How Are Real Life Influencers Reacting To The FTC\'s New Disclosure Guidelines?

Under the old-fashioned theory of capital stock with a definite par value, pranks enough and misfeasance a plenty played around the matter of surplus, also; but with the advent of no-par stock, so often accompanied by practical disappearance of any precisely defined capital fund or estate, the doors were thrown wide open to all sorts of shenanigan here as well.

Surplus, but imperfectly distinguishable from profit and loss, has always been used to make assets and liabilities exactly equilibrate down to the last cent on the balance sheet. But now the entire capital stock, so far as it is stripped of par value, is bulked indistinguishably with the Surplus to constitute such a total as to produce that same perfect equilibrium. Here is the way it reads for the National Cash Register Company for 1925—a fair sample of newfangled accounting: —

Capital Stock and Surplus. $37,856,135.08 (Represented by 1,100,000 shares Coin-ion 'A' Stock and by 400,000 shares of Common 'B' Stock, both of no par value) (Including surplus of Foreign Subsidiary Companies)

And this is one of the seven figures on the balance sheet, constituting itself alone about four fifths of the total liabilities of this great concern. Its predecessor, with a par value, indicated that this sum was about half capital and half surplus, each being handled separately. But from this time forth all distinction is airily waved aside as if it were of no consequence.

The possibilities of obfuscation, to say nothing of malfeasance, as to surplus appear in the selfsame first annual report of 1925 of Dodge Brothers, Inc., purveying results of its first eight months' operation under banker management. This is the way the matter is now described: —

The company's surplus at December 31, 1925, totaled $31,477,234, of which $6,676,722 arose upon acquisition of assets on May 1, 1925, $14,958,543 upon conversion of debentures, and $9,841,969 from earnings.

This is the same balance sheet, by the way, for which the entry of the various no-par securities into the accounts in connection with goodwill has just been described. The balance sheet itself conforms strictly to this statement. But just suppose that in this instance—and it might perfectly well have been so done by anybody else—the mere total had been stated without further specification. What a magnificent achievement to have taken the old personal corporation of April 1, 1925, with its surplus of $4,608,000, and, after adding in the actually undistributed earnings of $9,841,000, to have created within eight months a socalled surplus of $31,477,000. What really happened was that $15,002,000 of debentures, standing at $100 each, had been converted into 434,563 and 17/21 shares of Class A no-par stock, reserved for the purpose; which, as we have seen, went in on the new balance sheet at ten cents each. In other words, the net reduction in the liabilities column due to this pen-and-ink performance was approximately $15,000,000. Taking it out of the capital stock valuation, this sum was simply shifted to the existing surplus, — the footing of assets remaining the same, to create an aggregate about seven times as large as the surplus eight months earlier. Otherwise stated, for every time that a $100 debenture retired, some odd shares at ten cents each stepped into its shoes—reminiscent of the rabbit sausage in the old, old story. That, too, was adulterated 'only fifty-fifty: every time we put in a rabbit, we put in a horse.' Nor is this to charge deception, in view of the frank textual avowal. Yet it stands, nevertheless, as an extreme example of the jugglery which is attendant upon some of these recent departures in American corporate finance.

The holding corporation is a particularly troublesome and confusing business as respects accounting. Even with the best of intentions it is extremely difficult to set forth the true condition of affairs, either as to the estate itself or as to the current income therefrom. The American International Corporation, for example, is largely a finance concern. It has no outstanding bonds; but, its income being derived entirely from investments, these, so far as they are stocks, are based upon dividends which can be paid only after the satisfaction of the fixed charges of each separate company owned. Nothing less than a complete disclosure of all of these investments makes clear the financial status of the concern.

The danger of incomplete disclosure is especially accentuated in the field of public utilities. The Electric Light and Power Corporation in 1925 asserts clearly enough that it has no funded debt; yet its subsidiaries, whence all its income arises, have in fact $140,000,000 of such indebtedness. So also with the American Superpower Corporation, which reports no funded or floating debt. Yet its two principal investments are bonded up to almost $50,000,000. If, with good intent, the true status may thus be obscured, how great is the danger when the morale is low. The bitter experience of United States Rubber shareholders in 1915 is matter of history. The United Dry Goods Company collapse, coincident with the failure of the H. B. Claim Company, was a public scandal. Published reports gave no indication of weakness of the top corporation, which, however, was contingently liable for over $30,000,000 on notes of its subsidiaries. The Corn Products Company in 1903 manipulated matters another way round. A highly discouraging balance sheet was issued, cutting its surplus by over $2,000,000. The holding company, of course, had no income of its own; so that when this particular subsidiary, the Glucose Sugar Refining Company, was caused to postpone its dividend date over into the succeeding fiscal year, this, and other things of the sort, completely transformed the picture. It is clear, therefore, that no annual report is worth the paper upon which it is printed, without complete consolidated statements, both of income and of condition, as of a date certain.


The first recourse by way of remedy for these irregular practices is that of vigorous private initiative from within, industry by industry, taking up the issue of orderly and adequate publicity as a matter both of duty and of expediency. The street railways, for example, have long since adopted a standard form of accounting, although it seems not to be universally put into effect. A uniform classification of accounts for gas companies has been adopted officially for over twenty states. The influence of the trade associations, for the moment confined to efficiency and production data, might well spill over into the field of finance. Much that is helpful might emanate from the Investment Bankers' Association of America. Much has indeed been accomplished. But one runs head-on against a serious obstacle. To a considerable degree within each industry it is a case of all or nothing. The laggard corporation, persistent in secretiveness, lays a heavy penalty upon its progressive rivals all down the line. This does not apply among public utilities, for they are industrial monopolies, more or less. But in the domain of private competitive enterprise it is only the all-powerful factor in the business, conscious of its own worth and importance, — like the Steel Corporation or the General Motors Company, — which can throw reserve to the winds, making a full disclosure of everything. In certain industries, also, the chain stores, for instance, — where profits are derived from a multitude of transactions in different commodities, the embarrassment of disclosure is less important. Profits on all kinds of things are averaged into a general figure, not disclosed for particular products. Competition, in other words, is much generalized. But let rivalry within an industry narrow down to two or three big competitors, and it takes a hardy perennial to stand the wind and weather of publicity alone.

Beyond peradventure of doubt the New York Stock Exchange is to-day the leading influence in the promotion of adequate corporate disclosure the world over. The evident disposition to accept fully the responsibilities of its status as the greatest organized market for securities in the world merits high praise. Its list requirements at present are immeasurably advanced beyond those of even ten years ago. It seeks to discover, first, that securities admitted to the trading list are sufficiently distributed so that there shall be a free and open market. This calls for a statement as to the ownership of the largest blocks of its stock, including the ten largest shareholders. Then a constantly elaborated questionnaire, approximating more nearly year by year to the highest standards of accounting practice, endeavors to place everything of material value upon the file. This file, it should be noted, is open to public inspection; and it is further noteworthy that the detail offered therein frequently greatly exceeds in specification that which is furnished to the shareholders in the published reports. For example, the Standard Oil Company of New Jersey has already been cited as distributing rather an inadequate statement of the leaflet type. But as far back as 1920 the stock list application affords a much more complete description of the business, including such important matters as the equity earnings of subsidiary companies by name. Or for American Can, with its curt official report, there is submission to the Stock List Committee, in 1926, of comparative statements of earnings for the preceding five years, along with a lot of other things.

The International Business Machines Corporation, in its stockholders' leaflet report, jumbles most of its possessions together as follows: —

Plant, Property, Equipment, Machines, Patents and Goodwill, as per books, after deducting surplus of Subsidiary Companies acquired at organization: $28,019,035.45

A contemporary stock list application, however, reveals that land, buildings, equipment, and machines aggregate about $6,000,000, whereas patents and goodwill are listed at $13,700,000. Why should not the shareholders, even more than the Stock Exchange, be entitled to know that two thirds of the listed assets, aside from inventory, represent capitalized earning power only? Whether such financial policy is wise or not depends upon circumstances. The point here is merely that the shareholders are better entitled to know all about it than anybody else. These instances show what a fund of information there is on file at the Stock Exchange, free of access, even by public invitation, for those who have a real interest in the business.

These requirements for admittance to list are steadily improving, as is also the discipline for failure to observe the conditions imposed. It is now more than twenty years since the American Steel Foundries were struck from the list for fraudulent statement of their working capital. Such downright misstatement is easy enough to deal with summarily. Far more difficult is it to impose drastic penalties for imperfect rendition of data, or, it may be, for failure to live up to the requirements, now more and more common, of quarterly as well as annual reports. To strike the security from the list, closing the market to thousands of shareholders perhaps, would work irreparable harm. It would also shut the door to further stimulation in the direction of sound practice, relegating the offender to outer darkness, so to speak. But the present administration is evidently solicitous to do its best. It now, furthermore, enjoys the expert attention and advice of a highly competent staff. New issues and principles are constantly arising. One of particular importance is the prevention of the use of misleading titles. To be listed as a bond, a bond must be a bond. And in these days of holding companies, especially among public utilities, very nice distinctions have to be drawn between securities offered for sale as bonds and others which are practically notes secured by collateral consisting of stock of subsidiary operating concerns, sometimes of rather doubtful character. A participating or preferred stock must possess all the attributes of such securities, judged by the highest technical standards. Even the form of the engraved certificate must pass muster. I have in mind, for example, condemnation of the legend in large letters across the top of one of these certificates, 'Stronger than the Government itself.' The discouragement, too, in 1925, of the issuance of nonvoting shares exercised an extraordinarily tonic effect upon a prevailing fashion.

But there are distinct limitations, nevertheless, upon the, activities of the New York Stock Exchange, this best of the private agencies. Its control is restricted solely to those corporations which seek admittance to that particular exchange. There always remain the unlisted securities handled on the curb or over the counter; as well as on the other provincial exchanges all over the United States, which for many purposes are sufficient for corporations of lesser size and importance, but among which there is the greatest diversity of standards. Unless Chicago Boston, Pittsburgh, and the others rise to the full measure of New York, its to requirements, a wide gap in supervision obtains. And it is, of course, for the lesser local corporations, more closely controlled and less susceptible to educational appeal, that the greatest need of improvement exists. Local jealousies count for something. Certain of the major public utilities with headquarters in Chicago adduce local pride as a sufficient reason for refusing 'to come to New York' for an open market. Such influences, where the desire for modest seclusion as respects accounting exists, are accentuated by other motives. A security not listed—that is to say, dealt with on the curb, over the counter, or in a provincial exchange—remains more completely under control of its own management as respects market price. But if once listed, quite apart from the obligation to file adequate data, there is the chance of having to support the stock in the open market against overt attack. For all these reasons, therefore, it is clear that, however wholesome and uplifting the practices of the New York Stock Exchange may be, its influence must of necessity remain circumscribed within certain rather definite limits.


Why should not the stockholders themselves, if necessary, bring about a reform in this business of publicity? Do they rest inert and mute because of their helplessness? There seem to be only two things which they can do. One is to boycott the sealed-up corporations. The other would be to take the bit in mouth and force the issue in open meeting. As for the boycott, mysterious corporations which have turned out to be bonanzas have always served as decoys for the public. The uninitiated are always ready enough to try a fling. But, even among the more wary, the personality and reputation of managers often afford sufficient guaranty, at all events to take a gambling chance, the more alluring because of the very mystery. The danger arises, however, from the ease with which real responsibility and power, under modern conditions, may often imperceptibly pass from strong and competent hands into others of a quite different sort. This is what is going on with great rapidity all about us at this time. And as for taking the bit in mouth, to register the opinions of thousands of stockholders is at best an expensive, difficult, and often well-nigh impossible performance. A first-class corporation, long notorious for its secretiveness, repeatedly issued statements like this, which appeared in its annual report for 1901: —

The settled plan of the directors has been to withhold all information from the stockholders and others that is not called for by the stockholders in a body. So far no request for information has been made in the manner prescribed by the directors [our italics].

Distribution of stock has not meant distribution of control. Surprising, was it not, that, with the characteristic inertia of stockholders at large, they never assembled and formally preferred this request? Was it, however, quite fair to assume that failure so to do signified approval of the official reticence?

That which stockholders ought to bring about, and right speedily too, either on private initiative or by induced legislation, is the introduction of shareholders' audit or of general checkup committees. The practice of such independent auditing, made at the expense of the corporation but under the supervision of shareholders entirely independent of the management, is necessary under the British Companies Acts; as also in Germany. Certified public accountants report to a stockholders' committee annually, and they are held to a strict obligation at law. Whether or not, for example, a given item should be charged to capital or income account is a matter of dictation by the management in private corporations in the United States. But in order to do thus and so in England, if it were a debatable matter, it would be at once referred for decision to such an independent executive committee of the shareholders. The object, really, would be to accomplish in the field of finance something akin to that which is expected to be brought about in the field of labor by the introduction of company unions. The principle of representation for employees by means of works councils has been widely adopted throughout the country since the war. The purpose is to establish a medium of communication between the employees collectively and the company. By and large, the relations have been highly satisfactory, within certain limits; although it is apparent that such representation does not conform to the full ideal of the trade-union movement. Here, in this other field of ownership, it is equally important that the management should be tied in, so to speak, with an appreciably articulate representative body of the owners. That plans are already under way for experimentation in this direction affords evidence that a present source of disquiet and abuse may possibly be dried up by resorting to some such private initiative.

Yet another activity of shareholders in the nature of a check-up, revision, or supervision, deserves consideration. This has to do with current valuations as carried on the balance sheets. As at present conducted, such appraisals, whether in prospectuses or in annual reports, are invariably made up, not by experts of independent status, but by those whose prospects and emoluments are directly dependent upon the existing management. It is inevitable under such circumstances that these valuations should be biased by the wish to please. Quite irrespective of artificial stimulation or suggestion, the impulse nine times out of ten is toward overstatement. We have had too many examples even of downright deception in this regard. Shareholders have a right, not only to an independent appraisal by engineers at the time of issuance of a prospectus, but also to a current check by independent engineers from time to time. Nor would the expense be an objection, since the cost should be chargeable to the operating expenses of the corporation. Some of these matters, too, are quite differently handled under the British Companies Acts. There is perhaps something for us in the United States to learn in this connection.


State legislation for stimulation or enforcement of publicity holds out little promise for the future. Widely differing standards between the commonwealths, already forcibly exemplified in respect to incorporation practice, bring insuperable difficulties. The pressure of local opinion in the case of important concerns can only be overcome by exercise of these powers from a distance. Heartbreaking experience in enforcement of factory legislation by local authority is of record. 'If I were to attempt to execute the present law [as to child labor], this village would be too hot to hold me,' was the way one of the Connecticut school visitors put it at the time. The leading instance of attempts by state legislation to invigorate business practice is afforded by the numerous blue-sky laws enacted upon the initiative of the State of Kansas in 1911. But these local commissions, serviceable enough when dealing with downright fraudulent issue of securities by mining, real-estate, or other adventurers, almost inevitably become apologetic or complaisant when confronted by serious situations in important close-by going concerns. 'They are directed, moreover, against the sale of gold bricks, whereas our present concern is with the distribution of lemons,' is the way one observer puts it. The Michigan blue-sky law is a case in point. The so-called Securities Commission, upon the promotion of Dodge Brothers, Inc., in 1925, promptly rendered a forceful decision, prohibiting the sale of the capital stocks in commerce within the state. Obviously, however, over business clone from New York it had no jurisdiction. Furthermore, apparently in accordance with the terms of the statute, this convincing and able statement, which if published would have clarified the whole situation, was closed to public view—at all events I was requested to refrain from giving it public circulation. The decision merely, and not the underlying facts, obviously exercised almost no outside influence whatsoever. Such experience renders one skeptical of all local endeavor in this direction, whether like the admirable Business Companies Act introduced under Roosevelt's leadership in New York in 1900, or like the numberless blue-sky laws of one kind or another now upon the statute books. They are all good enough in their way for downright fraudulent concerns. But by way of stiffening up conditions along accounting lines in the case of ordinary industrial or commercial businesses they will always be practically negligible.

Comprehensive and ambitious proposals for Federal incorporation or Federal license to engage in interstate commerce need hardly be considered in this particular connection of adequate publicity. Whether or not, on the ground of corporate shortcomings or abuses, such a proposal should be advocated need not concern us for the moment. The far-reaching proposal of President Taft, by special message to Congress on January 7, 1910, recommending Federal incorporation, turned out to be politically impractical on the one hand and economically inexpedient on the other. The immediate impulse was the decisive dissolution decrees of the Supreme Court of the United States in the Standard Oil, and the American Tobacco Company decisions. But the foregoing developments led forward logically to the enactment of the Federal Trade Commission Law of 1914, which is still in full force and effect, as an amendment of the Sherman Antitrust Law. This statute, which is usually thought of in connection with unfair trade practices and the regulation of monopoly, contains in Section 6 a positive delegation of authority to this body which is entirely adequate to the performance of the service so greatly needed at the present time. The Federal Trade Commission, had it chosen to exercise these powers, might since 1914 have gathered and compiled information—to paraphrase the statute—concerning the organization, business, and management of any large corporation engaged in commerce, except banks and common carriers. Furthermore, it might require by general or special orders such corporations to file with the Commission both annual and special reports in such form as the Commission might prescribe, such reports to be rendered under oath. The record of debate upon the subject makes it clear that Congress intended this work to constitute one of its chief activities.

What is the explanation for the neglect of this section of the existing law? It is partly, perhaps, because the Commissioners have been legalistically rather than economically minded, preferring to institute proceedings rather than to set constructive inquiries and practices on foot. Another reason is that since the war, with its concomitant overdevelopment of Federal power, a natural reaction against so-called paternalism supervened. A third is that this body is still in its incubatory stage of development. Even with the best of intent, it must of necessity, as did the Interstate Commerce Commission for years, light from point to point before the courts for affirmation of its powers under the law. A prime controversy now at issue in the courts is an outcome of the rise of prices and the attendant price fixing during and since the var. The Commission, by direction of the President, had instituted special inquiries into the cost of steel production, largely for the use of the War Industries Board. Such data turned out to be most valuable also for the Fuel Administration and for the other price-fixing or Federal purchasing agencies. Congress even made special appropriations for the collection of such material. In 1920, the peak year of inflation, the Federal Trade Commission called upon the steel companies to furnish balance sheets and income statements quarterly, along with other supply and demand data every month. The account of this endeavor will be found in its report on 'War Time Profits and Costs of the Steel Industry.' Certain of the steel and coal companies refused to accede to these orders, on the ground that they were engaged in production and not in interstate commerce, and that they were therefore not subject to the jurisdiction of the United States in this respect. Two decisions of the Federal courts have already held that the Commission had no such authority. The matter has been twice argued before the Supreme Court, indicative of considerable doubt upon the point. The chances might indeed be against the affirmation of this Federal authority, were it not that the final outcome in most of the trust and railroad litigation has heretofore in last resort been in favor of the plenary authority of the United States.

Here, then, we have plainly indicated the most obvious, the simplest, the most effective remedy of all. It lies inert in the hollow of the executive hand. No legislation is necessary. There is nothing revolutionary about it—nothing paternalistic, to use a dreadful word, unless that means the exercise by the Great White Father of his lawful prerogative on behalf of some millions of our citizenry who are in need of help. Nor will it pauperize—another ill-omened word—if the President declare it to be the policy of the administration to carry out this law. Quite the reverse! Nothing will more surely conduce to popular thrift than to throw all possible safeguards about the investments of the common people. Let the word go forth that the Federal Trade Commission is henceforward to address itself vigorously to the matter of adequate and intelligent corporate publicity, and, with the helpful agencies already at work, the thing is as good as done.

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