the payment of $7 million to four Great Southwest employees to renegotiate their employment contracts. Penn Central management and Dechert, however, decided to treat Odell's 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.34 343

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 having Great Southwest furnish "inside" information to the Pennco board.344 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 Arps 346 in mid-January that Saunders had said that the Dechert firm would give an opinion that Odell's 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 Central's. 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 Pennco got involved in Great Southwest affairs the board would be held liable 142 From Odell's letter of January 8, 1970 to the Pennco board:

SAN FRANCISCO, CALIF., 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 company.

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. 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 board.

"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."

"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.

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.3

347

THE FINAL MONTHS

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 manage

347 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 losses.

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 receivership.

348 One director described this period as "The Valley of Frenzied Finance."

349 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, Beven'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 Penn Central's request for assistance to the attention of Secretary Volpe. The first meeting was on March 12, 1970, in Secretary Volpe's office. Penn 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 jeopardize pending passenger assistance legislation. The DOT asked for information about the company's cash losses.

The discussion still had not gotten to the question of an immediate crisis even though Penn 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 their 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'Herron warned Secretary Volpe that the condition of Penn Central was more critical than Saunders was admitting and that the debenture offering would probably never be sold. Secretary 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.

GENERAL

The fact that Penn Central was experiencing difficulties did not come as a surprise to shareholders but the severity of the difficulties did. There had been problems in the railroad industry for years and it was recognized by 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 but 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." 350 It is clearly the latter standard which is the one applicable under the antifraud provisions of the Federal securities laws. In 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. It 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. 193,334 ED 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 but what is understood by the reasonable shareholder.

RAILROAD OPERATIONS: THE MERGER

The merger of the Pennsylvania and New York Central railroads was repeatedly held out, both before and after the merger, as a strongly positive factor for the future, despite internal misgivings. The position was publicly held by Penn Central until the end, in mid-1970.

Hearings on 8. 4011, 8. 4014, and S. 4016 before the Committee on Commerce, 91st Cong., second sess., part 3, at 681 (1970).