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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.

PRESSURES ON THE ACCOUNTING DEPARTMENT TO ALLOW THE REPORTING OF HIGHER INCOME

It 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 earnings to the greatest extent possible, is that correct?

Answer. Unquestionably correct.

Question. That mandate came from Saunders directly?

Answer. From Saunders directly.

He later indicated that there was a continuing effort on the part of top management "to create the most favorable income at all times by the best favorable transactions".

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

28 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. 27 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 public.

28 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.

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dared, although the staff has not attempted to measure the precise impact. In 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. In 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 Central's 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 company.

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.

THE NOVEMBER CONFRONTATIONS

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 which he kept in 1967 and 1968, assertedly for his own protection.30 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 is reflected in the diary involves a period in early November 1967.31 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 reported:

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 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 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 matters.

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. I 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

30 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 funetions 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 Penn 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. * * *

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(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 PRR 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 been subjected to improper and undo [sic] influence as to accounting."32 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

32 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 the first audit for the Penn Central (and the Pennsylvania Railroad 33), 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, 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.

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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

33 The Pennsylvania Railroad had not had audited financial statements prior to that time. 34 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.

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