Before L. HAND, CHASE, and CLARK, Circuit Judges .
This is a petition for review of an order of the Securities and Exchange Commission declaring petitioner, Morgan Stanley & Co., Inc. to be an affiliate of the Dayton Power & Light Co. for the purpose of denying underwriting fees to petitioner in connection with a refunding operation of Dayton. This order was issued pursuant to rule U-12F-2 of the Commission under the Public Utility Holding Company Act, 15 U.S.C.A. § 79a et seq. Petitioner urges that the record lacks substantial evidence to support the order, and that the rule is invalid under the Act. We do not agree with either contention of petitioner.
Before we take up the facts, some reference to the purposes of the Act and the Rule are necessary in order to place the problem in its proper perspective. The general background of the Act is well known. Both the unprecedented and generally unregulated growth of utilities, particularly electric, and the vicissitudes of the depression pointed the way for nationwide action. Because of the importance of holding companies as a means of obtaining credit, considerable attention was given to the financial practices of these companies. Here was found, among other evils, a close tieup between investment banking houses and large holding companies. As the National Power Policy Committee observed in its report to the President, transmitted by him to Congress: "Fundamentally, the holding-company problem always has been, and still is, as much a problem of regulating investment bankers as a problem of regulating the power industry." H.R. Doc. No. 137, 74th Congress, 1st session, 6*fn1
This evil was one of the many aimed at by the bill. Section 1 (b), 15 U.S.C.A. § 79a (b), observes that "the national public interest" is or "may be adversely affected - * * * (2) when subsidiary public-utility companies are subjected to excessive charges for services * * * or enter into transactions in which evils result from an absence of arm's-length bargaining or from restraint of free and independent competition; * * * (5) when in any other respect there is * * * lack of economies in the raising of capital." Many provisions of the Act, from the stringent requirements of registration with the Commission and approval of security transactions by the Commission to the disqualification of officials of banking institutions from serving as officers or directors of holding companies or their subsidiaries, implement the avowed purpose of protecting the public and investors from undue banker influence. In addition, the Commission is given broad rule-making powers for furthering the statutory provisions.
It is one of the Commission's rules which is in issue here. Rule U-12F-2 requires, in effect, that no underwriter's fee can be paid on security issue if the underwriter is in the holding-company system, is an affiliate*fn2, or is a person "who the Commission finds stands in such relation to the [issuer], that there is liable to be or to have been no absence of arm's-length bargaining with respect to the transaction." The Rule is not applicable, however, if there is an effort to obtain competitive bids, or if competitive bidding is not practicable and the fees are otherwise reasonable. The purpose of the Rule is obvious. As we noted above, one of the objects of the Act is to reduce the cost of financing by encouraging competition. Such requirements as the Act itself imposes were found of little avail because, for example, even after the elimination of interlocking directorates many banking relations continued unchanged. And since there has always been an unwritten rule that investment bankers do not disturb existing issuer-banker relationships, it was evident that some further step was necessary. See Comment, Competitive Bidding in the Sale of Public Utility Bonds, 50 Yale L.J. 1071-1075; and the TNEC hearings there cited. Rule U-12F-2 was designed to find these subtle relationships and prevent their continuance.
The rule became effective on March 1, 1939, and several cases soon arose in which it was applied without contest*fn3 The present case arose in January, 1940, when the Dayton Power & Light Co. filed its request to issue $25,000,000 in bonds. Representatives of the Commission indicated that they would question petitioner's status as principal underwriter under the rule. To avoid delay in financing the issue, stipulation was entered into whereby petitioner's underwriting fees were impounded pending a determination of its status. After hearing, the Commission found "that the special relationship between Morgan Stanley and Dayton was such that there was liable to have been such an absence of arm's-length bargaining in the Dayton bond financing of 1940, that it is both necessary and appropriate in the public interest and for the protection of investors and consumers that Morgan Stanley be subject to the obligations, duties and liabilities of an affiliate of Dayton for the purposes of Rule U-12F-2." Matter of Dayton Power & Light Co., 8 S.E.C. 950 (1941).Subsequently, the Commission ordered petitioner's underwriting fees, $100,562.50, paid over to Dayton, Holding Company Act Release No. 2693, Apr. 15, 1941. It is this finding and order which are contested.
The Commission's opinion - Matter of Dayton Power & Light Co., supra - is long and comprehensive, and we see no need for covering the same ground so thoroughly. Briefly, four steps are taken to adduce the likelihood of absence of arm's-length bargaining. They concern asserted connections from Dayton Power & Light to Columbia Gas & Electric Corp., the parent of Dayton, from Columbia to United Corporation, a holding company having a substantial stock interest in Columbia, and from United to Morgan Stanley through the connection of both these latter corporations with the banking house of J.P. Morgan & Co.*fn4 We consider each of these four relationships separately. First is the relationship between Dayton Power & Light and Columbia Gas & Electric, a conceded relationship because the former is wholly owned by the latter, with interlocking officers and directors.Second, is the relationship between Columbia Gas & Electric and United, which owns 19.6 percent of Columbia's voting stock. Although petitioner argues that the mere fact of Columbia's status as a "subsidiary company" within the definition of § 2 (a) (8), 15 U.S.C.A. § 79b (a) (8) - as owning 10 percent of the stock - is not controlling, we think there is little need to discuss this point. Columbia has never carried through any attempt to have the Commission find that it is within the exceptions of § 2 (a) (8); and in the absence of such action by Columbia, the Commission is warranted in relying on the statutory definition of a subsidiary company. Furthermore, the 20 percent holding of United is the largest block of voting securities; and there is supporting evidence in the record showing various connections between United and Columbia. We are not unaware that much less than a majority of stock is frequently sufficient for purposes of control, and we see no reason to contest the legislative view that 10 percent may be sufficient.
The third step is the relationship between United and J.P. Morgan & Co. This is the most difficult to establish, and we shall discuss it more fully below. The final step is the relationship between J.P. Morgan & Co. and Morgan Stanley. The latter was organized in 1935, when several partners and employees of J.P. Morgan & Co. and Drexel & Co., the Philadelphia office of J.P. Morgan & Co., left to form an investment banking house. Prior to 1933, J.P. Morgan & Co. had been both commercial bankers and investment bankers, but after the Banking Act of 1933, 48 Stat. 162, 188, and of 1935, 49 Stat. 684, 707, 12 U.S.C.A.§ 377, it was necessary for one activity to be dropped. Investment banking was discontinued, and creation of Morgan Stanley soon followed. Most of the old business of the Morgan house went over to the new company, as anyone would have expected. Whether these facts alone would be sufficient to warrant a conclusion that whatever investment business J.P. Morgan & Co. might be able to influence would be thrown Morgan Stanley's way we need not decide, for the Commission adduced still further facts. It was shown that at the time of organization most of the capital was supplied by other Morgan partners than those who formed the new company. Though not so large as formerly, Morgan partners still hold about 30 percent of the capital and surplus in the form of approximately 44 percent of the nonvoting preferred stock, 4 percent cumulative, 6 percent if earned*fn5 From this fact the Commission inferred that J.P. Morgan & Co. through its interested partners, stood to gain financially by getting business for Morgan Stanley. Petitioner claims that even all this is insufficient to support the Commission's conclusion. We admit that there are many facts in this case which require far-reaching inferences to support the conclusions announced. This is hardly one. Tangible proof of a goodly financial stake in successful business relationships should be enough to satisfy the most confirmed doubter that there is likely to be mutual effort expended in obtaining business.
We come, therefore, to what is undoubtedly the most tenuous step in establishing the likelihood of an absence of arm's-length bargaining - the relationship between J.P. Morgan & Co. and United. Here again, we see no need to detail the story so fully as the Commission has done. See Matter of Dayton Power & Light Co., supra , pp. 8-13. We think the following facts substantially state the high lights of the Commission's case. First, United was organized by J.P. Morgan & Co. and Bonbright & Co. in 1929. The two houses held large holdings in several holding companies, and these were exchanged for stock in United, which was soon disposed of. From the beginning Morgan and Bonbright named the directors, who in turn chose the president of United, Howard, who is still president. At least one Morgan partner remained on the board until March 28, 1938, the day the Supreme Court upheld the constitutionality of the Act in Electric Bond & Share Co. v. Securities and Exchange Commission , 303 U.S. 419, 58 S. Ct. 678, 82 L. Ed. 936, 115 A.L.R. 105. The resignation was prompted, of course, by the requirement that United register, and this could hardly be done with a banker on the board of directors. After this director's resignation in 1938, United's president conferred with him on three occasions about what apparently were the more important financial transactions engaged in by United. Petitioner says these were not "conferences." but merely instances of conversations after the fact.This is neither here nor there. In and of themselves the conferences indicate continuing interest. And the fact that the Morgan partner made no "suggestions" may indicate anything from lack of interest to satisfaction that the right thing was done.
But this original dominant influence over United, decreasing through the years, is only one element of the story. After United was organized, some of the pre-existing banking connecnections of companies put into the United structure were broken and the business sent to J.P. Morgan & Co.This was not, however, true of Columbia, which did not come into United's orbit until a short time after the formation of United. But Columbia's banker was the Guaranty Co., which was on extremely good terms with the Morgan house. In view of the unwritten rule that satisfactory banking arrangements are not disturbed, it seems reasonable for the Commission to have concluded that J.P. Morgan & Co. would not give the friendly Guaranty Co. the short shrift it gave others.Termination of Columbia's relation with Guaranty - resulting in its shift to Morgan Stanley - did, of course, become necessary with Guaranty's withdrawal from the investment business when the Banking Act outlawed commercial and investment banking combinations. Furthermore, after the formation of Morgan Stanley, all of the debt security flotations of the units of United, including Columbia Gas & Electric, were, with three minor exceptions*fn6, managed by Morgan Stanley. And no security flotation for gas and electric utilities outside the United orbit has been handled by them. This evidence is bulwarked by other evidence tending to show acceptance by the "Street" of the powerful position of Morgan Stanley in this as well as in other former Morgan lines.
Finally, there is the financing operation of Dayton here involved. It appears that of the $25,000,000 floated, only about $5,700,000 was new money. The rest involved refunding of bonds issued in 1935, maturing in 1960. Columbia officials, when they first approached Morgan Stanley, had in mind a flotation of only $5,700,000. The latter convinced them, however, that the additional refunding was desirable. True, there is an extension of maturity - until 1970 - and a net saving to Dayton of $48,000 a year for 20 years, or nearly a million dollars*fn7 But the present value of this is, of course, less, and set against it is absence of a pressing need for refunding and the loss of investor good will through calling 25-year bonds within 5 years of issuance. Furthermore, there were the underwriters' fees of about $400,000*fn8 Petitioner argues that the public, not Dayton, pays this, which in a sense is true. If, however, the issue could have been placed privately - as would have been likely for an issue covering only the required new money - there would have been no fees; and if there had been competitive bidding, the underwriting spread might have been less. All in all, we think the Commission could reasonably question whether this transaction would have taken place without some sort of prodding.
These, then, are the salient facts, elaborated in the record by various witnesses and from various points of view, by which the Commission sought to adduce a likelihood of an absence of arm's-length bargaining between Morgan Stanley and Dayton. The question for us is only whether or not the evidence is substantial.§ 24 (a), 15 U.S.C.A. § 79x (a). Petitioner seeks to detract from the evidence by implying that it in no wise supports the view that Morgan Stanley holds a club over Columbia and its subsidiaries, sufficient to force them, actually and legally, perhaps, to do Morgan Stanley's bidding. Obviously this is not the Commission's case; we do not understand the Commission to assert it or that the Rule requires it. The very wording of the Rule contemplates subtle relationships. There need not be an absence of arm's-length bargaining, only a likelihood that there is. "Arm's-length" can hardly be meant in the traditional sense of fiduciary relationships, for the very provisions of the Act require complete dissociation of banker and utility. The type of influence envisaged is not over-all control, but influence in choosing underwriters. In sum, the Rule aims at breaking up underwriting ties which owe their existence to factors other than competitive advantage, in the broadest sense of the word. In this light we think the Commission acted within its power of finding the facts by all reasonable inferences. N.L.R.B. v. Link-Belt Co. , 311 U.S. 584, 61 S. Ct. 358, 85 L. Ed. 368; F.W. Woolworth Co. v. N.L.R.B. , 2 Cir., 121 F.2d 658; and see Detroit Edison Co. v. Securities and Exchange Commission , 6 Cir., 119 F.2d 730.
Furthermore, the Supreme Court has recently observed that some leeway must be given to administrative bodies over and above simple fact finding. "It is not the province of a court to absorb the administrative functions to such an extent that the executive or legislative agencies become mere fact finding bodies deprived of the advantages of prompt and definite action." Gray v. Powell , 62 S. Ct. 326, 333, 86 L. Ed. 301. We do not read this to destroy full review of questions of law, but we do understand it to lessen somewhat the force of petitioner's argument based on Helvering v. Tex-Penn Oil Co. , 300 U.S. 481, 491, 57 S. Ct. 569, 81 L. Ed. 755, as giving a court full power to review mixed questions of law and fact. ...