From Baker's testimony on Macco:

"Question. Did Mr. Bevan take an active role in the reorganization of Macco?

"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 him?

"Answer. He was, you know, active as the one the company ultimately reported to and would take part in reasonably long director meetings where the company's prospects and plans were rather fully 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 Pennsylvania 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:

208 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 half financial statements. 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.

"The first such 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 I recall the number, and attempted to review rather specifically the various accounting treatments of the 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 significantly]?

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 trying 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, Robert Odell, showed concern. Odell was himself involved in California real estate. In July 1968 he wrote to Saunders to warn him of problems Macco could face and to counsel caution.210 When Odell later demanded that the board be furnished with information on Great Southwest activities, management refused Odell's 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 In a letter of July 3, 1968 to 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 expecially 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.)

211 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 Odell's 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, Odell 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.2 212

PROFIT MAXIMIZATION THROUGH SALES OF BRYANT RANCH, SIX FLAGS OVER GEORGIA, SIX FLAGS OVER TEXAS, AND OTHER SALES

As early as August 1967, in a memorandum to Wynne analyzing Macco'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 but 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. 213 Memorandum from Baker to Wynne Aug. 5, 1967.

214 "Q. 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 property 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 215 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. By the end of 1968, 15 percent of the syndicated interests remained unsold. The transaction was closed, however, before the end of the year and Macco deferred accounting for the 15-percent unsold portion until

1969.

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 yearly 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 of the Georgia park principal or 33% percent of the Texas park principal had been paid.27 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 Co. required GSC to pay Transportation for 95 percent of the tax savings realized from the shelter.

These syndications 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

215 This was an intrastate offering and no SEC filing was made.

216 These syndications were registered with the Commission.

217 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.

219 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.