THE SOUTHERN PACIFIC MERGER CASES New Era There is no question that the final separation of the finances of the Central Pacific from those of the United States government was a matter of very great importance to both parties. The direct result was to place the federal government outside the Central Pacific instead of inside it. Instead of holding the dual relation of creditor and regulating body, Congress now stood as regards the Central Pacific in the same position as with respect to every other railroad in the United States—without interest in the company’s internal finance, but free to act in the interests of the consuming, shipping, and investing public. This was an immense advantage, both from the point of view of the government and from that of the railroad itself. The Central Pacific reorganization of 1899, moreover, not only accomplished a desirable change in the external relations of the Huntington lines, but it also brought about a change in the relations between the Central Pacific Railroad and the Southern Pacific Company which was of considerable significance. It will be recalled that from 1885 to the time of the reorganization of the Central Pacific in 1899, these relations had rested upon a leasehold interest only. The insecurity of such a connection had been brought forcibly to the attention of the Southern Pacific management during the course of the reorganization proceedings. But as a result of the participation of the Southern Pacific in the reorganization which made possible the repayment of the government debt, that company became possessed of the ownership of the entire outstanding Central Pacific common and preferred stock. While such Separated from all financial connection with the government and with its parts joined together by the double tie of leasehold and stock control, the Central Pacific-Southern Pacific system, on the conclusion of the Central Pacific reorganization of 1899, entered upon a new era which contained possibilities of new policies, and of a sounder and more profitable development than it had yet known. There was, too, one additional circumstance which made it easy for the stockholders of the Southern Pacific in 1900 to embark upon new policies—namely, the death of Mr. Huntington. Of the original associates, Huntington was the last survivor. Mark Hopkins had died in 1878, Charles Crocker in 1888, and Stanford in 1893. For ten years, at least, Huntington had been the active manager of the Southern Pacific properties. Personally, he never owned so much as 50 per cent of the Southern Pacific stock outstanding, Purchase of Control by Union Pacific It was the death of Mr. Huntington, to repeat, which now made possible a very important change in the relations which Huntington died, however, in August, 1900, leaving his Southern Pacific stock to his widow and nephew in the proportion of two-thirds and one-third, respectively; and both, as had been anticipated, proved willing to dispose of their holdings. Negotiations were carried to completion in February, 1901. Four hundred and seventy-five thousand shares were purchased from the Huntingtons and from Edwin Hawley, the late financier’s most intimate business associate, while enough was secured from other parties through Kuhn, Loeb and Company to make an aggregate of 677,700 shares, at an average This, in Mr. Harriman’s opinion, was sufficient for control. A year or two later an attempt to force the Southern Pacific to pay in dividends earnings which its managers thought should be expended in improvements led the Union Pacific to acquire 150,000 additional shares. In January, 1910, purchases were renewed for the last time, in view of pending legislation in Congress which promised to make the possession of an absolute majority of Southern Pacific stock desirable; but these purchases ceased after 74,000 shares had been obtained, and 50,000 of these shares were subsequently sold. This concluded the episode. On June 30, 1911, the Union Pacific through the Oregon Short Line owned 1,266,500 shares of Southern Pacific common, or 46 per cent of all outstanding stock—sufficient to give undisputed control. Harriman System This purchase by the Union Pacific of a controlling interest in the stock of the Southern Pacific, made the latter a partner in a railroad system of about 18,500 miles, stretching from Omaha, Kansas City, and New Orleans on the east, to Los Angeles, San Francisco, and Portland on the west, and, by means of the Morgan Steamship Line, reaching New York. In addition, the Union Pacific owned a majority of stock in the Pacific Mail Steamship Company, which carried freight and passengers from the Pacific Coast to the Orient and to Panama. Of the total mileage west of the Mississippi-Missouri River and south of the Northern Pacific Railroad, the Harriman management controlled 19 per cent. Finally, through stock ownership Undoubtedly its association with the Union Pacific increased the prestige of the Southern Pacific Company at the time when the merger took place. The association involved, however, serious dangers, for it placed the credit and the earning power of the Southern Pacific at the disposal of Mr. Harriman for speculative projects in eastern fields, and also it ran counter to a national policy opposed to great accumulations of capital under single control which was presently to become clearly defined. It is true that public hostility toward big business seemed unimportant in 1901 when the Union Pacific and the Southern Pacific first combined, yet the attitude of the courts toward monopoly became a matter for serious consideration by the latter in 1911, ten years after the original merger had taken place, when the federal government attacked the Union Pacific-Southern Pacific consolidation as a combination in restraint of trade under the terms of the Sherman Anti-Trust Act of 1890. A brief discussion of the issues of this extremely important lawsuit is therefore necessary. There was perhaps some ground for conflicting views with respect to the motive which had induced the Harriman interests to seek control of the Southern Pacific. The obvious explanation of the operation was that the Union Pacific desired to increase its power in the South West. It was stoutly maintained by Mr. Kahn, of Kuhn, Loeb and Company, however, that the desire to control the Southern Pacific line from San Francisco to El Paso was not a motive in the transaction. The necessity of buying the Sunset route, he said, was considered an obstacle and a deterring feature. If a way could have been found to secure the Central Pacific alone, it would have been preferred at the time. The possible reduction of competition We knew it would require a great deal of money to be spent on it, we knew it added thousands of miles to the burden of administration and management. We were very anxious that the Union Pacific should receive as much of the administrative ability and of the railroad genius of Mr. Harriman as it was possible for him to give it, and we were rather disinclined to put upon him any more burden than was necessary to the best development of the Union Pacific; and therefore we, individually, felt that if the Southern Pacific could be separated, keeping only the Central Pacific and the north and south lines in California, and getting rid of the southern part of the Southern Pacific, we would be getting rid of a nuisance. Arguments of Railroad Counsel The contention of the Union Pacific Railroad in 1911 was that the consolidation of the Union Pacific and Southern Pacific properties was legal under the Sherman law irrespective of motive, because the two systems were not competing, and that the government was unable to interfere in any case because the consolidation took place through the means of a purchase of stock instead of by contract or agreement between the railroad corporations concerned. On this last point the railroad also argued that, as a matter of law, ownership by one railroad of another’s stock did not constitute control unless a clear majority was held. Control, said counsel, is a matter of power. A minority may direct the operation of a railroad because the majority has confidence in it, but this is lawful. The argument applied to the Southern Pacific case because it was known that Apart from this, counsel contended that a purchase of stock was a thing which the federal government could not control, for the reason that the acquisition or disposition of property was not commercial intercourse. “If any citizen should step into a broker’s office on Broadway, New York, buy some stock in the Pennsylvania Railroad, pay for it, put the certificates in his pocket, and walk out, would he, or the broker, or the broker’s principal, be engaged in commercial intercourse between nations and parts of nations?... Would a state corporation buying those certificates be in any different situation from an individual purchaser, if the State of its domicile had endowed it with corporate power to buy stock?” Moreover, to continue the argument, though purchases of stock were subject to federal law, they would violate no provisions of the Sherman Act. A purchase or sale is not a contract in restraint of trade, for a contract is executory, implying something yet to be done; while a sale is executed, completed when made and because it is made. Nor is a contract in restraint of trade necessarily unlawful. It must be undue, that is, not entered into with the legitimate purpose of reasonably forwarding personal interest and developing trade. The same may be said of an attempt to monopolize. Every act of competition tends to drive competitors out of business, but competition is legal, in the absence of fraud or duress. It follows that an individual may buy out a competitor, and then another competitor, and so on, and a corporation may do the same thing. “It is evident,” said Mr. Dunne’s brief, “fraudulent, intimidating, coercive, and other like wrongful and unlawful methods apart—that here we touch a fundamental principle of the freedom to buy and sell, of the legal right of the individual in respect to his own property.” Government’s Contention of Previous Competition The arguments of railroad counsel in defense of the Union Pacific-Southern Pacific merger rested predominantly, although not wholly, upon points of law such as have been mentioned. Fundamental as some of these were, the main interest in the case for the ordinary student will be found in the elaborate analysis of the competitive relations between the Southern Pacific and the Union Pacific which the government developed in the course of its argument. So far as the writer is aware, no record has ever been presented to any court in which the nature and extent of the competition between two great railroad systems has been so thoroughly discussed. In establishing the fact that competition had been active between the Southern Pacific and the Union Pacific before the merger of the two companies in 1901, the government insisted upon the fact that the Central and Southern Pacific managers had continuously diverted all the traffic which they could control to the Sunset route so long as they remained independent of Union Pacific dictation. Substantially all these witnesses testified that traffic from the Atlantic seaboard could move to the Pacific Coast either via the Morgan Steamship Line to New Orleans and thence over the Sunset route of the Southern Pacific to San Francisco, or via the trunk lines and their connections to Omaha, thence over the Union Pacific to Ogden and over the Central Pacific to the coast. Although the Southern Pacific was interested in both of these routes, it secured all the revenues from freight moving via the Sunset route, and only 30.1 per cent of the total revenue from freight delivered to it by the Union Pacific at Ogden. In consequence, it used its best efforts to influence freight to travel by the southern line. Map showing mileage owned in 1913 by the Central Pacific Railway and the Southern Pacific Railroad. The government showed by the evidence of shippers that freight was actually solicited in competition between the two Pacific companies. The Southern Pacific, it appeared, took traffic at New York rates from as far west as Buffalo and Pittsburgh, not including those cities, and from as far south as Norfolk. Not only this, but the Union Pacific was not altogether restricted to the route via Ogden. By diverting freight at Granger and sending it north to Portland over the Oregon Short Line and the Oregon Railroad and Navigation Company, it could affect the transcontinental rate in two ways. In the first place, it was physically possible for traffic to move from Portland to San Francisco by boat; and in the second place, a slight reduction in the rate to Portland compelled a cut to every Pacific terminal point in order to maintain these different cities in the same relative position for the distribution of eastern goods. As Mr. Stubbs expressed it, “Let the rate be cut on the Great Northern, and it goes down to the Gulf of California.” Mention may also be made of the route via the Isthmus of Panama, in which the Southern Pacific had an interest by virtue of its control of a steamship line from San Francisco to Panama. The business was not large, but in so far as any moved this way it was in competition with the rail lines via Ogden. Competition between Other Points In addition to competition between the Southern Pacific and the Union Pacific on business between the Pacific Coast and In return for the wool, cattle, hides, etc., shipped east, there were brought in shipments of miscellaneous merchandise, dry goods, machinery, and the like. When the Union Pacific handled the business, the freight moved from New York to Norfolk or Newport News, thence by rail to Omaha and over the Union Pacific lines to destination. When the Southern Pacific took it, the freight went by Southern Pacific steamers to New Orleans or Galveston, and thence over railroads controlled by the company to Fort Worth, Texas, where it was given to connecting lines for delivery at destination. The rate was the same either way, but the rivalry between soliciting agencies was intense. Still again, there was competition between Portland and Utah and Colorado common points, including certain points in Nevada. Portland enjoys a fairly direct route over the Oregon Railroad and Navigation Company’s tracks to Huntington, and from there over the Oregon Short Line to Granger, a few miles Other kinds of competition included competition for traffic between San Francisco and Portland, between San Francisco and points in Montana and Idaho, and competition for Oriental traffic destined to points in the United States east of the Missouri River. In short, the voluminous evidence thus summarized showed that active competition had existed of almost every conceivable kind. There had been competition of parallel routes between the same termini, of parallel or roundabout routes between different termini, of roundabout routes entirely controlled by the competing lines, of the routes in which the Union Pacific and Southern Pacific were links only in chains of connecting and independent roads, and finally there had been competition in cases where one competitor had to rely upon the other for a greater or less proportion of the haul. Dissolution of Merger This demonstration that the Union Pacific and the Southern Pacific had competed with each other before the merger of 1901, followed by easily secured evidence that the competition had ceased after the merger, was sufficient to persuade the Supreme Court to grant the government a decree, in spite of the protests of the defendant railroads. Attack on Control of Central Pacific When the United States Supreme Court declared that the Union and Southern Pacific systems must be separated, it merely restored the latter to a condition of independence. The United States Department of Justice was of opinion, however, that the logic of the decision went further than this, and, encouraged by its preliminary success, it took the dramatic step of attempting to separate the Southern Pacific and the The principal points in the case of the United States v. the Southern Pacific Company were as follows. A glance at the accompanying map will show that the Central Pacific Railroad, from Ogden to Sacramento, and the Western Pacific, from Sacramento to Oakland, were in practical effect but the western end of a route of which the Union Pacific formed the eastern part. So far as competition was concerned, all parts of the route were on a parity. If the Union Pacific competed with the Southern Pacific when it hauled eastern freight from Omaha to Ogden, the Central Pacific did likewise when it hauled the same freight from Ogden to Sacramento. If it would promote competition to place the Southern Pacific and the Union Pacific in separate hands, the same could be said of the Central Pacific and its southern neighbor. So much is reasonably clear even from a cursory examination of the facts. In at least two important respects, however, the relations between the Southern Pacific and the Central Pacific differed from those between the Southern Pacific and the Union Pacific. These points were emphasized in the briefs of counsel, and formed the basis of the companies’ defense. Unlike the Union Pacific, the Southern Pacific had obtained control of the stock of the Central Pacific at a time when and under circumstances in which the federal government was an interested party. If the details of the reorganization of 1898 are recalled, it will be remembered that the government then accepted notes in satisfaction The more important distinction between the later and the earlier merger cases in which the Southern Pacific was involved, lay in the circumstances that the combination of the Union Pacific and the Southern Pacific had been a recent matter, while the relations between the Central Pacific and the Southern Pacific had begun almost as soon as the latter corporation had been organized. In discussing the construction of the Southern Pacific, the remark has been made that the two enterprises were originally but different manifestations of the activities of a single group of men. The first statement in the brief of Mr. Herrin, chief counsel for the defense in the Central Pacific case, was similarly that: “This case does not involve any combination of competitive units, or any combination at all, for the Southern Pacific and Central Pacific lines were projected and built and have been operated since their organization as one property.” Final Decision Doubtful It must be pointed out, nevertheless, that in spite of the long and close association between the Central and the Southern Pacific railroads, there were certain features in this controversy which made it difficult to forecast the final decision of the Supreme Court of the United States. Counsel for the railroad company in the Union Pacific case dwelt much upon legal technicalities. But in the Southern Pacific case the forms were all opposed to the company’s contentions. For one reason or another, doubtless largely for political effect, the associates had always scrupulously insisted upon the separate identity of the two companies concerned. The corporations had been made to appear to deal with each other at arm’s length, and there had even been much discussion of the relative profitableness to each of the contracts concluded between them. Nor was the matter one of form alone, as we have seen in earlier chapters of this study. While the construction of both roads was financed by the same parties, after 1880 the associates disposed of the greater part of their Central Pacific holdings. The Southern Pacific and the Central Pacific were still held together by lease relations, it is true, but they then became separate, not merely in organization but also in ownership. The separate ownership continued until 1899, when the new arrangements were made to undo which the government brought suit. It followed that counsel for the defendant railroads were in the position of defending a combination of legally distinct corporations, owned by different parties, with no connection between them save through the minority holdings of individual stockholders and through the very arrangements of which complaint was made. As an answer to this indictment, the circumstance that the same parties had found their profit in building each of the defendant lines could hardly be given weight, nor was the fact that the original consolidation antedated the Sherman law important. The suit of the United States v. Southern Pacific Company was argued before the circuit judges of the Eighth Circuit sitting at St. Louis in December, 1915. The decision of a majority of this court was rendered in March, 1917, and was unfavorable to the government’s contention. |