ALLEGHANY'S WARRANTS

The outstanding perpetual warrants of Alleghany were issued in connection with a securities exchange transaction designed to reduce accumulated dividends and improve the financial stability of the company in return for a stake in its future. The present value of these warrants as appraised in the marketplace is a tribute to the sound judgment of the company's management and the ICC in respectively proposing and approving the transaction.

Nevertheless, because the elimination of Alleghany's section 3(c) (9) exemption would result in paramount jurisdiction over Alleghany being vested in the SEC under section 50 of the Investment Act, the SEC would seemingly be vested with the power to prohibit the honoring of such warrants because, when issued, the precise procedure prescribed by the Investment Act was not followed and the characteristics of the warrants were not in accord with the standards of section 18(d) of the Investment Act and because at any given time the honoring of the warrants might require a sale below the prevailing asset value of the common stock, as computed under that act, in possible violation of section 23(b) of said act. The contract rights and obligations inherent in these warrants were duly approved by the stockholders of the company and by the ICC and no contract right so authorized by a governmental agency should be subject to such a threat even though any attempt to exercise such power obviously would ultimately, after protracted and costly litigation, be sricken down as unconstitutional.

ALLEGHANY'S 6 PERCENT CONVERTIBLE PREFERRED STOCK

Inasmuch as the SEC as recently as November 1956 held that Alleghany's 6 percent convertible preferred stock is not a "senior security" as defined in section 18(g) of the Investment Act (despite its undisputed priority over the common stock as to distribution of assets and payment of dividends) but is a "right to purchase" and, as such, falls within the prohibition of section 18(d) of the Investment Act, there is even a danger that the legislation now proposed could be utilized to prevent the holders of the 6 percent convertible preferred stock from exercising their conversion rights. To be sure, that prejudicial decision of the SEC does violence to the plain meaning of the Investment Act, but it stands as the only expression extant of the SEC's attitude toward Alleghany's 6 percent convertible preferred stock. The administrative decision of SEC was never reviewed by the courts because the U.S. Supreme Court's action in Breswick v. Alleghany (353 U.S. 151 (1957)) rendered it a nullity. If the SEC should persist in regarding this convertible preferred stock as a warrant under section 18(d) and not the senior security that it is, that Commission could destroy the value of that security by treating it as a warrant within the meaning of secion 23(b) rather than as the convertible security which it is. The dire possibilities forecast above in the discussion of Alleghany's warrants would then apply with equal vigor to the 6 percent convertible preferred stock. It must be remembered and emphasized that SEC tried to invalidate Alleghany's securities after they had reached the marketplace and after their issuance had been approved by ICC. There can be no stronger evidence that SEC has opposite tests from ICC for carrier holding companies and that overriding SEC jurisdiction just will not work.

ISSUANCE OF SECURITIES BY ALLEGHANY

Again, by virtue of such paramount jurisdiction vested in the SEC, it would have the power to prevent, subject to certain exceptions, the issuance by Alleghany of any of its securities for services or property other than cash or securities (sec. 23(a) of the Investment Act) or the issuance or sale of any senior security (debt or stock) which fails to meet the asset coverage test prescribed by said act (sec. 18, Investment Act). If at any particular time the senior securities of Alleghany should fail to meet the asset coverage test, the SEC would have the power to prevent the issuance and sale of such securities although duly authorized by corporate action and valid orders of the ICC. Even the right to resell its own securities duly acquired and held in the Treasury within the restrictions of the Investment Act could be prohibited.

See 50 provides that in all cases of conflict with the jurisdiction of other Commissions tatutes, the Investment Act shall control.

Perhaps the most shocking threat to the enforcement of contract rights contained in section 18 of the Investment Act is the prescribed shift of voting rights to senior securities in the event the asset coverages thereon fall below prescribed minimum (sec. 18(a) (1) (c)-2(c) of the Investment Act). The threat can be implemented by refusal of the SEC to permit the issuance or sale of such securities.

REORGANIZATIONS

Any reorganization, consolidation or merger participated in by Alleghany, which could well directly involve a railroad and which would in any event be duly authorized by the ICC as desirable and in conformity with the public policy of the National Transportation Act, could, by virtue of the purported paramount jurisdiction vested in the SEC by section 50 of the Investment Act, be so hampered by advisory opinions of the SEC and by appeals to separate and distinct district courts of the United States as to nullify for all practical purposes said public policy (sec. 25 of the Investment Act). It is difficult to justify the advocacy by the SEC that it be given this power of interference, except on the assumption that it believes the ICC incompetent to determine in its investigation and evaluation of reorganization plans whether or not there has been gross misconduct or overreaching in formulating such plans. The burden is certainly on the advocates, who seek such power of interference with the duties of another governmental agency, to establish such incompetence or advance some more generous explanation.

The interference described above with respect to mergers and consolidations contemplated by section 5 of the Transportation Act will not be confined thereto since the definition of reorganizations in the Investment Act includes in addition to mergers and consolidations (1) a sale of 75 percent or more in value of assets; (2) a restatement of capital or an exchange of securities for outstanding securities of the issuer; (3) a voluntary dissolution or liquidation; (4) a recapitalization having for its purpose the elimination of the rights, preferences or privileges of any class of securities; and (5) an exchange of securities for securities of another company or companies for the purpose of effectuating any of the foregoing (sec. 2(a) (32) of the Investment Act). The foregoing indicates that the SEC's power to interfere under the provisions of section 25 of the Investment Act will be extended to practically every financial activity of Alleghany presently subject to the regulation of ICC.

THE CONFLICT WITH ICC RESULTING FROM SEC'S POWER UNDER SECTION 17 OF THE INVESTMENT ACT

The power to interfere under section 25 of the Investment Act, pervasive as it is, pales into insignificance compared with the power the proposed amendment will permit SEC to wield under section 17 of the Investment Act over many activities of the more than 70 actual rail carriers included in or affiliated with the New York Central Railroad system. The New York Central is constantly reshuffling the form of its control relationships with carriers in its system in the interest of accomplishing financial transactions or operational changes with greater legal ease. These changes all constitute "acquisitions of control" within the meaning of section 5 of the Interstate Commerce Act. As such they are all subject to careful review by the ICO and Alleghany is necessarily a party to each of the applications for approval. Now, because the New York Central is an affiliated person of Alleghany and virtually all of the carriers in the New York Central system are affiliated persons of Central (as that term is defined în sec. 2(a)(3) of the Investment Act), SEC proposes to make most and perhaps all of these railroad activities its concern. ICC could approve, but SEC could override the approval and expressly forbid under section 17 of the Investment Act. It would be but another instance of inexpertness prevailing over expertness. ICC would cease to be a coordinate Government agency and become a subordinate body.

SEC has stated its duty under section 17 in its memorandum opinion in the Matter of E. I. du Pont de Nemours and Company (34 SEC 531, 534 (1953)): "Section 17 of the Investment Company Act calls upon us to determine, among other things, the fairness and reasonableness of certain transactions in securities or property to which investment companies or their affiliated persons are parties. The Congress found in section 1(b) of the act that such transactions adversely affected the national public interest and the interest of investors, when they were effected otherwise than in the interest, of all security holders. The review called for by section 17 (b) was designed to counteract such adverse 425605936

effect, and under the congressional declaration of policy in section 1(b) we are obligated to interpret section 17 to mitigate and, so far as is feasible, to elimi nate the possibility of such transactions being consummated contrary to the interest of security holders."

To single out just three of the limitless kinds of ICC approved transactions which, if the SEC proposal is enacted, railroads controlled by Alleghany could not consummate without SEC's imprimatur, we suggest the following:

1. The transfer of securities by an affiliated person of a registered invest ment company to a person presumptively controlled by such invstment company. 2. An acquisition by an affiliated person of a registered investment company of securities from a person presumptively controlled by such investment company. 3. The statutory merger of two non-investment-company affiliates of a regis tered investment company.

The first two of the foregoing illustrations paraphrase those which SEC's Du Pont decision (p. 532) held to be within the scope of that Commission's sweep ing section 17 power. The other is a restatement of the fact situation in SEC's decision in the Matter of Phoenix Securities Corporation (9 S.E.C. 241 (1941)). In 1941 SEC took the view that the Phoenix facts were not within section 17's ambit, but Du Pont says the SEC's 1941 limit on its own section 17 power is not to be considered "any longer as authoritative in the construction of section 17(a)." The list could be multiplied dozens of times over. The mere thought of the infinite additional types of transactions which ICC would cease to have ultimate control over is staggering in the extreme. It is not only Alleghany and its stockholders whose interests would be affected, but also the interests of the dozens of railroads in the New York Central System and the stockholders of each of them.

DUPLICATIONS AND NUMEROUS CONFLICTS

The duplications and conflicts to which Alleghany would be subjected if the proposed amendment should be adopted could be elaborated herein at greater length. To do so would merely further emphasize in varying degrees the basic fallacies and defects of the proposal. No such elaboration seems necessary or desirable to establish the basic unfairness to Alleghany of the proposal or the threat it poses to a proper regulation and administration of the policies and purposes of the National Transportation Act, to say nothing of the havoc it would wreak on the orderly conduct of the functions of the two coordinate administra tive agencies which would be saddled with its interpretation and implementation.

CONCLUSION

It is no answer to the problems presented above and particularly the constitutional questions which could arise as a consequence of the adoption of the proposed amendment, to point to section 6(c) of the Investment Act as a de vice which will permit the SEC to escape any unconstitutional activity. If there is no intention on the part of the SEC to regulate the capital structure and issuance of securities of carrier holding companies (such regulation being the heart of the Investment Company Act) in conformity with the restrictions, tests, and procedures of such act, the proposed amendment is without a purpose or an objective The contacts of Alleghany with the SEC in the past, however, as well as SEC's prior unsuccessful efforts to convince ICC to voluntarily relinquish its plenary jurisdiction over Alleghany, strongly point to a desire and intent by the SEC to subject the operations of Alleghany, including its capital structure and financing, to regulation under the tests of the Investment Act by any means available. If there is any possibility that the proposed amendment might authorize unconstitutional action by the SEC, it, of course, should not be placed on the statute books where it will give rise to constant threats of litigation againsts the legitimate operations and activities of Alleghany, already subject to adequate regulation by ICC To place such a threat in the hands of any governmental agency is not conducive to the development of public confidence in the agency or its determinations.

To make Alleghany the victim in SEC's administrative struggle for power, to place Alleghany's stockholders again in the vise they were in before the Supreme Court upheld ICC's jurisdiction over Alleghany in 1957, is to injure the innocent investor and reflect unfavorably upon the competence of the ICC. It is submitted that the proposed amendment poses so many doubts as to its constitutionalilty, and the desirability and necessity of its adoption for the purposes and objectives anticipated, it should be rejected in the interest of fairness to the ICC, if not Alleghany.

Be follow

(The following was ordered inserted in the appendix.)

MEMORANDUM OF THE SECURITIES AND EXCHANGE COMMISSION ON PROPOSED
AMENDMENT TO SECTION 3(c) (9) OF INVESTMENT COMPANY ACT OF 1940

Alleghany Corp. has objected to the proposed amendment of section 3 (c) (9)
of the Investment Company Act of 1940. The gist of the objections is (i) that the
proposed amendment is directed solely against Alleghany and is unconstitu-
tional; (ii) that regulation under the Investment Company Act is unnecessary
because the Interstate Commerce Act provides Alleghany's security holders
with greater protection; and (iii) that Alleghany and its carrier affiliates will
be subject to conflicting dual regulation by the SEC and the ICC.

The SEC will show by this memorandum that the first two of these objections are wholly without merit and in many respects frivolous, and that, as respects the third objection, there will be no dual regulation in respect to matters of direct importance to the national transportation policy.

1. THE LOOPHOLE UNDER EXISTING LAW

As the committee is aware, section 3 (c) (9) of the Investment Company Act excepts from the definition of an investment company any company which is subject to regulation under the Interstate Commerce Act, and generally speaking, also excepts their controlled companies which hold securities of issuers which are themselves subject to such regulation.

This provision makes it possible for an investment company to escape the provisions of the Investment Company Act, by the simple expedient of using a portion (which might be relatively minor) of its assets to acquire control of two or more carriers, thus subjecting itself to regulation under some or all of the provisions of the Interstate Commerce Act specified in section 5 (3) thereof. The significance to the national public interest of this possibility becomes readily apparent when it is realized that any one of the approximately 500 registered investment companies with total assets of over $18 billion, by the investment of a few hundred thousand dollars in interstate transportation carriers might avoid the regulation which Congress intended to apply to investment companies.

The Commission has not made a detailed study of the number of companies which might be affected by the proposed amendment. Such information can only be obtained by an exhaustive search of the financial reporting services or other sources. Several instances can be cited, however, in which Commission jurisdiction would have been clearly established had the proposed amendment been the law.

There is presently registered under the Investment Company Act the American Hawaiian Steamship Co. The company for many years had been engaged in intercoastal shipping both directly and indirectly through controlled companies. It disposed of all of its shipping interests and invested substantially all of its assets in securities. The company holds an irrevocable certificate of convenience and necessity granted by the Interstate Commerce Commission, and is required only to file reports with the ICC. For this reason it claimed that it was excepted from the definition of an investment company under section 3(c) (9) and refused to register. Only after the Commission instituted action in the Federal district court to prevent a continued violation of the Investment Company Act did it register thereunder on February 24, 1959. Its counsel stated that in his opinion the company was entitled to the exception of section 3(c) (9) but would register to avoid further litigation.

The Detroit & Cleveland Navigation Co. presented a fact situation almost similar to that of American Hawaiian Steamship Co. However, the company voluntarily surrendered the certificate of convenience and necessity to engage in shipping and voluntarily registered under the Investment Company Act in 1954. In the case of Alleghany Corp. it had registered under the Investment Company Act on November 1, 1940, and had remained subject to regulation thereunder until October 4, 1945, when the SEC terminated the registration because of the entry of an order in that year by the ICC, under section 5(2) of the Interstate Commerce Act, subjecting Alleghany to regulation under certain provisions of the Interstate Commerce Act. In 1945, immediately before the SEC terminated Alleghany's registration, 86 percent of Alleghany's assets of

$83 million, taking investments at the then current market values, were invested in carriers, including 38 percent in stock of the Chesapeake & Ohio Railway Co., and only about 5 percent in the securities of noncarrier issuers. The investment in the C. & O. stock consisted of about 600,000 shares (8 percent of the outstanding shares) and gave Alleghany control over that company, which control was the basis for the ICC order of 1945.

Shortly after the termination of its investment company status Alleghany began a program of disposition of its C. & O. stock and in 1954 it sold the last of its holdings consisting of 104,854 shares. It also sold all of its other railroad securities except its interest in the Missouri Pacific Railroad Co. Since that time it has acquired control of the New York Central Railroad Co. and holds 979,000 shares (15 percent) of that company's common stock.

The following table shows the composition of Alleghany's assets which, on the basis of market prices at May 25, 1959, of marketable securities, total ap proximately $165 million.

Total..

From an earnings point of view, the following table presents the major source of Alleghany's income for the past 5 years:

In this same 5-year period Alleghany's interest in the undistributed earnings applicable to its common stock holdings of New York Central and Investors Diversified Services, Inc,, has not been reflected in the foregoing table. These should, of course, be taken into consideration.

2 Since 1956 interest on notes primarily represents interest at the rate of 5 percent per annum on $19,950,000 of notes of Webb & Knapp.

The foregoing portrayal of Alleghany's assets is not to be considered a determination by the SEC of Alleghany's status as an investment company. That determination, if the proposed bill is adopted, will be made in a proper ad ministrative proceeding. These figures are presented, however, to show that Alleghany falls within the presumptive test of an investment company which is contained in section 3(a)(3) of the statute. As will be explained later, this section raises the presumption of an investment company, generally speaking. if more than 40 percent of the assets, on a value basis, consist of investment securities.

These figures are also presented to show the wholly misleading nature of Alleghany's statements to this committee that "62 percent of Alleghany's in vestments on a cost basis are stock of the New York Central Railroad Co. *** and the Missouri Pacific Railroad Co." and that it "owns stock, representing 1.4 percent on a cost basis of its total portfolio in an investment company, Investors Diversified Services, Inc."

On a cost basis Alleghany's total assets amount to approximately $65,648,000, on a value basis $165 million. The IDS stock which Alleghany holds had a cost of approximately $1,200,000 in 1949 while its market value now approximates $92 million. The MoPac stock which cost approximately $26 million has a