Collectible Stocks and Bonds from North American Railroads     by Terry Cox

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Cox's Corner
August, 2011

Scripophily 86

This article appeared in:
Scripophily, Aug 2011

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Classifying certificates by the rules...what rules?

It is not always easy to explain the stock and bond hobby because there are so many different kinds of certificates. The variety seems almost paradoxical. After all, companies only have two ways of raising money. It doesn't seem like there should be so many different ways of selling shares and borrowing money.

Raising money through sales of company shares

At first blush, raising money by selling stock seems simple. Founders try to sell shares of their companies in return for cash. Investors try to earn money through profit sharing or by reselling shares to other investors.

Companies often entice sales by offering several classes of stock, each with different ways to participate in company profits and governance. Stock classes offer variations in dividend distribution, voting rights and even how shares are resold. From company perspectives, multiple classes of stock allow manipulation in the amount of money they keep in company coffers or redirect to classes of their choosing.

In the early days of U.S. stock sales, shares were assessable. That meant companies retained the right to assess operating funds from shareholders as needed. Many early companies used a variation of that theme and sold initial stock offerings at fractions of stated par values. Once shares sold out, companies then requested subsequent installment payments. Companies that sold out initial stock offerings at ten percent down had the ability to raise as much as nine times more through subsequent installment requests.

Raising money through borrowing

Startup companies rarely had the ability to borrow money. Investors were wary of loaning money to companies until they proved themselves through successful management and growth. That is not to say that early companies entirely lacked the ability to "borrow."

Some companies issued currency (more properly, "scrip") backed by nothing but promises to repay at futures times. Some early currency was ingenious in its issuance, often involving repayment in freight and passenger conveyance. Some companies issued scrip as receipts for partial payments on stock, knowing that only part would ever be converted into actual shares.

Whenever companies achieved good reputations through operation, they gained the ability to borrow money from investors through the issuance of bonds. Most bonds carried the contractual promise to repay principal twenty or thirty years in the future and to pay semi-annual interest until then.

The types of bonds issued, however, varied dramatically from company to company. Mortgage bonds allowed bondholders to receive proceeds from the sale of company property in the event of default. Debentures offered nothing but the promise to repay at some future time. Some bonds allowed companies to defer interest payments during hard times and some bonds allowed companies to hold principal indefinitely.

Competition for investors required companies to be inventive when borrowing money. Some offered very high interest rates and many promised repayment in gold coins. Some offered repayment in steps or with accelerated schedules. Some borrowed money for only five years and some companies issued notes with repayment in only one or two years.

While seldom stated on bonds, many managers retained the right to alter repayment rules over time. It was not uncommon for some companies to extend their bonds and thereby double or triple their periods for repayment. Some companies replaced original bonds with new issues that carried completely different repayment terms and interest rates.

Certificates issued after bankruptcy

Not every company was as forthright in their corporate behaviors as their stock prospectuses and bonds might have suggested. I think it fair to say that some companies never intended to repay investors. From what I've seen in railroading, it looks like the majority of companies went bankrupt, some purposely and some more than once. Such financial troubles created yet another class of certificates issued not by companies, but by groups of individuals.

Trust certificates are prolific in the railroad specialty. If companies encountered financial trouble, groups of major investors often formed steering committees with the intention of directing the companies that had lost their way. They accomplished this by accumulating large numbers of shares. In effect, trustees asked shareholders to trust them to act on their behalves. Trustees acquired voting shares by issuing trust certificates and trading them for stock certificates.

Generally during bankruptcy, anyone who loans money to companies is first in line to receive funds from subsequent sales of corporate assets. Once companies default on their loan obligations, courts normally step in and appoint receivers. Depending on court intentions, receivers are normally charged with keeping operations going long enough to either repay debts or find other buyers. During those periods, receivers sometimes offer receiver's certificates in exchange for outstanding bonds. Receiver's certificates often tried to stop mounting interest obligations while the companies were trying to preserve cash.

Of the millions of companies that have existed, each had its own methods for procuring and keeping money from investors. The tremendous variety of certificates we see today reflects their widely variable attempts to use financial rules for their own benefits. That variety forces us to be highly flexible in classifying the types of certificates we collect.

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