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

47 For example, reports filed with 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.

SUMMARY AND CONCLUSIONS

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 Governmert 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 it appeared to be a major factor propelling management's lack of candor.409 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 rear, 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

408 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.

409 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

410 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.

1970

1969

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

Not railway operating income (9.0)

"Parent railroad company"?! (56.3) Nat milway operating incomm (41.3)

PENN CENTRAL CONSOLIDATED SOURCE & APPLICATION OF FUNDS/YEAR 1968 (in millions)

EXHIBIT IG-2-Continued

Penn Central Consolidated Source & Application of Funds/Year 1969 (in millions)

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 period.

The following summary shows how your 1969 dividend compares with annual payments in recent years:

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. It 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, we now have approximately 7,500 less employees than we did at the highest level since our merger and inclusion of the New Haven. We are accelerating our early retirement program and have retired 541