
remained available for Penn Central j)rior to the bankruptcy.
On May 25,1970, MacWilliams was informed by FNCB of a meeting
to be held involving the revolving credit loan to Penn Central because
Penn Central had estimated it needed a new loan of approximately
$225 million if the debenture issue had to be postponed. Approximately $100 million of this amount was to be used to repay commercial paper, the balance was to go for operating losses. MacWilliams
was also told that Saunders, Bevan, and O'Herron of Penn Central
were in Washington with Treasury Secretary Kennedy and White
House Special Counsel Flanigan to try to obtain a Government guarantee on the new debt.
1 A bridge loan is a loan to bridge the creditor over until a pending publicfinancingis completed. In this
instance the loan was to be repaid from the proceeds of the $100 million debenture offering.

A memorandum of these conversations was sent to Dewitt Peterkin,
president of the bank, Stuart Cragin, chairman of the credit policy
committee, and Frank Sandstrom, senior vice president because of the
importance MacWilliams had placed on the telephone call. MacWilliams testified he did not talk to anyone in the trust and investment
division or the research department during the time between the
telephone calls and the FNCB meeting on May 28 and to his knowledge
neither did his immediate superiors.
The FNCB meeting took place at mid-morning on May 28, 1970.
MacWilliams and G. Kenneth Crowther, both bank officers, and
Bruce W. Nichols of M G T s counsel, Davis Polk & Wardwell, represented MGT. Upon returning from the FNCB meeting, MacWilliams
wrote a confidential memorandum dated May 28, 1970, to the credit
department files reporting the events that had occurred. This memorandum contained a good deal of information about the financial and
operational condition of Penn Central which at that time had not
been publicly disclosed. It specifically referred to the existence of the
negotiations regarding the Government guaranteed loan, the postponement of the $100 million debenture offering, and the serious
financial condition of Penn Central.
Copies of this memorandum were directed to Meyer, Cragin, and
Peterkin in addition to the normal distribution in the credit department. MacWilliams testified that he did not talk to anyone in the
trust and investment division concerning Penn Central on May 28 or
May 29 nor was he aware of any events involving Penn Central that
occurred at the bank on May 29, for example, the global order directing sales of Penn Central stock in all pension accounts.13 Crowther
testified that he could not recall specifically speaking to anyone at
MGT upon returning to the bank after the FNCB meeting but someone, such as chairman Meyer, might have contacted him to find out
what happened. Crowther and MacWilliams were cautioned to say
nothing concernfaig the meeting.

The trust and investment department administers investments in
connection with basically three types of accounts: personal trust
accounts; investment advisory accounts; and pension accounts. For
the personal trust and investment advisory accounts, the bank normally shares the investment responsibility with a cotrustee, while in
the case of most pension accounts, the bank has sole investment
responsibility. An advisor is responsible for the investment decisions
for the account, but he is guided by two committees within the trust
department: the committee on trust matters and the common stock
The internal committee on trust matters meets twice each week to
review accounts, to consider recommendations presented by the officers
of the trust and investment department and to formally ratify actions
taken between regular committee meetings. The investment officers
base their recommendations to the committee on trust matters on
conclusions of the common stock committee (a committee of eight
officers of the investment department), on information received from
the research department, the economics department, and on previous
13 See pp. 85 fl.

decisions of the committee on trust matters. The total committee on
trust matters usually meets twice a month prior to meetings of the
board of directors or executive committee of the bank. These meetings
are limited to consideration of general investment policies and no
discussions are held regarding individual accounts or approval or
.disapproval of specific investments.
The common stock committee considers both individual securities
and industries. Although there is no rating system fcr individual
securities the common stock committee recommends by categories a
particular issue as a "fielder's choice" to sell, or a "fielder's choice" to
buy or to hold. When the common stock committee determines that a
particular security falls within one of these categories, each account
manager considers the recommendation in relation to the circumstances of the individual account, for example, the tax effect, the client's
wishes, the company trustee's instructions and such. A recommendation is not a mandatory instruction for the account manager, but the
manager must satisfy the committee on trust matters that acting in a
contrary fashion to the recommendation of the common stock committee is best for a particular account in light of all the circumstances.
MGT had purchased most of the Perm Central shares held in its
various trust accounts just prior to the Pennsylvania Railroad and
New York Central merger. Nearly 900,000 shares of Penn Central
were acquired in 1966 when the yearly high was 73 and the low was 40.
The stock was purchased primarily because of the savings expected to
result from their merger. MGT's research department had determined
the PC would earn $5 per share during a good economic year and the
merger should increase PC's earnings an additional $5 per share from
cost savings. Other reasons included the high book value of Penn
Central as compared with the then current price of PC stock, and the
tax shelter which would result from the peculiarities of railroad accounting. No shares were acquired after 1969.
The following table shows shares held by MGT in various accounts
at the end of 1969 and at the time of the May 28, 1970, meeting of
Dec. 31,1969
Personal trust
Investment advisory

May 28,1970



* 847,308





i Besides sales, certain shares were delivered to clients by the bank for various reasons.

Between December 31, 1969, and May 28, 1970,14 MGT sold 64
percent of Penn Central securities in the personal trust accounts, 75
percent of the Penn Central stock in the investment advisory accounts
and 5 percent of the Penn Central stock held in the pension accounts.
Included in the pension sales was the sale on May 19 of the entire
position of 7,600 shares held for the Morgan Guaranty Trust Co. of
New York and Affiliated Companies Ketirement Plan for the U.S.
« Between May 25 and May 28, MGT sold 7,000 shares of Penn Central. May 28 was chosen for analysis of
Penn Central trading because it was the day of the FNCB meeting when confidential information concerning
Penn Central came from Bevan.

Employees. This sale was represented as necessary to provide the funds
necessary to pay for a recent purchase of Federal National Mortgage
notes, because the fund is a static fund and most purchases must
therefore be offset by a sale of other securities in the fund.
The common stock committee considered Penn Central on January 21, 1970, and again on May 19, 1970. A report by the research
department, distributed prior to the January meeting, contained the
following information:
It now appears that the railroad operating deficit for the fourth quarter of 1969
will equal or exceed the $47 million loss reported for both the third quarter of
last year and the fourth quarter of 1968. The credibility gap between management
and the investment community seems to be widening, since these anticipated
results are in direct contrast to the recent remarks of Mr. Saunders. In a letter
to stockholders on December 1, it was stated that the merger was progressing
satisfactorily and that railroad operating losses will show a favorable trend in the
fourth quarter. Our estimated final quarter results would put the operating deficit
for the year at about $170 million, compared with $122 million for 1968 ($153
million including the New Haven). No special transactions by the railroad or
real estate subsidiaries took place during the fourth quarter. Thus, consolidated
earnings for the year 1969 could be as low as $0.50 pershare, compared with the
$3.91 reported for 1968.
The lack of meaningful published information and the reticence on the part of
management to thoroughly discuss the now-sensitive area of railroad operations
makes us more uncertain about the near-term prospects for Penn Central than
at any time in the recent past. Heretofore, our conclusions have been based on
an analysis of management's documentation of the swing variables—i.e., severance and overtime, abnormally high per diem charges, and the attainment of
merger savings. Despite the recent rate increase and management's statements
that merger costs were being reduced and that merger savings in the fourth quarter were running at an annual rate of $34 million, it is quite evident that the net
benefits are being lost to yet to be defined areas.

The common stock committee at the January 21 meeting categorized
Penn Central common stock as a fielder's choice to sell.
A report prepared for the May 19, 1970, meeting concluded that:
Penn Central does control nearly $7 billion of assets on which it should be able
to earn a reasonable return, but we do not think it will happen in 1970. Because
of the poor first quarter results, we are reducing our earnings estimated for thisyear to $1.00 per share, from the previous $2.00. However, we do not have much
confidence in our estimate, because of the many variables involved and management's continued credibility gap.

The research analyst who prepared these reports, John C. Holschuh,
did not recall speaking to anyone at Penn Central, other analysts, or
anyone at MGT. The common stock committee at the May 19, 1970,
meeting continued Penn Central stock as a fielder's choice to sell.
MGT normally exercises sole investment discretion for pension
accounts; thus transactions in these accounts differ slightly from the
procedures for effecting transactions in personal trust and advisory
accounts. Each pension account is reviewed quarterly by the committee on trust matters, but most of the activity occurs between the
formal review and is approved by the officer in charge of the pension
account managers and later ratified by the committee on trust matters.
A global order is used to designate a security to be bought or sold
for all pension accounts managed by MGT. In the case of a global
order to sell, all shares held by the pension accounts are sold at the
best price obtainable with allocation of specific sales to individual
accounts done on an equal basis, each account receiving a daily average
price for the shares sold. A global order thus, in effect, preempts the
opinions of all individual account managers ard it does not take into
consideration the individual circumstances of each pension account.

On May 29, the day after the FNCB meeting, Samuel R. Callaway,
executive vice president and head of the trust department, Harrison V.
Smith, senior vice president, and Carl E. Hathaway, senior vice
president met in the morning and decided to place a global order to
sell all the Penn Central shares held by the pension accounts. All
three men met shortly after arriving at work and discussed what they
felt was the serious financial condition of Penn Central. While Callaway and Hathaway could not recall the specific details of the meeting,
Smith testified:
Question. Then after you arrived at the bank on the morning of the 29th, you met
uith Mr. Callaway and Mr. Hathaway?
Answer. That's right. And we decided despite the decline in the price in the
stock, it should be sold for pensions on a global basis, and Hathaway implemented
that decision.
Question. Now was this meeting the first thing in the morning, do you recall?
Answer. I don't recall exactly. It was probably sometime after our routine 9:15
meeting of the entire department, so I would place it at half past nine or 10
o'clock, something like that.
Question. Do your recall where you met?
Answer. Somewhere on the fourth floor, but I can't recall whether it was Mr.
Callaway's office or in the space outside of it where the rest of us sit.
Question. How long did this meeting last?
Answer. I believe it lasted 2 or 3 minutes at the most.

The decision was reached without contacting the research department at MGT because all three felt they knew enough to make an
informed investment decision. The sale was not discussed at the
routine staff meeting that morning, but according to Hathaway such
B sale would not normally be discussed at the staff meeting.
The decision to sell was based primarily on the disclosure in the May
29, 1970 Wall Street Journal of the postponement of the debenture
offering. Smith testified concerning the significance of the postponed
Question. And there was a very real feeling, then by those making this investment
decision for the bank, that if Penn Central could have gotten the $100 million they
possibly might have been able to survive?
Answer. I t mght have given them enough breathing space to bring some order
into the operation of the railroad, and salvage somethng from the situation.
Question. In view of the fact the debenture had is rating lowered to Double B, and
in view of the fact that the interest rate was set at 10}i percent, could it not have been
fairly anicipated at this time that this offering would not go through? Did it come as
any surprise to you, Mr. Smith, that the debenture offering was postponed?
Answer. Yes, I was surprised that it had gone this far, and it would have been
more usual if First Boston, who are the principal investment bankers involved in
a situation like this had said early on there is no point in this. And they had gone
so far as to schedule the issue for early in June. So it was surprising to us that they
wouldn't sell it. Because, of course, that was the situation that caused the postponement of the offering was that they didn't have the buyers.
Question. Did you attach importance to the fact that they had gone so far and did this
have any effect on your investment decision on the morning of the 29th?
Answer. I can't remember any discussion along those lines. The significance of
it was that when the offering was scheduled in May, the underwriters felt there
was a possibility or they wouldn't have done so. By the time May 29 came alon
the sentiment had deteriorated so that it was no longer possible to do so.

In arriving at the decision to sell Penn Central, all three men testified that they did not contact anyone else either at Morgan Guaranty
Trust or outside the bank concerning Penn Central. Smith and
Hathaway testified that they were not then aware of the negotiations
concerning the government guaranteed loan or the meeting the previous day at FNCB attended by representatives of Morgan Guaranty

After the decision to sell was made, Hathaway placed by telephone
a global order to sell approximately 800,000 shares of Penn Central
with the trading desk at Morgan Guaranty Trust 15 with no specific
instructions concerning the price, the timing of the sales or the manner
in which the stock was to be sold. Standard procedure at Morgan
Guaranty Trust is to sell as much as possible at the best price obtainable without affecting the market.
Between the institution of the global order and the bankruptcy
petition, Morgan Guaranty Trust sold 371,000 of the 847,308 shares
held for the pension accounts on March 29. In the personal trust accounts, only 4,102 shares out of 15,308 were sold during this period,
and 29,660 shares in advisory accounts were sold out of 42,770 shares.
In all, sales due to the global order represented 92 percent of all the
Penn Central sales druing the period between May 29 and June 19.
The table on the next page shows the sales by Morgan Guaranty
Trust during the period:
May 29


sales as a
percentage of












The majority of the sales were placed through Dean Witter, but on
two occasions sales were executed through Eastman Dillon, Union
Securities & Co.
The orders for sales were normally given to Dean Witter to sell "at
market" in 5,000 and 10,000 lots. When a particular lot was sold, the
trader would give Dean Witter another order and vary the instructions
as to whether it was to be a limit order or a market order. Ronald C.
Ivory, the trader, testified that he tries to sell about one-third of the
volume when attempting to liquidate a large position because he has
found this to be the best procedure to follow so as not to depress the
market price of the security. Furthermore, he would not try to sell a
position as large as the Penn Central holdings in several block transactions because a broker positioning a block would compete in the
marketplace with Morgan Guaranty Trust when it unloaded the block
As the table reflecting the trades by Morgan Guaranty Trust reveals,
roughly half of the global order was sold between May 29 and June 11.
The only day Morgan Guaranty Trust did not trade was on June 8.
Ivory testified that he was instructed not to sell any shares of Penn
is The exact amount to be sold was later determined after checking the bank's records.

Central on that date by his immediate superior, who gave no reason
for the instructions. Apparently Meyer had ordered the trading
stopped. In a memorandum supplied by counsel, the reasons for not
trading on June 8 are set forth:
ON JUNE 8, 1970

On Saturday and Sunday, June 6 and June 7, 1970, a series of meetings were
held at the Federal Reserve Bank in New York City which were attended by
representatives of the U.S. Department of Commerce, counsal for the U.S. Department of Transportation, officers of the Federal Reserve Bank of New York,
representatives of three New York banks (Morgan Guaranty, First National
City, and Chemical), and representatives of First National Bank of Chicago and
Mellon National Bank & Trust Co. In attendance from Morgan Guaranty were
John M. Meyer, Jr., Chairman of the Board, and Kenneth E. Mac Williams, a
Vice President, who were accompanied by Bruce Nichols of Davis Polk & Wardwell, counsel for Morgan Guaranty.
During the course of these meetings, several statements were made which led
Mr. Nichols to conclude that at some time on Monday, June 8, a Board of Directors meeting of the Penn Central Company would be held at which important
top-management changes might be made, changes which would be of such an
unusual nature as clearly to indicate that Penn Central was in the gravest financial
No one from the Trust and Investment Division of Morgan Guaranty was in
attendance at any of the meetings over this weekend, and neither Mr. Meyer,
Mr. Mac Williams, nor Mr. Nichols informed any member of the trust and investment division of what had occurred. Nonetheless, Mr. Nichols was concerned that,
because of the quasi-public nature of these meetings, which he felt might attract
attention by reason of their being held on Saturday and Sunday at the Federal
Reserve Bank with so many prominent persons in attendance, information as
to the possible impending management change might leak out and come to the
attention of someone in the Trust and Investment Division from some other
source. He was further concerned that if sales were made on June 8, someone might
later contend that information relating to such change had come to them from
Mr. Meyer or Mr. Mac Williams. Under these circumstances, he felt that the
safest thing to do was to advise the Trust and Investment Division not to make
any trades in Penn Central on June 8.
On the afternoon of June 8, the news of the management shakeup was publicly
announced and this news was prominently featured in the New York Times and
the Wall Street Journal on June 9. In view of the public disclosure of this information, it was felt that there was no longer any reason to refrain from making sales
under the global order and the Trust and Investment Division was so advised
before the opening of trading on June 9.

After resuming trading on June 9, Morgan Guaranty Trust all but
ceased selling PC in significant amounts on June 12 until after the
bankruptcy petition. By June 21, 44 percent of the shares under the
global order had been sold.16 Hathaway testified that a hold was placed
on the sales because the market price of Penn Central had fallen aproximately 25 percent from the time the global order was placed, and
ecause he believed that the Federal Government would not permit a
company the size of Penn Central to fail. It was Hathaway's responsibility to obtain the best price possible once the decision to sell was made
and ne felt the price of PC would regain some of the 25 percent decline.
Although Penn Central was discussed at the corporate office meeting
on June 10, the discussion did not involve the sales of Penn Central
other than the change in Penn Central management on June 8. Meyer
did not attend the meeting and although Callaway was present at the


*• Practically all the remaining 468,500 shares of Penn Central held for the pension accounts were sold
between June 26 and June 30. Morgan Guaranty Trust sold the rest of Penn Central for the pension accounts
after the bankruptcy petition because it felt there would be nothing left for the shareholders in any type of
eventual liquidation. Selling was not immediately resumed because the initial news of the bankruptcy
petition depressed the price of Penn Central. After several days the price of Penn Central rose somewhat
and Morgan Guaranty Trust liquidated its holdings.

meeting, he stated that no one instructed him to cease selling Penn
By June 19, Morgan Guaranty Trust had sold 57 percent of the total
Penn Central shares held for the various trust accounts at the beginning of 1970. Specifically, 77 percent of the shares held in the personal
trust accounts, 92 percent of the investment adviso^ holdings, and 50
percent of the pension shares had been sold. In the accounts for which
Morgan Guaranty Trust exercised sole investment discretion 50 percent of the shares had been sold. Eighty-nine percent of the shares had
been sold in the accounts in which Morgan Guaranty Trust shared the
investment responsibility with a cotrustee.
The allocation of the sales under the global order to particular pension accounts was done in a manner so as to affect each account equally.
The percentages of Penn Central held in each pension account were substantially identical on May 29 and June 19.
At the time of the filing of the bankruptcy petition, there were 19
personal trust accounts and nine advisory accounts which still held
Penn Central. Documents submitted by Morgan Guaranty Trust
indicate that the appropriate party for each such account had been
contacted by his adviser before June 19 with the recommendation to
sell Penn Central, but the person sharing the investment responsibility
declined to sell Penn Central at the time. Smith testified concerning
the decision to place the global order and the effect of this decision on
the nonpension accounts:
Question. Now, during the discussions which occurred at this very brief meeting
[when the global order was placed] was any thought given to the accounts still holding
Penn Central which would not have been involved in the global order?
Answer. I don't recall any discussion of those accounts, however, entering the
global order did change the situation for the nonpension accounts, because it
meant that there was unanimity among the trust committee members, who were
in the trust investment division, that it should be sold. And I am satisfied that
John McGinnis and Harry Barbee, who are in charge of the nonpension side, put
additional pressure on the investment advisors who report to them, to try to get
their clients to sell the stock.
The nonpension side had been selling the stock for months, and as I mentioned
earlier, they sold 70 percent, roughly, of what they had . . . we were down to
what seemed to be a hard core of accounts. It was difficult to move the stock out
because of the attitude of the client or cotrustee. In addition, I was going to say,
there is a certain amount of latitude, even under these circumstances, allowed to
the investment manager in charge of specific accounts, the interpretation of
instructions, such as fielder's choice to sell, and some of the investment advisors
on the nonpension side were not so eager to sell the stock as some others.
And while I am sure they had all contacted their clients as they had been
instructed to, I don't know how forcefully they had to put it, but in any case,
after the global order was entered on the pension side, and McGrinnis and Barbee
had put additional pressure on all the investment advisors to go back to their
accounts and see what they could do to get it out.

Smith stated that it was unlikely that each nonpension account
cotrustee or beneficiary was told that Morgan Guaranty Trust had
placed a global order for the pension accounts but that increased
emphasis was put on obtaining the approval of the cotrustees to sell
Penn Central.
Since the bankruptcy petition, 27 of the 28 trust accounts have sold
their Penn Central holdings. Most of the accounts liquidated their
positions in June and July after filing of the bankruptcy petition;
several held their Penn Central securities until October, 1970.



Morgan Guaranty Trust has an established policy regarding the
treatment of confidential information obtained by its representatives
in the normal course of their duties. The bank's general rules and
regulations prohibit the improper use of such information. Rule 1
concerning confidential information states in part:
In the case of confidential information received from a customer, disclosure
within the company must not extend beyond those persons who need to know the
information in order to serve the particular customer from whom the information
was received. In the case of confidential information of other types [including
but not limited to such matters as customer identification, balances other account
information, security trading activity and investment programs] disclosure must
not extend beyond those persons within the Company who require such information
for the efficient performance of their duties.

In addition to the general rule, Morgan Guaranty Trust has circulated memoranda concerning special responsibilities to both the
general banking division and the trust department.
The memorandum to the general banking division, which was first
issued on November 8, 1968, specifically prohibits the transmitting or
providing confidential information obtained from a client of the banking division to anyone making an investment decision for Morgan
Guaranty Trust. Procedures adopted to implement this policy include
a prohibition against transmitting trip reports or conversations with
clients to the trust department and the research department, and the
denial of access to the banking department files to the trust department. In addition, a memorandum to the trust department originally
circulated in September 1968, requires each member of the trust department to clearly identify himself as requesting information from
an investment standpoint and not from a commercial banking standpoint.
Before May 27, 1970, the corporate research department at Morgan
Guaranty Trust served both the banking division and the trust
department. The research department was divided at the end of May
to serve the trust department and the remainder of corporate research
was moved to the banking division to serve that division exclusively.
This separation was represented as designed to ease the administrative burden and to remove the problems caused by having one research
department serve two entities. Smith also conceded that another
purpose was served:
Answer. * * * Of course, I am also aware that while the research and corporate
research personnel had seemed to be able to handle problems of potential conflicts
of interest arising from their working for more than one part satisfactorily, it put
us in the position that somebody might say that this was a hole in the wall that
existed between us [the Trust Department] and the commercial bank.

The timing of the division of the research department, it was testified, has nothing to do with Penn Central.
Holschuh was a vice president of Morgan Guaranty Trust, and its
analyst in charge of railroads. During April and May of 1970, he met
with officers of both the banking division and the trust department
concerning Penn Central. Holschuh met with MacWilliams of the
banking division on several occasions. During the course of these
meetings, Holschuh briefed MacWilliams on the operational history
and organizational structure of Penn Central, but Holschuh stated

that MacWilliams did not tell him anything about Penn Central.
Holschuh further testified that he never was aware of the size of loans
to Penn Central by Morgan Guaranty Trust nor was he aware of any
banking arrangements between Penn Central and Morgan GuarantyTrust and that MacWilliams never sent any information to Holschuh
about Penn Central. On May 27^ the day before the F N C B meeting,
Holschuh was transferred permanently to the banking division and
assigned to do statistical studies on Penn Central to assist Morgan
Guaranty Trust in evaluating its loans in light of Penn Central's
financial condition. He did not, however, learn of the sale of the pension
shares 01 the trades of Penn Central during May and June until some
2 years later.

Admittedly the commercial department of Morgan Guaranty Trust
Co. was in possession of nonpublic information regarding the financial
condition and future viability of Penn Central prior to the global
order sales by the trust department on May 29, 1970. However, Morgan Guaranty Trust personnel state'd that such information was not
passed to the trust department and that the global order and the subsequent sales were based upon information which was available from
the news media.

Continental Illinois National Bank & Trust Co. of Chicago, 111.
(CINB) was involved with Penn Central both by virtue of loans
extended to Penn Central and its subsidiaries and by its holdings of
common stock of Penn Central in trust accounts managed or advised
by its trust department. As of June 1,1970, the commercial department
of C I N B held outstanding debt of approximately $24 million of Penn
Central and its subsidiaries and during early June it became a member
of a 10-bank steering committee which was participating in a plan to
secure a federally guaranteed loan to Penn Central. CINB's trust
department held for various pension and profit sharing trusts, personal
trusts, and agency trusts approximately 422,000 shares of Penn Central common stock as of June 11, 1970. The overwhelming proportion
of CINB's holdings of Penn Central stock were sold between June 12,
1970, and June 19, 1970, at which time the commercial department
was receiving information regarding the financial situation of Penn
Central and the status of negotiations for the Government guaranteed
loan. That the bank was the recipient of significant nonpublic information which would reflect on the value of Penn Central securities
while the trust department was engaged in a program of selling Penn
Central securities raises questions as to whether such information
was passed on to the trust department forming the basis for sales of
Penn Central stock.

CINB's commercial department for a number of years prior to 1970
had participated in various lending arrangements to Penn Central and
its subsidiaries. In June 1970, C I N B held outstanding loans to
Penn Central and its subsidiaries of approximately $24 million comprised of the following: (1) a $15-million participation in a $300

million revolving credit loan which was secured by 100 percent of the
common stock of the Pennsylvania Co.; (2) a $4 million participation
in a $50 million unsecured revolving Eurodollar commitment; (3)
$3,898,000 of direct equipment lease financing arrangements; (4)
$735,000 of equipment financing comprised of conditional sales contracts; and (5) a $140,000 equipment financing comprising a conditional sales contract to the Indiana Harbor Belt Kailway Co.
Thus, CINB with $19 million of outstanding loans was the ninth
largest lender to 17
Penn Central excluding direct equipment loans and a
Swiss franc loan.
CINB first became involved in attempts to raise additional emergency financing for Penn Central when it was invited to a May 28,1970
meeting called by First National City Bank and Penn Central. Although the invitation was extended to a senior officer of CINB's main
office in Chicago, Donald Myers from the New York City office attended. Myers had not been previously involved in loan arrangements
with Penn Central, but he attended the meeting because Gerald Mast,
the officer most closely associated with Penn Central, was only just
returning to a partial work schedule after an illness. Myers, the only
CINB representative to attend the May 28, 1970, meeting, was
generally unfamiliar with the particulars of Penn Central financial
At the May 28 meeting, David Bevan, chief financial officer of
Penn Central, outlined the causes of the liquidity crisis as the result
of merger problems, namely an inability to keep refinancing its commercial paper in quantities greater than repayments due on maturity
dates and Standard & Poor's downgrading of the Pennsylvania Co.
debenture offering to a double " B " rating. Bevan stated that Penn
Central required an aggregate of $263 million of cash in 1970 primarily
to meet maturing debt obligations including $100 million of commercial paper, and to underwrite anticipated losses. Bevan proposed
that the necessary funds could be rasied by a $225 million bank loan
guaranteed by the Federal Government, a $25 million increase of an
existing $50 million loan to the Pennsylvania Co. and $13 million
from renn Central's continued sales of real estate or cutbacks in
compensating bank balances. With regard to future prospects, Bevan
expressed the view that the diversification program of Penn Central
should produce increased profits in coming years and that he anticipated that railroad operations could break even in 1971. Following
this general meeting, First National City Bank and Chemical Bank
were to meet with Bevan to structure a banking lending committee
to work out the details of bank participation in the refinancing
v The 10 largest lending banks based upon composite bank loans excluding direct equipment loans and a
Swiss franc loan were:
First National City Bank
Manufacturers Hanover
Ctrase Manhattan Bank
Chemical Bank.
Irving Trust Co
First National Bank of Chicago
Morgan Guaranty Trust Co
Mellon Bank.
Bankers Trust
Total of all participating banks


At the next meeting of banks on June 3, 1970, called by First
National City Bank for the 10 largest bank lenders to Penn Central,18
interim developments were reviewed including the June 2 application for the $225-million loan, the rejection by the various banks of the
proposed $25-million increase in the Pennsylvania Co.'s revolving
credit, and the drawing down by Penn Central of the remaining $33
million of a $300 million revolving bank credit arrangement. Also
discussed at this meeting were plans to secure the $225-million loan
and a proposed interim measure consisting of the 10 participating banks
each providing $5 million as a forerunner of the Government guaranteed loan. Six of the banks attending the meeting had previously
agreed to their ratable share; Chase, Irving Trust, Morgan and CINlJ
were still uncommitted. The loan policy committee of CINB on
June 5 reviewed the Penn Central liquidity crisis and the plans for
refinancing, and approved the bank's $5 million participation "If a
proper spread of collateral could be arrived at to improve our present
position.,, (All CINB loans were secured except for the $4 million
Eurodollar loan.)
The next meeting of participating banks was held on June 10 at
the Federal Reserve Bank of New York at wilich three representatives
of CINB attended. Paul Gorman, chairman of Penn Central,19 made a
presentation of Penn Central's financial and operational plans while
a representative of First National City Bank reported that the 10-bank
steering committee had reached general agreement on the $225-million
loan, with each bank taking a prorata share, and on a moratorium on
present debt. The final speaker was Paul Volcker, Under-Secretary of
the Treasury, who reviewed the administration's intentions to utilize
the Defense Production Act to guarantee the loan with a maturity
to October 31, 1971, at which time new legislation was anticipated to
provide financing for Penn Central and other railroads.
In between these meetings, CINB personnel involved in the negotiations for the loan to Penn Central kept contact with the primary
banks involved and kept officials at the Chicago office appraised of
developments of the plans for the Government loan. However, each
of the witnesses from the commercial department and the trust department denied that there was any contact or flow of information between
these departments. The first time that CINB apparently became aware
that the Government was not going to support the loans was on
June 19.

The trust department of CINB is divided into three groups by
general classification of types of accounts managed or advised, namely
employee pension or profit-sharing trust, personal trust, and agency
trust. Account advisers have responsibility for the investments in
specified accounts. Their discretion regarding investment decisions,
however, is guided by the trust department's stock selection committee
(SSC) which has the responsibility for conveying to the portfolio
managers information given out*by security analysts from the trust
department and from outside brokerage firms, and making recommendations for the purchase and sale of securities. The SSC transmits

See list of banks in previous footnot? on page 223.
Stuart Saunders, chairman of Penn Central and David Bovan, chief financial officer, had resigned on
June 9,1970.

its recommendations to account advisers by weekly "buy" and "source
of funds" lists. Changes in these lists are brought to the attention of the
advisers by flash memoranda (so named because of the word flash
imprinted on them), which are intended to denote matters which should
be given immediate attention.
Although the scope of authority of an account adviser to authorize
a purchase or sale does not appear to be formalized in the trust
department, generally he can buy securities from the buy list and sell
securities from the source of funds list by virtue of the SSC recommendation. In other situations, he must obtain the approval of a superior.
The group head of the personal trust group, however, indicated that
it was his policy to allow account advisers latitude to trade broader
than that contained solely to the buy or source of funds list. This
position is relevant to the Penn Central situation in that several
account advisers within this group authorized sales of Penn Central
stock on June 11, 1970, that is, prior to the issuance of a June 12
flash memorandum of the SSC which for the first time recommended
the sale of Penn Central.20
Whereas the SSC concentrates on recommendations for specific
securities, the trust investment committee (TIC), to which the SSC is
responsible, promulgates policy guidelines based upon economic and
industry analysis and establishes such priorities as the percentage
of investments which should be in equity versus debt securities and the
percentage of overall investments by industry groups. Normally the
TIC is not involved with investment decisions concerning individual
securities, but where a recommendation of the SSC relates to a major
holding of the department the TIC's approval is solicited by the SSC.
In 1969 and 1970, personnel in the trust department were aware of
the deteriorating financial condition of Penn Central. The predominant
source of their information was apparently articles in the financial
press including the Wall Street Journal, the newspaper which witnesses
uniformly identified as a daily source of information. However, except
for a short page and a half report of the trust department analyst
relating a visit in January 1970 with Stuart Saunders, chairman of
Penn Central, it does not appear that any in-depth analysis was performed. Sometime in early 1970, the analyst responsible for transportation securities was reassigned to an area outside the trust department
and his responsibilities were transferred to another analyst, Samuel
Sylvester. Except for an analysis in May 1970 of the financial impact
of the Eailway Passenger Act legislation, Sylvester was not involved
in any analysis of Penn Central until after the bankruptcy. The SSC
had placed Penn Central as a "hold" security in September 1969, but
as events indicated the deteriorating condition of Penn Central, this
status was not altered nor did the SSC or anyone else cause any indepth analysis to be performed. When asked who was responsible for
investment analysis of Penn Central, personnel from the trust department indicated that Sylvester had that responsibility, but in explaining
why he had in fact not performed such analysis, Sylvester indicated
that he concentrated during the first half of 1970 on an analysis of the
airlines industry.
In certain individual situations the sale of Penn Central stock was
recommended even though the overall trust department position was
None of the three account advisers who wrote sales order slips on June 11,1970, could recall the circumstances surrounding the preparation of these slips.

a continued "hold" on Penn Central securities. At an initial meeting on
April 20, 1970, after the opening of an account for a church organization, members of the trust department indicated that Penn Central
was "under consideration" as a sale candidate. Subsequently, on
May 15, 1970, 7,000 shares of Penn Central common stock were sold
from this account. In another account, CUT Equity Fund, CINB's
pool-type common stock fund for smaller employee benefit trusts,
CINB, on May 19, 1970, sold 20,000 shares out of a position of 60,000
shares of Penn Central held by that account. These sales were made
to raise funds to meet the anticipated withdrawal of one of the larger
participants in the CUT Equity Fund. Other than tbese two instances,
it does not appear that any substantial sales were made of Penn
Central securities in accounts managed by CINB's trust department.
As of June 11, 1970, CINB held 422,337 21 shares of Penn Central
stock for accounts managed and advised by its trust department, as

of shares

Personal trusts
Pension trusts
Profit-sharing trusts
Investment agency
Managing agency
Profit-sharing agency
Other fiduciary (pooled funds, other)

54, 920
206, 485
11, 000
27, 817
2, 615
17, 800
36, 700
65, 000

Specifically relating to Penn Central, the members of the SSC were
concerned about Penn Central for some time, but did not issue a sell
recommendation until the morning of June 12, 1970, at which time
they issued a flash memorandum which concluded regarding Penn
[The SSC] recommends the sale of the common stock in all accounts.
Commentary: Recent events indicate that the likelihood of returning to a
profitable basis appear quite distant at this point in time. Despite the possibility
of government aid in securing additional financing, the basic operational problems
of the railroad company will still remain and it is doubtful that substantial losses
can be avoided for the foreseeable future.

Personnel from the SSC and TIC, including Thomas Larocca,
chairman of SSC, Joseph Alaimo, member of SSC, and Philip J.
Dambach, chairman of TIC and head of the trust department, were
unable to recall precisely the sequence of events which led to the
issuance of the June 12 "flash memorandum." Generally, these and
other witnesses were able to recall some of the information reported
in the press relating to the financial condition of Penn Central, including the omission of dividends, quarterly earnings reports, the
cancellation of the proposed $100 million debenture offering of the
Pennsylvania Co., the maturation of Penn Central commercial paper
at a rate faster than it could be refinanced, and the res;gnations
of Stuart Saunders, David Bevan, and Alfred Perlman. However,
other than representing that these events evidenced to them a deterioration of Penn Central financially, they could not relate specific
discussions among the members of the SCC, the TIC, or with other
These figures were supplied by CINB with a caveat that "despite the apparent specificity of the figures,
complete accuracy cannot be guaranteed."

members of the trust department other than the fact that they were
certain that Penn Central had been discussed.
The SSC concluded that Penn Central securities should be sold some
time prior to June 12, but whether this was a few days prior or a week
or more prior was not specifically recalled by any of the witnesses.
In any case, at least by June 10, 1970, at the regular meeting of TIC,
the SSC communicated its view to the TIC that it wanted to issue a
sell recommendation. The SSC sought the concurrence of the TIC
because of the substantial holdings of Penn Central by trust department accounts. The TIC continued to believe that Penn Central stock
should not be sold, but again witnesses did not recall the specific views
of individual members of the TIC. Apparently, Dambach, as the head
of the trust department and chairman of the TIC, was the last to be
converted to the view that Penn Central should be sold. Dambach
believed that because the Federal Government had been so instrumental in the merger of the Pennsylvania Kailroad and the New York
Central Railroad the Federal Government would come to the aid of the
distressed Penn Central and not allow it to go bankrupt.
On the morning of June 12, 1970, Larocca reiterated his concern to
Dambach that Penn Central should be sold. Dambach finally agreed
apparently because of a news item in that day's papers which indicated that there was congressional opposition of a Government
guaranteed loan to Penn Centra1. With Dambach's decision thus
changed, Larocca relayed this to Alaimo who then contacted a trader
for the trust department with instructions to execute a 100,000 share
block trade. A "flash memorandum" was then drafted by an analyst
and circulated throughout the trust department.
The initial trade after the decision to sell Penn Central was consummated through Salomon Bros., which sold shares in the market
down to $10 per share and positioned the remaining 45,000 shares.
The average price per share for the block was $10.18975. Alaimo
testified that he contacted the group head of pension and profit sharings trusts so that he could have the advisors execute sale authorizations and allocate the trade among the accounts in this department.
This department was chosen because it had the largest proportion of
Penn Central common stock. Of this initial trade, 3,200 shares were
allocated to profit sharing trusts, including 2,000 shares for the Continental Illinois Employees Profit Sharing Trust, and the remainder
for various pension trusts including 6,800 shares for Continental
Illinois Employee Pension Plan Trusts. Later trades on June 12 and in
the following week were executed at prices slightly higher than the $10
for the initial block trade. The distribution of sales among the various
accounts administered by the trust department is set forth in the
following table:
Trade date

June 11..
June 12..
June 15..
June 16..
June 17..
June 18..
June 19..

Pension Profit-sharing

23,500 ....

900 ....










Except for the 100,000 share trade on June 12 initiated by Alaimo
as director of portfolios, sales were made upon the initiative of individual account advisors.
An advisory service offered by the bank recommended by a letter
dated June 16, 1970, that its clients sell Penn Central and invest the
proceeds in Howard Johnson securities. CINB also contacted other
accounts over which it did not have discretionary authority in the
usual manner by telephone.

Although the commercial department of Continental Illinois
National Bank and Trust Co. possessed nonpublic information concerning Penn Central's financial problems by virtue of its role as one
of the banks attempting to secure emergency financing for Penn
Central, personnel of the commercial and trust departments denied
that such information was passed to the trust department. Rather,
CINB maintained that the sales of Penn Central common stock
between June 12 and June 19,1972, were based upon publicly available

Alleghany Corp. (Alleghany), a public corporation whose predominant business activity is investing in corporate securities, and
Investors Mutual Fund, Inc. (IM), a mutual fund managed by
Investors Diversified Services, Inc. (IDS), were included in this
investigation because both sold substantial quantities of Penn Central
common stock on May 27, 1970, a day prior to the announcement of
the cancellation of the Pennsylvania Co. $100 million debenture
offering.22 Because until a few months prior to this, three Alleghany
directors had served as Penn Central directors, and because Alleghany
controls IDS, the sale of a combined total of 212,000 shares of Penn
Central common stock by Alleghany and IM raises questions as to
whether these sales were prompted by knowledge of adverse nonpublic
information and whether there was coordination in the sales of Penn
Central stock by these affiliated entities.

Traditionally, Alleghany's principal business has been investing in
corporate securities with particular emphasis, other than its investment in IDS, on the railroad industry. For instance, as of December 31,
1967, approximately 21.7 percent of Alleghany's assets of $187,794,396
was invested in railroad securities and approximately 58.8 percent of
its assets were comprised of noncarrier securities including 40.7 percent
of its assets invested in the capital stock of IDS.23 Even though the
nature of Alleghany's business was somewhat altered in 1970 by the
acquisition of the operating rights and licenses of a motor carrier
(the Jones Motor Co.), as of December 31, 1970 investments in
securities were $127,178,072 as compared to total assets of $176,465,22 On May 27,1970 the P e n n Central board of directors was informed that the proposed debenture offering,
was to be canceled. This information was not publicly released until May 28.
23 See Alleghany Corp.'s 1967 annual report.

216. In that year, securities transactions accounted for net profits of
$1,800,753 and net income exclusive of securities transactions was
In 1954 and early 1955, Alleghany purchased 384,100 shares of New
York Central Railroad (Central) stock. I t increased its holdings by
purchasing 600,000 shares of Central stock between 1955 and 1959
(200,000 shares were also acquired at the same time by Allan P.
Kirby, ST.). By 1966 Alleghany owned 984,000 shares of Central (15
percent of the total outstanding voting shares) and Allan P. Kirby,
Sr., chairman of Alleghany at the time, owned 300,100 shares of Central or approximately 4.5 percent of the total outstanding. Seven of
the 10 Central directors were members of Alleghany's board of
directors, and, in addition, three of the five members of the executive committee of Central had joint affiliations with Alleghany.
On March 28, 1966, after the approval of the merger between the
Pennsylvania Railroad Co. and Central, but prior to the actual consummation of the merger, Alleghany offered the Central securities in
its portfolio to Alleghany shareholders in exchange for their Alleghany
securities. 25 As a result of this offer 833,181 shares of Central common
stock were exchanged so that Alleghany continued to hold 150,919
shares of Central stock. The reasons for the exchange offer as stated in
the offering circular were the inadvisability of maintaining a substantial
portion of its portfolio in stock of a corporation Alleghany would not
control; the ability to liquidate the Central holdings without incurring
a substantial capital gains tax; the changing nature of Alleghany's
portfolio from that of a railroad holding company to a more diversified
portfolio. Although not so stated, another reason was that the Kirby
family control of Alleghany would be ultimately increased. 26
After the Penn Central merger, Alleghany owned 196,195 shares of
Penn Central common stock representing .85 percent of the total
outstanding and Allan P. Kirby, Sr., owned 390,130 shares of Penn
Central common stock or 1.69 percent of the total outstanding shares.
Although Alleghany and the Kirby family might not be considered in
control of Penn Central, they had a substantial interest in its affairs
as evidenced by the fact that five of Penn Central's 22 directors were
also Alleghany directors: James S. Hunt, Fred M. Kirby, William G.
Rabe, Carlos Routh, and Daniel E. Taylor.
This close relationship was obvious on its face and admitted by
Fred M. Kirby at an Alleghany shareholders meeting on April 26,
1968, when he stated in response to a shareholder question: "We have
incidentally very fine representation on the Penn Central Board and
are very close to that situation and feel that we're in a very good
position to appraise the desirablity of it as a continuing investment." ^
From the above figures, it is readily apparent that more than 40 percent of Alleghany's assets are inves tment securities, thus placing the company within the definition of an investment company under Section
3(a)(3) of the Investment Company Act of 1940. However, Alleghany was exempted by the Commission
from regulation as an investment company in 1945 and again in 1970 by reason that Alleghany was subject
to regulation by the Interstate Commerce Commission and thus exclude 1 from the Commission's jurisdiction as provided in Section 3(b)(7) of the Investment Company Act of 1940.
Allan P . Kirby, Sr. did not mclude his Central shares in the offer nor did the Kirby family interests
exchange any of their Alleghany securities.
2 Whereas on February 28,1966, Allan P. Kirby Sr. owned 40.4 percent of the common stock of Alleghany,
on April 15,1966 after the exchange offer he was the beneficial owner of 55.36 percent of the Alleghany common
stock. Notice of annual meeting to shareholders of Alleghany, April 19,1966.
2 Fred M. Kirby became chairman of Alleghany in 1967 after his father, Allan P . Kirby, Sr., suffered a
severe stroke. F. M. Kirby and Allan P . Kirby, Jr., were appointed guardians of their father's property also
in 1967.

Unheeded investment advice
Information and documents received by Penn Central directors at
board meetings did not permit sufficient time for thorough analysis
by them. F . M. Kirby frequently relied upon John J. Burns, vice
president of finance for Alleghany, for his analysis of the financial
condition of Penn Central. Although Burns was not a rail expert as
such, his background in motor carriers and his responsibilities at
Alleghany for investment analysis of present and potential holdings
included expanding his knowledge of railroads.
Beginning sometime in the spring of 1969 and continuing into 1970
Burns was formulating the belief that Alleghany should sell its Penn
Central stock because of the operational and financial problems. The
earliest evidence of the crystalization of Burns' growing belief that
Alleghany should sell its Penn Central holdings is found in a March 11,
1969, memorandum to F . M. Kirby in which Burns stated that he
regretted not having s t r o n g ^ recommended sale at a higher price
and that he had "not firmly made up my mind b u t feel the odds favor
a sell rather than a hold some time soon." The subject of selling Alleghany's Penn Central stock was presented at Alleghany's March 1969
board of directors meeting at which time Burns outlined the "pros"
and "cons" of a sale. The minutes of that meeting reflect that counsel
to Alleghany pointed out that substantial legal problems existed in that
prior to a sale, Alleghany might have to announce its intention to sell,
followed by a waiting period before the sale. The sense of the directors
was to not dispose of the Penn Central holdings at that time.
Following the April 23, 1969, Penn Central board of directors meeting F. M. Kirby forwarded to Burns Penn Central's consolidated
income statements for the first quarter of 1969 and an income statement for the parent railroad company. Kirby in an attached note to
those statements said:
Directors impressed today with MGT position that Penn Central foul-up
has been largely corrected. Will not show up in earnings for some time unless
unexpected surge of volume develops.
I believe the attached figures, entrusted to you in confidence, contradict Wall
Street assumptions.

In a reply memo Burns, using these first quarter figures, calculated
the net railway operating income after fixed charges as a $20 million
loss in the first quarter of 1968 and a $36 million loss in the first
quarter of 1969. Annualizing these figures, losses would have been $80
million in 1968 versus $144 million in 1969. However, Burns pointed
out that losses in 1968 were actually $150 million. Thus apparently
$130 million of losses were attributable to the last three quarters of
that year. Accordingly, with first quarter 1969 showing no turnaround,
losses were predicted by Burns to be close to $200 million for 1969.
In concluding this memorandum Burns referred to the legal problems
of a sale by stating:
Since we have apparently no choice but to hold on to Penn Central for the time
being, this memo is somewhat unnecessary, nonetheless, I did feel constrained
to briefly comment on the confidential figures which you gave me.

In July 1969 Burns had reached the conclusion that Alleghany's
holdings should be liquidated, but again this necessitated overcoming
the legal problems which counsel had previously presented. Burns
again wrote a memo to Kirby with a new approach of securing a

private placement of Alleghany's Penn Central stock as well as the
IDS and Kirby family Penn Central shares:
For various reasons I have been interested in seeing Alleghany Corporation
dispose of its investment in Penn Central. In conversation with John Tobin it has
developed that one feasible way for a sale of our holding to be effectively accomplished in a manner that would minimize the possibilities of any successful
litigation, would be for Alleghany, the Kirby family and IDS to sell all of their
shares, preferably at the same time, to a group who could be considered sophisticated institutional-type buyers.
I have determined t h a t IDS has partially completed a selling program of its
IDS shares, and t h a t they would be interested in participating if a block transaction was to be accomplished to the extent of all of their remaining 440,000 shares.
Counting our shares, the Kirby family shares and IDS shares, we would need
to sell approximately 1,136,000 shares of Penn Central to dispose of all of the
stock. If such a sale is to be contemplated, timing if of prime importance. At the
present time, I understand that since Penn Central stock is an "exempt security''
(because of its ICC status). A sale of Alleghany and the family's stock would not
require either an investment letter of a registration statement. However, once
the Penn Central shares are turned in for the new holding company shares
(probably later this summer) the new shares will have lost their "exempt" status
and will have to be sold on either an investment letter or a "registration" basis.
This could possibly make a sale both awkward and expensive.
Therefore, timing is very important.
In order to accomplish a major sale such as this, I feel the cooperation of the
railroad's management will be almost essential. Since we cannot induce buyers
ourselves (for obvious legal reason), large institutional purchasers would probably
be most easily found by an enthusiastic management who should have a real
interest in seeing a large block of the company's stock successfully placed in good
Accordingly, I would like to discuss this matter with Mr. Saunders at once,28
assuming that you and the family are seriously interested in a sale at this time
and under these circumstances. If you are not interested on behalf of your family
holdings, I would like to see if another way can be found to enable us to sell our
shares in a manner which would minimize potential legal problems.
Comments would be appreciated.

This view that a sale of their Penn Central stock should be made
was presented by Burns again in a July 15. 1969, memorandum to
P. M. Kirby reviewing the status of Alleghanj^s investment portfolio:
You know my opinion of this one (Penn Central). I feel the sooner we get out
the better, even at these prices, since in my opinion, the company with its current
inept management and large, uneconomical, ungainly, high cost, rail system will be
particularly vulnerable to the impending labor squeeze I see forthcoming in the
early 1970's. If we must maintain a railroad investment of some kind, it would
not be this one, in my opinion.

Burns continued to press his method of selling the Penn Central
holdings to a sophisticated investor or financial institution especially
because when the Penn Central holding company would be created it
would fall within jurisdiction of the Securities and Exchange Commission rather than the Interstate Commerce Commission. A Burns
memorandum of September 25, 1969, to Kirby presents this view:
According to the attached announcement 29 our Penn Central shares (now
representing shares in a carrier corporation) will be automatically exchanged
for noncarrier holding company shares on October 1. I feel that this plan is detrimental to Alleghany Corporation since, according to counsel, once our Penn
Central shares no longer represent shares in an ''ICC regulated carrier corporation"
they will either have to be registered, or an investment letter will have to be
obtained, if and when sale is to be effectuated. As I understand it, right now,
assuming resolution of various other problems, we could sell our Penn Central
shares to a knowledgeable buyer without either a registration statement or an
investment letter.
2* In his testimony before the staff on Apr. 29,1971, Burns stated he at no time met with Saunders.
« News article in Wall Street Journal, Sept. 25,1969.

I do not know what we can do about this situation but it appears to me that this
"automatic" exchange of Penn Central railroad shares for Penn Central holding
company shares without any vote or registered exchange offer to shareholders is
unfair to stockholders, such as Alleghany Corporation.

In furtherance of his view that Alleghany should sell its Penn Central
stock, Burns discussed in October 1969, such a sale during the course
of a general conversation on the condition of Penn Central with E.
Clayton Gengras, chairman of the board of Security Corp. of New
Haven, Conn.,30 Burns thought perhaps Gengras might be interested
in purchasing Alleghany's stock, but again this approach was not
followed up. A number of other memoranda in 1969 and 1970 to Kirby
continued to emphasize the poor condition of Penn Central and
that the Alleghany holdings should be sold.31
Events leading to sale of Penn Central common stock
At the same time that Burns was recommending sale of Alleghany's
Penn Central shares, Alleghany in April 1969, had filed an application
with the ICC for authority to acquire control of Jones Motor Co. and
its subsidiary32 as to be able to have the operating rights to act as a
motor carrier. During the course of the hearings before the ICC on this
matter it became apparent that Alleghany would probably be required
to divest itself of any other interests in an ICC-regulated carrier.
At various times Burns had suggested that to improve its position with
the ICC, Alleghany should sell its Penn Central shares.
By order of Janaury 27, 1970, the ICC granted Alleghany's application to acquire the operating rights and properties of Jones Motor
Co., but because of the close relationship between Alleghany and Penn
Central, Alleghany was directed to place its Penn Central securities
in a trust and within 5 years sell them, and also to terminate all joint
director affiliations between Penn Central and Alleghany. Although
the Penn Central shares owned by Allan P. Kirby, or. did not have
to be sold, they also were directed to be placed in a voting trusteeship.
Joint directorships were terminated by Daniel E. Taylor resigning
from the Alleghany board in March 1970, and F. M. Kirby and Carlos
J. Routh resigning from the Perm Central board in March 1970.
Those Alleghany directors serving on boards of Penn Central subsidiaries likewise resigned from those positions.
The trusteeship of Alleghany's shares was placed with Irving Trust
Co. by an initial agreement of March 26, 1970. Various amendments
were made to the trusteeship agreement with the final agreement
executed on April 27, 1970. Basically the trusteeship provided for
initiative for sales to rest with Alleghany at the early stage of trusteeship, with consultation with the trustee.33
Apparently the decision by Alleghany to sell its Penn Central
shares was made shortly before the May 15, 1970, Alleghany board of
directors meeting. The minutes of that meeting reflect that the sale
of Penn Central Co. capital stock was discussed at length and Burns
stated that, "it was management's intention, if given suitable market
conditions, to dispose of this investment."
Gengras in December 1969 become a director of P e n n Central.
3i One memorandum of Apr. 16,1970 from Burns to F . M. Kirby summarized a meeting with D a v i d B e v a n ,
chief financial officer of P e n n Central, in which B e v a n "did not seem shocked at m y suggestion of the possioility of future insolvency if current trends continue m u c h longer."
32 Alleghany m a d e a successful tender offer for Jones Motor Co. shares i n 1968.
33 This was set forth i n a plan for accomplishing the disposition of Penn Central shares owned b y Alleghany
and held in t i u s t b y Irving Trust Co. which was drafted on May 26, and submitted to Alleghany on May 27,

That Alleghany was interested in selling its Penn Central stock was
communicated to an institutional sales representative, John Shepherd,
who handled Alleghany's account at Goldman, Sachs. Although the
time has not been precisely fixed, Burns told Shepherd in February
or March 1970 that Alleghany would be in a position to sell its Penn
Central stock. However, no action was taken either by Goldman,
Sachs or by Alleghany to sell the Penn Central stock.34
On the evening of May 26, 1970, at a dinner hosted by Shepherd
for his clients, Burns had occasion to discuss Penn Central with the
head block trader of Goldman, Sachs; Robert Mnuchin. Burns
recounted the discussion with Mnuchin on the evening of May 26
and the sale on May 27 as follows:
During the course of the evening, he mentioned to me he knew I had been
listed by Jack (John Shepherd, an institutional sales representative for Goldman,
Sachs) as a possible seller of Penn Central,35 which I had been, and that in his
opinion, the market was active in Penn Central and that he might be able to make
me a good bid if I was still interested in selling and I asked him why and as I
recall his answer was: there are plenty of buyers in Penn Central and I think it
is a good trading stock right now.
So before the evening was over, I asked Mr. Mnuchin to give me a call the
next day, which was the 27th and if he had a bid to make, possibly I would
entertain it. I went home that night. The next day Goldman, Sachs phoned, Jack
Shepherd did call, put Bob Mnuchin on the phone, and gave me the opening in
Penn Central, and said I can give you a bid for approximately 200,000 shares at
somewhere—at a discount, would you be interested in entertaining a bid?
Now, this was the first time anybody had told me that, (A) I could sell this much
stock, and, (B) in effect, put up or shut up. My recollection is that I went in and
had a general discussion with one of my associates—a discussion which lasted
about an hour concerning the state of the market, the decline in the stock on the
one hand and our pessimistic feeling concerning the losses for this year of the railroad and [sic] the other, that we thought it would be a good idea to sell half of our
position, about half of our position.
I then went back, call Mr. Mnuchin directly and asked what he was prepared to
do on 96,000 shares—roughly 96,000. Maybe exactly 96,000, and after checking
the market, as I recall, he came back and said that—I am not sure of the exact
figure, so you will have to forgive my inaccuracy, the last sale was 13%, that he
would like to make a position bid on or around 13% and that he would give me the
benefit of any sales that he was able to get off in brining the stock down to the 13^£
level where he would be the buyer and I would be the seller and the block would
I believe we negotiated a little, he might have given me a bid and I got him up
to 13J£> he might have given me 13}^ and I got him up to 13%. I am not sure of
the facts. I told him that would be acceptable, but I had to speak to the Irving
Trust Company who was the record holder of the stock (trustee for Alleghany's
Penn Central stock).
I called Mr. McCabe and spoke with him and in line with our trust agreement,
I was recommending a sale at this particular time and Goldman, Sachs and Company had made us a bid and that I would recommend that he go along and accept
the bid on behalf of us as beneficial owner.
He said he thought that was all right. I then called Mr. Mnuchin and asked him
to get in touch with Mr. McCabe or one of his assistants directly. The trade was
consummated somewhere around 12:00. The stock closed that day higher and
there was quite a bit of buying.
Those are the circumstances under which I accomplished that trade.

The sale of 96,000 shares of Penn Central was executed by Goldman,
Sachs at $13% per share for 70,000 shares, with the remainder sold in
the market at prices ranging from $13% to $13% per share. The
balance of Alleghany's 100,000 shares of Penn Central were sold in
M Goldman, Sachs was a dealer in Penn Central's commercial paper and was in frequent communication
with Penn Central during this period, especially in late May.
3 Mnuchin's recollection somewhat differs in this regard as he believed Burns initiated the conversation
about soiling Penn Central, although Mnuchin did not specifically recollect who initiated the discussion
on Penn Central.

January 1971, and the Kirby family holdings of Penn Central were
disposed of on September 22, 1970.

Investors Diversified Services, Inc. provides, among its other lines of
business, advisory and distribution services for six open-end mutual
funds with assets as of September 30, 1971, of approximately $6.6
billion. Three of these funds, Investors Mutual Fund (IM), Variable
Payment Fund (VP), and Investors Stock Fund (IS) sold common
stock of Penn Central in 1969 and 1970. In September 1968, Penn
Central common stock owned by IDS-managed funds totaled 1,020,000 shares divided as follows between the funds: Investors Mutual—
500,000 shares; Variable Payment—200,000 shares; and Investors
Stock—320,000 shares. These positions had been accumulated over a
period of time commencing in 1967. The following table shows the
holdings of Penn Central of the three funds, beginning on January 1,
1968, and showing subsequent purchases and sales.

Holdings on
Jan. 1,1968
Investors Mutual
Investors Stock..
Investors Variable

Purchases Jan. 1,1968 Mar. 27,1969
Aug. 26,1968 July 17,1969

Oct. 8,1969 Jan. 19,1970
Oct. 16,1969 Mar. 26,1970

May 6,1970
May 27,1970













Events surrounding sales by IM
Whereas IS and VP began to sell their Penn Central stock in
March and April 1969, respectively, and had completely sold out
their holdings in May 1969, IM continued to hold all of its Penn
Central shares in its portfolio until June 13, 1969, when the investment committee of IM authorized the sale of 100,000 shares of Penn
Central from its holdings of 500,000 shares. Such an authorization
permits the fund's portfolio manager to sell the stock at his discretion.
This authorized sale of 100,000 shares was completed on July 8,1969,
and the sale of an additional 100,000 shares was authorized on July 9,
1969, by IM's investment committee. After the sale of the initial
authorization was completed, sales of Penn Central stock were intermittent during the remainder of 1969 and until May 1970.
It is apparent that the portfolio managers of IS and VP were more
strongly convinced that Penn Central stock should be sold, than was
the portfolio manager of IM. Harold A. Schwind, portfolio manager
of IM with responsibility for Penn Central, commented on the long
period of time it took to sell the Penn Central stock:
Answer. I think the most important reason was I didn't feel that I had enough
information and a strong enough feel of the situation to warrant holding it. It
sounds like reviewing the problem from a little different focus, but at no time did
I have hard, fast, specific reasons for selling it. If I had, I think I would have sold
it quickly.
One of the unusual things about the sale of this stock is it took us 11 months to
sell it. I can't remember ever taking that long to sell anything before.

Question. What was the most important reason for your not selling it quickly?
Answer. I guess I was never sure that I was making the right decision. In fact,
when we sold the final block of the stock in May, there was no feeling of elation
because I wasn't sure I was doing the right thing.

After the additional authorization to sell 100,000 shares of Penn
Central was made on July 9, 1969, only 8,100 shares were sold before
IM ceased selling. The reason for this is associated with a conversation
between Stuart F. Silloway, president of IDS, and Jack L. Nienaber,
vice president of IDS. Nienaber recalled the conversation:
He (Silloway) noted that we were selling additional Penn Central Stock. * * *
And he urged that we take another look and not sell it, because he thought there
were good reasons on the basis of conversations he had with people he considered
well informed who felt the company, if you will, had a very real chance to turn

This information was relayed to the portfolio manager of IM,
Harold A. Schwind:
My superior, Mr. Nienaber, came to me one morning—it was early in the day—
and related a conversation he had just had with Mr. Stuart Silloway, the president of IDS, and Mr. Silloway had told him that he had a contact—some acquaintance or broker, some contact—that was never identified to me—who apparently
was aware that we were selling Penn Central and felt that we were making a
mistake and would like to tell us more about the situation and the attractiveness
of the stock.
We discussed it, Mr. Nienaber and I, and felt that under the circumstances
we had better put a hold on the stock and stop selling it.

Silloway's well informed source was Fred M. Kirby, chairman of
IDS and Alleghany Corp. and a director of Penn Central. Silloway's
version of the conversation with Kirby was similar to Nienaber's in
that as he recalled the conversation:
He (Kirby) expressed a point of view that, well, maybe there will be some improvement that you will see. Perhaps there will be something; maybe the thing
is not as bad as you think it is—nothing tangible or nothing specific.

Later in his testimony Silloway restated Kirby's view as more of
a hope some progress would be made by Penn Central in its operations.
This information was apparently of sufficient import that IM made
no sales of Penn Central until October 1969. As Schwind stated, he
decided to sell Penn Central again because:
Well, nothing was ever heard back from Mr. Silloway or Mr. Nienaber with
regard to the original comment of talking to some contact with regard to Penn
Central. * * * I didn't really consult with anyone about resuming of the sale. I
believe—I'm sure I mentioned \% to Mr. Nienaber. So we just simply opened up
the balance of the stock and began to sell.

After the authorization for sale was again approved in October
1969, sales were sporadic: between October 8-16, 1969, IM sold
45,600 shares and between January 1, and March 26, 1970, 103,100
shares were sold. The hiatus from selling in November-December
1969 was not explained by any of the witnesses, other than being
based on indecision.
However, another contact this time with Charles Hodge, chief investment adviser to Penn Central and a partner of Glore Forgan,
William R. Staats, may have resulted in this cessation from selling.
Silloway called Hodge after seeking guidance from a friend in Philadelphia as to the name of someone who "really knew Penn Central inside
and out * * * somebody who had done a lot of work and had access
perhaps to people within management who would help them put infor-

mation together." Silloway was supplied the name of Hodge as one who
could provide such information. SiJloway then called Hodge in late
September or early October of 1969, but was unable to obtam answers
to his specific questions on operating expense trends of Penn Central
other than that Hodge had confidence in the Penn Central situation
and was going to recommend the stock to some people who hopefully
would purchase substantial amounts of the stock and that then he
would be an influeace in changing the management.
The lack of sales in April 1970 was explained as caused by an oversight by the portfolio manager in that the authorization for sale of the
remaining portion of Penn Central lapsed 6 months after the September 1969 authorization. A new authorization was obtained on
May 5, 1970, to sell IM's remaining position of 243,200 shares of Penn
Central. When sales commenced on May 6 again there was little urgency in the disposition of the Penn Central stock.
John P. Vervoort, president of IDS securities and the trader of
Penn Central for IM, commented on this lack of aggressive selling.
Answer. I do not recall specifically the instructions. However, if I look at the
sales as they occurred none of them indicate to me that there had been any urgency,
if you wish, or guidance or expression of opinion that this stock should be sold
in a very definite manner. None of these trades are of any relative size with the
exception being the 27th of May. So I cannot recall any precise instructions.
Question, Can you recall any instructions whatsoever, precise or imprecise?
Answer. I do vaguely recall a number of times having had participating instruction. When, precisely they were, I do not recall.
Question. Could you describe what these participating instructions were?
Answer. Participating instructions are generally construed as meaning to
participate in the floor activity on a stock and we generally think in terms of
20,000 and 25,000 shares. Anywhere between that.

Participating sales were accomplished in this situation by a continuing order at the brokerage firm of Mitchum, Jones & Templeton
to sell as many shares as possible within a specified price range. At
the conclusion of the day, the Mitchum firm would notify Vervoort
of sales executed on its behalf that day. Even on days which resulted
in the sale of significant amounts of Penn Central stock, a number of
smaller trades contributed to the larger total.
Date and number of shares in trade
May 6:
May 7:
May 8:
May 14:
May 15:
May 19:












Date and number of shares in trade
May 19—Continued
May 21:
May 26:
May 27:




-- \r>


.... \m


.... 13


1 Trade was for 110,100 with 81,600 positioned by Shields & Co., after trades available at higher prices were executed.


The sale of 110,100 shares through Shields & Co., was a variation
from the previous pattern of selling small pieces of I M ' s Penn Central
holdings. From the testimony of a number of witnesses at IDS, the
change in selling pattern occurred because of a comment from the
I D S analyst of Penn Central to the trader. Apparently at some time
during the lunch hour. Richard Warden, the" rail analyst for IDS,
entered the trading room seeking the trader for Penn Central to discover how much P C stock I M continued to hold. Previously Warden
had without success looked for Nienaber and Schwind for this information so he sought out the trader. Warden told the trader: "that
I was concerned that this was a possible bankruptcy, and I felt that
the stock should be sold. ,, The trader then contacted Shields & Co. for
a block bid and thereafter Mitchum, Jones & Templeton to find out
how much had been sold that day on the participating sale instructions.
Upon learning that 6,200 shares had been sold, the remaining order
was canceled. Vervoort stated his reasons for the decision to sell:
My decision to sell that stock on that day was based upon a long period of selling
this stock, passing a number of opportunities to have sold stock before, to have
seen the price deteriorate constantly over a rather long period of time, having
been involved in the wrong decision to purchase part of that stock, to the remark
that Mr. Warden made, to the fact that the portfolio managers, Mr. Hal Schwind
and Mr Nienaber were not available. I was just sick and tired of this stock and I
was sick and tired of the indecisiveness. I probably felt guilty about having been
involved in the suggestion that the stock be bought much earlier at much higher
prices, that this was—it just reached the peak, if you wish at that time on that day
or a combination of all these factors as the trend of the stock indicated that this
thing could slip down further and I just took this opportunity to once and for all
get it off the books.
To be done with a decision that had been made much earlier but had never been
fully executed.

Vervoort had had this feeling of indecisiveness for a number of
months, but characterized Warden's comment as the excuse needed
to then act decisively. Warden's comment concerning the possible
bankruptcy of Penn Central resulted from being told of a report over
the Dow Jones on M a y 26, and an article in the Wall Street Journal
on May 27, that Penn Central's commercial paper was maturing faster
than it was being sold. While this information was conta ; ned in a prospectus dated May 12, 1970, issued by the PennsyH^ania Co., Warden
testified he did not recall whether in fact he had seen the prospectus
and did not learn of the information concerning PC's commercial
paper until May 27.
Thus Vervoort made a definite change to clearn out the position
by diverting from the prior pattern of selling.36 Schwind stated that
the trader's cancellation of the sales order at Mitchum Jones and the
solicitation of a block bid at a discount from the current market price
would be somewhat inconsistent with the instructions the trader had
and that it is a customary practice for a trader soliciting a discount
bid to first talk with the portfolio manager. However, Schwind also
characterized a discount of three-fourths of a point as not clearly
excessive but in a "gray area" in which the trader could in his discretion make such a decision. Nienaber also stated that the trader's
action was within the limits of his discretion.
3 A telephone call was made from the Goldman, Sachs trading room to IDS shortly before IDS's sale
of Penn Central, but who made or received the call and the substance of the conversation is not known.
Mnuchin from Goldman, Sachs testified that this commercial call could have been made because the direct
line had broken down.

Additional circumstances relating to IM's May 27 sale of Penn Central
At the initial stages of the investigation of the circumstances relating to sales by both Alleghany and I M of substantial quantities
of Penn Central stock on May 27, 1970, coordination between sales
was believed to be possibly linked to several telephone calls recorded on
telephone toll slips of Alleghany to various personnel at I D S . A certain
number of telephone calls should certainly be expected because of the
close affiliation between Alleghany and IDS, but most likely such calls
would be to management personnel at the higher corporate levels
of I D S due to Alleghany's interest in overall corporate policy of I D S .
Indeed, this was primarily the situation in that calls normally made
were to such individuals as the vice president for public relations,
the comptroller, vice president for law, et cetera. However, calls were
made on May 25, 26, and 27 which did not follow the prior pattern of
calls from Alleghany to I D S .
On May 25, 1970, a call was made to the telephone number of
Thomas R. Reeves, vice president for investments, which lasted for
19 minutes. A few minutes after the conclusion of that conversation, a
call was made to the telephone number of Robert B. Johnson, vice
president—investment research which lasted for 34 minutes. The next
day, May 26, at 10:11 a.m. (New York City time), which would be 9:11
a.m. Minneapolis time, Johnson of I D S apparently conversed with
someone from Alleghany for 15 minutes. On May 27, the day of the
trading by Alleghany and IDS, SUloway's secretary received a call
at 11:15 a.m. which lasted for 2 minutes.
The obvious question is what was the purpose of these calls? A
reason for focusing on these calls is that neither Reeves nor Johnson
had received direct phone calls from Alleghany for the year prior to
M a y 1970. In addition, Silloway received only one phone call from
Alleghany on his direct number during the year prior to May 1970. I t
is possible that these calls bear no relationship to the trading in Penn
Central but the suspicions exist in that after Alleghany had placed its
order to sell then I D S may have been given the green light for it to
sell. Counsel for Alleghany stated that "we are unable to determine
who placed these calls but Mr. Burns does not recall making any of
From affidavits of Thomas R. Reeves and Robert B. Johnson, it does
not appear t h a t either person was the recipient of these calls from
Alleghany on those dates. Reeves was in New York City on May 25
through May 27 and stated that it was his practice to use Alleghany's
office to keep contact with his office in Minneapolis. In addition,
Johnson was not in his office on May 25, but was playing in a golf
tournament which was verified to the best of their recollection by three
other persons. Both Reeves and Johnson denied discussing Penn
Central with anyone on May 25 through May 27.
Other coordination could have existed due to an I D S executive
committee meeting on May 26 at Alleghany's office attended by
Kirby and Silloway. However no, evidence was uncovered that Penn
Central was discussed either informally or formally and furthermore,
both these persons denied any conversations occurring on that date
or at any other time, other than previously described in this section.


Officers and employees of Alleghany Corp., Investors Mutual Fund,
Inc. and Investors Diversified Services, Inc. asserted that the sales
on May 27, 1970, of Penn Central stock were made independently
without any communication between these entities and that none of
the sales was made on the basis of material nonpublic information.


Between the time of the formation of Penn Central Transportation
Co. in February 1968 and the June 1970 bankruptcy, as management
deliberately and increasingly glazed its public reports with distorted
optimism, many members of37management succeeded in selling many
shares of Penn Central stock. This section of the report deals with the
detailed inquiry the staff has made into the sales of Penn Central
officers and directors after the merger.38
The securities laws, in particular rule 10b-5 of the Securities
Exchange Act of 1934, prohibit stock transactions based on material
inside information which has not been disclosed to all parties in the
transaction or to the public in general. Therefore, any officer aware that
the company's prospects were significantly more dismal than the
public had been led to believe would have been precluded from trading
in Penn Central shares while the disclosure gap existed, even though
such officer's unwillingness or inability to correct the disclosure gap
could have had the effect of locking him in to his investment.
Other sections of the report analyze in depth the areas in with the
Penn Central disclosure gap existed, and the widening of that gap
with the passage of time and the decline of the company. This section,
which examines the timing and extent of officers' sales, the reasons
given for them, and the position of the officers in the corporate structure, is intended to be read in conjunction with the full report in
determining whether any officer trading was done on the basis of
material inside information.39 The reader's attention is also called to
the chronology of events which accompanies the disclosure report,
and which should also used to shed light on the possible culpability
of various officers for their sales. Finally, even though very difficult to
assess, the existence of rumors should not be discounted. Considering
the broad and fundamental nature of the problems facing Penn
Central, their impact may well have been widespread and significant.
During the course of this investigation, the trading of over 80
officers and directors was reviewed, including officers and directors
who left prior to the bankruptcy and/or joined the company post
merger. A large amount of documents of such trading and the reasons
for it were submitted and reviewed, and in certain cases outside confirmations of various events were obtained. Any major trading which
occurred after the merger was questioned in testimony or through the
use of affidavits. The staff found that virtually no outside directors,
37 The 15 officers whose trading is summarized in this report held, at the time of the bankruptcy or of
their departure from the company prior to bankruptcy, only about ?0 percent of the total amount of Penn
Central stock they had owned at the time of the merger. (Thisfigureexcludes thrift plan distributions).
38 The term "officer" in this report means anyone with the title of president, vice president, treasurer,
secretary, comptroller of Penn Central Transportation Co. or of Penn Central Co.
«e Although the news coming out of the company was, in retrospect, optimistic to the point of absurdity
it was, even in its watered-down form, mostly bearish. Some officers' trading occurred at times when specific
items of bad news were known within the company, but had not reached the public in any form, such as,
for example, earnings reports. Where there appears to be a connection between an officer's sale and such
specific information, it is discussed below as part of the summary of the officer's trading.


most of whom owned only minimal amounts of Penn Central stock,
had made significant sales for their own accounts during the postmerger period.40
The investigation revealed that, although the trading carried on by
man^r officers raised few questions concerning its propriety under the
securities laws, the conduct of a significant number of officers demanded serious consideration in this regard. The staff has selected from
these questionable trades those which appear to raise the most serious
questions under the securities laws, and has summarized them in this
Many factors complicated this retrospective study.41 The price of
Penn Central stock slid ineluctably from a high of 86 J^ in July 1968,
to a low of 10 in June 1970, just prior to the June 21 reorganization
announcement. The 2-year performance of the stock makes it very
possible that some officer sales were legitimately made simply on the
basis of public adverse information. On the other hand, it must be
remembered that there were many investors not bailing out during
this period. Indeed the optimism or thoughtlessness of a number of
major outside investors found them with large amounts of Penn Central stock in the spring of 1970, the sales of which are dealt with in the
previous section of this report.
Apart from insider trading questions, it should be noted that the
extent of the bail-out by officers during the steady price decline of
the stock is somewhat inconsistent with the concepts underlying the
option system, whose supposed purpose of generating and rewarding
corporate loyalty was lost in the shuffle as officers bailed out of Penn
Central stock to protect their investments and realize their paper
profits. Over the years, some Penn Central officers had built fortunes
based on the company's large option grants.42 Although the officers
had been allowed to profit from these grants on the theory that they,
as key employees, were contributing to the betterment of the company,
including the rise in price of the company's stock, many of them felt
no compunction against bailing out in the down market, thus providing themselves with extra compensation due to the company's
good fortunes and evading penalization for any adverse happenings.
Further, the staff found that certain banks (some with Penn Central
connections) had made a number of large, long-term, unsecured loans
to high Penn Central officials, mostly in connection with their exercise of Penn Central stock options, and mostly at the very favorable
terms of one-half to 1 percent above the prime rate. Even though
these were unsecured loans, many Penn Central officers appeared to
This section is limited to examining officers' and directors' personal holdings of Penn Central common
Sales by directors were as follows:
1. William L. Day* sold 450 of his 1,000 shares in 1968 and 1969, but purchased 450 shares in Nov. 1969,
leaving him with the same balance of 1,000 shares at his resignation from the board on June 21,1970, as at
the time of the merger.
2. JR. W. Graham* sold 3,568 of 8^,708 shares owned by him in Nov. 1969, repurchasing 3,860 shares in
March 1970. Graham maintained his investment in this large amount of Penn Central stock until after
the bankruptcy.
3. Edward J. Hanley,* who owned 200 shares during this period, reported that his wife sold 300 of 800
shares which she owned in Dec. 1969. Hanley, who was the chairman of the Conflict of Interest Committee,
stated through his attorneys that the 300 shares had been sold "in order to establish a tax loss to off-set
taxable gain on other securities which Mr. Hanley had sold."

•Day and Graham, directors of Penn Central Transportation Co., were both elected to the board of Penn
Central Co., on June 18,1970. Hanley was on the board of Penn Central from its formation.
« Not the least of these complications was that in October, 1969, when the Penn Central Co. was formed,
the Penn Central Transportation Co. became a wholly owned subsidiary, and only vice presidents of Penn
Central Co. reported their purchases and sales to the Commission under section 16 of the 1944 act.
42 Although, prior to the merger, the New York Central had also had a generous option plan, Penn Central's officer compensation program, including options, was far more extensive.

have irrevocably associated them with their stock purchases, using
the proceeds from Penn Central stock sales to pay off the loans. Obviously, the presence of these loans, which enabled officers, with no cash
outlay of their own and at the most favorable terms possible, to
bei efit from a price rise in Penn Central stock, also acted to encourage
officers to sell in a down market to protect their investments.
A stunning example of such a bail-out is that conducted by David
Be van, who was at the vortex of Penn Central's machinations, and
who sold 15,000 shares of Penn Central stock in the first half of 1969
at prices ranging between $50 and $66, paying off a $650,000 stock
option loan and managing to keep his personal fortune virtually
intact. I n contrast to this was the trading, or lack thereof, of Stuart
Saunders, who has made no sales since 1967, even though his 45,000share block of stock represented almost his whole fortune, and large
loans he had made to purchase the stock remian outstanding. Of
course, Saunders was virtually locked in to his no-sale position both
because of the potential liability which his insider knowledge would
have caused for him, and the possible harm to the fortunes of the
company which such a vote of no-confidence bv him could have
engendered. 43
The heaviest concentrations of officer selling occurred in June and
July 1969, a time when the accumulation of Penn Central's major
problems in the areas of operations, earnings, and finance culminated with a discussion at the June 25 meeting of the board of directors as to whether Penn Central should withhold its time-honored
quarterly dividend from its shareholders. 44 Between June and July
1969, Bevan chose to make the last sale (2,300 shares) of his program
of sales which halved his ownership of Penn Central stock; three other
officers sold over 50 percent of their holdings—Roberts (2,000 shares),
Haslett (3,000 shares), and Smucker (3,600 shares); and two more
officers virtually liquidated their Penn Central investment—Flannery
(236 shares—100 percent) and Knight (3,950 of 3,957 shares). The
circumstances surrounding these sales, including each officer's reasons
for them, are discussed below as part of the summary of each officer's
All officers who were questioned denied that any of their sales
had been made on the basis of material inside information. I t appears
that few officers were concerned that the public might be deluded about
corporate affairs, and that the possibility that there might be inadequate disclosure had figured very little, or not at all, in their trading.
Thus could a high fincancial officer try to explain his sale in February
1970, by stating blandly that he had merely waited until after the
1969 financial figures had been disseminated. 45
Manjr of the explanations most commonly given by officers concerning their postmerger trading in Penn Central stock appear, under
examination, to lack the sense of urgency reasonably required to cause
an officer to make a forced sale. The most obvious example of this
was the claim that some sales were made to pay off loans, when in
fact the idea to pay off the loan had originated with the officer, and
not the bank, or when the officer made a choice to sell Penn Central
« I t is interesting to note, however, that neither of these reasons stopped Bevan. (See below for a full
discussion of Bevan's sales).
« This discussion concerned the third quarter of 1969 dividend, which was ultimately declared. The
fourth quarter dividend was the first one not declared.
« Another officer, when queried concerning his trading, claimed the subject of insider trading had not
entered his mind.

stock over other liquid assets. Likewise, the claims of some officers
that they sold because they sought to diversify their assets, either for
general purposes or in contemplation of retirement, lose credence when
the officer is at a loss to explain how his interest in diversification
happened to come to him at a specific time, particularly when such
officer's financial situation and dependence on Penn Central stock
had remained stable for a number of years preceding his sale. Trading
based on a well-established window pattern of purchases and sales
does serve to show a lessened reliance on inside information, although
it cannot be assumed that such patterns excuse all insider sales.
The company and the board of directors had seen to it that all
officers had been clearly informed of the prohibitions against insider
trading. In October 1969 a "Penn Central Manual on Insider Securities Trading" was widely circulated at and below the top management level, and in December 1968, and March 1970, memoranda sent
out discussing the company's disclosure policy emphasized the duty of
insiders to refrain from trading prior to full public disclosure of
important corporate news.
Perm Central did a very poor job of watching over the trading of
its officers. Saunders claimed that he had turned over all corporate
responsibilities in this area to the Conflict of Interest Committee when
it was formed in 1968. The Conflicts Committee considered that it had
discharged its duties in this area with the publication of various
reports, memoranda and manuals prepared by the law firm it had
hired.46 Although the 1969 Insider Trading Manual and the 1970
disclosure memo refer to procedures to be carried out through the
office of general counsel in connection with undisclosed material
information, no one, including the Conflicts Committee, the president
and office of general counsel, paid the slightest attention to implementing the proposed procedures.
Over the years, many officers had been in the habit of consulting
D. L. Wilson of the office of general counsel concerning the propriety
of their trading under the short-swing trading prohibitions of the 1934
act. As the company drew closer to bankruptcy, a few prospective
traders also broached the subject of insider trading. Without, apparently, a deep analysis of the subject, Wilson raised no major
objections to these sales, with the exception of discussions he held
with Saunders concerning the possibility of his selling at this time.
The secretary's office, under the direction of Secretary Bayard
Roberts, prepared and relayed to the Commission the form 4 reports
of officer and director trading. According to Roberts, preparation of
these reports was a purely bookkeeping function, and the reports were
not subjected to any sort of review. When Penn Central Transportation Co. officers stopped filing form 4 reports in October 1969, no one
at any level of the company had -any thoughts concerning monitoring
«• The 1969 manual and the 1970 memo had been prepared by an outside law firm at the direction of the
Conflict of Interest Committee. Although sent out with the knowledge of this committee, the 1968 memo
had been prepared by the legal department at Saunders' instigation. The Conflict of Interest Committee,
which had been set up in September 1968, sent, in early 1989, an extensive questionnaire to officers and
directors of the company and its subsidiaries seeking information concerning officers' trading and possible
conflicts of interest. The committee's report on the questionnaires noted that officers had made substantial
sales in 1968, but found no evidence of improper motives. The questionnaires also uncovered some potential
short-swing trading violations which were referred to the company for action. The committee delved no
further into the subject of officers' trading in general following the questionnaires, and although it did
entertain the idea of urging that further questionnaires be sent out on a periodic basis, this suggestion was
shelved within the committee and had not been acted on by the time of the bankruptcy.

the further trading of even those officers whose trading was no longer
the subject of public scrutiny.47
One caveat must be given concerning the individual trading reports:
Although the numbers have been checked and rechecked for accuracy,
many times the purchases and sales discussed will not balance out to
the numbers given. This is because, for reasons of clarity, only major
transactions have been signaled. Gifts and charitable donations have,
in general, been omitted.48 Most officers were members of Penn
Central's thrift plan, contributing up to 5 percent of their income to
make regular purchases of stock at half-price. The major distribution
of these shares came after bankruptcy (or after prebankruptcy
retirement), but some small distributions were made on an annual
basis and have been figured into an officer's total holdings, although
not recorded as separate purchases.

The finance department, run very much as a separate entity by
David Be van, dealt on a daily basis with the company's problems in
obtaining cash and the enormous demands for cash made by the
subsidiaries as well as the parent company.
It should be noted that the sales of the four men discussed in this
section, all top finance department officers, pursue a remarkably
similar pattern in that each of the four stated that his sales had been
made to pay off bank loans whose need to be paid off at the time was
questionable, to say the least. Three of these officers, Bevan, Gerstnecker, and Haslett, who all took part in the Penphil venture, all made
their major sales during the beginning of 1969.
Feb. 1,1968
Mar. 11,1968
Jan. 6,1969
Mar. 11,1969
Apr. 9,1969
May 6,1969
May 27,1969
June 25,1969
June 19,1970
June 24,1970
July 3,1970


3,600 . . .
8,146 . . . .


There is no doubt that David Bevan was the key financial officer
at Penn Central, responsible for initiating or effecting all financial
machinations of the postmerger period. He held the title of chairman
of the finance committee throughout this period, and also served on
the board of directors except for the period between February 1968
and the fall of 1969. He was one of the three top officers abruptly
severed from the company following the dramatic June 8, 1970
meeting of the board of directors.
*7 In October 1969, Saunders asked Cole for a list of officers' stock sales. Cole had the secretary's office
prepare the list, and forwarded it to Saunders. When shown a copy of the list, Cole, Roberts, and Saunders
all claimed they had forgotten about it, and could not remember why Saunders had asked for it or what
he did with it.
« Family gifts which remained under the control of the donating officer are counted as part of his Penn
Central holdings.

Bevan liquidated his substantial holdings of Penn Central stock in
two separate series of transactions. The first occurred between December 1968 and June 1969 when he ceased his program of buying Penn
Central shares and sold almost half his holdings of Penn Central
stock.49 The final sell-out occurred between June and August 1970.
Between 1964 and 1968, Bevan had acquired a sizable amount of
shares by exercising options at 21 and 2 4 ^ .
By the end of 1968, he had acquired 34,400 shares of stock pursuant
to these options, and he had outstanding with Mellon National Bank
and Trust Co. an unsecured loan in excess of $650,000 which he had
used to purchase these shares. Between January and June 1969
Bevan sold 15,000 shares of Penn Central stock in six separate transactions.50 The explanation that Bevan presented concerning the 1969
sales was that he had liquidated his $650,000 loan at the insistence
of Mellon Bank, and that in any case he had planned as early as 1965
to sell Penn Central stock to liquidate his outstanding loans by 1970.
As complete evidence of this, Bevan pointed to a December 1968
letter from Spencer R. Hackett, Mellon Bank vice-president, suggesting that Bevan consider making gradual periodic reductions on his
loan, and Bevan's January response agreeing with the suggestion.51
Bevan claimed that in 1965 he had notified both the Mellon Bank and
the Chemical Bank that he intended to pay off his loans within 5
years from the sale of Penn Central stock.52
Whatever Bevan's reasons for the 1969 sales, they were not caused
by any pressure from Mellon Bank. According to Hackett's sworn
statement, Bevan called Hackett in December, 1968, to ask for the
letter from Mellon Bank requesting a pay-down. The only reason
Hackett wrote the December, 1968, letter was to comply with this
request; prior to Be van's phone call, Hackett had had no thought of
asking Bevan to reduce the loan.53 Bevan, however, denied categorically under oath that he had initiated the Mellon pay-down request.54
<9 Bevan left unexercised 3,600 option shares available to him at 24^.
so A reasonable guess as to why Bevan held on to the balance of his stock would be that Bevan, as chief
financial officer of the company, was reluctant to make such a public show of no-confidence in the company,
since he reported his stock transactions to the Commission on form 4's. It also appears that the company
was very conscious of sales by officers and directors during this period. In its April 1970 proxy statement
it listed, as required by proxy rules, sales of option shares made between 1965 and 1970 by Saunders (4,000)
Perlman (9,230), Bevan (16,000) and eight other officers (29,411). Then it added a footnote to this breakdown
which stated: "The sales by Messrs. Saunders and Perlman were made prior to February 1,1968, the effective
date of the Pennsylvania New York Central merger. Prior to the same date, Mr. Bevan sold 1,000 shares
and other officers as a group sold 17,752 shares."
6i Bevan's letter to Hackett, dated January 8,1969, reads in part, as follows: Thank you very much for
your letter of December 24, and I understand perfectly the spirit in which it was written. You are quite
right that my loan has been on the books for quite a period of time. Do not feel guilty about this. As I explained to you and John Mayer, I do not think anyone in top management should be a quick-buck artist.
There is a limit to everything and the bank has been very good to me.
Your letter also made me stop and reassess my whole position. I have been so busy that I had not really
stopped and considered what I had in the way of stock options. In December, I completed earning an additional 3,600 and on February 1 1 will have earned an additional 10,000 and as of February 1,1970, there will
be another 10,000 for a total of 23,600 shares that has to be financed. Therefore, I agree with you that it behooves me to gradually reduce my outstanding loan.
52 A letter to Chemical Bank indicating this was submitted as an exhibit. No such letter to Mellon Bank
has been located.
53 Hackett stated that Bevan gave no reason for the request, and Hackett did not ask for one, as " I did not
consider this my affair or that of the Bank." In a further letter, dated January 9,1969, Hackett took pains to
assure Bevan that he was prepared to authorize further loans on his behalf.
Q. Did you ask Mr. Hackett to write the letter to you?
A. No.
Mr. GERMAN (attorney for Bevan). I didn't hear the question.
Q. The question was, Did you ask Mr. Hackett to write the letter to you?
A. No. I don't like the implication. The answer is no.
Q. Do you remember making a phone call to Mr. Hackett at any time in December of 1968 concerning
your personal loan?
A. Concerning my personal loan, no.
Q. Information has been given to us that such a phone call was made and such a request was made. Do you
remember anything about a phone call of that kind?
A. No. I don't recall any unless you indicated before maybe he said he was writing such a letter or that
I should do it. He may have warned me that it was coming or something of that sort, but my answer still

The proceeds of Bevan's 1969 sales came to about $835,000, most
of which was used in liquidating the Mellon loan (which exceeded
$661,000 in December, 1968) and to reduce the Chemical loan by
about $114,000, leaving an outstanding loan balance at Chemical of
about $16,000.55 Both of these loans had been outstanding in significant amounts since 1965.66 Bevan's considerable reduction of his
debts during this period appears, however, not to have been the cause
of his 1969 sales, but simply the end result of a decision he made
independently that the first half of 1969 was a propitious time to
reduce his substantial financial reliance on Penn Central stock.57
Bevan made no further sales of Penn Central stock until after his
June 8, 1970, dismissal. Between June and August 1970, Bevan sold
all of his remaining shares of Penn Central stock, including 3,370
shares from the thrift plan which were distributed to him on August 3,
1970. His first sale was made on June 19, 1970, the last trading day
prior to the Penn Central bankruptcy. On this day, pursuant to an
order entered with his broker at Yarnall, Biddle & Co., on June 18,
Bevan sold 4,900 shares at UK in a limit order transaction.58 On
June 24, Bevan's broker entered and executed a further limit order to
sell 5,100 shares at 8.59 At that time, Bevan still maintained his office
at company headquarters "trying to get things straightened out for
the railroad. * * * " He had decided on June 8, the day of his dismissal
by the board of directors, to sell all of his Penn Central shares.60
stands that T would have no recollection of it. I did say he may have called me to tell me it was coming or
called me afterwards and expressed a hope that it didn't annoy me or anything, but I haven't any recollection of it.
Q. Are you certain then that you yourself did not initiate a call to Mr. Hackett in connection with your
A. I have no recollection of it. If anything had happened, if there was such a phone call, he may have called
me, and I may have said, well, then put it in writing.
Q. No; but I am asking you if you are reasonably certain that you never initiated any such call?
A. I am as certain as I can be.
Q. So I take it that means that you are virtually certain?
A. I am virtually certain.
Q. So that you did not about that time initiate a call to Mr. Hackett or to anybody else at the Mellon
Bank indicating to them that you would like them to write you a letter requesting that the loan be reduced?
A. I can't even—well, a bank of the quality and character of Mellon, they wouldn't connive with anybody
anyway. I don't understand it really at all. This ties in with the whole record. It does tie in completely.
I don't recall, but the most I could say is that if they asked me verbally to do it I may have asked them to
put it in writing, but I don't recall that.
Now, I may have called Hackett to say, "Merry Christmas." I call a lot of our banks. It is a matter of
custom, where we had relations, and maybe he brought it up at that time, I don't know. 1 don't recall. I am
trying to reconcile with you, but, no, this would be always true when Pixley was there. I didn't know
Hackett as well. Either he would call me or I would call him either before Christmas or New Years just as
a matter of courtesy between us, and that happened with a whole number of banks.
Q. But it is your testimony that at this time late in 1968 the suggestion that you did not suggest in any
A. I didn't initiate reduction of the loan.
Bevan claimed the proceeds were used to pay the Mellon Bank loan and capital gains taxes.
During this time, Bevan had a third significant loan outstanding, with Provident National Bank,
which was increased rather than paid down between 1968 and 1969.
As of December, 1967 Penn Central stock, at its market value at the time, comprised about two-thirds
of Bevan's total assets. By the end of 1969, Penn Central stock, selling at less than half of its 1967 price,
equaled about one-fourth of his total assets. Bevan's net worth both in December, 1967, and December,
1969 hovered around $2 million.
This was also the last day the thrift plan made its regular daily purchase. On this day Goldman,
Sachs purchased 2,800 shares for the thrift plan at 1 % the market high of the day.
*• On June 22 and 23, trading in Penn Central stock had been suspended, except for one large trade each
day which took place at the closing bell.
° Q. When did you decide to sell at this time?
A. As fast as I thought that I was allowed to after June 8th.
Q. When did you reach that decision?
A. June 8.1 wanted to make a complete severance.
Q. Can you tell us why you waited until June 18 to send in the first order, or why you decided on June 18
t o send in the first order?
A. I suppose it was to allow a reasonable length of time after I got out. I think—I am not sure of this—I
think that I waited until it was announced that the Government was going to make the guaratneed loan.
I didn't know about whether it was going to be made or not when I left. I thought it was going to be made,
but that might have been interpreted [as] insider information, but I wasn't sure. I was optimistic about it.
I think I waited until they announced they were going to make it, and then it was changed when they
reversed themselves. But that is again recollection.


Jan. 8 , 1 9 6 9 . . .
Jan. 9 , 1 9 6 9 . . .
Jan. 29,1969..
May 26,1969..
Nov. 28,1969..





Gerstnecker was vice president—corporate (finance) from the time
of the merger until August 1969 when he retired to become the vice
chairman of Provident National Bank. In this capacity, he functioned
primarily as right-hand man to Bevan and was privy to all information
on the company's finance problems.
Gerstnecker owned 6,206 shares in February 1968, including 100
shares held in his wife's name. The bulk of these shares had been
acquired through an option purchase in 1964, and though he had made
some purchases and sales between 1964 and the time of the merger,
he had maintained an ownership of between 4,700 and 6,900 shares
during that period. In January 1969, Gerstnecker sold 4,000 shares in
four 1,000-share transactions, and he sold an additional 1,000 shares
in May 1969, leaving him with a balance of 1,275 shares. On November
28, 1969, he made his final option exercise, purchasing 1,400 Penn
Central shares at 2 4 ^ .
Gerstnecker determined at the end of 1968 to resign from Penn
Central after July 1969, and go with the Provident National Bank.
He testified that his four January sales were for the purpose of liquidating a large loan outstanding at Provident, so that it would not be
outstanding when he moved over to Provident, and to purchase 1,000
shares of Provident stock. The Provident loan had been outstanding
since March 1964, and totaled during most of that time approximately
$155,000. Although Gerstnecker had made the sales in January, he did
not pay off the loan immediately, but reduced it between February
and July 1969. He purchased the 1,000 Provident shares in August
1969 at a price of $24,750. The price of these shares plus the loan total
about $175,000. Even though this amount was less than the $272,000
proceeds of the January sales, Gerstnecker could not recall what uses
he made of the balance of the proceeds. Gerstnecker claimed that his
May 26 sale, which grossed $55,500, was to finance his planned final
option exercise 6 months later, which in fact did take place just 6
months later, commanding a total purchase price of $34,300. Again,
Gerstnecker could not recall the uses to which he put the balance of
the proceeds.
After further questioning, Gerstnecker also stated that the January
sales may have been made due to a desire for diversification of his
assets, since he was contemplating changing jobs. He did not elaborate,
however, on why a prospective job change would necessarily prompt
such diversification. Neither could he point to any reason for having
decided to make the sales in January—even after it was called to his
attention that his claimed uses of the proceeds, paying off the loan
and purchasing the Provident stock, occurred between February and
August, Gerstnecker simply indicated that he decided to make the
sales following his decision to join Provident.

Two other factors should be noted in connection with Gerstnecker's
January sales. First, David Bevan began reducing his holdings in
January 1969, and, although Gerstnecker disclaimed knowledge of
these sales at the time they were being made, his position as Bevan's
assistant makes the timing of these sales appear to be more than
coincidental. Second, all of Gerstnecker's transactions were reported
on form 4 as of the trade date, as required by form 4, with the exception
of two trades, which were reported as of settlement date rather than
trade date. These were the last two of his four January 1969 sales,
in which he sold 1,000 shares each on January 29 and 30. On those
2 days the Penn Central market price peaked—the Penn Central
market price had been rising for about 2 weeks—and Gerstnecker
sold his shares at 71-713^. The next day, January 31, the market fell
2 points, and the price of the stock resumed its steady decline which
had begun in the last half of 1968.61 Although Gerstnecker claimed
he did not remember directing the reporting of these trades as of
settlement date, it is clear that it was a conscious departure from his
reporting practice,62 and his representation to the Commission that
the trades occurred on February 5 and 6 rather than at the end of
January also made it appear in the published trading summary that
his trading had taken place after the publication of Penn Central's
financial report.
Feb. 1,1988
July 15,1969





From the time of the merger until after the bankruptcy, Haslett
served as vice president—investments of Penn Central. As such he reported directly to and worked closely with David Bevan. Haslett
owned 5,425 shares at the time of the merger. Five thousand of these
shares had been purchased pursuant to options in 1964 and 1967;
the balance was acquired from the thrift plan.
Haslett had made no sales of Penn Central stock since he began
acquiring it in 1964. On July 15,1969, he made his only prebankruptcy
sale, selling 3,000 shares, and thereby reducing his Penn Central
holdings to 2,402 shares. Haslett had no other transactions in Penn
Central stock prior to the bankruptcy, and he allowed the substantial
number of options at 24^ which had been available to him since
December 1967 to expire.
When Haslett had exercised his options in 1964 and 1967, he had
taken out unsecured loans for the full amount of the exercise price
from Girard Bank, amounting to $63,000 in 1964, and $50,000 in
1967. From 1964 on, Haslett consistently maintained the loan at its
original balance, and paid only the interest as it became due in
quarterly installments. The balance of $113,000, therefore, was
The market rise had been in response to Saunders' January 10 announcement of the proposed formation
of the holding company. On January 30 Penn Central published preliminaryfiguresfor 1968, which: although
registering an increase on a consolidated basis, indicated that the parent company had lost $2 million, down
from a profit of $11 million in 1967.
Gerstnecker's secretary apparently coordinated thefilingof Gerstnecker's reports with the secretary's
office at Penn Central. (Gerstnecker, of course, signed the form 4's which were submitted to the Commission). The documents submitted by Gerstnecker in connection with his trading contain a copy of the
letter transmitting the certificate for the 2,000 shares to his broker. Handwritten on the bottom of this copy,
in what appears to be his secretary's writing, is the notation, "Use settlement dates, Feb. 5 and 6, in reporting sale."

maintained from December 1967, until July 1969, when Haslett paid
off the loan in full. Haslett stated that his July 1969 sale of 3,000
Penn Central shares, which grossed him about $130,000, was for the
urpose of paying off the $113,000 loan, which was in fact paid off
uly 23.63 The bank had not requested that the loan be paid off or
reduced, and Haslett could not pinpoint why he chose July 15,1969, as
the time to sell stock to pay off a loan which had been outstanding,
in part, since 1964: "I sold the stock because it was acting poorly.
I had a large bank loan, and I sold enough stock to pay off my bank
loan, and sold no more stock, kept the balance.''


Feb. 1,1968
Apr. 23,1968
Apr. 26,1968
Apr. 29,1968
May 27,1968
Nov. 7,1968
Nov. 8,1968
Feb. 9,1970

1,842 . . .




O'Herron, who had worked for Penn Central's Buckeye subsidiary for
a number of years before he was brought to Penn Central to be groomed
as Bevan's successor, became Penn Central's vice-president—finance
in September 1969, following a 2-month stint in charge of accounting.
He replaced Bevan upon his departure in June 1970. At the time he
joined Penn Central in July 1969, O'Herron reported an ownership
in Penn Central stock of 2,575 shares (including shares held in the
names of his wife and children). Prior to joining Penn Central he had
received, through his employment at Buckeye, Penn Central option
grants of about 9,000 shares, all of which had been exercised and most
of which had been sold by 1968. After joining Penn Central O'Herron's
only sale prior to bankruptcy was the sale of 500 shares on February 9,
O'Herron stated that he made this sale, which grossed about
$13,000, to liquidate an outstanding (unsecured) bank loan of $12,000
which he had taken out for income tax purposes in April 1969, and
which he had told the banker granting it that he would liquidate
prior to the end of 1969. Although at the time of the sale O'Herron
had a number of other equity securities he could have sold to obtain
funds for the loan, O'Herron could only answer, when asked why it
was Penn Central stock he chose to see, that it had stopped paying
dividends. O'Herron stated that the February sale was purposely timed
to follow the dissemination of the 1969 preliminary financial figures
by a number of days. By February 1970, O'Herron was deeply involved in the preparation of both United States and foreign public
offerings, and he was taking part in the negotiations for private Swiss
franc financings and for stand-by bank loans to tide Penn Central
over prior to the $100 million Pennco offering. On February 5, 1970, a
few days before his sale, he had been informed by a representative of
Goldman, Sachs that they would no longer "roll-over" the Penn Central
commercial paper as it became due.
«3 From about 1964 to 1970 Haslett had another, secured, loan outstanding at Girard Bank in the amount
of $35,000.


Both of|the officers discussed in this section are tax specialists,
although one looked after the postmerger real estate transactions and
one for a time was also titular head of the accounting department. Both
of them attended the budget committee meetings, Saunders' monthly
policy meetings.
Feb. 1,1968
Feb. 14,1968
Sept. 3,1968
Sept. 4.1968
Sept. 16,1968
Sept. 17,1968


1,023 . . . .



Originally a New York Central officer, Hellenbrand became a Penn
Central vice president, taking charge of industrial development and
real estate following the merger. In March 1970, with the retirement
of T. K. Warner, Hellenbrand also headed the tax department. In
February 1968, following the exercise of all available options, Hellenbrand owned 3,867 Penn Central shares. In September 1968, Hellenbrand sold 3,500 shares, reducing his holdings to only 367 shares.
Although further options became available to him at attractive
prices at the end of 1968, Hellenbrand effected no further Penn Central
stock transactions, aside from his thrift plan participation, until after
the bankruptcy.
Hellenbrand claimed that his buying and selling followed no specifically laid out program, even though in 1965 and 1966 he had exercised
options and 6 months later each time sold at least as many shares as
he had acquired. In his testimony, Hellenbrand could point to no
specific reasons for his 1968 sales:
As I said, I recall among the reasons was a desire to pay down the loan which I
had outstanding in the bank, and of all the reasons which go into the operation of
the human mind to buy or sell something * * *. I do not know that there was
anything more 64
specific than the conclusion that I felt it was a wise thing for me to
do at the time.

I t is likely that Hellenbrand knew at the time of his 1968 sales of the
dubious tax-oriented transactions management was then planning for
the Great Southwest-Macco subsidiaries to conceal the disastrous condition of the railroad. Hellenbrand also was aware at that time that
the so-called Park Avenue properties were not, as they had been
advertised to be, a liquid investment which the railroad could sell for
cash, due to the formidable obstacles raised by heavy mortgages and
minority interests.
M The loans to which Hellenbrand referred were loans obtained in connection with the exercise of the
stock options. In September 1968 however, Hellenbrand had only $33,000 outstanding on his loans, While
the proceeds from his September sales equaled $228,000.




Apr. 2,1968
Apr. 5,1968
May 9,1968
May 21,1968

July 9,1968
Mar. 6,1969
Sept. 8.1969
Sept. 11,1969
Dec. 19,1969
June 12,1970









From the time of the merger until July 1969, Warner served as
vice president in charge of tax matters (from November 1968 to July
1969 his title was vice president—accounting and taxes). In this
capacity he functioned independently of the finance department.05
In July 1969 when Jonathan O'Herron was brought in, the accounting
department was moved from the control of Warner and given to
O'Herron. At that time Warner was made vice president—corporate
administration, and he kept this title until his official retirement in
May 1970. Warner looked upon this job change as being kicked upstairs to make room for 66
O'Herron and as early as June 1969, he began
to consider retirement. Nonetheless, between July 1969 and his
retirement in May 1970, Warner was in charge of the department of
corporate analysis and cost and profit analysis as well as taxes.
Between 1964 and 1969, Warner had made purchases and sales of
significant amounts of shares each year (in 1967 and 1968, he sold a
significant number of shares but made no purchases). From 1965 on,
however, the amount of shares he owned was never less than 3,000
shares. On March 6,1969, he made his final option exercise, purchasing
1,200 shares at $24.50 per share. At this time he borrowed $50,000 from
a bank, using $29,400 of the borrowed money to exercise his option.
Following the exercise of this option, he owned 4,480 shares. On
September 8 and 11, 1969 he sold 2,000 shares of stock each day, and
and on December 19, 1969, he sold an additional 100 shares. These
sales, along with gifts he made during 1969, reduced his ownership to
to a total of 240 shares at the end of 1969.
On May 1, 1970, Warner officially retired from the company. It
should be noted, however, that he sold 200 of the 296 shares he owned
at the time of his retirement on June 12, 1970, just prior to
the bankruptcy.
Warner's reasons for the 4,000 share sale he made in September 1969
were very unclear. First he mentioned that by selling in September,
he would have been able (under the 6-month rule) to buy further
option shares in March.67 The only options available to Warner
«5 He was, however, close enough to Bevan to be the only nonfinance officer chosen to participate in the
Penphil venture.
* Warner claimed that the reason his retirement was delayed some months was that Saunders had asked
him to remain.
Warner's testimony reads as follows:
"There were several factors, one of which is that under the stock option plan, when you terminate service
you can continue to exercise your stock option for 3 months thereafter. I had also already planned to leave,
therefore, when the 6 months expired on the 1969 exercise, sometime in February, by selling in September
I can buy 6 months later.
"I was then planning to leave December 31, so I could purchase stock through March 31 under the terms
of the plan."

were at 57%, and by September 1969, Penn Central had sold down
below 41. Reminded of this, and asked if he had expected the stock
to have climbed above 57% by March, Warner stated that diversification in anticipation of retirement 68 rather than a 69prospective
option purchase had been the major reason for his sales. According
to his recollection, Penn Central stock represented over 25 percent
of his investment portfolio in 1969. Warner did not elaborate on
why he chose to diversify by virtually eliminating Penn Central
stock from his investment portfolio nor did he indicate why he
decided to pursue this diversification policy in September 1969.
Warner invested the proceeds of the sales in other securities.
Warner's involvement in tax matters exposed him to much of the
covered-over activities of the Great Southwest-Macco group. By
late 1969, he was deeply involved in the program of maximizing
earnings through tax aspects and through exploration of the subsidiaries for possible opportunities to bring up earnings to the parent
company. Indeed, at the very time he was selling on September 9
and 11, 1969, he was involved in a tax accounting change for Macco
that would increase Macco's 1968 earnings. Warner knew that such
actions were important to continuing the Macco-Great Southwest
facade for the public offering of Great Southwest stock then being
readied.70 In a followup of earlier discussions Warner wrote to
Saunders on September 10, 1969:
This relates to the 1968 tax elections of the Macco group which will be included
in the Penn Central consolidated Federal income tax return which must be
filed on Monday, September 15. Last evening I was informed by Peat Marwick &
Mitchell (Philadelphia) that the Macco people were sending us tax return material
for their group in which they were increasing taxable income from $1 million to
$27 million. We have not yet received the Macco papers, but a letter on a related
subject confirms the P.M. & M. statement. The public accountants report that
the new elections will result in a change in Macco's (but not our consolidated)
book net income eliminating $13 million of deferred taxes and increasing its
book net income by that $13 million. This is important in preparing the SEC
financial statements for the sale of Great Southwest stock.

The next day (on which Warner was selling a second 2,000 shares)
Warner met with others to review the matter. Bevan reported to
Saunders in a memo on that day:
Messrs. Warner, Hill, Wilson and myself met this afternoon and are unanimously of the opinion that we should go along with the Macco management's
recommendation. This will add almost 50 cents a share to the reported earnings
for last year, and merely on a basis of 10 times earnings will add $5 a share to the
value of any stock sold, and if it goes to 20 times earnings it would add $10 a
share. Our capital gains would be enhanced by this amount.

It should be noted the overwhelming portion of Macco's profit that
year was in the Bryant Ranch transaction which produced little cash
but obligated Macco to heavy expenditure commitments.

All of the top operating people dealt with Penn Central's major
service problems, which peaked at the beginning of 1969. They also
« At no time, however, had Warner planned to retire without seeking other employment, and by December 1969 he was discussing employment with a law firm.
««Q. Did you expect the price of the stock to go beyond $57 within the 6 months before your retirement,
or up to your retirement, in the 3 months after?
A. I just never knew that much, understanding why stocks went up and down, so that I think one ought
to try remainflexible.But I want to add, I am not sure that was any more than another straw. I wouldn't
be surprised that my leaving was not the main thing.
w See Great Southwest section of this report.

experienced first-hand the crippling budget restrictions which the
finance department placed on the operating departments beginning in
mid-1969, and which magnified the operating problems which increased
again during the 1969-70 winter.
With the exception of Messrs. Funkhouser and Sullivan, all of these
operating officers attended the budget committee meetings, and must
have been fully aware from those meetings of the company's "profit
maximization'' policies, and of the contrast between Saunders' private
dissatisfaction with the company's performance and his soothing public
pronouncements on the subject.71 Further, dealing on a day-to-day
basis with budget restrictions and endless pressure to produce more
revenues brought home to these officers the realities of the company's
cash lag, and of the workings of "profit maximization". Apart from
company rumors, however, the operating people may have had only
the same knowledge as the public concerning the dealings between
Penn Central and its subsidiaries, since these nonrailroad activities
were dealt with only in summary fashion at the budget committee

Feb. 1,1968
June 12,1968
Mar. 17,1969
May 12,1969
May 13,1969
July 2,1969_
July 3,1969


325 ....



A former New York Central officer, Flannery served as vice president—systems development from the time of the merger until February 1969, when he was named vice president—operations. He remained with the company until after the bankruptcy.
In June 1968, following a purchase of 325 option shares, Flannery
owned 836 Penn Central shares.72 In 1969, he totally liquidated his
holdings in a series of five transactions between March and August.
Named to replace Smucker due to the winter 1969 operating crisis,
Flannery began liquidating his shares about 1 month after he took
charge of the operations department. Flannery claimed the proceeds
were used to purchase a house, on which he placed a down payment
on April 19, 1969, and which was completed in 1970. According to
Flannery's reckoning, he had invested a total of $143,000 in the
house by the time it was completed, including a $65,000 mortgage, and
also (it appears) approximately $47,000 in cash netted from the sale of
his previous house. The total gross proceeds of Flannery's Penn Central sales, $44,000, would have more than made up the cash difference
needed to reach $143,000, but Flannery claimed that, along with his
Penn Central shares, he liquidated his stock holdings in other companies in May and September, 1969, to raise money for his house. Flannery
did not sell his house in New York until August 1969. He claimed that
i It should be noted that after problems arising from possible leaks of information to the brokerage firm
of Butcher & Sherrerd in mid-1968, Penn Central attempted to restrict the internal dissemination of financial
information by sending the various officers only that information of particular interest to them prior to the
budget meetings. However, the full scope of the information was discussed during the meeting and so the
various officers would emerge with a fairly complete, general picture of what was occurring within the
Under a New York Central stock purchase plan, Flannery had contracted to buy an additional 130
shares in 1967. As allowed by the contract provisions, however, Flannery rescinded the sale within a 3-year

at the time he committed himself to buy the house in Philadelphia, he
did not know what price he would get for his New York property. He
had paid $63,500 for the New York house "And was quite fortunate
for selling same for $89,000 which was far more than I expected."
Except for the first Penn Central sale in March 1969, the proceeds of
which were used as the down payment on the house in April, Flannery
was unable to relate the timing of any Penn Central sales to a specific
need for cash:
You also asked me to clarify my purchase of a house in Philadelphia as related
to my savings account bank statement for the year 1969. You will note that on
February 18, 1969, my account was down to $968.88. I sold 300 shares of Penn
Central stock March 17, 1969, and deposited same in the account. A large part of
this was withdrawn in April in order to make the downpayment on the purchase
of my new home, copy of purchase agreement you have in your file. You are also
aware of the fact that I had made quite a commitment in purchasing this home
prior to disposing of my home in Hartsdale, N. Y. Also, the committed amount of
$120,000-plus was just for the bare minimum of a house. As stated to you, I eventually ended up with $143,000 invested and the difference between the original
commitment and the final amount was for drapes, carpeting, landscaping, and so
on. In fact, we paid several contractors direct for the installation of better fixtures
such as kitchen appliances, bathroom fixtures, electrical outlets, and so on, which
was over and above the committed price to the contractor. With this commitment, you will note I also sold Penn Central stock in May and July and other
stock in September in order that I could properly plan and know definitely how
many commitments to make in further improving the house.
Feb. 1,1968
June 24,1968
Dec. 26,1968
Jan. 26,1970
May 27,1970





1,900 _._.


Funkhouser was.a close associate of Saunders, having worked for
him at Norfolk & Western. From the time of the merger until March
1970, he was vice president in charge of coal and ore traffic. I n March
1970, in response to the gravity of Penn Central's passenger service
problems, he was made senior vice president—passenger service.
Funkhouser's last option exercise was in December 1968, giving him
ownership at that time of a total of 4,900 shares, all acquired through
options, plus 101 shares held by his family. Prior to the merger,
Funkhouser had acquired his stockholdings between 1964 and 1968 by
exercising options using borrowed funds, and selling a portion of the
purchased shares after 6 months to pay off the loan. The December
1968, purchase was not made with loaned funds, and it marked the
beginning of a holding period unbroken until 1970. On January 26,
1970, there was a sale of 100 shares he had given to his wife in 1967.
On May 27, 1970, Funkhouser sold 4,500 shares, representing the
major portion of his Penn Central holdings.
Funkhouser testified that the January 1970 sale of 100 shares was
pursuant to his wife's decision to sell since she did not want to hold the
stock because they passed the dividend. The public announcement that
the fourth quarter dividend would not be declared had been made in
November 1969. Funkhouser could not recall why she did not reach
this decision until January.

The May 27 trade had its origin in an April 28, 1970, limit order to
sell 4,000 shares at 20 J4 which Funkhouser changed on the morning of
May 27 to a market order to sell 4,500 shares. Funkhouser explained
that he decided to sell his shares after the April 22 publication of Penn
Central's first quarter earnings, which made him decide that the
company would not be able to resume paying dividends in the foreseeable future. Based on this decision, he placed his 2034 limit order
on April 28, anticipating that the market in Penn Central stock (which
had closed at 17% on April 27) would recover sufficiently to allow
execution of the order. The limit of 2034 had been chosen because
Funkhouser had arbitrarily set himself the goal at that time of realizing
$80,000 in liquidating his Penn Central investment. The price of the
stock did not recover, however, and Funkhouser explained his decision
to change his order to a sale of 4,500 shares at market as follows:
* * * there was an announcement on May 15 that the credit rating of the
Pennsylvania Co. had been downgraded. And I determined that the stock, after
that, probably wouldn't get back up into the 20's—and I executed a market order
on May 27. Now my reason for selling was basically because I wanted some return
on my investment. I did not not know the company was going bankrupt nor did
I—and I full[y] expected it to be turned around at that time. But I knew that we
were having tremendous earnings problems—that is, in brief, my reason for

Funkhouser decided to sell his shares at market on the afternoon of
May 26. That afternoon he consulted both Wilson and Roberts concerning his proposed trade, specifically asking each one if he knew of
any inside information why I should not sell my shares. Both men told
him that they knew of no reason why such a sale should not be made.
Funkhouser entered the market order the next morning, prior to the
opening of exchange trading.
Funkhouser claimed that by 1969 he was counting on the substantial
cash dividends which his sizable Penn Central holdings had been
When he sold, he deposited the proceeds in a savings bank until
August, when he reinvested the money in bonds:
Q. The question is, "When you made the sale in May, did you do it
with any specific investment in mind, or was it simply because you were
dissatisfied with the Penn CentraVs dividend policy at this point?"
A. I did not sell with any specific investment in mind. My motivating force was to obtain some return on that investment. Normally
I would have invested probably in some security soon after that on
the advice of my wife, but I don't know particularly why I didn't;
but we went into reorganization and I had the money in savings. I

w At that time, these shares represented about one-third of his equity investments, the other two-thirds of
which had been chosen for appreciation rather than dividend return:
Q. Did you contemplate, when you discovered that this investment was not going to bring in dividends,
making any changes in any of the other investments which you were holding which were not bringing in di
dends so that that money would give you a return on your money?
A. I don't recall doing that. The securities other than my Norfolk & Western for the most part were
being handled by Bonsai White, and it was, for the most part, an effort to seek appreciation rather than
income. And I had at that time, I think, substantial gains which, had I sold, would have resulted in
considerable tax, although I suppose it could have been offset against the Penn Central loss. But these
secutities were under—well, as a matter of fact I think I did take some gains that offset that loss. In
hindsight I may have made some changes.
But I would say this to you: The securities that Bonsai White was handling for me, the goals were more
appreciation than income. And I don't recall selling those stocks to seek more income. If I did sell—
and I think I may have sold some—it would have been to offset by taking the loss, and probably they
went back into the area of seeking appreciation under his guidance.
Q. Well would you say then that you did not have appreciation in mind when you invested in Penn Central
A. I did not have appreciation in mind?
Q. Well did you, or did you not?
A. Yes; I would say that appreciation was a factor. I was hoping to acquire as much of the stock as
I could, seeking both appreciation and income.

was drawing interest on the savings account, and then I decided to
put the money in tax-free bonds. My return on the tax-free bonds
would have been, I think, somewhere around 5 percent and 6 percent,
taking into consideration the taxes.

Feb. 1,1968
July 8,1968
Feb. 18,1969
June 10,1969
Sept. 17,1969






Large served as executive vice president—sales and marketing
from February 1968 until his retirement on June 1, 1970. A career
employee, he reported directly to the president. At the time of the
merger, Large owned 4,604 shares, most of which had been acquired
from options. Following the merger, he exercised no further options,
even though by December 1968, he was eligible to purchase 1,600
further option shares at 24%.
Large explained that his July 1968 sale, the proceeds of which were
$85,000, was made in order to pay off a stock option loan of $58,400
and an income tax loan of $15,000, and to provide cash for anticipated capital gains taxes. Bank records show the two loans paid off
as of July 17, 1968. Large claimed that each of his three 1969 sales
were made to meet income tax payments; the proceeds of the sales,
which were $18,336, $10,450, and $8,053, respectively, were used for
tax payments of $18,000, $7,000, and $7,000.
Large insisted that he only sold what he felt he had to sell of his
shares, although he did not indicate whether this involved a choice
between Penn Central shares and any other liquid assets he may have
Feb. 1,1968
Apr. 1,1970






Note: Between 1968 and 1969,960 shares had been donated as gifts.

Perlman was the president of Penn Central from the time of the
merger until December 1969, when Saunders brought in Paul Gorman
to be president. Insisting that the conditions oi his employment contract be adhered to, Perlman became vice-chairman of the board at
that time, retaining this position until his June 8, 19-70, removal by
the board.
Prior to the February 1968 merger, Perlman had exercised options
for 34,000 shares which were the total number of options granted to
him (these grants had been made before 1964) and had sold 32,890 of
these shares. As of February 1968, Perlman reported his ownership of
stock at 2,860 shares. His only transactions in 1968 and 1969 were
disposing of 960 shares as gifts. On April 1, 1970, he sold 500 shares
and held the remaining balance of 1,400 shares until after the

Perlman claimed that his 500 share sale resulted from turning over
his portfolio to Lionel D . Edie & Co., Inc. (an investment adviser).
Edie made its first appraisal of Perlman's portfolio in January 1970.
As a general policy, Edie was against buying railroad stocks at that
time, and favored the sale of its customers' current railroad stock
holdings. Although Perlman had given Edie complete discretion over
his account, Edie checked with Perlman as a matter of practice before
making a trade. When told of Edie's plans to dispose of all of his Penn
Central stock, Perlman stated he vetoed the idea because he believed
that as a director of Penn Central he should remain a substantial
holder of the company's stock. He said he told Edie it could only sell
up to 500 shares which in his view would still leave him a substantial
holder of Penn Central stock. Perlman claimed he characteristically
followed Edie's recommendations concerning his holdings, and noted
within 2 years of acquiring Perlman's portfolio, Edie had replaced
all stock originally held. Perlman stated that at no time did he discuss
the merits of Penn Central with Edie representatives, and insisted the
500 shares trade was made solely on the basis of the general Edie
Perlman's sale is included in this report because it came so close to
bankruptcy that he obviously had adverse information which was not
available to the public at the time of his sale. He knew, to an extent
that the public did not, that Penn Central was a sick company. He
had complained about money being diverted to real estate operations,
and of lack of funds for the railroad. He was unhappy with the way
the company was being managed and knew of all the operating
difficulties. He knew of the internal pressures to generate additional
earnings and sitting through budget meetings must have had a good
idea of some of the artificial techniques being used to accomplish this
purpose. On the other hand, for at least 6 months prior to his sale, since
the decision was made to replace him as president, he had been effectively isolated from regular sources of information within the company.
His awareness, if any, of the critical new problems which were then
developing would most likely have come from secondary sources.
Feb. 1,1968
July 8,1968
Feb. 21,1969
July 2,1969
July 3,1969
Feb. 25,1970
Apr. 10,1970
Apr. 20,1970



2,200 . . . .

2,067 . . . .



i 2,107


i Thrift plan distribution following Smucker's retirement.

Smucker was executive vice president in charge of operations until
February 1969. At that time, with Penn Central's operations in a
disastrous state, he was replaced by Flannery at the insistence of
Perlman, and made executive vice president—office of the chairman
until his March 1970 retirement. At the time of the merger, Smucker
held 12,600 shares, which he had acquired through options. He sold

9,000 shares in July 1968, hitting the market near its all time high at
about 85. In February 1969, he made his final option exercise of 2,200
shares. He sold 3,600 shares in July 1969, and 1,600 in February
1970, and made gifts to his family, leaving him with a balance of 40
shares at his retirement on March 1, 1970. Following his retirement,
he sold 2,000 of the 2,067 thrift plan shares distributed to him immediately upon receiving them in April 1970.
I t appears that about $83,000 of the proceeds of the July 1968, sale
was used to pay off loans Smucker had taken out in connection with
the exercise of his options in 1967. Smucker stated that the sale had
been planned at that time to obtain funds to exercise options when
they vested in December 1968, and for capital gains taxes. At this
time, according to Smucker, he was expecting to exercise in December
not only his remaining options at 24j^, but also up to half of his recently granted option to purchase 12,000 shares at 57%.u When
Smucker exercised his options in early 1969, however, Penn Central
stock was down to selling in the low 60's and the options at 57% had
lost their attractiveness to him, so he exercised only the options
remaining to him at 24KThe only reason Smucker gave for his 1969 and 1970 sales was t h a t
he had decided to retire. Smucker's official termination date was in
March 1970, and he claims that he actually left the company in
December 1969. B y July 1969, however, he had been relieved of
responsibility for operations and was contemplating retirement:
Yeah, by July of 1969 I had decided to retire. Mr. Saunders' 90 days had
elapsed and I decided to retire. And I was sitting there holding 3,600 shares of
stock, and we had been told by the legal department and by the financial department that if we've got any questions relative to purchases or sales of the company's stock to talk to Dave Wilson or Ted Warner or both. So I got Dave Wilson
up to my office, and I said, here I'm sitting, oh, buddy with 3,600 shares of stock
that I have owned since December of 1967; and I unfortunately exercised an
option to buy 2,200 shares last February. How long do I have to hold this.

According to Smucker's testimony, he decided following the consultation to sell his stock, even though it was less than 6 months
since he had made his last purchase in reliance on Wilson's advice
that recovery of profits would not be possible under section 16 of the
1934 act.
The gifts of 560 shares to Smucker's daughter and her family were
also prompted by Smucker's review of his financial affairs in contemplation of his retirement. 75 Smucker explained that the balance of
1,600 shares was not sold until February 25, 1970, because he had
placed a limit order to sell them at 45 on August 27 which he remained
hopeful of executing until February, when the stock had slid to 25.
Although Smucker's 1969 sales were made following his removal
from operating responsibility, he had continued to work for Penn
Central in Saunders' office and, as evidenced by various memoranda
he wrote, he was very much aware that the operating situation was
still critical. As an operating officer he recalled being "bumped over the
head to get the expenses down and see if you can't find or sell some
scrap or do something to get the income u p . "
The June 1968, sale grossed about $765,000. Figuring the cost of these options at about $400,000 leaves a
balance of proceeds, after payment of the loans, of about $280,000.
« These shares were subsequently sold, but Smucker claimed that he had refused to advise the donees as
to when they should sell and in fact did not know when the sales occurred.

Feb. 1,1968.
Feb. 29,1968
June 4,1968
Jan. 20,1969
Mar. 13,1970.



260 . . . .
325 . . . .



A former New York Central operating official, Sullivan served as
vice president (marketing) of Penn Central from the time of the merger
until after the bankruptcy. Sullivan, who was subordinate to Large
(later replaced by E.G. Kreyling) and who did not attend the budget
committee meetings, would have learned only indirectly of Penn Central's financial and diversification problems. He was, however, clearly
aware of all of the problems in the railroad end of the business. He had
been in favor of a slower approach toward integration of the two
roads, feeling that the acceleration plan was a mistake. When operating problems developed, as head of marketing he was very familiar
with the barrage of customer complaints which arose. He knew Penn
Central was losing business because of these problems, and from his
testimony it is clear that he was acutely aware of the conflicts between
former New York Central and former Pennsylvania Kailroad employees, and the impact this was having on the orderly functioning of the
Sullivan claimed that his 1969 and 1970 sales were made on the basis
of his broker's advice to diversify his portfolio. In 1965, he had opened
an account at Merrill Lynch, Pierce, Fenner & Smith, and from his
testimony, it appears that from the time of opening the account his
broker, Edward W. Kann, had discussed with Sullivan the advantages
of diversification. Ignoring his advice, however, Sullivan had steadily
increased his investment in Penn Central shares (which were, of
course, New York Central shares prior to February 1968) by exercising his options, so that by December 1968, Penn Central represented
about 75 percent of the value of his equity holdings. Sullivan emphasized that his broker's recommendation was not merely diversifying
away from reliance on one stock, but also diversifying from equity into
debt investments, due to the general stock market decline. Although
he did make substantial bond purchases with the proceeds of his Penn
Central stock sales, Sullivan also made substantial equity purchases in
1969 and 1970, and sold few or none of the other equity stocks he
owned, indicating that his "diversification program" was, in fact,
solely away from Penn Central, and not from equity stocks in general.
Sullivan's January 1969 sale was made to buy $30,000 worth of
1-year municipal bonds. ("* * * I am a little hard to convince sometimes, it takes a little while, and when we made this move, we went
with a relatively small excursions [sic] in the city of Goshen bonds.")
Apparently, Sullivan's broker had called in January to recommend the
Goshen purchase, but Sullivan could not recall why he chose January
1969 as the first time to take his broker's diversification advice
Later in 1969, Sullivan made further equity purchases and listened
to periodic suggestions from his broker to diversify into more bonds,
but he sold no Penn Central (and bought no debt securities) until

March 1970. Sullivan could give absolutely no reason why it was March
of 1970 when the diversification urge hit him again.76
This time, at the time of the sale Sullivan and his broker did not have
a crystal clear idea of what they would do with the proceeds:
We had discussions, I had had discussions with Kann about a number of things
that he had suggested in the way of diversification and we concluded that this
activity would require approximately that much money, so we proceeded accordingly.

Sullivan's March 13 sale of 2,300 shares (reducing his Penn Central
holdings to 515 shares) grossed about $56,000. About $40,500 of this
was invested immediately in long-term bonds, and $7,000 went to
purchase shares (equity) in Maui Land & Pineapple Co. In August,
a further $10,000 was invested in more bonds. (Sullivan stated that at
the time of his sale his broker had indicated "That he would probably
have something else at hand within a very short time," and that he
was surprised, but not disturbed, by the 5-month delay.)77
When questioned concerning the amount of shares he chose to sell in
March 1970, Sullivan responded as follows:
Question, Can you tell us in March of 1970 whether you considered selling that
remaining 600 shares or why did you decide to keep it?
Answer. No, I thought it was all right to leave it where it was and if I had been
disturbed about the thing, I would have throttled the thrift plan, but the idea
never occurred to me so we just let it go right along.
Question, Did it occur to you that in March of 1970, you were liquidating the
major part of your holdings in the stock for the first time in a number of years?
Answer. I don't know that it occurred to me in that context, what I was
[thinking] about was the advice of my counselor on the business of debt securities
and the outlook as he saw it and as I seemed to feel it was of the market, that
stocks were going to, in general—the stock outlook was not promising.

Sullivan knew of and dealt with the operating problems the company experienced during the 1969-70 winter. Claiming that the
appointments of Flannery and Kreyling to key operating posts had
made him optimistic about the future of Penn Central, Sullivan discounted the idea that his trading was in anticipation of the tremendous
first-quarter loss which those operating problems had caused. He also
claimed that in making his sales he didn't even think about "the
results of the first quarter or anything like that:"
Question. Was there any particular price consideration in March of 1970 when
you decided to actually follow Mr. Kann's advice apart from the 500 shares you sold
in 1970 and sold the bulk of your Penn Central holdings? Was there any consideration
that you gave to the price that Penn Central was selling at that time?
Answer. Not especially, of course we were anticipating, with the things that we
talked about at some length here, that the Penn Central might very well regain
its position, so it was a question to stay with that or to diversify as Kann had
recommended, so we decided to diversify rather than sell it all. If I had any real
serious concern about the thing, the sensible thing would have been to just
eliminate it all, but I stayed with the thrift plan or 600 whatever shares that are
Question. Can you say that at the time you sold, you did expect the price of the stock
to turn around eventually?
Q. Can you recall for us what went on to generate your decision to sell 2,300 shares of stock on March 13,
A. Yes; as I have indicated to you, I had these continuing discussions with Kann and our experience with
the Goshen bond thing seemed to go all right so it seemed to me that in the light of Kami's continued reminders on this subject and my feeling that his judgment was sound, that this was the thing to do.
Q. Why was it the thing to do so on March 13,1970?
A. That just happened to be the date that we decided to move off with it, just as January 20,1969, was
the7 date we decided to move off with the sale of the 500 originally.
? In the month prior to Mr. Sullivan's 1970 sale, his 1969 investment of municipal bonds matured. About
80 percent of the funds from the maturing bonds plus the 1970 Penn Central stock sale was invested in debt
securities and about 20 percent was invested in equity securities.

Answer. Yes; I thought it might very well do so.
Question. Was that in the near future or distant future?
Answer. I would think in the longer haul because of the problems we have just
been talking about.
Question. As far as the shorter haul, at that time as I understand it, well, the first
quarter earnings had not been calculated because the first quarter had not been closed.
Answer. That's true.
Question. Did you expect the stock was going to decline significantly before it
possibly turned around?
Answer. To be perfectly candid, I didn't give any special consideration to that
at all, as to what it was liable to do in the near future or the results of the first
quarter or anything like that. I didn't even think about it. I was concerned with
finally moving in the direction that Kann suggested that we ought to move and
we would still retain a quite substantial position in Penn Central, so as the turn
around occurred, we still have a fairly substantial equity and of course, we had
these other options.
Question. When you say finally, this is over a year after Mr. Kann hadfirstsuggested
Answer. Yes.
Question. And I would simply like to ask you one more time why you chose this
particular period of time to put this program into effect in a major way.
Answer. Well, simply because I became convinced that this was the right thing
to do.

Feb. 1,1968.
June 20,1968
July 15,1968
Dec. 20,1968
July 3,1969.
Sept. 4,1969








1,600 . . . .


i Sales made for account of children.

Knight was a senior vice-president in charge of personnel and labor
relations from the time of the merger until his October 1969 retirement.
While not directly connected with the operations of the company, and
not a participant in the budget committee meetings, Knight's position in charge of labor relations brought him into close working contact with Penn Central's operating people. He sold virtually every
Penn Central share he owned at the beginning of July, the same time
numerous operating officials had chosen to liquidate their holdings.
At the time of the merger, Knight owned 4,281 Penn Central shares.
In June 1968, he sold 1,750 shares. In December 1968, he exercised an
option for 1,600 shares. On July 3, 1969, along with a number of other
officers selling at this time, Knight liquidated his Penn Central holdings, selling 3,950 of his balance at that time of 3,957 shares.78
Since 1965, Knight had an established "window" pattern of exercising options and making substantial sales at 6-month intervals, and
his 1968 and 1969 transactions fall within this 6-month pattern. Even
with these sales, however, he had maintained a balance of at least
1,000 shares from August 1965 until the time of the July 1969
Asserting his rights under the fifth amendment, Knight refused to
supply any information relative to his Penn Central trading or any
other Penn Central related activities.
w In July 1968 and September 1969 Knight made sales on behalf of his children of 73 and 90 shares,


The two officers discussed in this section, although possessing no
expertise concerning the operational and financial aspects of the
company, had constant, day-to-day access to top management in pursuing their duties as head of public relations and corporate secretary.
Feb. 1,1968
Mar. 30,1970
Apr. 15,1970
May 22,1970




3 000


Lashley was vice-president in charge of public relations and advertising until after the bankruptcy. Keporting directly to Saunders,
he had virtually complete access to all company officers, and his
office was responsible for drafting almost every public statement
issued by the company. Having worked for Saunders for many years, 79
Lashley knew almost reflexively that the public relations department
was expected to stress—or manufacture—something hopeful out of
the bleakest announcement. I t is likely he knew of every significant
development in the company, and it appears that he knowingly and
actively participated in management's attempts to conceal adverse
information about the company.
Lashley steadily exercised his 1964 option to purchase Penn Central
shares at $28 per share until the end of 1967, so that, by the time of the
merger, he owned 3,000 shares. Sixteen hundred of these shares were
owned jointly with his wife, who had put up the purchase price for
some of them. Lashley made a 500-share sale of Penn Central stock
on March 30, and again on April 15, 1970, in response to bank pressure
to pay down the loan for which these shares were collateral. Although
Lashley claims that his Penn Central sales were made solely because
of the bank's demands, it is significant to note that at the same time
he was making Penn Central sales to reduce this outstanding debt
he was resisting pressure from another bank to sell out 300 shares of
Norfolk and Western stock securing another loan which was also
undercollater alized. 80
The sales point up the difference in regard which Mr. Lashley had
for Penn Central stock as opposed to Norfolk and Western stock at the
time, because the proceeds of the sale of Penn Central shares went to
reduce an 8-percent loan with a bank with which Lashley felt he had
a good relationship, 81 while, in contrast, Lashley was simultaneously
maneuvering to avoid selling his Norfolk and Western stock to pay
off an 8^-percent loan with another bank (Lincoln Bank) with which

Lashley had previously worked for Saunders at Norfolk and Western.
8° Lashley claimed that he had no inside information at the time of his sales, but that "I had hesitation
to sell because I was a corporate officer and might be accused of having inside information." Prior to his
sales, Lashley consulted with Wilson and Saunders about his sales. Saunders was consulted because, "I felt
badly about it, about the situation, and told him that my personal finances were such that I was going to
have to sell some of the stock. I knew he wasn't selling any of his". According to Saunders, he advised against
the sale and told Lashley to consult the legal department. Lashley claimed he consulted with Wilson because
he believed the circulated guidelines had advised him to. "Dave Wilson, as I recall, said, 'Well, if you have
to you have to, but make sure you report the sales to the S E C "
» The Penn Central stock-secured loan had always been maintained at prime rate and, aware of this
beneficial rate, Lashley has to date maintained the loan in its reduced form.

he felt his relationship had become acrimonious. As Lashley's relationship with this second bank deteriorated, Lashley, "pretty upset and
angry at the Lincoln Bank for their constant harangues/' transferred
the loan to the Provident National Bank. When Lashley was asked
why he did not feel compelled to sell his Norfolk and Western stock to
reduce that loan at the same time he sold his Penn Central stock,
Lashley responded, "Because I wanted to hold on to it. I regarded
Norfolk and Western stock as a good investment, particularly from
the standpoint of dividend. They were paying, I think, about $6 a
At the time of his sales on March 30, and April 15, 1970, Lashley
knew that the first quarter results would be much worse than expected.
Before the March 25,1970 announcement of the filing of the debenture
application with the Interstate Commerce Commission, Lashley was
involved in Penn Central discussions about disclosing the fact that
Penn Central's first quarter results would be worse than expected.82
Ultimately, Penn Central decided not to make such a disclosure.83
At the same time that Lashley was ananging the loan with
Provident to retain his Norfolk & Western stock, he made a further
major sale of Penn Central stock, selling 1,000 shares on May 22, 1970.
This was part of the 1,600 shares purchased with his wife's funds and
held in, their joint names.84 Lashley regarded this stock as belonging
to his wife, and it had not been pledged in connection with any of
his loans. Lashley claimed that the May sale was made at the insistence
of his wife, who was "terribly worried about the loss of, the complete
loss of her investment, and I sold at her request in order to salvage
what we could of her investment."
Although Lashley claimed his wife did not seriously request him to
sell stock "before about April or May," he could not recall precisely
when the request began:
. . . she started making the request when I was telling her about my difficulties
with the banks and more loans. And she said "Why don't we just get rid of all of
it and sellout of Penn Central completely?'' And I said "I didn't want to do that,
that I was hoping the stock would come back and hold on as much as I could."
But she was very concerned about it so at her request I made those two sales.

When asked why he chose May 22 as the day finally to comply
in part with his wife's directives Lashley answered as follows:
«2 Penn Central officials believed that Chrysler Corp. had disclosed its anticipated bad first quarter while
announcing a securities offering. Lashley contacted Chrysler and reported as follows:
"Attached are copies of the news releases which Chrysler Corp. issued in connection with their public
offering of sinking fund debentures in February.
"You will note that neither the preliminary announcement on January 27 nor the release of February 20,
which was on Friday and therefore did not appear in the Wall Street Journal until Monday, February 23,
mentions the prospects for the first quarter in the release itself. However, a prospectus was attached to each
of the releases.
"Also, I suspect that Chrysler deliberately selected a Friday to put out the release in hopes that it would
not attract any great attention. I am certain they were somewhat upset by the full story in the Wall Street
Journal on February 23." (Memo from Lashley to O'Herron & Hill Mar. 20,1970.)
83 But Lashley realized disclosure would come sometime:
"Although we have not yet received clippings, I am enclosing accounts of the Pennsylvania Co. application to the ICC to authorize $100 million of securities as they appeared in the Wall Street Journal, New York
Times and Washington Star today.
"Because of the heavy amount of financial news resulting from the lower interest rate and spurt in the
stock market, neither the Wall Street Journal or New York Times had much space to go into details about
the securities involved, although they called us for information and we had to give it to them because it was
in the application filed with the IC C.
"Our friend Steve Aug of the Washington Star, however, went into more details.
" I expect that many more details of the transaction, together with the statements we will have to make
about the first quarter, will come out much more prominently when we offer the debentures for sale."
(Memo from Lashley to Bevan Mar. 26.1970.)
84 The remaining 600 shares were sold on June 29. Lashley turned the proceeds oi the sale of all 1,600 shares
over to his wife.

I think it was shortly—I think we talked it over the previous night and I came
in and made the decision during the morning to—I think it was in the morning—
to sell the stock.

Lashley must have been well aware by the last half of May 1970
that the debenture offer had been canceled and that senior management was meeting with Government officials about a guarantee. As
head of the public relations department, Lashley admitted receiving
queries concerning the financing during the month of May, but claimed
he referred the calls to Jonathan O'Herron. Although disclaiming
knowledge of inside information at the time of the sale, he did admit
in response to repeated questioning that he had spoken with O'Herron
concerning the status of the financing at some time during this period.

June 11,1969
June 29,1969

July 3,1969

Jan. 8,1970






Feb. 1,1968
Mar. 21,1968








Between merger and bankruptcy, Roberts served as secretary of the
company. This position afforded him access to vital corporate information, as he took minutes of the board of directors meetings, and the
meetings of the board's finance committee. He did not, however,
attend the budget committee meetings on a regular basis, and it does
not appear that he worked closely with the finance department. At
the time of the merger, Roberts owned 5,731 shares, acquired through
the exercise of options. His only post-merger acquisition of shares
was the inheritance of 59 shares from his father's estate. In March
1968, he sold 1,800 shares, applying most of the proceeds to liquidate
a loan incurred in exercising his options in 1966. By mid-1969 he
owned over 3,900 shares, with no large loans left outstanding. In June
and July 1969, he sold 2,000 shares, and he sold an additional 200
shares in January 1970, leaving him with a balance, through the time
of the bankruptcy, of 1,757 shares.
Roberts stated that he had opened an account with Drexel Harriman
Ripley in early 1969 at the time of the settlement of his father's
estate, and looked to that firm for investment guidance from that
time on. He claimed that Drexel was recommending in general the
sale of Penn Central stock at that time and that Roberts, determining
that his financial position was too heavily reliant on Penn Central,
decided to sell half of his Penn Central holdings, retaining half his
shares out of an "obligation to hold on" based on his status as a Penn
Central officer.85 Roberts also testified that he had been contemplating
diversifying his assets since prior to 1964, when he began exercising
his options. As to why he chose June 1969, as the time to put his
5-year-old diversification plan into effect, Roberts offered the following explanation:
Well, the decision to sell was made before I even opened up the account actually.
Just a question of when. Actually, I didn't want to sell before I had the account
with Drexel because I didn't know what I would do with the proceeds and I
wanted some advice on that. So after the account was opened then I gave some
s* Penn Central stock equaled about half the value of Roberts' investments in 1969.

serious thought as to the timing of the sale. And we were then coming in toward
the annual meeting and proxy material was going out and the annual meeting
was coming along and so I said, well, let us wait until that is all over and then I
will sell my stock. And that is about the way it worked out. The annual meeting
was the Tuesday before the second Wednesday of May and I sold it about a
month later.

On June 10 or 11 Roberts placed an order with Drexel to sell 2,000
shares. Drexel sold 1,000 shares at 51^-52 on June 11 and on June
24, 700 shares were sold at 49%. Noticing that his whole order had
not been executed, Roberts got in touch with Drexel at the end of
June, requesting that the final 300 shares be sold. Roberts claimed
he called because he was anxious to complete the sale in order to
enable him to exercise his options 6 months hence—he had outstanding
an unexercised option of 1,000 shares at 24j/£.86
Pursuant to his diversification program, Roberts reinvested all of
the proceeds of the 2,000-share sale at Brace's direction in various
equity securities. His January 1970, 200-share sale was made to pay
part of the capital gains tax on the major sale:
As you can see from the record I had a substantial capital gain on the sale of the
2,000 shares of Penn Central stock which I was able to offset by the sale of other
securities where I took a loss but I couldn't offset it all and I therefore had to
raise some more money to cover the tax on the capital gain. I was about to go
away on vacation toward the end of January. The entire market was sliding off at
that point and I wanted to go away with a free mind so I decided to sell some
more stock, Penn Central stock, to raise the cash so I'd have it available at the
time of the April tax return.

According to the testimony of D. L. Wilson of the office of general
counsel, Roberts had learned in the first 2 weeks of June 1969, that
Saunders was thinking of taking the unusual step of proposing that
the board of directors delay consideration of the third quarter dividend
until a special August board meeting, bypassing the traditional June
board meeting. Roberts consulted Wilson on Saunders' behalf about
this in mid-June.87
««A letter dated June 30,1969, to Roberts from Richard Bruce, his investment adviser at Drexel, appears
to confirm Roberts' statement. The second paragraph states:
"As you directed, I hav9 entered orders to sell 200 Penn Central at 5 0 ^ and 100 at 50>£. I expect these
orders will be executed in the next few days which will complete the program to sell your 2,000 shares and
will leave you free to exercise your option on additional Penn Central shares 6 months hence."
The 300 shares were sold on July 3.
N Saunders eventually decided against this course of action, probably at least partly due to Wilson's
recommendation that it be announced publicly.







Roberts, 1,800..
Warner, 300
Warner, 800
Warner, 400
Funkhouser, 1,900.
Knight, 1,750
Knight, 7 3 . —
Large, 1,000...
Smucker, 9,000..
Warner, 100



Hellenbrand, 3,500—




Bevan, 3,000
Gerstnecker, 4,000
Sullivan, 500
Large, 300
Bevan, 3,000.
Flannery, 300
Bevan, 3,000.
Bevan, 3,700
Flannery, 300



Bevan, 2,300
Large, 200...
Roberts, 1,700
Flannery, 236
Haslett, 3,000
Knight, 3,950
Roberts, 300
Smucker, 3,600..
Knight, 90
Large, 200.
Warner, 4,000
Warner, 100

2 ,402

Gerstnecker, 1,000






(Prior to June 21,1970)

Funkhouser, 100
Roberts, 200
O'Herron, 500.
Smucker, 1,600
Lashley, 500.
Sullivan, 2,300
Lashley, 500
Perlman, 500
Smucker, 2,000
Funkhouser, 4,500
Lashley, 1,000
Bevan, 4.900
Warner, 200





I I I - A . T H E SALE O F P E N N C E N T R A L T R A N S P O R T A T I O N

On July 22, 1968, the Interstate Commerce Commission authorized
Penn Central Transportation Co. (the Transportation Co. or the
company) to commence selling commercial paper. B y late 1969 the
Transportation Co. had $200 million in commercial paper outstanding. All sales were effected by Goldman, Sachs & Co. acting as dealer.
During the first half of 1970, the amount of the Transportation
Co.'s commercial paper outstanding dropped from $200 million to
approximately $82 million. This $82 million in commercial paper was
held by 72 customers who had purchased between November of 1969
and May of 1970. As commercial paper is universally believed to be a
very low-risk security, these customers were shocked to learn, prior to
the maturity date of their paper, that the Transportation Co. had
filed a petition in bankruptcy. Penn Central has repaid none of this
indebtedness, and there is little likelihood of repayment. 1
While in this section the focus will be on the role of Goldman,
Sachs in selling commercial paper, it should be noted that while the
company's paper was being sold, the company and certain of its
executives were making false and misleading statements to the public
concerning the company's financial condition. These activities are
being covered in other portions of the staff report.
Goldman, Sachs continued to sell the Transportation Co.'s commercial paper after they had received information about the financial
condition of the Transportation Co. which should have raised serious
questions as to the safety of an investment in the company's commercial paper, and Goldman, Sachs did not disclose such information
to its customers. The information which Goldman, Sachs received
should have put them on notice that a thorough examination of the
financial condition of the Transportation Co. would seem appropriate
in order that they, and through them, their customers would be
apprised of the current position of the Transportation Co. Despite
these warning signs, Goldman, Sachs made no meaningful investigation. Such an examination would have disclosed that the financial
condition of the company was more serious than had been revealed
to the public.

Commercial paper is a corporate, short-term promissory note. I t is
sold either directly by the issuer (borrower) to the purchaser (lender),
or by the issuer to a dealer who resells to the purchaser.
There are suits pending against Goldman, Sachs by almost all of the holders. Of these, $20 million in
claims have been settled for $0.20 on the dollar.



The most noteworthy factor in the commercial paper market (at
least until the Transportation Co. bankruptcy) was the common
belief held by purchasers, to a degree not even found among those
who invest only in the bluest of blue chip securities, that commercial
paper was designed to be entirely riskproof. Because safety of principal
so far and away transcended rate considerations, a very large number
of purchasers of commercial paper did not shop for rates at all. Most
looked upon commercial paper as the equal of U.S. Treasury notes or
bank certificates of deposit (CD's) in terms of safety. Because of the
short-term nature of the investment (average term is 90 days) it is
extremely important that the notes are repaid at maturity and thus
the liquidity of the company becomes a matter of vital concern to the
The importance of safety to those who invest in commercial paper
becomes apparent in a crisis. In the 30-day period following the
Transportation Co. bankruptcy, the runoff in commercial paper is
estimated to have reached $3 billion. Only quick action by the Federal
Reserve, which had been alerted to the approaching bankruptcy a
day or two before, appears to have saved the day. On June 19, 1970,
in anticipation of trouble, the Federal Reserve had agreed to let commercial banks borrow freely at its discount window. And on June 23,
it voted to change its regulation Q, which limits what banks can pay
for deposits, thus allowing them to buy money freely. And the banks
borrowed heavily from the Federal Reserve in the weeks that followed—$1.7 billion in just 1 week in mid-July. More than $2 billion
in bank money went to aid corporations in paying off maturing commercial paper. This rescue operation not only took some companies
out of trouble, it also restored lender confidence in the commercial
paper market. What could have blown into a major liquidity crisis
vanished almost before it began.
A second most noteworthy factor is that those who purchase commercial paper are loaning iunds to corporations which most often
they know little about. Furthermore, the purchasers have no control
over the use of the proceeds or any other of the borrowers' activities,
as a lender normally does.
I t is impossible to secure restrictive convenants limiting the commercial paper borrowers' freedom to raise additional debt or governing
the use of proceeds. In addition, the purchaser who becomes dissatisfied with the issuer usually has no readily available market to
which he can resell his paper before its maturity. 2
The only information the purchaser can get, and in almost all cases
does get, is either through the public media or through the dealer
who is selling him the paper. In addition to their dealers' recommendations, most purchasers relied on the ratings given various
commercial paper by the National Credit Office (NCO) as a basis for
making an investment decision.
The problems of making informed investment decisions about commercial paper were aggravated by the rapid growth of the commercial
paper market just prior to the company's bankruptcy on June 21,
1970. Witness the following:
Paper which is purchased directlyfromthe issuer, however, will usually be repurchased by the issuer at
the purchaser's request. Some dealers also, subject to market conditions, maintain a limited secondary
market in paper they handle.

A. In 1960 there was $4.5 billion in commercial paper outstanding:
On December 31, 1965, $9 billion outstanding;
On December 31, 1967, $16 billion outstanding;
On December 31, 1969, $31.6 billion outstanding; and
On June 30, 1970, $39.9 billion outstanding.
B. In December 1967, NCO was keeping tabs on 227 commercial
paper issuers. By April 1, 1970, its list had increased to 615.
Much of the growth was directly related to the monetary squeeze
in which U.S. industry found itself at the end of the 1960's. In December 1968, the Federal Reserve Bank imposed a ceiling on CD
interest rates. The banks, expectedly, strenuously objected to regulation Q, as it is known, which had the effect of diverting funds from
the banking system and into commercial paper and other money
market instruments, but the banks themselves were contributing to
the increase in commercial paper outstanding. Bank holding companies
began to issue commercial paper, and the banks put hundreds of
disappointed loan customers in the direction of commercial paper as
a cure to corporate liquidity problems.
It appears that commercial paper will remain an important money
market instrument. Some of the advantages are that the seller raises
short-term cash at less cost than bank borrowings, the investor
receives a higher rate of return than is otherwise possible through
purchases of other short-term money market instruments, and commercial paper is also relatively easy to sell, as it requires no registration
with the SEC. To make it possible for more institutions to issue commercial paper, legislation has been passed in Massachusetts and New
York to enable savings banks to put their cash into commercial paper.
Like Ohio, several other States have been authorized to purchase
commercial paper. Recent legislative moves have authorized the New
York State Teacher Pension Fund and the California General Funds
to acquire commercial paper. On the other side of the coin, dealers
are engaging in promotional activities to show small- and mediumsized companies the advantages of selling commercial paper.

The rapid growth of the market for commercial paper has involved
its increased use as a substitute for long-term financing. This has made
it more important than ever to reconsider the adequacy of Federal
securities law with respect to commercial paper. Almost all commercial
paper is exempt from registration pursuant to section 3(a)(3) of the
Securities Act of 1933.3 Thus, commercial paper customers have not
been furnished with all the current material information that would
be required by a registration statement.
In the absence of registration requirements, there are no customary
standards requiring dislosure of material information, to the extent
the same is disclosed in a statutory prospectus, to purchasers. In
many cases the information available to purchasers is limited and out
of date. Furthermore, there is no investigation undertaken by the
dealer which would even approximate that which is required of an
3 Under Section 3(a)(3) of the Securities Act of 1933 commercial paper, if used for "current transactions"
and having a maturity "not exceeding nine months," is an exempt security. In the case of the Transportation Company's paper, the Section 3(a) (6) exemption would apply to "Any security issued by a common or
contract carrier, the issuance of which is subject to the provisions of Section 20a of the Interstate Commerce
Act, as amended/' without regard to whether it was used for current transactions or whether its maturity
was more than mne months.

underwriter of a security offering registered with the Commission
pursuant to the 1933 act.
I n addition to the exemption from registration under the Securities
Act of 1933, commercial paper maturing within 270 days also is exempt from all of the provisions of the Securities Exchange Act of
1934.4 The sale of commercial paper is covered by the antifraud
provisions of the Securities Act of 1933, sections 12 and 17.5 Moreover,
the Investment Advisers Act of 1940, is applicable to commercial

Commercial paper sold through dealers—referred to as dealer
>aper as opposed to direct paper sold directly from borrower to
ender—as of late has constituted approximately 40 percent of the
commercial paper market—estimated to be $40 billion. The seven
major dealers are: Goldman, Sachs; A. G. Becker & Co.; Lehman
Commercial Paper, Inc.; Salomon Brothers; the First Boston Corp.;
Merrill, Lynch, Pierce, Fenner & Smith, Inc. and Eastman Dillon,
Union Securities.



Usually a commercial paper relationship will grow out of one of the
aspects of the investment banking relationship that a dealer has with
an issuer. Once the issuer decides that it wants to issue commercial
paper, the dealer will want to determine whether the issuer is creditworthy, i.e., able to repay the additional debt. The dealer will usually
have a credit department or a credit analyst who is charged with the
responsibility for making this determination. 6 With some dealers the
recommendation of the credit department or analyst can be overridden by a partner or by the head of the commercial paper department. With others, the recommendation is final.
The dealer, having decided that the issuer is creditworthy, will
usually then confer with the issuer to determine how much paper to
issue based upon how much the issuer wishes to borrow and how much
the dealer estimates can be marketed.
Next, the dealer and the issuer enter into an oral agreement whereby
the dealer is to be the exclusive dealer to market a specific amount of
commercial paper for a specific time. Normally, the dealer will buy
from the issuer as principal and reoffer it to the public at a markup
of from one-eighth to one-quarter of 1 percent. The dealer agrees to
Under the Securities Exchange Act of 1934 commercial paper is not an "exempted security" as that
tennis denned in Section 3(a) (12), but is excludedfromthe definition of a security found in Section 3(a) (10):
"The term "security" means . . . but shall not include currency or any note, draft, bill of exchange, or
bankers acceptance which has maturity at the time of issuance of not exceeding nine months. . . . "
Section 3(a) (10) of the '34 Act does not specifically require that in order to be excluded from the definition
of what is a security, commercial paper must be used for "current transactions," as does Section 3(a)(3) of
the '33 Act. However, see Sanders v. John Nuveen & Co., CCH Fed. Sec. L. Kep. paragraph 93,517 (7th
Cir. 1972), which used the "current transaction standard" in making its determination that paper of less
than 270 day maturity was not exempt from the definition of a security under the '34 Act.
The anti-fraud protection afforded by Sections 12(2) and 17 of the Securities Act of 1933 is expressly made
applicable to securities exempted by Section 3. Section 12(a) provides a civil remedy to purchasers where
securities are offered or sold by means of an untrue or misleading statemets or omissions "(whether or not
exempted by the provisions of Section 3 . . .)." Section 17(c) provides that:
"The exemptions provided in Section 3 shall not apply to the provisions of this section."
* The credit analyst considers various factors such as the potential issuer's net worth, its current debt
structure, its position in its industry, etc., which affect the issuer's ability to repay the additional debt.
Ordinarily this information is obtained primarily from public documents such as registration statements
andfilingswith the Commission and annual reports.

assist in the technical tasks involved.7 The issuer agrees to provide
certain information at certain intervals and access to information of
the nature provided to banks for line credit.
Since the dealer's compensation rarely varies from the one-eighth to
one-quarter of 1 percent per annum spread, the primary sales points
for a dealer are its financial capacity to purchase the paper and its
marketing ability to sell the paper at a favorable rate.

Those who invest in commercial paper are predominantly institutions of various types. A small percentage in terms of dollar amount
are purchased by individuals. In addition, banks will often purchase
in the bank's name for individuals who each may own less than
$100,000. Most investors have onty one thing in common: funds to
invest for a short period of time with the smallest possible risk and
the maximum return. Since treasury bills may not fit purchaser's
maturity needs and both bank CD's and treasury bills have a lower
interest rate, purchasers turn to commercial paper.

But why not direct paper instead of dealer paper? Direct paper has
many advantages:
A. usually the direct issuer is larger and more established;
B. usually the direct issuer will repurchase the paper if the
purchaser so requests prior to maturity; and
C. usually it is easier to obtain the desired denominations and
However, direct paper typically offers a lower interest rate—by
one-quarter percent—and most direct issuers do not have the same
ability to reach purchasers as do the large commercial paper dealers,
who more activelv solicit purchasers.
A purchaser will usually select a particular dealer based upon one or
more of the following factors: Prestige and reputation of the dealer;
past relationships with the dealer; solicitation by the dealer; variety of
paper offered by the dealer both as to type and maturity dates; and
the quality of the paper offered by the dealer. Frequently, the purchaser will tell the dealer that it is only interested in NCO prime-rated

Until recently, none of the dealers had a standing policy of repurchasing commercial paper prior to its maturity. Currently, a few
dealers will under certain conditions repurchase the commercial paper
of issuers which they handle. But a repurchase f acility usually is notfa
condition of the original sale and is completely discretionary with the
Those will usually include the following:
A. A determination by the issuer's counsel with assistance from dealer's counsel, if necessary, of the availability of the Section 3(a)(3) exemption which may require the granting of a no-action letter from the
Division of Corporation Finance.
B. The selection of a New York City bank to act as the issuing and paying agent and an agreement reached with the bank to function as such.
C. Formal authorization from the board of directors of the issuer specifying the total amount to be issued
and designating the offlcer(s) to execute the notes.
D. Selection of a format for the notes, printing, delivery of a minimum number of notes properly signed
by the authorized officers to the bank. These notes have a provision for the issuing bank to complete such
items as amount, maturity and payee.
E. The issuer obtains a rating from either NCO or Standard & Poor's, at its expense.

dealer. Infrequently, dealers will repurchase to preserve a good customer's relationship, although not as a condition of the original sale.

Because of the short-term nature of commercial paper and the way
in which investments in commercial paper are made—there is a continuous turnover and a customer usually must choose from whatever
commercial paper the dealer has available at the time which will meet
the customer's maturity requirements—the usual purchaser does very
little investigation or analysis of the investment merits of commercial
paper. He is not in a position to acquire information directly and must
rely on what he can get from the dealer selling the paper, rating services
and the public media.
The profit margin on commercial paper is very thin for dealers—
}i to y4 percent spread—who must meet the expenses involved in
soliciting and selling plus the cost of inventory. A major reason for
dealers to bother with commercial paper is the hope that it will lead
customers to use more profitable facilities such as stock or bond
underwriting. The low-profit margin would act to discourage dealers
from voluntarily undertaking the expense of a thorough examination
of issuers' creditworthiness and/or a thorough gathering of information
for purchasers.
Since the holder of commercial paper has the status of an unsecured
general creditor, there is an additional necessity to have access to
reliable and current information, for in the event of bankruptcy the
chance to recoup an investment is relatively small.
The dealers frequently prepare a dealer memorandum which is a
short descriptive analysis of the issuer. 8 These are provided either to
all potential purchasers or to those purchasers whom the dealer feels
might be specifically interested. Dealers update the memorandum at
least annually, and more frequently if significant events or circumstances should require.
Most customers assume that once they have told a dealer about the
type of issuer they are interested in investing in, the dealer will
provide only paper that meets the customers' standards. Without
regard as to wiiether they have any basis, a number of other presumptions are held by purchasers: that the dealer will only offer the
paper of an issuer which it considers to be credit-worthy and without
any substantial risk; that the dealer will inform the purchaser of any
adverse information concerning the issuers; and that the dealer will
repurchase the paper before maturity.
Although most customers are institutions, they range from highly
sophisticated investment oriented institutions to unsophisticated
institutions such as many college trust funds, small town banks, and
small manufacturing companies. However, as we indicated above,

The typical dealer memorandum consists of the following:
1. A description of the company: Its history and the nature and type of its business;
2. The latest year-end balance sheet;
3. Income statements for the preceding 5 years;
4. Bank credit arrangements including a list of the company's primary banks;
5. The company's NCO or S. & P. commercial paper rating; and
6. Interim earnings.
Additional data which may also be provided about the issuer includes the following:
1. Ratio of current assets to current liabilities;
2. Ratio of funded debt to net worth;
3. Market value of common stock;
4. Long-term debt ratings, if any, by Moody's and S. & P.; and
5. Capital expenditures: current and projected.

even the sophisticated institutions are n o t given all the information
as would be required by the Securities Act of 1933. Also because of
the short-term nature of the investment and the speed and the manner
in which it is made, investors do very little investigation on their own
either into the issuer or the investment merits of the security.

Most dealers provide one form or another of continuing review of
their issuers, although it is very limited. This usually involved checking with banks to see if adequate back-up lines are being maintained
in addition to the status of any other relationships between the issuers
and the banks.
Most firms which act as dealers in commercial paper have a trading
department staffed by individuals whose primary, if not sole, responsibility is marketing commercial paper. Ordinarily this trading department is separate and distinct from other marketing activities of the
firm. Commercial paper traders at most firms are responsible not
only for marketing the paper but also for maintaining relationships
with customers. The investors which the dealers solicit are a relatively
small group of institutions who apparently utilize the services of all
the dealers.
Most dealers maintain an inventory of commercial paper which is
made up of unsold portions of issuer's commercial paper. Dealers are
under substantial pressure to turn over their inventory as quickly
as possible for the inventory, which can run as high as $300 million,
is financed through bank loans. Such financing may be expensive
and difficult to find.



The first serious discussions between the company and Goldman,
Sachs concerning the issuance of commercial paper took place in
early 1968. David C. Bevan, chief financial officer of the company
at that time, had met Gustave Levy, managing partner of Goldman,
Sachs, while the former was with New York Life in 1946. The acquaintance was continued throughout the time Bevan was with New York
Life and during the time, from 1951 on, that Bevan was with the
company. At a meeting in March 1968, and after subsequent discussions between Bevan, Levy and Wilson, the decision was made
to issue commercial paper and utilize Goldman, Sachs. At this point,
according to Robert G. Wilson, a partner in Goldman, Sachs and
head of its commercial paper department, Goldman, Sachs followed
its usual precedures for taking on a new issuer. 9
Wilson could not, however, recall whether anyone other than
Jack Vogel, head of the commercial paper department's credit department, was involved in determining the credit-worthiness of the
company, nor could he or Vogel recall if there were any reports
prepared relating to the company's credit-worthiness at this time,
•This included obtaining the necessary borrowing resolutions, signature cards, annual reports, a copy of
the ICC order approving the sale, and financial data.

although Vogel stated that he personally did not prepare a written
While neither witness could recall the specific steps taken in the
case of Penn Central, they did testify as to the normal procedures
followed within the firm. The credit department, headed by Vogel,
would have made, in the ordinary course of business, a preliminary
decision on credit-worthiness,10 and it would have been up to Wilson
to make the final decision. The recommendation by Vogel is usually not
made in writing, but a checklist is made as to information received.
Usually no memorandum or written record is made of Wilson's
conversations with Vogel or of Wilson's decision. Wilson stated that
he has no particular standards or guidelines for making this decision
but draws upon his own experience and looks at each company
individually. Wilson noted that the credit department has informally
established certain minimum standards or guidelines. However, he
did add that there are some standards in this area:
You look for a history of earnings, you look for a ratio that shows a relatively
strong working capital position. You want to know about the management of
the company, its reputation, where the company stands in its field, this type of

Wilson also stated that there was no particular ratio or standard
applied to the level of outstandings but that he only relates borrowings in commercial paper to current assets and receivables and
the level of inventories since the proceeds from the paper are to be
used for current purposes.
VogePs testimony fairly much paralleled Wilson's in terms of the
absence of any standards or ratios that are applied to the factors
which are considered. He did, however, expand somewhat on the role
of the analyst:
* * * He would review the company's financial statements, determine whether
or not the company is, or has, an ongoing nature, whether its product line
is of the type that would do more in the next few years, or 10 years, whether the
company has a record of profitability, whether it has a reasonable chance to have
a record of profitability in the future, whether other lenders, or other suppliers
of funds have a favorable opinion of the company in its past, and in its present,
and of its future * * *.

As was mentioned earlier, Vogel could not recall having made a
written report on the company prior to its being approved by
Goldman, Sachs as an issuer, nor could he recall other than in a
general way, what factors were considered at the time (summer of
1968). Wilson's testimony was the same.11
The Interstate Commerce Commission on July 22, 1968, gave
the company authorization to issue $100 million in commercial
paper, and by August 5, 1968, sales were well underway.
Once the decision to carry a particular issuer has been made, the
credit department normally undertakes to review the public medis for
information about the issuer. Once a year the issuer is asked for confirmation of existing lines of credit. As will be shown, if the standards
described above had been applied in late 1969 or early 1970, Goldman,
Sachs would not have continued to offer the company's paper for sale.
« According to Wilson and Vogel the determination of credit-worthiness involves looking into the prospec>
tive issuer's borrowing practices, its access to credit, the opinions of banks with whom the issuer maintains
lines of credit, and reviewing itsfinancialstatements as found in the annual reports. At no time did Wilson
or Vogel indicate that it was normal procedure for Goldman, Sachs to investigate the issuer as an underwriter would be in a typical registered public offering.
Vogel testified that Goldman, Sachs takes on about one new issuer a week. These issuers must beinvestigated by his staff of four. In addition, this staff is also responsible for maintinaing an on-going review
of the approximately 250 issuers for whose paper Goldman, Sachs acts as dealer.


From September of 1969 through May of 1970, Goldman, Sachs
was very actively engaged in selling the company's commercial paper.
In fact, the amount outstanding was increased from $150 million to
$200 million during late 1969. During this period Goldman, Sachs
gained possession of material adverse information, some from public
sources and some from nonpublic sources indicating a continuing
deterioration of the financial condition of the transportation company.
Goldman, Sachs did not communicate this information to its commercial paper customers, nor did it undertake a thorough investigation
of the company. If Goldman, Sachs had heeded these warnings and
undertaken a revaluation of the company, it would have learned that
its condition was substantially worse than had been publicly reported.
Public information
Based on information publicly available by November of 1969, a
thorough reevaluation of the transportation company's financial
condition would seem to have been appropriate. For example, the
reported loss of the transportation company for the first 9 months of
1969 was $40.2 million, or $26.4 million more than in 1968. In late
November an announcement was made that Penn Central was passing the dividend. In testimony before the ICC, outside counsel representing the company told the ICC that Penn Central was having a
very difficult time effecting the merger (management was very upset
by this statement). This matter, as well as a reference to the same effect
by an independent expert a few days later, was reported in the news
The above information was available to Goldman, Sachs through the
public media. However, this did not cause Goldman, Sachs to reexamine the financial condition of the company whose paper Goldman,
Sachs was selling as prime rated commercial paper. ID addition,
thereafter, other public information came to their attention which
indicated a serious worsening of the company's financial condition.
Other information available to Goldman, Sachs concerning the general
financial condition of Penn Central Transportation Co.
Whether it was for these or other reasons, a memo written by Robert
Wilson on September 3, 1969, indicates that there was some concern
at this time about the company's financial situation. In the memo
Wilson states that as "* * * it has been a long time since we had
gotten together to talk about the company/' he had requested a meeting with the top officials in the company's finance division since, "We
have a lot of questions to ask about the merger, cash flow, and their
long term financing plans."
On September 19, 1969, Wilson and others in Goldman, Sachs met
with Jonathan O'Herron, vice president-finance of the company.
Among other things, O'Herron stated that the company would be in a
very tight cash position in the first quarter of 1970. Because of this,
he asked if Goldman, Sachs would sell as much commerical paper as
possible through April or longer, and disclosed that the company had
applied to the ICC for authorization to increase its outstanding commercial paper from $150 million to $200 million.

On October 22, O'Herron told Wilson that Penn Cential would
show a small loss in the third quarter, but he anticipated that the
fourth quarter would be in the black with a good improvement.
On October 29, the ICC approved an increase in the amount of the
company's commercial paper outstanding from $150 to $200 million.
There were, however, a number of important disclosures in the ICC's
order. In discussing approval of the issuance of this increased amount,
the ICC stated:
Applicant feels that long-term financing at the present time is not feasible due
to the tight-money situation. Although we are sympathetic to applicant's problem, short-term financing has traditionally been relied upon to finance short-term
needs and is not normally regarded as a proper source for long-term financing of
capital expenditures or for refinancing of maturing long-term debt. As of June 30,
1969, applicant had a deficit working capital situation which can be expected to
worsen if reliance on short-term financing is increased. The exhaustion of shortterm credit to refinance maturing long-term debt or to finance long-term capital
expenditures could expose a carrier to a serious crisis in the event of an economic
squeeze, at which time a carrier may require short-term financing for traditional
use. We are, therefore, concerned about the use of short-term financing for longterm purposes and feel that where necessary it should be resorted to cautiouslv.

The order went on to state that on the whole the company was in a
strong financial condition, and in view of the tight money market at
that time and the fact that the company had indicated its intent to
negotiate long-term financing as soon as possible, the ICC would approve the request for an increase in the outstanding commercial paper.
In approving the increase, the ICC order noted:
According to the investment banking firm which usually handles applicants*
commercial paper, unless market conditions change, there is a market for an
additional $50 million of applicant's notes.

Goldman, Sachs, however, never did explore in any depth the areas
of inquiry which they indicated would be the subject of the September
meeting. All of the information described above raised serious questions about the soundness of the Transportation Co. and the safety
of investing in its commercial paper. The information indicated that
the company was experiencing a liquidity crisis and that it might find
it extremely difficult in the future to meet its cash needs, thus jeopardizing commercial paper holders. A thorough study of the subject
would have disclosed how much more damaging the information about
liquidity of the company and its ability to pay off commercial paper
holders was. Although such a study would appear to have been in
order at this time, Goldman, Sachs did not conduct any further investigation, and made no disclosure of the above information while
continuing to actively promote the company's commercial paper.
Customers were not told that the company expected to be in a tight
cash position in the near future; were not told about the ICC order or
the information about the deficit working capital situation or the fact
that the company's commercial paper proceeds were being used for
long-term financing.
Requests by Goldman, Sachs that Penn Central increase the lines of
credit backing up its commercial paper
There was other information Goldman, Sachs was receiving in
the latter part of 1969 and in early 1970 which indicated a deteriorating
financial condition and raised questions concerning the liquidity of
the company.

As early as September of 1969, Goldman, Sachs initiated a request
t h a t the company increase its back-up lines of credit l% for its commercial paper. At the September 19, 1969, meeting described above,
O'Herron had described how the railroad was currently borrowing
$250 million out of a total $300 million revolving credit. He went on
to state that the company intended to use the remaining $50 million
of the revolving credit lines plus $50 million of outside lines of credit
as back-up for the $200 million in commercial paper. Wilson then
asked O'Herron if it were possible to get an additional $50 million in
back-up lines. According to Wilson, Q'Herron replied that it was,
but he would prefer not to do so. O'Herron's account is: " I can't
remember specifically whether I said I preferred not to, or said I
didn't think I could.'' When asked why the company could not have
increased its lines, O'Herron replied:
Because I think the Penn Central had already had a line of credit, some of
which was used at that time, of $300 million, and which was a pretty sizable
amount of credit availability, for even a company of that size. So, the probability
of increasing that was not very great in my opinion. So, I can't recall if I said
"preferred not to," or "couldn't," I think they are both the same.

Wilson testified that Goldman, Sachs' concern was to convey t a
the company their feeling that customers were considering back-up
line coverage as being more important because of the tight money
market which prevailed in late 1969 and early 1970. Although it is
his opinion that back-up lines were not a firm commitment to lend
money, Wilson did state that back-up lines are important to customers
as an indication of some willingness on the part of the banks to supply
credit to back up their paper, especially in times of tight money. In
fact, when asked what the average commercial paper investor looks
to in determining whether an issuer will be able to make repayment,
Wilson replied :
I think they look at all these things, I think they look at cash flow; I think they
look at back-up lines; I think they would look at capacity to get lines, capacity
to do financing, all these things.

There is conflicting evidence as to whether or not it was unusual
for Goldman, Sachs to have been requesting more than 50 percent
line coverage of the company at this time. In any case, Goldman,
Sachs was to ask the company repeatedly for an increase in line
coverage on into the first quarter of 1970 without success (eventually
Goldman, Sachs even began asking for 100 percent coverage). The
management of the company was very reluctant to ask the banks for
more line credit. Although Goldman, Sachs never in