I-D. PUBLIC OFFERINGS IN'l'RODUCTlON The only public offerings by the Penn Central follmving the merger of the two railroads were a $50 million Pennco debenture issue in December 1969 and a $100 million Penneo tlebenture offering in the spring of 1970.162163104 The latter offering was never sold. There was no requirement that the offerings be registered with the Securities and Exchange Commission because the issuing company, Pennco, was under the jurisdiction of the Interstate Commerce Commission. The Interstate Commerce Commission rules require that companies under its jurisdiction make I1pplications t.o the ICC for permission to increl1se their debt obligations. The purpose is to determine whether an increase in debt is justified in the public. interest.l05 There were no rules, however, on the use or composition of any selling literature disseminated to the public. loO Norml1lly, companies under ICC jurisdiction prepare I1nd distribute an offering c.ircular in the general forml1t of a prospectus for a registered offering because the civil liability provisions of the Federal seclll"ities laws concerning disclosure apply to selling literature used by these eompanies. Despite the I1bsenee of a· requirement that offerings be filed with, and subject to review by, the SEC the threat of civil lia­ bility forces issuers and underwriters to be cftUtious in their use of sl1les literature. 1i'IFTY ll1lLLION DOl.LAH DEBENTURE OFFERING The $50 million Pennco debenture offering was made on December 16, 1969. The underwriters were First Boston Corp. & Glore, Forgan, Wm. R. StalLts, Inc. The debentures were exchangeable for shares of 1 the common stock of Norfolk & Western Ry. CO. 67 The N. & W. shares mvned by Pennco had been its most valuable asset both in underlying value and production of cash income. Because of the exchange feature, these debentures kept their value even after the bankruptcy of the railroad. The underwriters have cited this exehunge value as one of the reasons why the circular contains no information about the Transportation Co. 01' the holding company. The informa­ tion in the circular is limited to the Pennsvlvama Co. and Norfolk & Western. " '" The Transportation Co. did issue commercial paper which was made available to public investors but no offering circular was used or was required by the ICC. 1113 Both offerings were made [or the stated purpose o[ suppl;~ng funds [or the Transportation CO. IDI Penneo made a $35 million private plncement o[ collateral trust bonds in July, 1969. The proceeds were suoolied to the parent company. I" The Penn Central had to seek and obtain ICC approval to inc.rease debt under the revolving credit agreement and the commercial paper authorization as well as [or th~se public offerings. lOG The Federal securities laws reauire issuers (except exempted issuers. such as those regulated by the ICC) to file with the Securities and Exchange Commission a registration statement contnining ~peeific types of information. There arc additional rules governing the distribution of,elling literature to the public. 10' Exchangeable from Nov. 1, 19iO, to Apr. 15, Wig, at the rate o[ 12.2 sbares of N. & W. for each $1.000 debenture (Le. at a price of $81.9i pp.r share of N. & W.). (108) 109 Despite the fact that investors have been protected by the exchange­ ability provision, the circular presents a misleading picture of Pennco, particularly. in connection with Great Southwest. The assets are described in the introduction as constituting $922 million in market value on December 10, 1969. Of this $922 million the Great Southwest stock comprised $435,400,000. 168 The market value of Pennco's GSa holding was as large as it was because of failure to disclose the true state of affairs at GSa. The overvaluation was known to Glore, Forgan because it had been the designated underwriter on a GSa offering in October 1969, which had to be abandoned because of the adverse dis­ closure that would have been required. 169 The circular contained other failures to fullv disclose the affairs of Pennco. The apparent dilution of N. & W. stock which had occurred in 1968 was described at the end of the previous section of this reportYo This would require Pennco to free N. & W. stock from pledge or to purchase more on the open market. No mention of this additional burden was made in the circular and Pennco never informed the Pennco preferred shareholders of this apparent dilution. The circular mentions a proposed sale of 2 million share's of Penn­ co's GSa stock to three senior officers of GSa for $20 million in cash and $16 million in notes. This was a frivolous proposal which was was never completed 171 and created a false impression as to the possible receipt of cash and as to the value of GSa stock. The circular failed to disclose a simultaneous proposal, which was actually carried out, to have Pennco accept GSa stock from GSa in exchange for the cancellation of a debt exceeding $20 million owed by GSa to Pennco, principalll for cash advances which had been made to GSa by 17 Pennco. · Disclosure of the exchange might have alerted investors to the cash drain from the railroad to the real estate subsidiaries. 10' Almost all of Pennco's assets were stocks and bonds. The followin(! is a list of stocks and bonds owned by P~nneo at Dec. 10, 196U: (l'rom the Penneo circular, footnotes omitted, p. 7.) [Doliar amounts in millions] Estimated Book market SecUlity Shares value value Arvida Corp, common stock ____ ........ _.. __ .. ______ ... __ 3,529,277 $22.0 $41. 5 Buckeye Pipe Line Co., common stock _____________ .. _.. 14,000 100.3 101. 8 Detroit, Toledo & Ironton Railroad Co., capital stock ____ _ 245,329 25.9 40.7 Great Southwest Corp., common stock _________________ .• 22,347,240 5U.l 435.4 Great Southwest Corp.: 6 percent cumulative preferred stock, series A......... 3,500,000 3.5 2.3 7 percent cumulative preferred stock, series B......... 3,650,000 .5 2.8 7.6 perccnt cumulative preferred stock, series C __ ..... 16,410,980 2.4 13.8 Norfolk & Western Railway Co.: Common stock _____ ...... ____ .. ____ .......... ____ .. __ 1,204,105 67.5 91.8 Common stock with exchange rights ...... _........... 400,000 52.0 31. 2 Philadelphia, Baltimore & Washington Rllilroad Co., capital stock. __ ' __ . __ . __ ..... ______________________ ..... ~77, 259 37.2 34.4 Wabash Railroad Co.: Common stock_ ........ ______________ .. ______________ 5U5,255 7.3 51. 1 4).<2 percent preferred stock .... ___________________ .. __ . 101,836 3.8 6.0 Other............•.... _. _. _. __ .. __________ ............... _.. _.. _.... ___ _ 92.5 69. ~ TotaL __ . __ ' __ . __ . ____ . __ .. ___ . ____ .. ______________ .. ______ ... ___ _ 474.0 D22.0 '"~ See page 137 et seq. 170 Sec page 104 et seq. '" See page 142 et seq. '" See section I-E of this report on Great Southwest for details. 110 Pelm Central avoided disclosing these and other ad verse facts about the railroad, Pennco, or GSD in the $50 million circular. As described below, it was not quite so fortunate in the next public offering. ONE HUNDRED :!',;!ILLION DOLLAR DEBENTURE OFFERING In 1970, the last vehicle that might be used for an attempt at a major financing was the Pennsylvania Co~ The Pennsylvania Co. itself had inherent drawbacks as a financing vehicle at this tilne and the drawbacks were becoming ever more serious. Debt instruments, in­ cluding that $50 million December 1969 debenture offerin&", contained convenlLnts restricting the amount of debt that could be mcurred by the Pennsylvania Co. in relation to the assets.173 The borrowings of Pennco had lllready increased by $85 million in 1969. At the same time the market price of Great Southwest shares, Pennco's principal asset, in terms of market price, was steadily declining in late 1969 and el1rly 1970. Penn Central management realized that the decline would continue as the deteriorating condition of Great Southwest was grad­ ually being perceived by investors. The Penn Central, however, had no choice about using Pennco as a financing vehicle because money was needed and there were no other means of obtaining that moDtw. On February 2,1970, O'Herron cl1lled N. Gregory Doescher of First Boston Corp. to inquire about the possibility of a debenture issue for Pennsylvania Co. which would include warrants for Penn Central Co. stock "and Great Southwest stock owned by Pennsylvania Co. The fact that this proposal was coming less than 2 months after Pennco had complet.ed a similar offering Wl1S a clear indication of the serious cash drain and the limited financing possibilities. Despite this warning, the­ llnderwriters began preparations for the offering. WAItRANTS FOR GREAT SOUTHWEST AND PENN CEN'I'RAL STOCK One complication ,,"as encountered immediately. Penn Central man­ agement ha.d proposed the use of Great Southwest wn.rrants despite the fact that Great Southwest had been forced to abandon a public offer­ ing in late 1969 because of the ad verse disclosure which would have been required in a registration statement. Glore Forgan, which had been the proposed manager of the abandoned Great Southwest offering, knew of the reasons for the abandonment. First Boston, the lead manager on the Pennco offerings, did not know about the aban­ doned Great Southwest offering.174 Doescher realized, however, that the GSC Wfl,rmnts and the holding company warrants were needed as "sweetners" because of the prevailing high interest rate and the fact that the Pennsylvania Co. debentures would be less than premi.um grade. Doescher understood that these factors might have required an interest rate so high that it would be self-defeating in that investors would he frightened awa.y by an offering thut had to pay such high rates.