Commissioner EICHER Concurring:

Although the record and the applicable law impel me to concur in the findings and opinion of the majority, I wish also to record my agreement with the observations on "reproduction cost" so lucidly set forth by Commissioner Healy in his supplemental opinion.

The public interest is flagrantly prostituted when a corporate structure that is built on a natural or statutory monopoly becomes the legal instrument for capitalizing property at valuations in excess of cost, whereby both the rate payer and the investor, through dilution of the underlying values, are made to assume the burden of an artificial capital pyramid disproportionate to the prudent investment in the property that is used and usable in the public service.

This Commission, to be sure, is not vested with rate-regulatory power, but in the public utility field, I believe, we are charged with a definite responsibility for the protection of consumers as an important segment of the public interest. Smyth v. Ames, unfortunately, as Commissioner Healy points out, has been perverted to support "reproduction cost new" as the controlling, if not the exclusive, factor in the determination of the rate base. Under the opinion's plain language there is no justification for applying the reproduction cost yardstick beyond the demonstrated need for present or prospective replacements in existing plant during the probable period of revised rate incidence. The majority opinion of Mr. Justice Reed, handed down on April 17, 1939, in the case of Driscoll et al. v. Edison Light & Power Company, 307 U. S. 104, when read in the light of the concurring opinion of Justices Frankfurter and Black, promises eventual limitation of the undue scope that Smyth v. Ames has been accorded in too many quarters.

Still less is there any reason or justice in permitting a periodic reappraisal to bulwark additional securities issues beyond the fair values gauged by the prudent investment upon which privately owned property devoted to public use enjoys constitutional protection against the confiscation that would result from the imposition of rates yielding less than a fair return. Such practice inevitably spawns the serpentine circle of higher rates followed by higher reappraisals to support more securities issues, and vice versa, ad infinitum.

Private business, it is true, is subject to no statutory prohibitions in its effort to keep the earnings ratio and the concomitant capital structure abreast of price or value fluctuations in capital assets; but, unlike a public utility, it does not (in theory, at least) conduct its operations in a monopolistic vacuum. Hence, it is liable, both as to capital and income, to all the hazards of a competitive order. In fact, established public policy, rightly or wrongly, seeks to hold it so.

Chairman FRANK concurring:

In the light of the concurring opinions of Commissioners Healy and Eicher, I think it desirable to add these comments:

1. In the concurring opinion of Commissioner Healy, stress is laid on the fact that in Atlanta B. & C. R. Co. v. United States, 296 U. S. 33, the Supreme Court quoted with approval the statement that "the only pertinent value is that for purposes of sale or exchange." Whether or not that case is precisely pertinent, I fully agree that, in considering the issuance of new securities, "sale or exchange value" is the proper criterion for this Commission. The courts have said that sale or exchange value is to be determined by the reasonably expected future earnings of the property; the courts have so held in condemnation cases, in cases involving purchases by municipalities under contracts, and in reorganization cases. [See cases cited In the matter of Genesee Valley Company, Inc., 3 S. E. C. 104 at 112 (1938) (footnote 19).] Accordingly, when we are considering the issuance of new securities, the controlling factor is the reasonable expectation of the future earnings of the issuing company.

2. It follows, then, that the rate base is not the controlling factor in determining the propriety of the issuance of new securities. The rate base merely sets the upper limit to the potential future earnings and is pertinent merely to that extent: It can happen, and has happened, that a company is unable to earn a reasonable return on the amount which the courts fix as the rate base. Thus, the rate base of a given company may be $100,000,000, and the proper going rate of return may be 6%, despite which the property may be capable of earning only 3% on $100,000,000; in such circumstances, securities could not be properly issued on the assumption that the property had a value of $100,000,000. On the other hand, the properties of a company may be earning 6% on $100,000,000, and yet the facts might show that it is highly likely that, in the reasonably near future, the state commission will so drastically reduce the rate base as to limit the earnings to a sum equal to only 3% on $100,000,000; in that event, again, in connection with the issuance of new securities, it would be improper to assume that the property had a value of $100,000,000.

In other words, when considering the issuance of new securities, the proper rate base can, at most, have an effect only as a limiting factor; that is, it fixes an upper limit to the sum which the company will be permitted to earn. If, therefore, the rate base were obviously far too high, that fact would affect a judgment as to the reasonably foreseeable earnings of the company; it is conceivable that there might be a case where the rate base was obviously too low, in which event that fact might affect a judgment as to the future earnings.

Accordingly, for the purposes of determining the propriety of the issuance of new securities, we should consider whether there is evidence indicating that there is a prospect that the earnings will be decreased, and, for that purpose, it is relevant to consider whether the rate base is too high. In doing so, however, we must bear in mind that these are matters as to which we have no power to order but at most a need to predict.

What then are the facts in this case as to prospective changes in the applicant's earnings? The answer is that there is nothing to show with any conclusiveness that the rate base is or is likely to be regarded by the state commission as unduly high and therefore nothing to warrant a compelling inference that, by future order of the state commission, the earnings of the company will be substantially reduced:

(1) In the first place, the facts set forth in the other opinions were known to the state commission in 1931, when the issuance of the presently outstanding securities (except for the temporary note) was authorized.

(2) There is no proceeding now pending for a revision of the rates of this company or any indication of the likelihood of such a proceeding in the future.

(3) If the state commission, in fixing the rate base heretofore, has considered evidence as to reproduction cost less depreciation, we are not at liberty, merely because of that fact, to conclude that the rate base is too high. For, in determining the proper factors to be considered in fixing a rate base, all commissions must be guided by the decisions of the United States Supreme Court; and, up to this date, that court has held that in determining the rate base, evidence as to reproduction cost less depreciation must be regarded as distinctly relevant. Unless and until the Supreme Court otherwise decides, this Commission-to the limited extent that it must regard the rate base cannot ignore the fact, whatever may be the personal views of the members of the Commission concerning that subject.

3. Nevertheless, to some extent, Driscoll et al. v. Edison Light and Power Company, 307 U. S. 104, needs to be considered in connection with new security issues. For it casts some doubt on the continued relevance of evidence as to reproduction cost in fixing a rate base, and serves as a warning that the Supreme Court may hereafter hold that evidence as to reproduction cost should be of much diminished importance. That is a possibility which a careful investor would, in some cases, take into account as disclosing a likelihood of substantial reduction in earnings, just as he would other factors which might have the

same consequence.18 And we, therefore, must also take such contingencies into account, especially when dealing with debt securities, for they carry with them the possibility of future defaults and resultant necessity for reorganization, if earnings substantially decline. In addition, if in any particular case, the issuance of new securities would in some manner preclude a state commission from reducing a rate base which, apart from the issuance of such new securities such commission would be in a position to reduce, then we would be required to consider the exercise of our specific power to impose conditions and would perhaps have the power to refuse permission to issue such securities,19 since the Act admonishes us to consider the interests of consumers as well as investors.

4. There can be no doubt that there were write-ups on the books of the applicant and its subsidiaries. Since, however, (1) the only proper questions for us are the applicant's reasonably anticipatable earnings, and since (2) those earnings so far as now predictable, are ample adequately to cover the fixed charges and, when capitalized at the going rate, yield a figure affording ample coverage to the debts as they will be when the new securities are issued, there appears (3) to be no further occasion to consider the propriety of the transactions resulting in the formation of this company or the propriety of the entries reflecting those transactions.

18 Thus, if reproduction cost is to be regarded as an important constituent of a rate base, he would, in considering the anticipated revenues of a company, take into account a declining price level.

19 If the case came before us under Section 6 (a), with the result that Section 7 would be applicable, we would have the power thus to refuse permission; whether we have similar power in a case coming up under Section 6 (b) need not here be discussed.

5 S. E. C.

[No. 773]

IN THE MATTER OF

FEDERAL LIGHT & TRACTION COMPANY

and

CITIES SERVICE POWER & LIGHT COMPANY

File No. 31-442. Promulgated June 19, 1939

DECLARATION OF STATUS.

Subsidiary Company.

Joint application having been filed by two registered holding companies for an order declaring a railroad company not to be a subsidiary of either of applicants pursuant to Section 2 (a) (8) of the Public Utility Holding Company Act of 1935, company declared not a subsidiary of either applicant.

FINDINGS AND OPINION OF THE COMMISSION

Federal Light & Traction Company and Cities Service Power & Light Company have filed joint application for an order of the Commission declaring Cowlitz Chehalis and Cascade Railway Company not to be a subsidiary of either of such applicants pursuant to Section 2 (a) (8),1 of the Public Utility Holding Company Act of 1935. After appropriate public notice a hearing was held on such application. A trial examiner's report and the submission of requested findings of fact by counsel for the parties were waived as were also

1 Section 2 (a) (8) of the Act provides: "Subsidiary company" of a specified holding company means

(A) any company 10 percent or more of the outstanding voting securities of which are directly or indirectly owned, controlled, or held with power to vote, by such holding company (or by a company that is a subsidiary company of such holding company by virtue of this clause or clause (B)), unless the Commission, as hereinafter provided, by order declares such company not to be a subsidiary company of such holding company; ...

The Commission, upon application, shall by order declare that a company is not a subsidiary company of a specified holding company under clause (A) if the Commission finds that (i) the applicant is not controlled, directly or indirectly, by such holding company (either alone or pursuant to an arrangement or understanding with one or more other persons) either through one or more intermediary persons or by any means or device whatsoever, (ii) the applicant is not an intermediary company through which such control of another company is exercised, and (iii) the management or policies of the applicant are not subject to a controlling influence, directly or indirectly, by such holding company (either alone or pursuant to an arrangement or understanding with one or more other persons) so as to make it necessary or appropriate in the public interest or for the protection of investors or consumers that the applicant be subject to the obligations, duties, and liabilities imposed in this title upon subsidiary companies of holding companies.

137