183 F.

2d 45

COMMON STOCKHOLDERS COMMITTEE OF LONG

ISLAND LIGHTING CO. et al.
v.
SECURITIES & EXCHANGE COMMISSION et al.
No. 215.
Docket 21641.

United States Court of Appeals Second Circuit.

Argued April 11, 1950.
Decided June 1, 1950.
On Petition for Modification July 5, 1950.
Writ of Certiorari Denied October 9, 1950.

See 71 S.Ct. 64.

COPYRIGHT MATERIAL OMITTED Harold G. Aron, Washington, D.
C., Lynne A. Warren and Charles B. McGroddy, Jr., New York City, for
appellant Common Stockholders Committee.
Graustein & Kormendi, New York City, Laszlo Kormendi, New York
City, of counsel, for appellant Louis W. Gordon.
Maurice B. & Daniel N. Blumenthal, New York City, for certain
individual stockholders, appellants.
Roger S. Foster, General Counsel, Harry G. Slater, Chief Counsel,
Division of Public Utilities, Ellwood L. Englander and Solomon
Freedman, Washington, D. C., for appellee Securities and Exchange
Commission.
Charles G. Blakeslee, New York City, David K. Kadane and Charles E.
Elbert, New York City, of counsel, special counsel for appellees Long
Island Lighting Co., Queens Borough Gas & Electric Co., and Nassau &
Suffolk Lighting Co.
Percival E. Jackson, New York City, Theodore N. Tarlau and Joseph J.
Bryer, New York City, on the brief, for Long Island Lighting Co. 7% and

6% Preferred Stockholders Group, appellees.

Unger & Pollack, New York City, Milton Pollack and Richard F.
Wolfson, New York City, of counsel, for appellee Committee of Preferred
Stockholders of Long Island Lighting Co.
Before L. HAND, Chief Judge, and SWAN and CHASE, Circuit Judges.
SWAN, Circuit Judge.

This is an appeal from an order of the District Court, following its opinion of
February 10, 1950, which directs enforcement of an amended plan filed under
section 11(e) of the Public Utility Holding Company Act of 1935, 15 U.S.C.A.
79k(e), for the reorganization and consolidation of Long Island Lighting
Company and its subsidiaries, Queens Borough Gas and Electric Company and
Nassau & Suffolk Lighting Company. These are utility companies incorporated
under the New York Transportation Corporations Law. They distribute
electricity and gas in the counties of Nassau and Suffolk and the Borough of
Queens. We shall refer to them as Long Island, Queens and Nassau. The plan as
amended was approved by the Securities and Exchange Commission by its
order of November 16, 1949.1 The Commission forthwith applied to the
District Court for an order of enforcement. After hearings at which all parties in
interest were represented, the court found the plan fair and equitable and
granted the requested order D.C., 89 F.Supp. 513. A committee for common
stockholders of Long Island and several individual holders of such stock have
appealed.

In brief the plan provides for the consolidation of Long Island, Queens and
Nassau and for the issuance by the consolidated corporation of common no par
stock which will be distributed in the following proportions: To Long Island
preferred stockholders 76.98 per cent., to Queens preferred stockholders 11.51
per cent., to Nassau preferred stockholders 5.80 per cent., and to Long Island
common stockholders 5.71 per cent. The outstanding debts of the constituent
companies will remain unaffected. In making allocations of stock of the
consolidated corporation the Commission estimated that its prospective total
net income will be $3,500,000 per year, without giving effect to any savings
from consolidation which the proponents of the plan estimate at $250,000
yearly after provision for federal income taxes. The substance of the appellants'
objection to the plan is that Long Island common stockholders should receive a
larger percentage and Long Island preferred stockholders a smaller percentage
of the consolidated corporation's capital stock. Their specific attacks upon the
actions of the Commission and the District Court will be discussed seriatim.

31. Jurisdiction of the Commission.

4

It is urged that the Commission has no jurisdiction over Long Island and its
subsidiaries because their operations are wholly intrastate, and that application
of the Act to them is violative of the constitutional provision reserving to the
states powers not granted. A sufficient answer is that interstate distribution of
Long Island's securities brings it and its subsidiaries within the coverage of the
federal Act. The point is mentioned merely to show that it has not been
overlooked. It is adequately dealt with in Judge Kennedy's opinion, with which
the Court of Appeals of the District of Columbia has recently expressed
agreement. Halsted v. Securities and Exchange Commission, 182 F.2d 660. Our
own view as to the triviality of the constitutional argument appears in Public
Service Com'n of New York v. Securities and Exchange Com'n, 2 Cir., 166
F.2d 784, 788.

52. Refusal to permit the Committee to solicit funds.

6

It is contended that the Commission's refusal to allow the Committee to solicit

from common stockholders five cents per share for expenses in opposing the
plan so hindered their defense as to vitiate the hearings before the Commission.
An appeal from the order of refusal was taken to the Court of Appeals of the
District of Columbia where it has just been affirmed. Halsted et al. v. Securities
and Exchange Com'n, supra. That decision is conclusive upon us as to the
Commission's power to make the order. It does not, however, determine
whether the effect of the order was such as to invalidate the hearings on the
section 11(e) proceedings. As to this Judge Kennedy found nothing in the
record to show that the Committee's representation of the common stock "was
stifled, or was in any way weakened by the Commission's action." The
Committee's claim of prejudice is chiefly based on the contention that lack of
funds deprived it of an opportunity to submit evidence of reproduction costs.
But reproduction cost is irrelevant except as it may indirectly bear on earning
capacity.2 So far as we are aware it has never been held under the Public Utility
Holding Company Act that reproduction cost studies are essential; and the
Commission says that in the only two cases where they were offered, they were
rejected, and rejection of the evidence was not even urged as error although
both plans were contested in the courts.3 The claim of prejudice from the
Commission's refusal to permit solicitation of funds is not substantiated.

73. Change of Circumstances.

8

The earnings data in the record before the Commission do not go beyond
March 31, 1949. The appellants argue that the record is already stale and that

developments subsequent to the Commission's approval of the plan on

November 17, 1949 require the proceedings to be resubmitted for further
evidence. Thus, the actual consolidated net income for the year 1949 was
$77,279 more than the $3,500,000 estimate of prospective yearly net income.
But if the year ending February 28, 1950 be taken, the actual net income would
be $51,146 less than the estimate. Such differences are negligible. Any estimate
of prospective earnings is a forecast which cannot possess mathematical
certainty. If every slight discrepancy between estimate and actuality requires
that the hearings be reopened, the case would never end, for necessarily there is
a time lag after the closing of the administrative record and before the plan can
be administratively approved and judicially enforced. We do not say that
unanticipated developments may never be sufficient to require reopening, but
certainly slight errors in the forecast of future earnings do not justify it.
9

The appellants also urge error in the Commission's refusal to grant petitions for
reopening filed with it after the issuance of its findings and opinion. The
Committee's petition was denied because it presented no matters of substance
not already considered. Appellant Gordon's petition was denied without
statement of reasons. He had purchased his stock after the administrative record
was closed, and filed his petition while the enforcement proceedings were
pending in the District Court. We see no abuse of discretion in the denial of
either petition.

4. Growth factors in the Long Island system.

10
11

Closely allied to the claim of changed circumstances, just discussed, are several
contentions relating to growth factors in the future which the Commission is
said to have understated or ignored, in making its estimate of future income.

12

First, it is said that the Commission did not take account of the system's large
plan for future construction. This appears to be accurate. The Commission's
estimate does not go beyond construction in progress or that for which working
capital was available as of March 31, 1949. Appellants claim that this exclusion
is erroneous because the expansion in physical plant will necessarily increase
the rate base and therefore the system's future earnings. Conceding that the
system may be allowed to earn a larger return in an expanded plant, it does not
follow that increased future earnings would inure entirely, or at all, to the
holders of present common stock. Their equity will be increased only if the cost
of financing the construction program is low a speculative prediction, at
best. Even if new capital is available at low rates it is doubtful, as Judge
Kennedy pointed out, whether the system's debt burden should be increased.
Thus, if future financing takes the form of stock flotation, as seems probable,

there is no great likelihood that the present common's equity will be increased.
If, on the other hand, the system's debt structure is enlarged, common's equity
will be increased, but so will its risk position. Either way, the possibilities of
increased return for common arising out of new construction are too remote and
speculative to require consideration in terms of the present value of the
common stock.4
13

Two other contentions merit little discussion. Appellants urge that insufficient
consideration has been given to increased earnings and reduction in operating
expenses that will result from a growth in the use of natural gas and, at large, to
the increased demand for the system's services that will result from the
anticipated future development of the Long Island area. No contention is made
that these factors were not considered. The Commission took much evidence on
the subject of natural gas and went so far as to reject the testimony of one expert
who did not give weight to that factor. Likewise, it received evidence of a
rather speculative nature on the future of the Long Island area. We are not
prepared to say that the consideration which the Commission gave to these
factors was insufficient or that it resulted in an understatement of the share
which present common stock should be allotted in the consolidated company.

5. The 1944 Recapitalization.

14
15

Originally Long Island and its subsidiaries were granted an exemption from
registration under the Act. This exemption was revoked on April 21, 1945 by
an order of the Commission entered in a proceeding initiated by a committee of
preferred stockholders on November 4, 1944. In the meantime, on December
16, 1944 Long Island filed with the Secretary of State of New York a certificate
for reduction of capital stock whereby among other things, the par value of
Long Island's preferred stock was to be reduced from $100 to $60 per share, the
outstanding 3,000,000 shares of common stock were to be cancelled and
503,800 shares of new common were to be issued on the basis of one share for
each share of preferred and one share for each twelve shares of old common. A
dispute arose as to whether this plan of recapitalization ever became effective.5
In approving the section 11 plan now before us the Commission took note of
the dispute but did not determine whether the plan became effective. If it did,
arrearages of dividends on the preferred stock could be paid off in 7.8 years,
taking the Commission's estimate of future Long Island net yearly income as
$2,815,000; if it did not, payment of the arrearages would take 14.5 years. The
appellants do not assert that the recapitalization did become operative but they
contend that the District Court erred in holding that the Commission was not
required to determine whether or not it did.

16

There is no merit in this contention. On commencement of the revocation

proceeding in November 1944 the jurisdiction of the Commission over Long
Island attached. Any change in its capitalization thereafter was subject to
review by the Commission and, even if effective under state law, could be
disregarded by the Commission in a plan filed under section 11(e), since what
is "fair and equitable" is a federal question.6 The Commission considered both
possibilities as to the recapitalization being effective or non-effective under
state law; it recognized the conflicting claims. In making what it determined to
be a fair and equitable allocation of stock between the preferred and common
stockholders it obviously took these claims into account. We do not think it was
required to decide the merits under state law of the conflicting claims, nor that
the District Court was obliged to do so.7

6. Depreciation Reserves.
17
18

The appellants contend that no valid estimate of future earnings can be made
until the existence and amount, if any, of deficiency in reserves for depreciation
have been determined. In a memorandum of August 6, 1946 the state Public
Service Commission found that the companies' reserves for depreciation were
inadequate on a straight-line basis by an amount totalling when projected to
March 31, 1949, $10,263,969. Throughout the proceedings before the
Commission the applicant companies stated their intention of eliminating the
asserted deficiencies in their book reserves for depreciation by increasing the
reserves with corresponding charges to earned surplus as a step in consolidation
and recapitalization. Later, in oral argument counsel for the companies
informed the Commission that they no longer intend, as formerly proposed, to
increase the reserves for depreciation of the consolidated company but would
place the amount of $10,263,969 in an account designated "unearned surplus
special" to be available for transfer to reserves for depreciation or for other
charges which may be approved by appropriate regulatory authorities. On the
basis of this change of position the appellants requested that the record be
reopened to correct exhibits and testimony based on the assumption that said
sum would be added to the reserves for depreciation. This motion was denied
for reasons stated by the Commission which we think adequate. The appellants'
argument seems to be that to estimate future earnings the Commission must
determine what rate base the state Public Service Commission will allow, and
to do this must ascertain the exact amount in the reserves for depreciation. But
no finding which the Commission might make would bind the state regulatory
body. In fixing a rate base the state Commission is free to determine the amount
of depreciation actually existing in the properties without regard to what the
books may show. 8 Considering that the state Commission had tentatively found
a deficiency of $10,263,969 in the reserves for depreciation and that no one had

proved the figure wrong, we see no impropriety in the Commission's

acceptance of this figure without further independent inquiry in arriving at a
rate base and rate of return for use in checking the accuracy of its estimate of
future net income.
7. Consolidation Savings.
19
20

The final contention which requires consideration is that the Commission, in

arriving at its estimate of future earnings, ignored the savings which would
result from consolidated operation. The appellants assert that such savings will
amount to approximately $250,000 per year. The Commission's stated reason
for rejecting this item is that to add consolidation savings to its estimate of
future earnings would "in effect, make it inure entirely to the benefit of the
Long Island common stockholders." We are unable to follow this argument,
and the Commission's brief makes no effort to explain it. We can see no reason
why, if this is a legitimate item of future income, it cannot be allocated, first,
between Long Island and the other companies and then, as to Long Island's
share, between preferred and common. Thus, if the consolidated system's
foreseeable income should be stated at $3,750,000 rather than $3,500,000 and
83.7% thereof were allocated to Long Island, it would receive 83.7% of the
additionally foreseeable $250,000, or $209,250, and the apportionment between
Long Island preferred and common would be based on an income of
$3,024,000 rather than $2,815,000. It is evident that this difference would
materially affect the allocation. At the larger income, arrearages in preferred
dividends would be paid up nearly two years sooner than the 14 years
estimated by the Commission on the assumption of no reduction in depreciation
reserve. An earlier elimination of arrearages would, in turn, entitle Long Island
common to a larger share vis-a-vis Long Island preferred.

21

If the Commission completely disregarded this $250,000 item, we think it was

in error in so doing. We are, however, not entirely clear that it did so. While the
Commission explicitly stated that it did not give any effect to consolidation
savings in estimating future income, it may have considered the factor in
making its allocation between Long Island common and preferred. Another
possibility is that it considered the item as an offset against the losses which
Long Island, during the period of its control, imposed upon Queens and Nassau.
Such losses the Commission proposed to debit against Long Island common in
its allocation. However, we cannot accept the exclusion of so substantial an
item without an adequate explanation of the Commission's reasoning. See
Securities and Exchange Com'n v. Chenery Corp., 332 U.S. 194, 196, 67 S.Ct.
1575, 1760, 91 L.Ed. 1995.

22

It is therefore necessary to modify the order and remand the cause to the
Commission upon the sole issue of consolidation savings. If the Commission
did in fact have an unexpressed reason for excluding the item, or if it took the
item into account in some unexplained manner it should so state. If it did not, it
should recompute the percentage of new common to which Long Island
common is entitled on the basis of an estimated future income for Long Island
of $3,024,000 rather than $2,815,000. It is true that a remand on this issue may
prove a futile gesture, since it may be that the Commission will come out with
the same allocation supported by reasoning which the court will accept as
adequate. But on the present record the allocation between preferred and
common is not supportable. On the issue of consolidated savings the cause is
remanded to the District Court with instructions to remand to the Commission.
In all other respects the order of the court is affirmed.

Notes:
1

See Holding Company Act Release No. 9473 dated November 2, 1949

Consolidated Rock Products Co. v. DuBois, 312 U.S. 510, 526, 61 S.Ct. 675,
85 L.Ed. 982; Group of Institutional Investors v. Chicago, M. St. P. & P. R.
Co., 318 U.S. 523, 539-541, 63 S.Ct. 727, 87 L.Ed. 959

Southern Colorado Power Co., 14 S.E.C. 115, 116, plan enforced without
opinion, and order affirmedsub nom. Disman v. Securities and Exchange
Commission, 10 Cir., 147 F.2d 679, certiorari denied 325 U.S. 863, 65 S.Ct.
1200, 89 L.Ed. 1984; In re Jacksonville Gas Co., 11 S.E.C. 449, 460, plan
enforced D.C.S.D.Fla., 46 F. Supp. 852.

See In the Matter of Electric Power & Light Corp., Holding Company Act
Release No. 8889, pp. 35-36, affirmed 2 Cir., 176 F.2d 687

The Securities and Exchange Commission sought to restrain Long Island from
carrying out the plan. A temporary injunction was denied, Securities and
Exchange Commission v. Long Island Lighting Co., D.C., 59 F.Supp. 610 and
the order was affirmed by this Court, Judge Clark dissenting, in 2 Cir., 148 F.2d
252, certiorari granted 324 U.S. 837, 65 S.Ct. 869, 89 L.Ed. 1401. Thereafter
the certiorari was dismissed as moot, 325 U.S. 833, 65 S.Ct. 1085, 89 L.Ed.
1961, Long Island having registered under the Act on April 23, 1945. This
Court in West India Fruit & Steamship Co. v. Seatrain Lines, 2 Cir., 170 F.2d
775, 779, disapproved its former decision in the Long Island case. The New
York Public Service Commission has stated that the 1944 plan did not become

effective. In re Long Island Lighting Co., 73 P. U. R. (n. s.) 266, 271-2

6

Schwabacher v. United States, 334 U.S. 182, 198, 68 S.Ct. 958, 92 L.Ed. 1305;
Securities and Exchange Com'n v. Central-Illinois Securities Corp., 338 U.S.
96, 134, 69 S.Ct. 1377, 93 L.Ed. 1836

See In re Electric Power & Light Corp., 2 Cir., 176 F.2d 687, 692

Consolidated Edison Co. of New York v. Maltbie, 300 N.Y. 196, 90 N.E.2d 35,
and cases cited therein at page 204

On Petition for Modification

23

PER CURIAM.

24

In the division of our opinion dealing with the issue of Consolidation Savings
we directed a remand to the Commission, saying: "If the Commission did in
fact have an unexpressed reason for excluding the item, or if it took the item
into account in some unexplained manner it should so state. If it did not, it
should recompute the percentage of new common to which Long Island
common is entitled on the basis of an estimated future income for Long Island
of $3,024,000 rather than $2,815,000." Shortly after the opinion was filed and
before our mandate had been issued, at the request of the proponent companies
and upon representations concerning the hardship which will result from
unnecessary delay in consummating a plan, the Commission presented to this
court Supplemental Findings and Opinion, accompanied by a petition that they
be accepted as a response to the court's questions and that the order of the
District Court be affirmed. The appellants were given leave by us to reply to the
Commission's petition and have done so.

25

The Supplemental Opinion of the Commission states that it did not ignore the
item of consolidated savings but disregarded it for two reasons: first because it
was not clear how far, if at all, the Public Service Commission would allow the
new company to profit by consolidated savings, and second that the
Commission had taken it into account by reckoning that in bad years the new
company might not be able without it to earn the full amount of the rates
allowed. If these reasons are an adequate explanation no new hearing would
seem to be necessary. The situation was that we did not understand the
Commission's original reasoning and therefore we could not dispose of the
appeal. They have now told what their reasons were. That requires us to decide
whether the effect they gave to consolidated savings was right. But this cannot
be an issue requiring a new hearing by the Commission any more than a new

hearing would be required before a district judge if we asked the judge to say
what findings of fact he had acted on but had not expressed in his opinion.
26

Coming to the merits of the Commission's treatment of consolidated savings in

the light of its supplemental opinion, we think the explanation adequate. What
the future earnings of any company will be is largely guess work. When to the
uncertainties inevitable in such a prediction there is added the uncertainty of
forecasting how much of the predicted earning the Public Service Commission
will allow the consolidated company to keep, the guess becomes even less
prophetic. Now that the Commission has shown that it has made at least a
rational guess about the expectable influence of this factor, we see no basis for
us to say that the Commission is necessarily wrong. The doubts which the first
report left in our minds are satisfied by the supplemental report.

27

Talk by the appellants of lack of due process seems baseless. By replying to the
petition they have had their opportunity to convince us either that the
Commission did not use the item at all in their computations or that the use they
did make of it was not permissible.

28

Our former opinion is modified, and the order of the District Court is affirmed.