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 ownership still lacked the completeness
which would have followed the assumption of direct title to the Central
Pacific road-bed and rolling stock, it was considered satisfactory, and
certainly was an improvement from the Southern Pacific’s point of view
over anything which had gone before.
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,[591] but by virtue of the support of the Crocker and the
Hopkins interests, he exercised almost undisputed control. Huntington
had reached the ripe age of seventy-nine years in 1900, and his death
was not unexpected. The effect was none the less great, however, for
the passing of Mr. Huntington meant the removal of the last of the men
to whom the integrity and independence of the Central and Southern
Pacific companies were matters of personal pride.
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 the Central Pacific
and the Union Pacific railroads bore to each other. While the Union
and the Central Pacific roads both owed their existence to the same
federal legislation, and while they had been close business associates
for over thirty years by virtue of geographical necessity, both had
uncompromisingly maintained their independence. Neither Jay Gould,
who was long influential in Union Pacific affairs, nor Huntington
himself, were men who cared to form part of organizations which they
could not control. Moreover, Huntington distrusted Gould. He once
wrote Colton that Gould had scared the Kansas Pacific people so that
they had let him, Gould, get into bed with them. For his part, he did
not intend to follow the Kansas Pacific example. Gould might frighten
him so that he would leave the bed, but never so that he would share
it. After Gould’s death in 1890, the same disinclination to combine
persisted. The Huntington group was now powerful, and still unwilling
to enter a combination which it could not control. The record shows
that proposals were made. The Union Pacific, dependent upon the Central
Pacific for direct connection with San Francisco, and fearful lest at
Mr. Huntington’s death his Southern Pacific stock should fall into
unfriendly hands, offered to purchase his shares, or, failing in this,
to conclude a permanent alliance. To this offer Mr. Huntington remained
indifferent.
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 price of 50.6146. Market
quotations were then in the neighborhood of 45. On February 4, Kuhn,
Loeb and Company engaged to deliver to the Union Pacific one month
later 72,300 additional shares at the same price, plus 4 per cent
interest from February 11, bringing the company’s holdings up to
750,000 shares.
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 in the Illinois Central, the
Chicago and Alton, and other lines, and by contract with the San Pedro,
Los Angeles, and Salt Lake, it possessed in varying degree influence
over connecting and competing roads.
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 was not even considered at any of the meetings of the
executive committee at which the subject was brought up. Speaking of
the Southern Pacific, Mr. Kahn declared:
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.[592]
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 the Union Pacific
possessed only a minority interest in the first-named company.
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.[593]
The government examined no less than seventy witnesses—shippers,
Southern Pacific employees and ex-employees, and representatives of
independent railroad lines. Among those who testified were Mr. Hawley,
for nineteen years eastern agent of the Southern Pacific and afterwards
a financier of prominence; Messrs. Stubbs, Spence, and Munroe, of the
traffic department of the Southern Pacific; Paul Morton, one-time
vice-president of the Equitable Life Assurance Company; Mr. Jeffery,
president of the Denver and Rio Grande; and Mr. Hannaford, in charge of
traffic on the Northern Pacific.
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.
[Illustration: 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 points east of the
Missouri River, the government succeeded in showing the existence of
competition between the Atlantic seaboard and Colorado and Utah common
points. A good many sheep wintered in the desert west of Salt Lake,
and in the spring moved to the summer ranges in Idaho where they were
sheared. The railroad near which the shearing took place secured the
outbound wool, and for this reason the Union Pacific, Southern Pacific,
and Rio Grande Western offered every attraction possible in order to
influence the movement of the flocks. The Union Pacific for instance,
at one time paid a head tax which Wyoming levied on all sheep brought
into that state. The Oregon Short Line purchased salt on behalf of the
sheep owners, carried it to Idaho, and collected the purchase price
only when the salt was delivered. In the same way there was competition
in respect to cattle and horses which wintered in southern Idaho and
northern Nevada and moved east in the spring.
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 east of Ogden. The Southern Pacific
runs south from Portland to Roseville, near Sacramento, and thence
east through California, Nevada, and Utah to Ogden. The distance over
the one route is 945.3 miles, and over the other 1,487.3 miles. The
Roseville route has nearly twice the rise and fall of the route via
Huntington, while the curvature also is greater. In a calculation
made by Mr. Kruttschnitt, he estimated that the direct line haul
was equivalent to 3,498 miles of straight level track, but that the
haul via Roseville was equivalent to 6,164 such miles. The evidence
nevertheless showed that some business, especially lumber, had moved
the long way round before 1901. Traffic had also moved via the Oregon
Short Line and Central Pacific to points as far west of Ogden as Wells,
Nevada. How much all this amounted to was not clearly shown—at best
it was probably not a great deal. After the consolidation of the Union
Pacific and Southern Pacific in 1902, through rates with the Oregon
Railroad and Navigation Company via the Shasta route were discontinued
and competition ceased.
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.[594]
The effect upon the Southern Pacific was of course important. A
drastic reorganization of the affairs of the company was called for
in order to take the Southern Pacific out of the control of the Union
Pacific and to re-establish the conditions of the Huntington régime.
Such a reorganization presently occurred. While the details of this
transaction are not of present significance, it may be said, in brief,
that after several abortive attempts the Union Pacific disposed of all
its Southern Pacific stock under a reorganization plan dated May, 1913,
delivering some of this stock to the Pennsylvania Railroad in exchange
for stocks of the Baltimore and Ohio Railroad, and selling the rest
to the general public.[595] Henceforth the rail lines of the Southern
Pacific were not to reach east of New Orleans and of Ogden.
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 Central Pacific companies by the application of the same
principles which had torn the Southern Pacific and the Union Pacific
apart. The new suit was known as the United States v. Southern Pacific
Company, and, like the old, was brought under the Sherman law.[596]
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 of its claims against the Central Pacific which
were secured by mortgage bonds carrying a Southern Pacific guaranty.
This guaranty, in turn, was offered by the guaranteeing company as one
element in a series of transactions which included the acquisition
of Central Pacific stock by the Southern Pacific in exchange for the
latter’s own stock certificates. The implications of this episode were
mentioned when the transaction was described. While it certainly gave
no permission to the Southern Pacific to violate the Sherman or any
other law as a consideration for assisting the Central Pacific to pay
its debts, the government did lay itself open to the charge of having
at one time approved and enjoyed the fruits of a transaction of which
it later complained.
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.”[597] These two
characterizations indicate a difference of considerable significance
between the Union Pacific and the Central Pacific cases.
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.[598] The grounds of this opinion were not brought out with
complete distinctness, but two judges held that there had never been a
“natural and existing competition” in interstate commerce between the
Southern Pacific and the Central Pacific. Nearly half of the text of
the decision, moreover, was devoted to a description of the financial
settlement of 1899, in which Congress appeared to have treated the
control of the Central Pacific by the Southern Pacific as consistent
with the statutes of the United States. Judge Carland dissented from
the conclusions of his colleagues in a carefully prepared opinion.
The case was appealed, and after full oral argument, was submitted to
the Supreme Court on April 19, 1921. An early decision is expected.
Meanwhile, the continued close relations between the Central Pacific
and the Southern Pacific are approved by public sentiment upon the
Pacific Coast, while the continuance for the present of common control
of the two companies certainly avoids many practical difficulties.