talized and carried in the account representing development costs as of March 31, 1938.17 Wemple endeavored to defend the reasonableness of the charges for depreciation, depletion, and amortization on the theory that the mine was in the early stages of development. It is clear, however, that at least since 1932 production has not been a mere incident to development and exploration.18 Moss agreed that the fact that provision had been made for depletion, depreciation and amortization of development costs, however inadequate, would indicate that the management regarded the company as being in the production stage, and that full provision for such charges should therefore have been made. The accountants have sought to justify their position on the ground that they relied upon the judgment of the management in the matters of depletion and amortization of development. We agreed that managerial judgment is one factor to be considered. But that factor is not to be considered to the exclusion of other factors. In the instant case, a proper investigation of registrant's policy of depreciation, depletion, and amortization of development costs would have revealed the glaring inadequacy of charges for those purposes. Absent an adjustment of registrant's policy in line with the realities of the situation, the accountants should have expressed in their certificate, in a definite and forthright manner, their disagreement with that policy. Miscellaneous items and adjustments. In their audit covering 17 The accountants based their treatment of this item on Wemple's statement that it represented development in excess of production. After the $15,000 expended for development was capitalized, the accountants prevailed upon the registrant to increase the amount set aside for depletion and amortization of capitalized development costs to 35¢ per ton. Moss testified that a conservative policy would have dictated an increase of an additional 10¢ or 15¢ per ton. Although the record is not clear on the point, it may be inferred that the registrant thereafter amortized current development costs as incurred. 18 The record of production of raw ore from registrant's mine contained in the registration statement is as follows: Year 1932-33. 1933-34 1934-35 Tons 78, 239 80, 223 Year 1935-361936-37-. Tons 128, 412 118,751 Although the record is not clear on the point, it seems reasonable to conclude that during these periods any profits resulting from the processing and sale of the ore produced is reflected in the registrant's profit-and-loss account. If, as contended by Wemple, the mine had been truly in the development stage, such profits should properly have been credited to development. McGrath, Mine Accounting (1921), p. 33. 6 S. D. C. the year ended September 30, 1938, Peat, Marwick, Mitchell & Co. wrote off the following items against earned surplus: Concentrates at idle plant at Peru, Ill---- Obsolete and slow-moving supplies and other inventory items at idle plant at Peru, Ill__-. Supplies at Deming, N. Mex_--_. @ $12, 496. 76 11, 268. 43 4, 909.71 • These concentrates were left at the Peru plant when smelting operations were transferred to Dumas in 1936. In the opinion of Peat, Marwick, Mitchell & Co., the above reductions in inventory values were properly allocable to the period prior to their audit and should have been reflected on the registrant's books at September 30, 1937. The necessity for reduction in value of the concentrates at registrant's Peru, Ill., plant was discovered when representatives of Peat, Marwick, Mitchell & Co. visited the plant and observed an actual count of stock taken by company employees. An inventory shortage of 324 tons was brought to light in this manner. The record does not disclose the reason for the shortage. There was also deducted from the valuation of these concentrates the freight charges that would be incurred in moving them to the company's smelter at Dumas, on the supposition that the concentrates would be processed by the company rather than directly sold. The adjustment of these items totaled $12,496.76. Tylman, Pond & Co., it appears, did not inspect the concentrates, but relied on an inventory certificate signed by the plant manager as to their value. During the course of their observation of the inventory count at Peru, Ill., Peat, Marwick, Mitchell & Co. arranged with the plant officials for a classification of obsolete and slow-moving items. Thereafter, such items were written down to scrap value, the adjustment amounting to $11,268.43. Moss testified that Tylman, Pond & Co. had received detailed inventories of supplies from the plant but that no indication had been given of the obsolescence of any of the items. The supplies at Deming were written down in the amount of $4,909.71 by Peat, Marwick, Mitchell & Co. on the basis of an analysis of the accounts and information received from the plant manager. In their certificate, Peat, Marwick, Mitchell & Co. stated that although they did not examine the property, plant, and equipment accounts prior to October 1, 1937, they had observed during the course of their audit that certain charges had been made to those accounts which apparently should have been made to profit and loss. It appears that registrant charged the cost of new financing (legal and registration expenses, etc.) aggregating $9,454.31 to the property account. Judged by prevailing accounting standards, that was improper.19 Registrant capitalized in the property account a loss in the amount of $11,109.13 incurred during a preliminary trial period. Even though it might be permissible to capitalize such losses in some cases, it is plainly improper to place such capitalized losses in a property account.20 The registrant has stipulated that: During approximately the first 5 months of the operation of the company's new smelting plant at Dumas, Texas, the company suffered a loss from the operation of said plant in the amount of $65,186.75, which loss was charged to earned surplus rather than to profit and loss; that said loss principally resulted from the cost of handling materials by hand prior to the completion and installation of mechanical equipment necessary for the economical operation of said plant; that in both schedules VII and VII (a) of the financial statements contained in Registration Statement No. 2-3641 said loss is charged to earned surplus as "Extraordinary operating expenses of Texas Smelter prior to completion, March 1, 1937 * * * $65,186.75" whereas the loss should have been charged to the profit-and-loss account for the fiscal year 1937 * Had the latter loss been charged to the profit-and-loss account, there would, of course, have been a reduction in the net income for the year in the amount of that charge. Conclusion. The record establishes, beyond peradventure, that at least one of registrant's principal officers, Wemple, deliberately manipulated and falsified the accounts in order to create the picture of a good operating record. The malfeasance was so carefully veiled that even the auditors were misled. There is nothing to indicate that the accountants were aware of the practices in question at the time they certified the financial statements. So far as appears, they were the innocent dupes of designing corporate officials. This fact, however, cannot exonerate them of all blame in connection with the false and misleading financial statements filed with the registration statement. Had they been completely alive to their functions as independent auditors, they would have discovered many of the improper practices and accounting improprieties. Too much reliance was placed on statements of the principal officers regarding many important matters. They apparently made no comprehensive effort to substantiate those statements by contact with employees having first-hand knowledge of the facts or by observation of the physical aspects of the business. And even their analysis of the records was lacking in thoroughness. In short, the audit, as conducted, did not measure up to the type of audit to which stockholders are entitled. 19 Paton, Accountants' Handbook (1937), p. 890; Montgomery, Auditing Theory and Practice (1934), p. 290; Bell, Auditing (1924), p. 255. 20 Hatfield, Accounting (1927), p. 68; Paton, Accountants' Handbook (1937), p. 802; Daniels, Financial Statements (1939), p. 27. As previously shown, registrant has filed an application to withdraw its registration statement. Rule 960 of the General Rules and Regulations under the Securities Act of 1933 provides in part: Any registration statement or any amendment thereto may be withdrawn upon the application of the registrant if the Commission, finding such withdrawal consistent with the public interest and the protection of investors, consents thereto In our opinion, the withdrawal of this registration statement is consistent with the public interest and the protection of investors. It was not the primary purpose of the registrant to make a public offering of the bonds covered by the registration statement. It was the registrant's intent to pledge those bonds with the New York Trust Company for banking accommodations. However, as the bonds were convertible into capital stock, it was necessary that they first be offered pro rata to stockholders in satisfaction of their preemptive rights. The offering to stockholders made necessary the registration of the bonds and stock under the Securities Act of 1933. The application for withdrawal states that out of a total of $600,000 principal amount of bonds offered, only $7,000 principal amount was purchased by the stockholders; the balance was pledged with the New York Trust Company. None of the stock has been issued. When apprised of the manner in which its affairs had been handled, the registrant's board of directors immediately undertook to put its house in order. The accounting firm of Peat, Marwick, Mitchell & Co. was retained and was instructed to and did make an investigation and audit of the registrant's affairs. The report of the auditors was filed with this Commission and the New York Stock Exchange, and was mailed to stockholders, brokers, banks, and statistical organizations. Wemple resigned as president and treasurer in September 1938. Arrangements were made to purchase all of the bonds outstanding in the hands of the public. As a result, only one bond remained outstanding at the time the application for withdrawal was filed. The holder of this bond, a nonresident of the United States, refused to accept the offer of the registrant to purchase the same at its principal amount and accrued interest. We find that withdrawal of the registration statement is consistent with the public interest and the protection of investors, and we therefore consent thereto. An appropriate order will issue. 21 Since the record was closed, registrant has advised the Commission that the one bord which was outstanding at the time the application for withdrawal was filed has been repurchased. [No. 983] IN THE MATTER OF SAN FRANCISCO BAY TOLL-BRIDGE COMPANY, Debtor Filed February 19, 1940 REPORT OF THE COMMISSION ON PROPOSED PLAN OF REORGANIZATION This is an advisory report of the Commission on a proposed plan of reorganization for the debtor, San Francisco Bay Toll-Bridge Company. The plan was filed on December 19, 1939, and was amended and referred to the Commission on January 12, 1940, for examination and report pursuant to the provisions of Chapter X of the Bankruptcy Act. We have examined the plan in accordance with our statutory duty. In our opinion, it does not meet the statutory and judicial requirements in that it is not fair to the persons entitled to participate and it is not feasible. I. DEBTOR'S HISTORY The debtor, incorporated in 1927 in the State of Delaware, owns and operates the San Mateo-Hayward toll bridge across San Francisco Bay. It holds a 50-year franchise expiring in 1977, when, under the provisions of California law, the bridge and its approaches will become a free public highway.1 The construction of the bridge was financed through the sale to the public of $4,500,000 face amount of 30-year 62% first mortgage bonds, and $2,000,000 face amount of 15-year 7% debentures, under indentures dated November 1, 1927. In partial payment of bridge and franchise costs, 7,205 shares of preferred stock and 125,650 shares of common stock were issued; subsequently 1,500 additional shares of preferred stock and 3,000 additional shares of common stock were issued for other purposes. Except for $197,000 face amount of first 2 1 Record of hearings, January 8-9, 1940, p. 59. The additional preferred stock was issued for services said to have been rendered in connection with a loan during the period 1931 to 1934. The additional common stock was issued from time to time as directors' fees. Since, as we discuss subsequently, we believe the proposed plan properly accords no recognition to the stock interests, and since no dividends were ever paid upon the shares, we do not undertake an inquiry into the circumstances of the issuance of any of the stock. |