UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT NEW YORK
October 14, 1953
MORGAN et al. [Part 1 of 2]
The opinion of the court was delivered by: MEDINA
TOPICAL ARRANGEMENT OF OPINION
The Offense as Charged in the Complaint.
Certain Alleged Unifying Elements
Abandoned or Disproved.
The Applicable Law Relative to Conspiracy.
The Investment Banking Business.
I. Prior to the First World War.
II. Between World War I and the Securities Act of 1933.
III. Further Developments 1933-1949.
IV. How the Investment Banker Functions.
The Seventeen Defendant Investment Banking Firms.
1. Morgan Stanley & Co.
2. Kuhn Loeb & Co.
3. Smith Barney & Co.
4. Lehman Brothers.
5. Glore Forgan & Co.
6. Kidder Peabody & Co.
7. Goldman Sachs & Co.
8. White Weld & Co.
9. Eastman Dillon & Co.
10. Drexel & Co.
11. The First Boston Corporation
12. Dillon Read & Co. Inc.
13. Blyth & Co., Inc.
14. Harriman Ripley & Co., Incorporated.
15. Stone & Webster Securities Corporation.
16. Harris Hall & Company (Incorporated).
17. Union Securities Corporation
The Syndicate System.
I. Did the Seventeen Defendant Investment Banking Firms Use the Syndicate System as a Conspiratorial Device in Connection with Any Integrated Over-all Combination?
II. Alternate Claims Belatedly Attempted to Be Asserted against the Investment Banking Industry as a Whole.
A. The Rule of Reason. B. The Securities Act of 1933, the Securities
Exchange Act of 1934, and the Amendments Thereto; the Rules, Interpretations and Releases of the SEC Thereunder; and the Organization and Functioning of the NASD.
C. The Opinion of the SEC in the Public Service
Company of Indiana Case.
Some Interim Observations.
Did the Seventeen Defendant Investment Banking Firms Combine for the Purpose of Dominating and Controlling and Did They in Fact Dominate and Control the Financial Affairs of Issuers by Directorships and Solicitation of Proxies?
The Evidence Generally Applicable to Directorships Discloses No Conspiratorial Pattern but Rather the Contrary.
Addinsell and Phillips Petroleum.
United Air Lines.
Directorship Evidence against Goldman Sachs, Lehman Brothers, Kuhn Loeb, Dillon Read and Blyth.
Cleveland Cliffs Iron Co.
National Cash Register.
Beneficial Industrial Loan.
Commercial Investment Trust.
Pan American Airways.
Some Further Interim Observations.
The 'Triple Concept'. Semantics. 'Historical Position'. Chicago Union Station. The Alleged 'Practice' of 'Traditional Banker' and 'Successorships'.
1. Morgan Stanley.
The 'Master Mind'. The Telephone Business. Consumers Power. The Alleged 'Caretaker' Situations. Dayton Power & Light. Atlantic Coast Line, Toledo & Ohio Central, Chicago &
Western Indiana, Nypano (New York, Pennsylvania & Ohio) and Dominion of Canada.
2. Kuhn Loeb.
The Otto H. Kahn 'Show Window'. Bulgaria. Commonwealth of Australia. Armstrong Cork. Bethlehem Steel. R. H. Macy & Co. Crucible Steel. General Cable.
3. Smith Barney (Edward B. Smith & Co.).
What Is Now Taking Shape Is Not a Static 'Mosaic' of
Conspiracy but a Constantly Changing Panorama of Competition Among the Seventeen Defendant Firms.
Wilson & Co. Rochester Gas & Electric. A. E. Staley Manufacturing Co. Aluminum Koppers, Jones & Laughlin, Lone Star Gas, Gulf
Southern Pacific. Standard Oil of New Jersey.
4. Lehman Brothers.
Crown Zellerbach. Giannini Interests. The So-Called 'Treaties' Between Lehman Brothers and
National Dairy Products. Butler Bros., Associated Gas & Electric, Indianapolis
Power & Light and Tidewater Associated Oil.
5. Glore Forgan.
Indianapolis Power & Light.
6. Kidder Peabody.
Pennsylvania Power & Light.
7. Goldman Sachs.
8. White Weld.
9. Eastman Dillon.
11. First Boston.
Province of Cordoba, Androscoggin Electric Corp., and
Central Maine Power.
12. Dillon Read.
Scovill Manufacturing Co., Scripps, Porto Rican American
Tobacco Co., Argentine Government, American Radiator and Grand Trunk Western.
United Drug. Shell Union Oil.
Pacific Gas & Electric. Competition for Leadership 1934-1936. The Alleged Overly-Large Syndicate Formed By Blyth in
Connection with the $ 80,000,000 Issue of March 27, 1945.
The Sale in 1945 of 700,000 Shares of Common Stock of
Pacific Gas & Electric Held by North American.
14. Harriman Ripley.
15, 16 and 17. Stone & Webster, Harris Hall and Union Securities.
Alleged Conspiratorial Opposition of the Seventeen Defendant Banking Firms to 'Shopping Around,' and to the Campaign for Compulsory Public Sealed Bidding; and the Alleged Adoption of Devices to Sabotage SEC Rule U-50 and Compulsory Public Sealed Bidding in General.
General Views on Competitive Bidding and the Advantages to Issuers Arising Out of Continuing Banker Relationships.
The Eaton -- Young -- Halsey Stuart Campaign.
Responses to Requests from SEC to Express Views Relative to Proposed Rule U-20 and Further Amendments to Rule U-12F-2.
Alleged Overly-Large Syndicates and Other 'Devices' to Sabotage Public Sealed Bidding.
The 'Insurance Agreement,' Alleged to Have Been Made on December 5, 1941, and 'Approved' on May 5, 1942.
Administrative Features and Statistics of the Trial
Summary, Rulings on Motions and Dismissal.
Summary Description of Statistical Compilations, Tables and Charts.
MEDINA, Circuit Judge.
This is a civil action in equity to restrain the continuance of certain alleged violations of Sections 1 and 2 of the Sherman Act, Act of Congress of July 2, 1890, c. 647, 26 Stat. 209, 15 U.S.C. §§ 1, 2, 4. It is charged that defendants entered into a combination, conspiracy and agreement to restrain and monopolize the securities business of the United States and that such business was thereby unreasonably restrained and in part monopolized.
The "securities business" which is the subject of these charges is defined in the complaint in terms that are uncertain and in part contradictory. In the clarifying process of pretrial hearings and trial, however, counsel for plaintiff receded in part from the allegations of the complaint. As finally re-defined, plaintiff's position is that the "security issues" to which the charges of the complaint should be understood to relate are intended to include new issues, and secondary offerings registered with the Securities and Exchange Commission under the Securities Act of 1933, 15 U.S.C. § 77a et seq., of securities of domestic and foreign business corporations and foreign governmental units and foreign municipalities, offered to or placed with investors in the United States, but to exclude domestic railroad equipment trust certificates, all notes and serial notes representing term loans by commercial banks, all general and revenue obligations of domestic governmental units and domestic municipalities, and all unregistered secondary offerings of any securities.
The combination, conspiracy and agreement to restrain and to monopolize and the actual restraint effected thereby are claimed to have embraced every method and type of transaction by which issues of the above-defined securities have been transferred from the issuers (or from sellers of blocks of such securities in registered secondary offerings) to the hands of investors, whether underwritten by investment bankers or non-underwritten, whether privately placed or publicly offered to existing security-holders or the general public, and whether in negotiated transactions or at public sealed bidding, with the exception, however, of direct offerings by issuers to their security-holders in which investment bankers are not employed as agents or underwriters. The part of the securities business which is charged to have been monopolized by the defendants in the course of and through the operation of the conspiracy is claimed to have consisted of all new issues of the above-defined securities, and all registered secondary offerings thereof, which have been underwritten by investment bankers in negotiated transactions and publicly offered to existing securityholders or to the general public.
The Offense as Charged in the Complaint
The complaint charges an integrated, over-all conspiracy and combination formed "in or about 1915" and in continuous operation thereafter, by which the defendants as a group "developed a system" to eliminate competition and monopolize "the cream of the business" of investment banking. The prolixity of the complaint and its various involutions are such that it will be convenient to summarize and paraphrase its contents, as was done in the trial brief submitted at the opening of the trial by counsel for the government. The mortar to cement together the various parts of this extraordinary document is provided by a series of definitions, many of which bear little resemblance to the meaning of the various words or phrases used in the business.
The central theme is what has been referred to throughout the case as "the triple concept" of "traditional banker," "historical position" and "reciprocity." To quote from the brief above referred to:
"Under the traditional banker concept that banker who first manages an underwriting for a particular issuer is deemed entitled to manage in the future all additional security issues offered by such issuer. * * * Under the concept of historical position once a banker participates as a member of a buying group in the purchase of the securities of a particular issuer, such banker is deemed entitled to participate on substantially the same terms as a member of the buying group in all future issues offered by such issuer. Under the concept of reciprocity the defendant banking firms recognize a mutual obligation to exchange participations with one another in the buying groups which they respectively manage."
In this connection the complaint specifically charges that:
"Each defendant banking firm keeps a reciprocity record to show the business it has given to each of the other defendant banking firms and the business it has received from each of such firms."
"Over a period of time, the amount of gross spreads which one of such firms enables another to earn by selecting it for participation in buying groups is substantially equivalent (with due allowance for differentials in prestige and underwriting strength) to the amount of gross spreads it has earned in the same period of time as a participant in buying groups formed and managed by such other firm."
As it is evident that no such parcelling out of the investment banking business could function so long as the management of issuers was free to choose and deal with any investment banking house it wished, there is alleged in the complaint as one of the terms agreed upon by the defendants, and as part of the conspiracy and combination, that there should be a species of control over issuers so as to "preserve and enhance their control over the business of merchandising securities:"
"(1) by securing control over the financial and business affairs of issuers, by giving free financial advice to issuers, by infiltrating the boards of directors of issuers, by selecting officers of issuers who were friendly to them, by utilizing their influence with commercial banks with whom issuers do business."
One of the terms of the agreement said to have been made by the members of the combination and conspiracy is that when a "representative" of one of the 17 defendant banking houses becomes a director of an issuer, this is understood by all the rest to be the equivalent of "raising a red flag," and thus warning the others to keep off.
As a measure of combined control over issuers and the several hundred other investment banking houses against whom the conspiracy was to operate, it is charged in the complaint that in 1915 "the modern syndicate method of distributing securities was invented by defendant banking firms and their predecessors," and that defendants agreed that with certain modifications this method should be utilized by defendants to stabilize the business "by fixing and controlling the prices, terms, and conditions of purchase, sale and resale of securities." This "device" is said to be manipulated by defendants in various ways, all as part of the general plan or scheme. For example, it is alleged that defendants as managers of such syndicates not only further the ends of the combination or conspiracy by dealings among themselves, but that they sometimes exclude other firms from participations or selling group positions, and sometimes include such firms "which might otherwise attempt to compete with defendant banking firms;" and that by means of this "device" defendants "agree among themselves upon a uniform, non-competitive price" which, having thus been "fixed" by them, is foisted upon issuers, by what can only euphemistically be called "negotiation," in view of the domination and control exercised or attempted to be exercised over the issuers by defendants. It is worthy of note that the allegations with reference to the syndicate system and its so-called price-fixing features are made solely in reference to the charge of the integrated, over-all combination and conspiracy.
Certain statutory and regulatory provisions of great significance, which became effective in 1934, 1941 and 1944 are reflected in other phases of the combination and conspiracy as charged.
In 1933 the Congress passed the Glass-Steagall Act,
pursuant to the terms of which commercial banks and their security affiliates were required to go out of the investment banking business, if the banks desired to continue taking deposits and performing their other banking functions. The deadline was June 16, 1934. The affiliates were accordingly dissolved; and such banking houses as had bond departments or otherwise engaged directly in the investment banking business, with very few exceptions, elected to continue their banking functions and restricted their operations in the field of securities to governmental and other issues specifically exempted from the operation of the new law. Thousands of employees of these institutions were forced to make new connections, and many joined the staffs of some of the 17 defendant investment banking houses.
It is the theory of the complaint that the pre-existing and flourishing combination and conspiracy met this situation by a further agreement among the conspirators to the effect that certain of the defendant firms should succeed to or "inherit" the conspiratorial "rights" theretofore parcelled out to the commercial banks and their affiliates by the operation of "the triple concept" above described, and that the combination or conspiracy should accordingly, and it is alleged did, continue to operate as before. This is the predecessor-successor phase of the case in a nutshell.The complaint originally read as though certain firms became and were the real successors of others in a legal sense whereas what was intended to be pleaded, as disclosed by an amendment of the complaint made in the course of pre-trial conferences, is that the "successors" were such only in the sense that the alleged conspirators so agreed as part of the operation of their integrated, overall combination and conspiracy.
In 1941 the Securities and Exchange Commission promulgated a rule requiring securities of companies, affected by the provisions of the Public Utility Holding Company Act of 1935, 15 U.S.C.A. § 79, et seq., to be sold by compulsory public sealed bidding, and similar action, relative to debt securities of railroads, was adopted by the Interstate Commerce Commission in 1944. In this connection and in very comprehensive terms the complaint charges that these 17 defendants as part of the same integrated, over-all combination and conspiracy agreed to discredit the use of competitive bidding, private placements and agency sales as methods of disposing of security issues. The competitive bidding phase of the charge is divided roughly into three parts: (1) Opposition to campaigns which resulted in the adoption of the rules above referred to.(2) Refusal to submit sealed competitive bids and the adoption of a great variety of "devices" for the purpose of sabotaging the new rules and hence defeating the purposes of the two governmental agencies which had made public sealed bidding compulsory with respect to a not inconsiderable area of security issues. Such "devices" were alleged to have included: the organization of overly-large syndicates, the grant of participations equal to those of the manager, the reduction of management fees and the merger of accounts. (3) After certain insurance companies had bid in a large issue of securities of the American Telephone & Telegraph Company in the fall of 1941, it is charged that a certain agreement was made on December 5, 1941 and "approved" on May 5, 1942, by virtue of which the insurance companies were to be eliminated as direct bidders for security issues.
According to the complaint the means adopted by the conspirators to accomplish their ends were many and various. They seem to include, under the heading of "customs and practices," said to have been agreed upon to effectuate the design of the conspirators, many of the alleged abuses which over the years have been charged against investment banking houses in general, but which have not as yet been affected by specific legislation.
This in brief is the framework and the essence of the charge against these 17 defendant investment banking firms.Much of the detail is omitted for the moment in the interest of clarity. Many of the charges against defendants were from time to time abandoned and removed from the case and no further reference will be made to them.
Thus "the substantial terms" of the "continuing agreement and concert of action" originally alleged against the group of 17 in paragraph 44 of the complaint included: (1) an agreement to cement their relationships with issuers by securing clearances from such issuers before making their investment banking facilities available to competing business enterprises and by refusing to act as advisers or underwriters for small business concerns; (2) an agreement to utilize their domination and control to encourage and promote consolidations, mergers, expansions, refinancings and debt refundings to increase their investment banking business; and (3) an agreement to concentrate the business of purchasing and distributing security issues in a single market. These were all withdrawn by counsel for the government.
The following "customs and practices," alleged in paragraph 45 to have been "formulated and adopted" by agreement of the group of 17 were originally included but later dropped: (1) the formation of "standby accounts" for all security issues of a particular issuer to prevent the assembling of competing groups and thus discourage issuers from disposing of issues at competitive bidding; (2) in the event of insolvency or reorganization of issuers with whom a "traditional banker" relationship existed with a member of the group, to cause a partner, officer or other nominee to be appointed to influence protective committees for the benefit of such "traditional bankers"; and (3) subsequent to the divorcements required by the Investment Companies Act of 1940, 15 U.S.C.A. § 80a-1 et seq., continuing to influence managing investment companies or trusts in which capital had been "strategically invested" so that voting powers would be exercised "in the interests of defendant banking firms."
Such other issues as were removed from the case by consent need not be specified, except as they may be hereinafter referred to.
The complaint bears every evidence of careful and prolonged preparation, its articulation is close and compact, every word is carefully chosen and fitted exactly in its proper place. Thus it is the 17 defendant banking houses, arrayed against the balance of the investment banking industry, and alleged to be acting in combination to monopolize "the cream of the business," and divide it up among themselves, by excluding those investment banking houses which are not part of the conspiracy. If the charge is true the restraints are ingeniously devised to create a controlled rather than a free market at every level. The operation of "the triple concept" prevents competition as between defendants themselves; the domination and control over issuers and the "fixing" of the price to be paid issuers for their security issues deprives issuers of a free market in which to raise the money they need; non-defendant firms are deprived of an opportunity to compete for the business; the trading operations of dealers and brokers are restricted during the period of the continuance of syndicates formed for the distribution of new security issues; and investors are deprived of an opportunity to purchase securities in a free market.
And all this is said to have gone on for almost forty years, in the midst of a plethora of congressional investigations, through two wars of great magnitude, and under the very noses of the Securities and Exchange Commission and the Interstate Commerce Commission, without leaving any direct documentary or testimonial proof of the formation or continuance of the combination and conspiracy. The government case depends entirely upon circumstantial evidence.
Certain Alleged Unifying Elements Abandoned or Disproved
During the prolonged and extensive pre-trial conferences, there was much discussion of the method to be pursued by the government in attempting to prove that these 17 defendant investment banking houses had formed a combination and were acting jointly as a group. As pointed out in my memorandum of April 9, 1951, filed with Pretrial Order No. 3, United States v. Morgan, D.C., 11 F.R.D. 445, 454-455, the unifying elements of the alleged conspiracy were obscure, as no industrywide uniformity was charged, there was no powerful group such as the "Big Three" operating against independents in the American Tobacco Co.
case, no letter or series of agreements presenting a definite plan to which others might consciously adhere as in the Interstate Circuit
and Masonite Corp.
cases and there appeared to be many non-defendant investment banking firms which were larger, had more capital and did more business than some of the defendants herein. Certain aspects of the present case, however, which have since been abandoned or disproved seemed to have relevance to this important phase of the case.
The first of these was the fact that it was claimed that defendants and their "predecessors" had invented the syndicate system to further their plan or scheme. This charge, which was evidently the basis for the allegation that the conspiracy was formed "in or about 1915," has been conclusively disproved and has been virtually abandoned.
The second such possible unifying element was the Investment Bankers Association, originally joined and for many months of the trial continued as a defendant and alleged co-conspirator.Each of the defendant firms was and had for many years been a member of this Association, particularly during the period when the Association, through its officers and committees took a strong position against the adoption of rules and regulations requiring compulsory public sealed bidding for certain types of new security issues. On motion of the government, however, the Investment Bankers Association was, with my approval, eliminated as a defendant and the charge that it was a co-conspirator was withdrawn. The name of its president Emmett F. Connely, was, however, continued in the list of alleged co-conspirators, evidently because he had made a speech on October 7, 1941 criticizing the purchase of the American Telephone & Telegraph bonds by a group of certain large insurance companies at public sealed bidding and one or two men connected with some of the defendant firms had in one form or another expressed their approval of the speech.
Perhaps the most impressive indication of joint action by the defendants lies in the detailed and explicit allegation of the complaint relative to reciprocity. Not only is it charged that each defendant banking firm keeps a reciprocity record to show the business it has given to each of the other defendant banking firms and the business received from them; but also that over a period of time the profits from such participations are substantially equivalent, with due allowance for differentials in prestige and underwriting strength. If substantiated, these allegations would indicate some systematic and continuous arrangement between the defendants to pay one another off in return for the alleged agreement to defer to one another as "traditional bankers."
Here again, however, there was not merely a failure of proof but an affirmative demonstration that the allegations are without foundation in fact.
No evidence of any kind, whether by way of alleged reciprocity records, deposition proof or documents, was produced on this phase of the case against Dillon Read, Drexel, Glore Forgan, Morgan Stanley, Smith Barney, Union Securities and White Weld; nor were any alleged reciprocity records introduced against Harriman Ripley and Kuhn Loeb. Such records as were received in evidence were of the most disparate character. They covered different periods of time, included non-defendant firms as well as defendant firms, and were so fragmentary and different in character one from the other as to make it clear that they had not been prepared as the result of any joint action whatever. No calculations of reciprocal obligations, such as would have been required by the operation of the conspiracy as alleged, could possibly have been made from these miscellaneous and incomplete loose leaf books and cards.
A careful scrutiny of the documents received in evidence on this part of the case, taken in connection with the socalled reciprocity records and such testimony as was taken by deposition, indicate that a few individual defendant firms, motivated by various considerations of a purely business character, and acting separately and not in combination, did no more than is often found done by business men generally. In the course of a business relationship it is a natural and normal thing for those in the same industry occasionally to seek business on the basis of business given.Were there some uniformity or some common pattern the case would be different. As it is, there is a pattern of no pattern; and I find that, considering all the evidence in the record, including the stipulated statistical data, the reciprocity charge has been disproved.
The Applicable Law Relative to Conspiracy
The Sherman Act is not an open door through which any court or judge may pass at will in order to shape or mould the affairs of business men according to his own individual notions of sound economic policy. Nor was it ever intended by the Congress that judges should determine such policy questions as: the desirability of compulsory sealed bidding for new security issues; the propriety of officers or partners of investment banking firms accepting directorships on the boards of issuers; the good or bad effects of the solicitation of proxies by investment bankers; and whether investment bankers should be permitted to advise issuers concerning their financial affairs, the formulation of long range plans for expansion and refunding, the setting up of specific security issues and kindred subjects and also perform services and assume risks in connection with the registration and distribution of such security issues. The regulation of such matters is a legislative function and the series of statutes which have become law since the great depression of 1929 and the following years bear ample testimony to the fact that the Congress is mindful of its power to regulate such matters, by reason of their connection with interstate commerce.
What the Sherman Act does is to declare illegal "every contract, combination * * * or conspiracy" in restraint of trade or commerce and to make guilty of a misdemeanor "every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce" among the states or with foreign nations. The task of the judge is to determine whether the conduct challenged in the litigation contravenes the prohibitions of the statute. This is no mandate to the judiciary to decide anti-trust cases according to individual ideas of expediency, which may change according to the personal philosophy or even the political affiliation of the judge. It is the combination or joint action of the many which is the essence of the offense. Unless there is some agreement, combination or conspiracy the Sherman Act is not applicable.
But it is supposed by some that the requirement of combination is a mere empty phrase to which one must indeed do lipservice, but which may easily be got around by finding agreement, combination or conspiracy when in truth and in fact no agreement, combination or conspiracy exists, provided the result obtained seems desirable and in the public interest. This is not the law but only another aspect of the false but seductive doctrine that the end justifies the means which, so far as I know, has never taken lodgment in American jurisprudence; and I hope it never will.
True it is that conspiracies whether by business men or others engaged in unlawful schemes are often hard to detect. No direct proof of agreement between the wrongdoers is necessary; circumstantial evidence of the illegal combination is here as elsewhere often most convincing and satisfactory. But, when all is said and done, it is the true and ultimate fact which must prevail. Either there is some agreement, combination or conspiracy or there is not. The answer must not be found in some crystal ball or vaguely sensed by some process of intuition, based upon a chance phrase used here or there, but in the evidence adduced in the record of the case which must be carefully sifted, weighed and considered in its every aspect. This is an arduous but necessary task.
Especially is this true in a case such as the present one where the great bulk of the documentary evidence is initially received against a particular defendant and only subject to connection against the others in the event that the combination or conspiracy is proved. According to well established precedents such documents may be used circumstantially against all; but this works both ways as the probative force of such proof, when considered circumstantially may not tend to support the factual conclusion that the combination or conspiracy existed but rather the contrary. In any event it is well settled that statements contained in such documents, received subject to such connection, may not be used to establish the truth of their contents, except as against the particular defendant against whom such documents are received generally. And it is well that this is so for much that is contained in casual memoranda and even in messages, reports, teletypes and diary entries is mere rumor and gossip, which frequently turns out to be unreliable hearsay. Once the conspiracy is established, however, all such statements become those of agents of the group, to be considered against all the defendants as part of the proofs in the case generally.
The Investment Banking Business
It would be difficult to exaggerate the importance of investment banking to the national economy. The vast industrial growth of the past fifty years has covered the United States with a network of manufacturing, processing, sales and distributing plants, the smooth functioning of which is vital to our welfare as a nation. They vary from huge corporate structures such as the great steel and automobile companies, railroads and airlines, producers of commodities and merchandise of all kinds, oil companies and public utilities, down to comparatively small manufacturing plants and stores. The variety and usefulness of these myriad enterprises defy description. They are the result of American ingenuity and the will to work unceasingly and to improve our standard of living. But adequate financing for their needs is the life blood without which many if not most of these parts of the great machine of busines would cease to function in a healthy, normal fashion.
The initial inquiry in any anti-trust case must be into the character and background of the industry involved. In a case such as this, which covers so long a period of time and a multiplicity of issues and which is largely documentary in character, it is not too much to say that it is impossible to pass upon questions of credibility of witnesses and to understand and interpret the thousands of miscellaneous exhibits, including memoranda, letters, diary entries, teletype inter-office messages and so on without some fairly adequate understanding of the way in which the business is and has been conducted. Thus we turn to the evolution and growth of the investment banking business and the way it functions in the modern American scheme of financial affairs.
By way of prefatory comment and to facilitate orientation, it may be helpful first to describe some of the major factors. The central thought, as in every anti-trust case, must be the character and scope of competitive effort or the lack of competitive effort.
The principal factors which one must constantly bear in mind are: (1) the evolution of the syndicate system from its inception prior to the turn of the century, and its function in the issuance and distribution of securities; (2) the impact on the investment banking business of economic forces and a series of acts of Congress including the Banking Act of 1933, the Securities Act of 1933, the Securities Exchange Act of 1934 and the Public Utility Holding Company Act of 1935, and the various amendments to these statutes, supplemented by rulings and regulations of the Securities and Exchange Commission and the Interstate Commerce Commission; and (3) the complete and comprehensive static and statistical data which show the details of every relevant security issue in the period from January 1, 1935, to December 31, 1949.
While the complaint alleges that the syndicate system was invented at or about the time of the Anglo-French Loan in 1915 by the defendants and their "predecessors," it has been conclusively established, as already stated, that the syndicate system as a means of issuing and distributing security issues was in use at least as early as the 1890's; and in this early period price maintenance was to some extent used, as it was appreciated even in those days that the problem of placing upon the market a large bulk of new securities required careful management and planning lest the very quantity involved should depress the price and make distribution within a reasonable time difficult if not impossible.
The present method for issuing and distributing new security issues thus has its roots in the latter part of the nineteenth century. It is the product of a gradual evolution to meet specific economic problems created by demands for capital, which arose as the result of the increasing industrialization of the country and the growth of a widely dispersed investor class. It was born in large part because of, and gradually adapted itself to, conditions and needs which are peculiar to the business of raising capital.
I. Prior to the First World War
Prior to the year 1900, the large majority of industrial and business units which existed in this country were small in size and their capital needs were small; use of the corporate form was not widespread. There was no substantial and widely scattered class of persons with surplus savings who sought promising investment opportunities. A large part of the capital needed came from abroad.Securities sales operations were conducted principally by selling agents who sold on a commission basis, and more often than not it was the issuer who bore the risk of how successfully and how quickly the required funds would be obtained.
The evolution of the investment banking industry in the United States is illustrated by the early phases of the development of two of the defendant investment banking firms, goldman, Sachs & Co. and Lehman Brothers.
Goldman, Sachs & Co. traces its origin back to the year 1869, when Marcus Goldman started a small business buying and selling commercial paper. In the year 1882, he was joined in that business by Samuel Sachs, and at that time the firm, which had been known as Marcus Goldman, became M. Goldman & Sachs. In the year 1885, when additional partners joined the firm, the firm became Goldman, Sachs & Co., and has continued as such from then on to today. At that time, it was very difficult for small manufacturers and merchants to get capital with which to operate, so Goldman, Sachs & Co. developed the business of buying their short-term promissory notes, thus furnishing them with needed capital, and selling these notes to banks or other investors. This commercial paper business prospered and continued to expand in the 1880's and 1890's, and, by the time of the year 1906, when the opportunity first arose for Goldman, Sachs & Co. to underwrite some financing for United Cigar Manufacturers, now known as the General Cigar Company, the firm had established many contacts all over the country with merchants and manufacturers. During this period, also, partners of Goldman, Sachs & Co. took frequent trips to Europe, because at that time it was difficult to raise capital for American enterprises in the financial markets of this country, and they entered into arrangements with European bankers, whereby they would lend money in this country for their account.
Likewise, the firm of Lehman Brothers traces its ancestry back to about 1850. Since then, a series of partnerships, formed from time to time upon the withdrawal or death of partners or the addition of new ones, has conducted business under the name of Lehman Brothers. The firm had prospered greatly as "cotton bankers," and, years before the turn of the century, it had established its headquarters in New York City.
In the late 1890's and the early 1900's, the prime securities were railroad bonds and real estate mortgages. The public utilities business had not as yet achieved great importance, and, consequently, public utility securities were generally looked upon with disfavor. Railroad and public utility financing was handled by a small number of firms. The railroad financing was done to a considerable extent by Kuhn, Loeb & Co., J. P. Morgan & Co., Vermilye & Co. and August Belmont; and a large percentage of the capital was furnished by French and German underwriters. The public utility financing was done to a large extent by Harris, Forbes & Co., which had become a specialist in the securities of companies providing power and light. Harris, Forbes & Co. was becoming known as an underwriter which understood and knew how to solve the problems of those companies, and had the knack of raising capital for the growing industry. There was an open field in certain light industrial and retail store financing which had been neglected or overlooked.
After the beginning of this century, as family corporations grew larger and needed more capital for expansion, or when the head of a family died and money was needed to pay inheritance taxes, it became increasingly apparent that commercial paper, which was short-term money, was insufficient to meet the capital requirements of those small enterprises. At about this time, Goldman, Sachs & Co., desirous of entering the business of underwriting securities, conceived the idea of inducing privately owned business enterprises to incorporate and to launch public offerings of securities. In the early 1900's it was considered undignified to peddle retail store securities, but Goldman, Sachs & Co. believed that, with the growth in size of family corporations and other privately owned business enterprises, there would be a market on a national basis for their security issues. The problems involved in offering securities to the public, where no securities were previously outstanding in the hands of the public, were new and difficult of solution, and different from the problems involved in the underwriting of bonds of a well known railroad. The sale of retail or department store securities required a different market.
When the opportunity arose in the year 1906 for Goldman, Sachs & Co. to underwrite the financing of United Cigar Manufacturers, it was unable to undertake the entire commitment alone, and could not get the additional funds which it needed to underwrite from commercial banks or other underwriters, as they would not at that time underwrite this type of securities. Henry Goldman prevailed upon his friend Philip Lehman of Lehman Brothers to divert some of his capital from the commodity business and to take a share in the underwriting.The result was that the two firms, Goldman, Sachs & Co. and Lehman Brothers, became partners in the underwriting of the financing of United Cigar Manufacturers. When the opportunity arose in that same year for Goldman, Sachs & Co. to underwrite the financing of Sears, Roebuck & Co., it was perfectly natural for it again to turn to Lehman Brothers for assistance, and the two firms became partners in that enterprise.Thus it was through this oral arrangement between two friends, Henry Goldman and Philip Lehman, through this informal partnership, that Goldman, Sachs & Co. was able to obtain the capital which it needed to underwrite these two security issues in the year 1906. Without such capital, it would have been unable to enter the business of underwriting securities.The events which occurred in the year 1906 set the pattern for subsequent financings which Goldman, Sachs & Co. underwrote prior to the First World War. In the period from the year 1906 to the year 1917, although Goldman, Sachs & Co. occasionally underwrote financings with other partners, notably Kleinwort Sons & Co., merchant bankers of London, its principal partner was Lehman Brothers.
These two firms, as partners or joint adventurers, continued to act together thereafter underwriting securities of clothing manufacturers, cigar manufacturers, department stores and merchants, and the kind of businesses that most investment bankers, who were interested only in the securities of heavy industrials, railroads and to some extent public utilities, would not touch. The two firms began to cultivate acquaintances and build up relationships with securities dealers in other parts of the country who could market in their respective cities or towns the type of securities in which the two firms were particularly interested; and, as their reputations grew, they began to underwrite securities in the industrial field. They added to their staffs persons who were experts on merchandising and retail store methods, and they developed the business of selling their services to family and other privately owned enterprises.
While the evidence is not explicit on the point it would seem reasonable to assume that, prior to World War I, the firms interested in the securities of railroads, public utilities and heavy industries were establishing similar contacts, building up similar staffs of experts in their particular fields and otherwise doing whatever they could to enhance their reputations in their own specialities.
In the period from the year 1906 to the year 1917, Goldman, Sachs & Co. and Lehman Brothers together underwrote the financings of many enterprises which had a small and humble beginning, but which later grew to very great size, among them being United Cigar Manufacturers, Sears, Roebuck & Co., B. F. Goodrich Company, May Department Stores Company and F. W. Woolworth Company. Many of the business concerns whose securities were underwritten by Goldman, Sachs & Co. and Lehman Brothers during this period were houses with which Goldman, Sachs & Co. had previously had commercial paper transactions.As Goldman, Sachs & Co. and Lehman Brothers were better known at the time than many of the business enterprises whose securities they underwrote, investors bought the securities to some extent in reliance on their reputation.
There thus grew up between these two firms an informal, oral arrangement whereby they, as partners or joint adventurers, purchased security issues directly from issuers, and divided equally the profit which was realized from their sale.
There was then no network of securities dealers throughout the country, such as there is at the present time. In or about the year 1905 or 1906, there were only about five investment banking houses which had a national distribution system for securities: Lee Higginson & Co.; N. W. Harris & Co.; N. W. Halsey & Co.; Kidder, Peabody & Co.; and William Salomon & Co. Investment banking houses such as J. P. Morgan & Co., Kuhn, Loeb & Co., and William A. Read & Co. were underwriters of securities primarily in the New York market. Up to about the year 1912 or 1915, there were approximately only two hundred and fifty securities dealers in the entire United States, most of whom were concentrated in the eastern and middle eastern parts of the country. It was not until the time of the launching of the Liberty Loan in the year 1917 that we find a large number of independent dealers engaged in the business of distributing securities throughout the country.
As there was no network of securities dealers on a nation wide scale, the underwriters sold as many securities as they could directly to individual investors, and the sale of security issues generally was not completed rapidly. For example, it took Goldman, Sachs & Co. and Lehman Brothers three months to sell the Sears, Roebuck & Co. security issue which they underwrote in the year 1906, and, in many other instances, it took the underwriters much longer to complete the distribution of security issues. The personnel of the distributing organizations was small, and their operations were concentrated in the eastern and northeastern parts of the country. The purchase and banking groups were characteristically organized to last for a period of one year, and the manager had broad powers to extend the period. This power to extend was frequently exercised by the manager; there are records of such groups continuing from two to five years or longer. Investment banking firms kept lists of investors, and, whenever they underwrote a security issue, they would go directly to the investors and try to sell them that particular security.
This method of distribution was adequate for the sale of a limited number of security issues to a limited investing public; it was wholly inadequate for a later time when new security issues were to follow each other in rapid succession, since the slowness of distribution of a greatly increased volume of securities required excessively large capital resources on the part of the originating banker and the purchase and banking groups for the purpose of carrying the securities. Accordingly, it is interesting to observe that, as an incident of the long periods of distribution, the investment banker's "spread," that is, the difference between the price paid to the issuer for the security and the price received for it from the investing public, was larger during this period than in later years.
Prior to World War I, the United States was a debtor and not a creditor nation. Investment banking firms in this country turned to Europe to find wealthy individuals and other investment bankers who would be willing to share the risk and underwrite the security issues of business enterprises in the United States. European investment banking firms also sold to investors in Europe the securities of American business enterprises. Among some of the European investment banking firms to which Goldman, Sachs & Co. and Lehman Brothers turned to during this period were Kleinwort Sons & Company, Helbert, Wagg & Russell and S. Japhet & Company, all of London, Labouchere Oyens & Company, of Amsterdam, and others in Berlin and Zurich. Goldman, Sachs & Co. had established business relationships with all of these investment banking firms prior to the year 1906, when it was anxious to enter the international banking business in order to be able to furnish its American clients with letters of credit and foreign exchange. All of these contacts became very useful when Goldman, Sachs & Co. entered the investment banking business.
With this background, it is easy to see that many of the issuers, especially those whose securities were not well known to the public, leaned heavily upon the sponsorship of the investment banking firms under whose auspices the securities were sold. Issuers invited partners or officers of investment banking firms to serve on their boards of directors, in order to interest investors in their securities. Some of the prospectuses, which in those early days were little more than notices, stated that a partner or officer of a particular investment banking firm would go on the board of directors of the issuer whose securities were being offered to the public for sale. Investment bankers sometimes asked to be put on the boards of directors of issuers in order to know how they were managed and to protect the interests of the investors to whom they had sold the issuer's securities. Since the investment bankers sponsored the securities and lent their names to their sale, they felt a certain obligation to the investors to whom they sold the securities to see to it that the issuers did not adopt any policies or engage in any practices which would impair the value of those securities. This was especially important in connection with foreign investors.
Another development which was to have repercussions later on arose out of the difficulty of obtaining underwriters to share the risk. Thus it was that, prior to World War I, it was not unusual to find officers, directors and shareholders of issuers made participants on original terms in the underwriting of security issues; and investment bankers approached wealthy friends and other moneyed individuals, who were willing to take the risks involved, and asked them to participate. Commercial banks also took participations in substantial amounts.
In the period under discussion, it was common for an investment banker to purchase an entire issue directly from the issuer at a stated price, and that banker alone would sign the purchase contract with the issuer.Generally, the investment banker's agreement to purchase represented a firm obligation. This investment banker would then immediately organize a larger group, composed of a limited number of investment banking firms, which was sometimes called a "purchase syndicate," whereby he would, in effect, sub-underwrite his risk by selling the securities which he had purchased alone from the issuer to this larger group, at an increase or "step-up" in price. The investment banker who purchased the entire issue directly from the issuer was known as the "originating banker" or "house of issue." The originating banker became a member and the manager of the "purchase syndicate." Goldman, Sachs & Co. is said to be one of the first investment banking firms to develop this method of underwriting securities; and, although this method may have been developed to underwrite the securities of the smaller, less well-known industrial enterprises and of the family concerns which were for the first time launching securities for sale to the public, other investment bankers used the same method to underwrite the securities of large industrial enterprises, railroads and utilities. As business enterprises in this country grew in size, and as the amounts of capital required by these enterprises became larger, sometimes a second group, more numerous than the "purchase syndicate," would be formed in order to spread still wider the risk involved in the purchase and sale of the securities. The "purchase syndicate" would then sell the securities which it had purchased at an increase in price from the originating banker to this second larger group, which was sometimes called a "banking syndicate," at another increase or "step-up" in price. The originating banker and the other investment banking firms, which were members of the "purchase syndicate," usually became members of the "banking syndicate" and the originating banker became its manager. The transfer of the securities to the "purchase syndicate" and then to the "banking syndicate" was practically simultaneous with the original purchase of the securities from the issuer by the originating banker.
Even at a time before there was any delegation of powers to any particular one of the original purchasers, according to the testimony of Harold L. Stuart of Halsey, Stuart & Co., "there was an agreement between the houses to buy them and to sell them and to maintain a price" which was even then called a "public offering price."
Stuart also described the first syndicate in which his firm participated, which was a $10,000,000 issue of First Mortgage Bonds of the Commonwealth Edison Company in December, 1908. There were two managers who were paid a fixed fee, an equivalent of the present day management fee, and the two managers had broad powers. Sales through the manager pro rata for the accounts of the members of the syndicate and also sales of non-withdrawn bonds on behalf of the syndicate members through dealers and directly to institutions and other buyers were contemplated. Further details appear in the syndicate agreements of certain issues of bonds of the Pacific Gas & Electric Company and United Light & Railways Company in 1912 and 1913.
From all the above it is evident that the various steps which were taken, including use of the purchase and banking groups above described, were all part of the development of a single effective method of security underwriting and distribution, with such features as maintenance of a fixed price during distribution, stabilization and direction by a manager of the entire coordinated operation of originating, underwriting and distributing the entire issue.
This evolution of the syndicate system was in no sense a plan or scheme invented by anyone. Its form and development were due entirely to the economic conditions in the midst of which investment bankers functioned. No single underwriter could have borne alone the underwriting risk involved in the purchase and sale of a large security issue. No single underwriter could have effected a successful public distribution of the issue. The various investment bankers combined and formed groups, and pooled their underwriting resources in order to compete for business. These groups of investment bankers were not combinations formed for the purpose of lessening competition.On the contrary, there could have been no competition without them. Unless investment bankers combined and formed such groups there would have been no underwriting and no distribution of new security issues. Perhaps the English system,
which seems superior in the view of some, has many advantages. But the investment banking business in America grew and developed and prospered according to an indigenous American pattern.
The most significant fact about the period prior to World War I is that in it will be found the beginnings, the seeds as it were, from which in the course of time and by a gradual and traceable evolution there grew the elaborate and effective modern methods by which investment bankers, skilled in the application of their special techniques, perform the integrated services by which they earn their livelihood.
Thus in these early times we find investment bankers employing trained experts who spend much of their time developing plans and designing the set-ups of issues of securities which will be especially suitable for the needs of a particular issuer, at a particular time and under particular circumstances. We find groups forming for the purposes of competition, sometimes small groups developing into larger ones. And we find the already well developed shaping up of the syndicate systm, with features of price maintenance and stabilization and broad powers delegated to the managers in connection with distribution and otherwise, not as a means of merely merchandizing securities, as one would buy and sell hams and potatoes, as suggested by government counsel, but rather as a means of integrating the steps of purchase and distribution necessary to the attainment of the ultimate goal of channeling the savings of investors into the coffers of the issuer as a single unified, integrated transaction. No longer does the issuer bear the risk alone and distribute its securities by agents selling on a commission basis. The pattern of performing a series of interrelated services by the investment banker, including the formulation of the plan and method to be pursued in raising the money, the undertaking of the risk and the distribution of the security issue as a whole, has already emerged.
II. Between World War I and the Securities Act of 1933
The aftermath of the war was a period of over-production and mal-distribution accompanied by a sharp decline in the prices of commodities. A nation at peace could not absorb all the products of an economy, which, but a short time before, had been geared for the effective waging of war. Many business enterprises were faced with the problem of reorganizing in order to get their operations back on a profitable basis. By the year 1923, however, the nation's economy had recovered from the "commodity or inventory panic," and business enterprises began to enjoy more prosperous conditions.
In the following decade there was an unprecedented expansion of industrial and business enterprises, an increase in the number and geographical distribution of investors; and the use of the corporate form was adopted more and more widely. As domestic business units increased in size and number, the demands for investment capital reached a magnitude never before experienced. The United States had become a creditor nation; and, for the first time, foreign governments, foreign municipalities and foreign corporations turned to this country to raise capital from private American investors. Those investment banking firms which were dependent upon European capital for their underwriting strength went into eclipse and other banking investment firms came to the fore.
J. P. Morgan & Co. was the leading firm. But all the great publicly owned banks were in the investment banking business, first for their own account and later indirectly through either subsidiary or affiliated corporations formed for the purpose. Dillon Read, Lee Higginson, the old Kidder Peabody and Blair appear to have been perhaps the best known names in all-around business. Kuhn Loeb together with J. P. Morgan & Co. were leaders in railroads, in which field older firms such as Speyer, J. & W. Seligman, and Ladenburg Thalmann were also important. Bonbright, Harris Forbes, Halsey Stuart and Coffin & Burr were leaders in public utilities. Lehman and Goldman Sachs were leaders in merchandising and other fields. The largest distributing firms were those particularly connected with the banks, such as National City, Guaranty and Chase. But a number of other banks were active, such as First National, Bankers Trust, the principal banks in Boston, Chicago, Cleveland and Pittsburgh, and others. Among other firms then in existence but appearing less frequently were E. B. Smith, C. D. Barney, White Weld, Blyth Witter, Stone & Webster, Field Glore, Hallgarten and Brown Brothers.
Security issues followed one another in rapid succession and, whereas before World War I an issue of one million dollars was considered large, in the middle 20's issues of twenty and twenty-five million dollars were by no means unusual.
The impact of these economic forces upon the investment banking industry was precisely what one would have expected. The number of underwriters in the syndicates increased, in order both to spread the risk and to effect a widespread and rapid distribution of the securities to the public. Even so the problems of distribution became so complicated that it became customary to form an additional group called a "selling syndicate" or "selling group." The new "selling syndicate" was much larger and more widely dispersed than the purchase and banking groups had been.
There were three types of these selling syndicates throughout this period. While they represented successive steps in the development of investment banking, and while there were shifts in the type that was most extensively used, all three were used throughout the 1920's.
The first type was known as the "unlimited liability selling syndicate." In this group, each member agreed to take a pro rata share in the purchase of the security issue by the selling syndicate from the previous group, at a stated price, and to take up his share of any unsold securities, which remained in the syndicate at the time of its expiration. The syndicate agreement stated the terms upon which the offering to the public was to be made. Each member was given the right to offer securities to the public, and he received a stated commission on all confirmed sales. However, regardless of the amount of securities which he sold, he still retained his liability to take up his proportionate share of unsold securities. The undivided syndicate combined selling with the assumption of risk; therefore, both houses with distributing ability and houses with financial capacity, but without distributing ability, were included in the syndicate. Usually, a banking group was not organized where this type of selling syndicate was to be used. The purchase group sold the security issue directly to the selling syndicate.
The dealers who did the actual selling of the securities objected to the "unlimited liability selling syndicate," as they were compelled to take up in their proportionate shares the securities, which the other dealers, who were members of the selling syndicate, were unable to sell. Consequently, the second type of selling syndicate, which was known as the "limited liability selling syndicate," subsequently was developed.This syndicate operated in much the same manner as the undivided syndicate, except that the obligation of each member was limited to the amount of his commitment, and, when he distributed that amount, he was relieved of further liability.Each member retained his proportionate liability for the costs of carrying the securities, shared in the profits or losses of the trading account, and was liable for such other expenses as occurred after the purchase from the purchase or banking group. A banking group was usually organized where the "limited liability selling syndicate" was to be used.
The "limited liability selling syndicate" gradually evolved into the third type of selling syndicate, which was simply known as the "selling group." The "selling group" differed from the "limited liability selling syndicate" in that its members relieved themselves of all liability for carrying costs, the trading account and other expenses. Each member of the "selling group" was concerned only with expenses connected with the actual retail distribution of securities. The financial liability of the member was restricted to selling or taking up the amount of securities for which he subscribed. Usually, a large banking group was organized where the "selling group" was to be used. The banking group took over the liability for carrying costs, the trading account and other expenses.
The size and makeup of the selling syndicates varied with the circumstances of the particular security issue.Among the important factors, which were considered in the selection of dealers, were the size of the security issue, the type and quality of the security, the size and nature of the class of investors to whom the distribution was to be made, and the ability of a dealer to distribute securities of a particular type. All of these factors were considered in the selection of underwriters and dealers for the formation of the underwriting syndicates and selling groups.
In all of these types of selling syndicates, the members acted as principals, and not as agents of the manager, in distributing securities to the public. The syndicate agreement specified the price at which the securities were to be sold, and it was a violation of the agreement for a member to sell at any other price. The manager traded in the open market during the period of distribution in order to maintain the public offering price. Through such stabilizing operations, the manager sought to prevent any securities, which had been sold by dealers, from coming back into the market in such a manner as to depress the public offering price. It was felt that with respect to the securities which appeared in the market, the members of the selling syndicate had not performed their function of "placing" with investors, for which they were paid a selling commission; and, consequently, "repurchase penalties" were provided for, whereby the manager had the right to cancel the selling commission on the sale of those securities which he purchased in the market at or below the public offering price. Under most agreements, the manager had the option of either cancelling the selling commission on the sale of the securities, or of requiring the member who sold the securities to take them up at their cost to the trading account.Records of the serial numbers of securities were kept, and the securities which appeared in the market were thus traced to the dealers who sold them. Stabilizing operations and the repurchase penalty were used in all of the three types of selling syndicates which prevailed throughout this period.However, where a "selling group" was used, it became more and more common practice to restrict the re-purchase penalty to the cancellation of commissions.
The operations of the "selling syndicate" like those of the pre-war withdrawing subscribers, dealers and selling agents, were directed by the manager whose general supervisory function over the whole machinery of purchase and distribution was continued.Even in the earlier period provisions for maintenance of the public offering price by persons to whom title had passed had been included in some agreements.
As testified by Harold L. Stuart "you simply had to have such a clause in order to make this business function in putting the securities on the market," because "there were many ways that shrewd people could beat the game and spoil the putting of any security issue on the market unless you did this."
A significant development and one quite in keeping with the economic conditions above referred to, is that the periods for distribution became much shorter than they had been in the period prior to the war.Usually the life of the syndicate was designated as from thirty to sixty days, with a provision for earlier termination or for extension not exceeding a like period by the manager. As a matter of fact, however, the periods of distribution were generally much shorter.
The "market out" clause was evidently developed somewhere in the neighborhood of 1914 or 1915, and its use was fairly general at an early date.
As the amounts of capital required by business enterprises became larger, and the number and size of securities issues greatly increased, the problems with which investment bankers were confronted, in connection with the underwriting of security issues, multiplied. Extensive investigations had to be conducted into the affairs of a business enterprise, and studies made of its financial structure and capital needs, at considerable expense to the investment banker, before that banker would undertake the risk and underwrite the securities of that enterprise. In this connection, investment banking firms were compelled to bring into their organizations individuals who had new types of specialized knowledge and experience; so that they gradually built up teams of specialists, who were experts in the different fields in which their respective investment banking firms underwrote securities.
Throughout this period prior to 1933, officers and directors of issuers continued to be made participants on original terms in the underwriting of the security issues of those issuers and other moneyed individuals also continued to participate. This was the much criticized "gravy train" about which much was heard in the early stages of the trial.The practice seems to have gradually disappeared in the course of time, due perhaps to the fact that the investment bankers in adequate numbers became available as underwriters and the liability provisions of the Securities Act of 1933 made such opportunities for profit less attractive. In any event, government counsel now agree that this issue is out of the case.
While there were some instances in the earlier period of a purchase by the members of a banking syndicate in severalty, the more usual legal form in which the transfer was made from the issuer to the participating underwriters in the decade now under consideration was a joint or joint and several purchase.
More important than any of the other developments between World War I and the passage of the Securities Act of 1933 was the effect of the unprecedented era of expansion upon the participation of the great banking institutions and their affiliates. As the need for vast amounts of new capital for expansion, plant construction and the establishment of thousands of new enterprises made increasing demands for new money, the banks and their affiliates became increasingly interested in managing and participating in the various underwritings. While the evidence in this case relative to the pre-Securities Act period is far from complete,there is ample documentary evidence to show that many of the banks became directly interested through their bond departments and many others formed affiliates, as above stated. J. P. Morgan & Co., the First National Bank and the Bankers Trust Company and many others in New York City, as well as large banking institutions in Chicago, Cleveland and other cities did a large investment banking business. The National City Company, the Guaranty Company and Chase Securities Corporation, affiliates of the National City Bank, the Guaranty Trust Company of New York and the Chase National Bank were in the investment banking business in a big way. The National City Company as of December 31, 1929, had a capital of $110,000,000. On the same date the capital of the Chase Securities Corporation was over $101,000,000. The economic power of these huge aggregations of capital vis-a-vis the relatively small capital of issuers was a factor of no mean significance in the period just before the great depression. There was an additional leverage in the multiplicity of banking functions which could be placed at the disposal of issuers. Added to this was the vast influence and prestige which must have made itself felt in a variety of ways. Issuers were dependent upon these great banking institutions in a way which finds no parallel in the relations between issuers and investment bankers in the period subsequent to the passage of the Banking and Securities Acts.
Before it became necessary by law to choose between commercial banking on the one hand and investment banking on the other, many of these great banking institutions were private banking houses under no statutory duty to make the disclosures required of national banks and others and this, coupled with the lack of legal requirements for disclosure of relevant facts connected with security issues, helped to make the period under discussion what has been described in the trial as an era of "dignity and mystery."
In such an atmosphere it seems altogether probable that, wholly in the absence of any conspiratorial combination, issuers felt a strong inclination to continue to bring out issue after issue with the same bankers. Indeed, it is probably not too much to say that many issuers took pride and satisfaction from the very circumstance of their connection with these giants of American finance. Such sponsorship of an offering of securities to the public was of real value.
In any event, these great banking institutions and their affiliates were doing a huge investment banking business, and they were using the money of their depositors as well as their own resources to underwrite one security issue after another.
Some of the evidence which goes back to this earlier period leads to the suspicion that with reference to one or two particular issuers there may have developed some arrangement or combination of participants, continuing throughout a number of successive issues, which might, taken in isolation and separately, have constituted violations of the Sherman Act.At this late date, after practically all of those personally concerned have died and the files and other documentary evidence are no longer available, no adjudication of the legality of such isolated transactions is possible, nor is such adjudication requested by the government. Some references have been made in the evidence to contracts with a few issuers by which an investment banker was given "preferential rights"; and Harold L. Stuart testified that he tried to get such contracts whenever he could.They seem to have been ineffectual, however, and have long since gone out of use, due at least to some extent to the disapproving attitude of the SEC. In any event, I cannot find that they were sought or used to any extent by the defendants in this case.
III. Further Developments 1933-1949
Following the Armstrong Insurance investigation
in 1905 and Governor Hughes' Committee Report in 1909
there had been other investigations which covered activities of investment bankers. The Pujo investigation
was conducted in 1912 and 1913, the Utility Corporation inquiry by the Federal Trade Commission
started in 1928; and these were followed by a long series of hearings, under the auspices of various committees of the Congress, which resulted in the Banking Act of 1933
(known also as the Glass-Steagall Act), the Securities Act of 1933
and the Securities Exchange Act of 1934.
From December 10, 1931 through February 1932 the Senate Committee on Finance pursuant to the Johnson Resolution
undertook to investigate the flotation of foreign bonds and other securities in the United States. Perhaps the most important of these investigations was the Gray-Pecora investigation of the Senate Committee on Banking and Currency
which began on April 11, 1932 and continued through May 4, 1934.
In this chronological survey of the history and development of the investment banking business it will suffice to say that these statutes, together with the Public Utility Holding Company Act of 1935
and the Maloney Act,
effective June 25, 1938, which added Section 15A to the Securities Exchange Act of 1934, and authorized the organization of the National Association of Securities Dealers, Inc. (NASD), under the supervision of the SEC, which followed,effected changes of the most radical and pervasive character; and these changes were made with a complete and comprehensive understanding by the Congress of current methods of operation in common use in the securities issue business, such information having been made available in the course of the investigations to which reference has just been made.
Institutions which had previously engaged both in commercial and deposit banking on the one hand and investment banking on the other were required to elect prior to June 16, 1934, which of the two functions they would pursue to the exclusion of the other. This resulted in the complete elimination of the commercial banks and trust companies from the investment banking business; and the various bank affiliates were dissolved and liquidated.
The elaborate procedures which now became necessary in connection with the sale of new issues of securities were at first implemented by the Federal Trade Commission and then, upon the creation of the Securities and Exchange Commission, transferred to it. The regulation of the securities business which followed with such salutary and beneficial results has been one of the significant developments of our time. The era of "dignity and mystery" was over.
When we come to discuss the syndicate system and its operation, it will be appropriate to treat in some detail the various applicable provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, with their respective amendments, and also the numerous regulations, interpretations and releases of the SEC relative thereto. For the sake of continuity and clarity, however, this brief recital of the development of the investment banking business will be continued in order to furnish general background.
Security issue financing was relatively inactive as the result of the great depression, up until about the end of 1934. Thereafter, except for an occasional falling off in the depression of 1937 and in the early years of World War II, the needs of industry kept the demand for new capital at a high level. The reduction of interest rates as the result of government manipulation brought about refundings on a large scale and further refundings continued in volume as interest rates continued to fall.
The size of issues increased. An issue of $5,000,000 was considered small. In this period there were 155 issues of $50,000,000 and larger; 559 issues of $20,000,000 and larger and over 1,000 issues of $10,000,000 and larger.
Due largely to the impact of the income and inheritance tax laws, the importance of the individual as an investor diminished and there was an extraordinary and continued growth in the size and investment needs of large institutional investors such as life and casualty companies, savings banks, investment trusts, pension funds, universities, hospitals and fraternal orders.
Perhaps the most significant change of all was caused by the withdrawal from the field of investment banking of the capital funds of the commercial banks and their affiliates, which had previously been among the foremost managers and underwriters of security issues. As already stated, investment banking firms could participate in and manage underwritings only with their own money. As of the end of 1949 only 7 of the defendant firms had a capital of 5 million dollars and larger, 8 a capital of between 2 and 5 millions and 2 a capital of between 1 and 2 millions. Nor could any of them use all of their capital or borrowing power for underwritings, as each was engaged in other activities which tied up a part of their capital funds and they were all subject to certain regulations of the SEC and the various exchanges which promulgated rules and regulations affecting the amount of capital available for underwriting.
The Revenue Act of 1932, which became effective on June 22, 1932, for the first time imposed a tax on the transfer of bonds, Sec. 724, 47 Stat. 274, 26 U.S.C.A. Int.Rev. Acts, p. 634. A transfer tax on stocks had previously been enacted in 1914; but in 1932 this tax was greatly increased in amount, Sec. 723, 47 Stat. 272, 26 U.S.C.A.Int.Rev. Acts, p. 630. Section 11 of the Securities Act of 1933 imposed on each underwriter a civil liability, for any omission or misstatement of a material fact in the registration statement, equal to the entire amount of the issue. By later amendment in 1934, Title II, Sec. 206 (d) of the Securities Exchange Act of 1934, this liability was changed to "the total price at which the securities underwritten by him and distributed to the public were offered to the public." 15 U.S.C.A. § 77k(e). The liability thus defined plus the transfer taxes made it necessary for the underwriters to abandon the purchase of security issues jointly or jointly and severally, and resulted in the purchase by the various underwriters in severalty, which has been the prevailing method ever since. Otherwise an underwriter might still be liable under Section 11 of the Securities Act of 1933, as amended, for the entire amount of the issue. Significantly, since the 1933 Act, the underwriters still frequently take title jointly or jointly and severally when the security is a municipal or other issue not subject to the Securities Act of 1933.
The old banking and purchase syndicates with the "step-up" of earlier days which had been gradually going out of vogue, now completely disappeared. The form in which underwriting transactions commonly took place from the passage of the Banking and Securities legislation up to the present time is that of a purchase or "underwriting agreement" between the issuer and the underwriters represented by the manager, and an "agreement among underwriters."
The substance of the entire transaction is substantially what it was before. The manager, like the originating banker or manager in the previous periods, handles the negotiations with the issuer and supervises the whole process of underwriting and distribution. The management fee of today is not a new development either in form or in purpose after the Securities Act of 1933, but is the direct equivalent of the management fee paid by the members of the syndicate to the manager for his services in pre-1933 financings, where the syndicate either purchased directly from the issuer or from a prior "original purchaser."
Dealer and group sales are still made, under the authority of the manager who directs the entire process of distribution. But the change in the character of the investing public and especially the development of institutional investors on such a large scale and the impact of regulation by the SEC and of the Securities Act of 1933, the Securities Exchange Act of 1934 and the organization and functioning of the NASD, brought about a gradual decrease in the use of selling group agreements, especially in issues of the higher grades of debt financing and preferred stock.It is worthy of note that in performing his function of making sales for the accounts of the underwriters both to dealers and to institutions the manager sells "out of the pot." In other words, he does not allocate particular bonds to particular underwriters but simply sells "bonds" and does not allocate numbers to any participant until the time comes for delivery of securities to the purchasers.
In accordance with the trend of the previous period spreads are gradually becoming smaller and smaller; and the maximum life of the syndicates is now 15, 20 or 30 days, although in some cases the maximum period may be longer, and it is not unusual to find clauses authorizing the manager to extend the period with or without the consent of a certain proportion of the underwriters. Price restrictions may, however, be removed earlier than the actual termination date of the syndicate, and as a practical matter they are generally terminated within a few days after the offering.
Stabilization provisions have become commonplace pursuant to statutory provisions and administrative regulations and interpretations relating to their use. While the authority to stabilize is generally given, it is only in relatively few cases that the authority has been exercised.
The use of "penalty clauses" has varied and the same is true of the use of price maintenance clauses. This subject will be discussed in greater detail when we come to the portion of this opinion devoted to syndicates. But it is well to bear in mind throughout that the entire pattern of the statutory scheme above referred to, as implemented by the various rules and regulations of the SEC and the rules of Fair Practice of the National Association of Securities Dealers, Inc., approved by the SEC pursuant to legislative authority, contemplates the sale of each security issue at the public offering price proposed in the prospectus and set forth in the registration statement as finally made effective by the SEC. Having proposed and tendered a security issue to the public at the public offering price, it is not strange that those who propose to sell the entire issue at this public offering price should be required to make a bona fide attempt to do so.
Otherwise,the elaborate statutory provisions relative to "the public offering price" would be meaningless.Nor, under these circumstances, should one wonder that some investment banking houses continued to use price maintenance clauses while others did not.
In the previous period a few issues were brought out by public sealed bidding and there were some private placements. In the present period public sealed bidding transactions very greatly increased due to the adoption by the SEC in 1941 of Rule U-50, in connection with all security transactions of companies affected by the Public Utility Holding Company Act of 1935 and to the ruling in 1944 of the Interstate Commerce Commission, requiring all debt issues of railroads to be sold at public sealed bidding.
Due in part to the registration provisions of the Securities Act of 1933, but also in large measure to the increase in the number of institutional investors and their particular requirements, private placements grew by leaps and bounds.
In 1937 the $48,000,000 Convertible 3 1/2s of the Bethlehem Steel Corporation which came out on September 8, 1937 and the $44,244,000 issue of 5% Convertible Preferred Stock of the Pure Oil Company on September 3, 1937 were conspicuously unsuccessful and many of the underwriters suffered serious embarrassment.Repercussions were felt throughout the entire investment banking industry; and thereafter the number of underwriters in practically every syndicate was largely increased in order to spread the risk more widely.
The period 1933-1949 is the critical period in this case, as it includes the years immediately prior to the filing of the complaint in October, 1947.
Fortunately, there is in the record accurate and complete stipulated data with respect to every relevant security issue in the United States from July 26, 1933 to December 31, 1949. The Issuer Summaries, in two volumes, give the name of the issuer, the date of the offering, the description of the issue, the type of transaction, the number of underwriters and whether defendants or non-defendants, the name of the manager or co-managers, contemplated gross spread and certain other information relative to secondaries. The Issue Data Sheets for all underwritten issues of $1,000,000 or more, in the fifteen year period 1935-1949, give all the information and particulars concerning the names and positions of the participants, a breakdown of the contemplated gross spread and so on. Public Sealed Bidding Sheets, which are to be read together with the Issue Data Sheets, set forth the names of the managers of the winning and losing accounts, whether defendants or non-defendants, and the names of the defendant firms who were participants therein. This permits statistical analysis of the entire period. With respect to the period prior to July 26, 1933, Pre-Securities Act Issuer Summary Sheets, containing further stipulated data, whenever available, are in evidence and give the necessary background applicable to all issuers whose various security issues touch controverted issues of fact in the case.
Few if any of the documents in evidence can be properly understood except with reference to the detailed information thus stipulated. Here is an indisputable record of what the defendant firms did as distinguished from mere scraps and fragments of miscellaneous documents containing surmise, conjecture and the thoughts of some who were scarcely in a position to define or implement firm policies. To make matters worse, casual memoranda are subjected by government counsel to critical analysis, such as might be applied to deeds or wills or other documents prepared by lawyers, using technical, closely integrated words of art. Had this complete and accurate static data been available to the government before the suit was brought I gravely doubt that the action would have been filed.
In this last and final period the Securities and Banking Acts, the numerous and detailed rules and regulations of the SEC, the multiplicity of forms, prospectuses and registration statements which were required to be prepared and filed, and the organization and operation of the NASD, all had a profound effect upon the investment banking business. But none of these developments altered the basic function of the syndicate operation as a unitary, integrated means of underwriting and distributing a security issue, under the direction of a manager. This remained fundamentally the same as it was in the beginning. Such changes as had taken place from first to last were the normal and natural reactions of business men with common problems, to the course of economic events and the legislation which has been described.
IV. How the Investment Banker Functions
It was extremely difficult, in the midst of the conflicting statements of counsel and the welter of miscellaneous documents which followed one another into the record without witnesses to describe the attendant circumstances, to get any adequate grasp of just what investment bankers did. Finally, when Harold L. Stuart of Halsey Stuart P Co. was called as a government witness and remained on the witness stand for many months the light began to dawn. I watched him closely for many weeks, asked questions which were designed to test his forthrightness and credibility and checked his testimony with the utmost care against many of the documents already in evidence and much of the testimony taken by deposition, which had already been read into the record. I became convinced that this man, who probably knows as much if not more about the investment banking business than any other living person, was a man of complete integrity upon whose testimony I could rely with confidence.
Thereafter, and with the consent and approval of counsel for all parties, I went with counsel for both sides to the office of Halsey Stuart & Co. and watched one of the large issues "go through the hopper." I examined the bundles of securities, the tickets and slips from which the various book entries were to be made, watched the deliveries and snooped into every nook and cranny of what was going on. This was all done with the understanding that anything that occurred would be placed upon the record if anyone so desired; and, with a similar understanding, the greater part of two weeks was spent in my chambers with Stuart and various assistants and members of his staff going over every aspect and practically every document connected with two typical security issues from beginning to end. One was a negotiated underwritten issue and the other an issue brought out at public sealed bidding.Neither of these issues had any relation whatever to this case and nothing of a controversial character was included. But the result was that for the first time I felt possessed of the necessary background, and could thereafter, with a modicum of assurance, interpret and assess the probative value of the documents which constituted the greater part of plaintiff's proof. As Stuart continued to testify as a witness for many weeks thereafter, the facts relative to the actual operation of the investment banking business were fully developed in the record.
The types of issues, methods of raising money and the general apparatus of finance which I am about to relate are the ABC's of investment banking, known to every investment banker but not to others.
The problem before an issuer is in no real sense that of selling a commodity or a manufactured article. In essence what the issuer wants is money and the problem is how and on what terms he can get it. Basically, it is simply a question of hiring the money.
Thus a knowledgeable issuer, and most of them are definitely such, will scan the possibilities, which are more numerous than one might at first suppose.
The available types of transactions include many which may be consummated by the issuer without using any of the services of an investment banker. In other words, the raising of a particular sum may be engineered and consummated by the executive or financial officers of an issuer according to a plan originated and designed by them; and this may be done after prolonged collaboration with one or more investment bankers, whose hopes of being paid for the rendition of some sort of investment banking services never reach fruition. Thus the necessary funds may be raised by:
1. A direct public offering by the issuer without an investment banker.
2. A direct offering to existing security-holders without an investment banker.
3. A direct private placement without an investment banker.
4. A public sealed bidding transaction without the assistance of an investment banker.
5. Term bank loans, commercial mortgage loans, leasebacks and equipment loans by commercial banks, life insurance companies and other institutions.
Where the services of an investment banker are used, the typical transactions are even more varied. The principal ones are:
1. A negotiated underwritten public offering.
2. An underwritten public offering awarded on the basis of publicly invited sealed bids, an investment banker having been retained on a fee basis to shape up the issue.
3. A negotiated underwritten offering to existing security-holders. Here the investment banker enters into a commitment to "stand by" until the subscription or exchange period has expired, at which time the investment banker must take up the securities not subscribed or exchanged.
4. An underwritten offering to existing security-holders awarded on the basis of publicly invited sealed bids, an investment banker having been retained on a fee basis to render the necessary assistance.
5. A non-underwritten offering to existing security-holders, with an investment banker acting as agent of the seller on a negotiated basis.
6. A private placement with an investment banker acting as agent of the seller on a negotiated basis.
There are many and sundry variations of the types of transactions just described, depending on the designing of the plan, the amount of risk-taking involved and the problems of distribution; and these variations are reflected in the amount of compensation to be paid to the investment banker, which is always subject to negotiation. And it is worthy of note that, where the services of an investment banker are availed of in the preparation of an issue for publicly invited sealed bids, then pursuant to SEC, ICC and FPC rulings, the investment banker who has rendered financial advisory services for a fee cannot bid on the issue.
Moreover, the static data reveal numerous instances where combinations of these types of transactions are used. The avenues of approach to the ultimate goal of hiring the money on the most advantageous terms, and in ways peculiarly suited to the requirements of the particular issuer at a given time and in a certain state of the general securities market, are legion. And issuers, far from acting in isolation, are continually consulting and seeking advice from other qualified financial advisers such as their commercial bankers and others.
Sometimes an issuer knows pretty well in advance which type of transaction it wishes to use.More often this is not determined until every angle has been explored. In either event, the methods to be followed present a complex series of possibilities, many of which involve intricate calculations of the effective cost of the money and a host of other features affecting the capital structure of the issuer, plans for future financing, problems of operation of the business and so on.
Generally the money is needed for a special purpose at a particular time, which may or may not be determined at the will of the issuer. Examples are: for expansion, the building of a new plant, the purchase of existing facilities, the scrapping of one set of elaborate and costly machines and their replacement by others more efficient and up-to-date, or for refunding. Often it is deemed important by the management that there be a wide distribution of the securities or that they be placed with investors in a particular geographical locality or among those who utilize the services of the issuer or purchase its products. When good will is involved or favorable treatment of existing security-holders is desired, the issuer may have sound reasons for not wishing to obtain the highest possible price for the issue.
If a given type of transaction is tentatively selected, the issuer has before it an almost infinite number of possible features, each of which may have a significant bearing on the attainment of the general result. the method to be pursued may be through an issue of bonds or preferred or common stock or some combination of these. If a debt issue is contemplated there are problems of security and collateral, debentures or convertible debentures, serial issues, sinking fund provisions, tax refund, protective and other covenants, coupon rates and a host of other miscellanea which may affect the rating (by Poor's or Moody's, Fitch or Standard Statistics), or the flexibility necessary for the operation of the business and the general saleability of the issue in terms of market receptivity. These details must each be given careful consideration in relation to the existing capital structure and plans for the future. If equity securities seem preferable on a preliminary survey, the available alternatives are equally numerous and the problems at times more vexing.What will do for one company is not suitable for another, even in the same industry. At times prior consolidations and reorganizations and an intricate pattern of prior financing make the over-all picture complicated and unusually difficult. but in the end, sometimes after many months of patient effort, just the right combination of alternatives is hit upon.
The actual design of the issue involves preparation of the prospectus and registration statement, with supporting documents and reports, compliance with the numerous rules and regulations of the SEC or ICC or FPC and the various Blue Sky Laws passed by the several States. In view of the staggering potential liabilities under the Securities Act of 1933 this is no child's play, as is known only too well by the management of issuers.
This hasty and far from complete recital of available alternatives will suffice to indicate the milieu in which the investment banker demonstrates his skill, ingenuity and resourcefulness, to the extent and to the extent only that an issuer wishes to avail itself of his services. It is always the hope of the investment banker that the issuer will use the full range of the services of the investment banker, including the design and setting up of the issue, the organization of the group to underwrite the risk and the planning of the distribution. If he cannot wholly succeed, the investment banker will try to get as much of the business as he can. Thus he may wind up as the manager or co-manager, or as a participant in the group of underwriters with or without an additional selling position; or he may earn a fee as agent for a private placement or other transaction without any risk-bearing feature. Or someone else may get the business away from him.
Thus we find that in the beginning there is no "it." The security issue which eventuates is a nebulous thing, still in futuro. Consequently the competition for business by investment bankers must start with an effort to establish or continue a relationship with the issuer. That is why we hear so much in this case about ingenious ways to prevail upon the issuers in particular instances to select this or that investment banking house to work on the general problem of shaping up the issue and handling the financing. This is the initial step; and it is generally taken many months prior to the time when it is expected that the money will be needed. It is clear beyond any reasonable doubt that this procedure is due primarily to the wishes of the issuers; and one of the reasons why issuers like this form of competition is that they are under no legal obligation whatever to the investment banker until some document such as an underwriting agreement or agency contract with the investment banker has actually been signed.
Sometimes an investment banking house will go it alone at this initial stage. At times two or three houses or even more will work together in seeking the business, with various understandings relative to the managership or co-managership and the amount of their underwriting participations.These are called nucleus groups. Occasionally one comes across documents pertaining to such nucleus groups which seem to contemplate the continuance of the group for future business, only to find that in a few weeks or less the whole picture has changed and some realignment of forces has taken place.
The tentative selection of an investment banker to shape up the issue and handle the financing has now been made; and there ensues a more or less prolonged period during which the skilled technicians of the investment banker are working with the executive and financial advisers of the issuer, studying the business from every angle, becoming familiar with the industry in which it functions, its future prospects, the character and efficiency of its operating policies and similar matters. Much of this information will eventually find its way in one form or another into the prospectus and registration statement. Sometimes engineers will be employed to make a survey of the business. The investment banker will submit a plan of the financing, often in writing; and this plan and perhaps others will be the subject of discussions. Gradually the definitive plan will be agreed upon, or perhaps the entire matter will be dropped in favor of a private placement, without the services of an investment banker. Often, and after many months of effort on the part of the investment banker, the issuer will decide to postpone the raising of the money for a year or two.
In the interval between the time when the investment banker is put on the job and the time when the definitive product begins to take form, a variety of other problems of great importance require consideration. the most vital of these, in terms of money and otherwise, is the timing of the issue. It is here, with his feel and judgment of the market, that the top-notch investment banker renders what is perhaps his most important service. The probable state of the general security market at any given future time is a most difficult thing to forecast. Only those with ripe trading experience and the finest kind of general background in financial affairs and practical economics can effectively render service of this character.
At last the issue has been cast in more or less final form, the prospectus and registration statement have been drafted and decisions relative to matters bearing a direct relation to the effective cost of the money, such as the coupon or dividend rate, sinking fund, conversion and redemption provisions and serial dates, if any, are shaped up subject to further consideration at the last moment. The work of organizing the syndicate, determining the participation positions of those selected as underwriters and the making up of a list of dealers for the selling group or, if no selling group is to be used, the formulation of plans for distribution by some other means, have been gradually proceeding, practically always in consultation with the issuer, who has the final say as to who the participating underwriters are to be.The general plans for distribution of the issue require the most careful and expert consideration, as the credit of the issuer may be seriously affected should the issue not be successful. Occasionally an elaborate campaign of education of dealers and investors is conducted.
Thus, if the negotiated underwritten public offering route is to be followed, we come at last to what may be the parting of the ways between the issuer and the investment banker -- negotiation relative to the public offering price, the spread and the price to be paid to the issuer for the securities. These three are inextricably interrelated. The starting point is and must be the determination of the price at which the issue is to be offered to the public. This must in the very nature of things be the price at which the issuer and the investment banker jointly think the security can be put on the market with reasonable assurance of success; and at times the issuer, as already indicated in this brief recital of the way the investment banker functions, will for good and sufficient reasons not desire the public offering price to be placed at the highest figure attainable.
Once agreement has been tentatively reached on the public offering price, the negotiation shifts to the amount of the contemplated gross spread. This figure must include the gross compensation of all those who participate in the distribution of the issue: the manager, the underwriting participants and the dealers who are to receive concessions and reallowances.Naturally, the amount of the spread will be governed largely by the nature of the problems of distribution and the amount of work involved. The statistical charts and static data indicate that the amount of the contemplated gross spreads is smallest with the highest class of bonds and largest with common stock issues, where the actual work of selling is at its maximum. While no two security issues are precisely alike and they vary as the leaves on the trees, it is apparent that the executive and financial officers of issuers may sit down on the other side of the bargaining table confidently, and without apprehension of being imposed upon, as data relating to public offering prices, spreads, and net proceeds to issuers from new security issues registered under the Securities Act of 1933 are all public information which are publicized among other means by the wide distribution of the prospectuses for each issue.
And so in the end the "pricing" of the issue is arrived at as a single, unitary determination of the public offering price, spread and price to the issuer.
With public sealed bidding issues the whole procedure is radically different. The issue is designed and shaped up by the management of the issuer, with or without the services of an investment banker. As the problems of distribution are not the same, due particularly to the high quality of the securities generally involved, their sale in bulk to institutional investors, and the fact that, as no one knows in advance who the successful bidder will be, there is no time available for preparing the market or setting up any elaborate distribution machinery, the formation of the underwriting group follows a different pattern; and the issuer is not concerned with the public offering price but only with receiving the highest amount bid for the issue. However, when the participating underwriters in a public sealed bidding account confer at their "price meetings" before agreeing upon the amount of the bid to be submitted on their behalf by the manager, they first make up their minds on the subject of the price at which they think the entire issue can be sold to the public.
After the bids are opened, and without reference to the issuer, the underwriters in the winning account promptly decide among themselves the public offering price, the method of sale and the amount of any concessions or allowances.The difference between the bid price and the public offering price thus arrived at is the spread or anticipated gross compensation of the participants and the manager.
this very brief outline has been telescoped into bare essentials by way of general background. As a matter of fact no two security issues present quite the same problems; some are relatively simple and follow somewhat standardized lines, especially in many public sealed bidding transactions. the methods and practices of the various defendant investment banking firms vary greatly. The competitive pattern of the different firms will be found to depend largely on the background, the personnel and matters of policy peculiar to each firm. But one thing stands out.This record has not revealed a single issuer which can fairly be said to be the "captive" of any or all or any combination of these seventeen defendant firms.The reason why private placements of new debt issues, with or without the services of an investment banker, increased from 14% of the total of all such issues in 1936 to 73% of the total of all such issues in 1948, is because the issuers were free to choose and did choose to use this type of transaction to raise the funds they needed, rather than to go by the negotiated underwritten route or any of the others which were available. And it is equally clear that, although there has never been any rule, regulation or statutory or other law preventing issuers from resorting of their own free choice to public sealed bidding as a means of raising capital, issuers have done so only in rare and exceptional cases, unless compelled to resort to public sealed bidding by the mandate of the SEC or the ICC or some state regulatory body having jurisdiction.
The Seventeen Defendant Investment Banking Firms
The last but far from the least important feature of the background of the case concerns the origin, organization, personnel and general competitive pattern of each of the defendant investment banking houses. Without a clear understanding of the significant differences between them, and the circumstances under which they were formed and developed their respective policies and ways of doing business, it is futile to attempt any rational appraisal of the documents which form the bulk of the government's case.Here again one must bear in mind that the facts about to be described are all matters of common knowledge throughout the investment banking industry. Letters, reports and memoranda are interpreted and understood by investment bankers in the light of these facts. The descriptions of the various firms will follow the order in which their names appear in the complaint.
1. Morgan Stanley & Co.
On July 1, 1871, Francis A. Drexel, Anthony J. Drexel and J. Pierpont Morgan, with others, formed a co-partnership for the transaction of a general foreign and domestic banking business under the firm names of Drexel Morgan & Co. in New York and Drexel & Co. in Philadelphia. Following the death of Anthony J. Drexel in the year 1893, the co-partnership of Drexel & Co. (Philadelphia) and Drexel Morgan & Co. (New York) expired on December 31, 1894, and the partners thereof, on the same day, formed a co-partnership for the transaction of a general foreign and domestic banking business under the firm names of J. P. Morgan & Co. in New York and Drexel & Co. in Philadelphia.The partners of Drexel Morgan & Co. and of J. P. Morgan & Co. were at all times partners of Drexel & Co., but, from about the year 1910, certain persons possessed the authority of partners in Drexel & Co., who were not partners of J. P. Morgan & Co. This Drexel & Co. is not the same investment banking firm as the Drexel & Co. which is a defendant in this case.
J. P. Morgan & Co. was, at the time that the Banking Act of 1933 was enacted on June 16, 1933, a private banking firm, engaging in what was known as a private banking business. This included investment banking, deposit banking, and other kinds of commercial banking and letter of credit business, both foreign and domestic.The important investment banking business of J. P. Morgan & Co. was conducted on a wholesale basis, as J. P. Morgan & Co. had no distributive facilities for securities. It had only one office in New York city, and no branches or offices elsewhere, excepting the office which was maintained in Philadelphia by Drexel & Co., which was regarded as the "Philadelphia end of J. P. Morgan & Co." J. P. Morgan & co. was not a departmentalized firm, but mingled its commercial and investment banking activities. Among the partners who have been shown in the record to have engaged in investment banking work were George Whitney, Thomas W. Lamont, Arthur M. Anderson, William Ewing and Harold Stanley.
On or about June 16, 1934, J. P. Morgan & Co. elected to cease engaging in the investment banking business, and chose to remain a bank of deposit, in compliance with the provisions of the Banking Act of 1933, which required the separation of commercial and investment banking to be effected by June 16, 1934. J. P. Morgan & Co., in effect, discontinued its investment banking activities on or about June 16, 1933, the date upon which the Banking Act of 1933 was enacted, with the exception of one or two security issues. The investment banking business of J. P. Morgan & Co., therefore, simply ceased to be.By the time that Morgan Stanley & Co. Incorporated, commenced business, the investment banking business of J. P. Morgan & Co. had been discontinued, as a practical matter for approximately two and one-half years, and, absolutely, for approximately one and one-half years.
Morgan Stanley & Co. Incorporated, was organized pursuant to a decision made by some of the partners of J. P. Morgan & Co. to resign from that firm and to form another investment banking organization. The first discussions within J. P. Morgan & Co. concerning a new investment banking organization were had in June and July, 1935, as the securities market was opening up, and the final decision to organize Morgan Stanley & Co. Incorporated, was made around the middle or 20th of August, 1935. Various alternatives were examined and abandoned before the ultimate form of organization was decided upon. There was some thought of using the Drexel name, but difficulty arose with the heirs of the Drexel Estate.Another plan considered was the formation of a company to be known as Ewing & Co., which would have small capital, and would not underwrite but only give financial advice, but this plan was abandoned as unsound.
Morgan Stanley & Co. Incorporated, was organized on September 6, 1935, under the laws of the State of New York, and commenced business on September 16, 1935.Certain of the partners and employees of J. P. Morgan & Co., and certain of those persons who possessed the authority of partners in Drexel & Co., most of whom were active in the investment banking business of those firms, withdrew from those firms and formed the new organization. Of the then seventeen partners of J. P. Morgan & Co., Harold Stanley, Henry S. Morgan and William Ewing resigned; and, at about the same time, there also resigned from J. P. Morgan & Co. certain employees, namely, John M. Young, who was head of the Bond Department, Allen Northey Jones, who was head of the Statistical Department, and Archer M. Vandervoort. These men, together with Perry E. Hall and Edward H. York, Jr., who at that time possessed the authority of partners in Drexel & Co., organized the new Morgan Stanley & Co. Incorporated.On February 13, 1936, Alfred Shriver became an officer and a director of Morgan Stanley & Co. Incorporated, and, on October 19, 1936, Sumner B. Emerson became an officer and a director. The previous association of both of these men had been principally with the Guaranty Trust Company of New York or its securities affiliate, the Guaranty Company.
On September 16, 1935, when Morgan Stanley & Co. Incorporated, commenced business, Harold Stanley was president. William Ewing was executive vice-president, Henry S. Morgan was treasurer and secretary, and each of these three men was a director.Prior to December 31, 1927, when Harold Stanley became a partner in J. P. Morgan & Co., he had been an employee and subsequently vicepresident of the Guaranty Trust Company of New York from 1915 to 1927, and president of the Guaranty Company from 1921 to 1927; and prior to the time that William Ewing became a partner in J. P. Morgan & Co., he had been an employee of N. W. Harris & Co. and subsequently of the Harris Trust & Savings Bank from 1906 to 1916, and an employee of J. P. Morgan & Co. from 1916 to 1927.
On or about September 16, 1935, all of the common (voting) stock of Morgan Stanley & Co. Incorporated, was owned entirely by stockholders who were both officers and directors, with the exception of Allen Northey Jones, who was an officer but not a director. Allen Northey Jones, however, became a director on February 13, 1936. Alfred Shriver and Sumner B. Emerson became common stockholders of Morgan Stanley & Co. Incorporated, shortly after their employment as officers and directors. On September 18, 1935, Morgan Stanley & co. Incorporated, issued $7,000,000 (70,000 shares) of preferred (non-voting) stock, of which $400,000 (4,000 shares) was purchased by two officers of Morgan Stanley & Co. Incorporated, namely, Henry S. Morgan and William Ewing, and of which the remaining $6,600,000 (66,000 shares) was purchased by nine partners of J. P. Morgan & Co. In 1936, Harold Stanley acquired $100,000 (1,000 shares) of preferred (non-voting) stock, pursuant to an option dated September 18, 1935.
On or about November 28, 1941,Morgan Stanley & Co. Incorporated, adopted a plan of liquidation.On December 5, 1941, all of the outstanding preferred (non-voting) stock was redeemed and cancelled pursuant to the plan of liquidation which was completed on December 23, 1941. Morgan Stanley & Co., the partnership, was formed on December 16, 1941, and it is this partnership, apart from certain withdrawals and additions, which is a defendant in this case. The corporation was dissolved and the partnership formed by the former common stockholders in order, among other reasons, to qualify Morgan Stanley & Co. for membership on the New York Stock Exchange, and to enable William Ewing to retire from active participation while becoming a limited partner.
When Morgan Stanley commenced business on September 16, 1935, it set up an entirely new office at No. 2 Wall Street, and organized an entirely independent staff. Morgan Stanley never conducted business in the premises of J. P. Morgan & Co., but moved into its own office the day it opened for business.Morgan Stanley and J. P. Morgan & Co. remained thereafter as distinct, independent and autonomous firms.Morgan Stanley & Co. Incorporated, did, however, conduct closings of its underwritings, that is, the payment for and the delivery of securities, on the premises of J. P. Morgan & Co. very often until the year 1941, and, thereafter, the current partnership "generally" conducted its closings in the same place. Morgan Stanley paid a fee to J. P. Morgan & Co. in connection with each closing. No legal succession or privity of title existed as between Morgan Stanley and J. P. Morgan & Co. There was no devolution of any kind from one to the other. Morgan Stanley was run by its common stockholders as an independent, separate business, without consultation with J. P. Morgan & Co., although casual talks may have occurred.
Morgan Stanley was a conspicuously small organization when it first opened for business, and it has remained, to this day, a small organization. It had only one office when it first opened for business, and still has only one; it had only seven common stockholders when it first opened for business, and it does not have many more partners today. When the new organization commenced business, it immediately proceeded to try to obtain business from whatever source it could, and, in this connection, it made every kind of new business effort that its executives could think of. It broadcast announcements of its formation; compiled studies of outstanding securities that might be refunded at a saving; its personnel took turns calling on various people throughout the country; and they called on banks and asked them, if they knew of any business that might be done, to remember that Morgan Stanley was in business.
Morgan Stanley was a new organization for the underwriting and wholesaling of investment securities, and it confined its activities entirely to underwriting and wholesaling. Morgan Stanley started out exclusively as a wholesale organization, underwriting and selling to dealers, and from the beginning made no effort to build up an organization for the handling of distribution. It was not until some time in May, 1941, that it began to retail securities.Morgan Stanley has done primarily a high-grade bond business, but it has also managed issues of common and preferred stock. Unlike some of the other defendant firms, Morgan Stanley did no business in equipment trust certificates, and there is no evidence that it did any business in municipals. It has sought the managership of security issues, rather than participations in underwriting syndicates, and, consequently, has been in a position where other investment banking firms have sought from it participations in underwriting syndicates which it has formed and managed. Morgan Stanley was opposed to competitive bidding and did not participate in competitive bidding before it was made compulsory by Rule U-50, which became effective on May 7, 1941, as to the securities of public utility companies which were subject to the Public Utility Holding Company Act of 1935.
2. Kuhn Loeb & Co.
The partnership of Kuhn Loeb was founded in New York City in 1867, and has continued as such ever since. There is no problem of successorship, as the firm elected to eliminate its private banking functions on or prior to the date fixed by the Glass-Steagall Act. Until the late '20's it was a strictly family affair, and the partners included over the years many names of distinction in the banking business, including Jacob H. Schiff, Felix M. Warburg, Otto H. Kahn, and Mortimer L. Schiff. The first partner to be taken in, who was not related by marriage or otherwise to one or another of the others, was Jerome J. Hanauer in 1911.
The firm decided at an early date not to become interested in public utilities, but it had a large and select clientele among the railroads. With a small organization, Kuhn Loeb concentrated its efforts in the fields of railroad and industrial financing.
During the early and middle '20's there were only four partners. Lewis L. Strauss, the son-in-law of Hanauer, George W. Bovenizer and Sir William Wiseman became partners in 1929; John M. Schiff, Gilbert W. Kahn and Frederick M. Warburg, all of the younger generation, entered the firm in 1931; and Benjamin J. Buttenwieser, an employee, joined in 1932. Elisha Walker, a banker of wide experience, and Hugh Knowlton became partners in 1933. In 1941, after a long interval, two more employees were taken in, Percy M. Stewart and Robert F. Brown. In 1942 Hugh Knowlton left the firm but again became a partner in 1946.In 1949 the firm had only twelve partners, including J. Emerson Thors and Robert E. Walker, who became such in that year.
This firm, with a limited number of employees and a single office in New York City, differs radically from many of the other defendant firms, which are highly organized and departmentalized, have large distributing facilities, and hundreds of employees. While some of these other firms had large buying departments, most of this work was done in Kuhn Loeb by the partners.
The old Kuhn Loeb "prestige" business with the railroads was seriously affected by the ICC order requiring public sealed bidding for railroad securities which became effective on July 1, 1944. Thereafter, the firm's policies as to the number and character of the issues it would sponsor as manager radically changed.
3. Smith Barney & Co.
The firm of Chas. D. Barney & Co., a partnership, was organized in Philadelphia in 1873 to do a general investment banking business. The investment banking firm of Edward B. Smith & Co. was also founded in Philadelphia, in 1892. From their organization to December 31, 1937, these two firms were in no way connected or affiliated with each other.
At the time that the Banking Act of 1933 was enacted on June 16, 1933, the Guaranty Company of New York was a very large organization, with a total personnel of approximately 500 persons, including 17 senior officers and 21 junior officers. The decision of the Guaranty Trust Company of New York to dissolve its securities affiliate, the Guaranty Company, presented an acute personal problem to these officers and employees, since this action would necessarily eliminate most of their jobs. On June 6, 1934, William C. Potter, chairman of the Board of Directors of the Guaranty Trust Company of New York, wrote a letter to the stockholders of the Guaranty Trust Company of New York concerning this proposed dissolution. This letter explained how the problem of the future employment of those officers and employees was partly solved:
"* * * Arrangements have been made by Mr. Joseph R. Swan, President of the Guaranty Company of New York, and some of the principal executives (all of whom are retiring from the Guaranty Company of New York on or before June 16, 1934) to become members of the firm of Edward B. Smith & Co., a banking house that has for many years conducted a general securities business. It is expected that a majority of the staff of the Guaranty Company will become associated with the new firm. Certain others of the Guaranty Company organization will remain and liquidate its affairs. Others will be taken into the organization of the Trust Company, and the remainder we shall endeavor to assist in finding employment elsewhere."
On June 16, 1934, 4 of the 17 individuals, who had been senior officers of the Guaranty Company on June 16, 1933, joined Edward B. Smith & Co. as general partners.These were Joseph R. Swan, president, and Burnett Walker, Irving D. Fish, and J. Ritchie Kimball, vice-presidents. Similarly, on June 16, 1934, 13 of the 21 individuals, who had been junior officers of the Guaranty Company, were employed by Edward B. Smith & Co. Among these 13 individuals were Holden K. Farrar, James N. Land and Karl Weisheit, all 3 of whom eventually became partners in Smith Barney.
In 1934, 3 other individuals, who had been senior officers of the Guaranty Company, joined other investment banking firms as partners or officers: John D. Harrison joined Lazard Freres; Frederick L. Moore joined Kidder Peabody; and John F. Patterson joined Blyth. In 1936, Alfred Shriver, who had been a senior officer of the Guaranty Company prior to June 16, 1934, and president of the Guaranty Company in liquidation thereafter, joined Morgan Stanley, as a vice-president and director. In late 1933, John A. Wright, Jr., a junior officer of the Guaranty Company, joined the investment banking firm of Drysdale & Company. The remaining 9 of the 17 senior officers and the remaining 7 of the 21 junior officers of the Guaranty Company remained with the Guaranty Company in liquidation, joined the staff of the Guaranty Trust Company of New York, or went with other commercial banks, brokerage houses, industrial or business corporations.
Looking at the reorganized firm of Edward B. Smith & Co. on and after June 16, 1934, we find that it included 15 general partners, 3 special or limited partners (2 of whom were also general partners), and 522 employees. Of these, 4 general partners and 237 employees had formerly been with the Guaranty Company, either as senior or junior officers or employees; 11 general partners, all 3 special or limited partners, and 285 employees, had been with the old firm of Edward B. Smith & Co. The 237 employees of Edward B. Smith & Co., who had formerly been with the Guaranty Company, constituted slightly more than one-half of the total personnel of the Guaranty Company as of June 16, 1933. The capital of Edward B. Smith & Co., as of June 16, 1934, totalled $5,000,000, of which $3,500,000 was general capital, and $1,500,000 was limited capital. All of its capital was contributed by the general and special partners of the firm.
Edward B. Smith & Co. did not succeed,either de jure de facto, to the investment banking business of the Guaranty Company, the securities affiliate of the Guaranty Trust Company of New York, by reason of the fact that individuals, who had been with the Guaranty Company as senior or junior officers or employees prior to June 16, 1934, joined Edward B. Smith & Co. on that date as general partners or employees, or for any other reason.
The firm of Edward B. Smith & Co. as so constituted, remained without substantial change until December 31, 1937, when it was dissolved in connection with the formation of Smith Barney & Co.
In 1937, as a result of two highly unsuccessful security issues, namely, an offering to shareholders of $44,244,300 of 5% cumulative convertible preferred stock of the Pure Oil Company on September 3, 1937, and an offering to shareholders of $48,000,000 of 3 1/2% convertible debentures of the Bethlehem Steel Corporation on September 8, 1937, Edward B. Smith & Co. not only suffered heavy losses, but found itself in the difficult position of having its available capital, which was required to be free if the firm was to continue in the underwriting business, substantially frozen in the then unsaleable securities of these two companies. Accordingly, as of the close of business on December 31, 1937, the firm of Edward B. Smith & Co. in effect merged with the theretofore wholly separate firm of Chas. D. Barney & Co., which had the necessary capital, to form the new firm of Smith Barney & Co.
Smith Barney & Co. was organized to begin operations as of January 1, 1938, as successor to the business of Edward B. Smith & Co. and Chas. D. Barney & Co., as a limited partnership under the laws of the State of New York, by a group of 27 general partners and 4 special partners (one of whom was also a general partner), all of whom had been general or special partners of either the firm of Edward B. Smith & Co. or of the firm of Chas. D. Barney & Co. Of the 27 general partners of Smith Barney as of January 1, 1938, 13 had been partners of Chas. D. Barney & Co. and 14 had been partners of Edward B. Smith & Co. Among those general partners of Smith Barney as of January 1, 1938, who had previously been partners of Edward B. Smith & Co., were Joseph R. Swan, Burnett Walker, Irving D. Fish, J. Ritchie Kimball, James N. Land and Karl Weisheit, all of whom had been affiliated with the Guaranty Company either as senior or junior officers.
Since at least June 16, 1934, Edward B. Smith -- Smith Barney has had a large organization with extensive distribution facilities. It has principal branch offices in charge of one or more partners in Philadelphia and Chicago, and the firm has or has had offices in other important cities, including Boston and Cleveland. In addition to the usual Buying and Syndicate Departments, the firm has New Business, Trading, Sales and Municipal Departments. Smith Barney is engaged in a general investment banking business, and distributes all types of securities at both wholesale and retail.
The size of the organization and the widespread location of its offices, indicate the great importance to the firm of obtaining a relatively large volume of securities for distribution. With a large distributing force, a large number of participations in issues managed by other houses is essential to the economic and proper functioning of its organization.Accordingly, Edward B. Smith -- Smith Barney has always been very much interested in participations as well as managements, and the evidence shows many instances in which its principal effort was directed toward this objective. Joseph R. Swan testified on deposition that his "principal concern" personally was to try to obtain the managership of financing, or so to establish himself with the issuer that, if he could not obtain the managership of the business, he would get as large a participation as possible.
The stipulated static data confirm this. Thus, the participation tables show that in the period 1935-1949, Edward B. Smith -- Smith Barney participated in almost five times as many negotiated underwritten issues managed by others as it did in those which it managed or comanaged itself. Edward B. Smith -- Smith Barney managed or co-managed some 130 negotiated underwritten issues during this period. It participated, however, in 607 such issues managed by others. Similarly, in total dollar volume of participations in all negotiated issues $1,000,000 and larger (including those managed by itself), Edward B. Smith -- Chas D. Barney -- Smith Barney ranked third among all defendant and non-defendant firms for the period 1935-1949.
The stipulated public sealed bidding sheets show that Smith Barney was a member of an account headed by the alleged co-conspirator, Lee Higginson, which bid unsuccessfully for a $6,860,000 bond issue of Chicago Union Station, which was offered on June 10, 1941.
Prior to this time Chas. D. Barney & Co. had bid unsuccessfully on several issues offered at public sealed bidding, twice as a member of accounts headed by others (Connecticut River Power Co., February 18, 1936; Pennsylvania Railroad Co., January 10, 1936), and once as manager of an account (Turners Falls Power & Electric Co., November, 1936).
During the period 1941-1949, Smith Barney, bidding as either the head or a member of a bidding account, bid for a total of 275 new and secondary issues $1,000,000 and larger of domestic and foreign business corporations (excluding domestic railroad equipment trust certificates). It bid for 86 issues as the head of a bidding account, winning 16 issues.
4. Lehman Brothers
Since about 1850, a series of partnerships, formed from time to time upon the withdrawal or death of partners, has conducted business under the name of Lehman Brothers. The early phases of its development have already been discussed in Part I of this opinion
and will not be recounted here. At the date of the commencement of this action, the firm of Lehman Brothers consisted of 16 partners.
Lehman Brothers' principal place of business is in New York City. It also has offices in Chicago, Los Angeles and Houston, and it holds memberships on the New York Stock Exchange, American Stock Exchange,
Chicago Board of Trade and Midwest Stock Exchange.
Lehman Brothers ranks high among the leaders of the investment banking industry in the amount of capital employed. In 1944, its capital was about $10,000,000.
Throughout the record there are frequent references to a number of persons who are or have been partners of Lehman Brothers. Members of the family have always been its leading partners, as today in the person of Robert Lehman, who has been a partner since July 1, 1921, and is now the only partner bearing the Lehman name.Philip Lehman, who was a partner from about September 1, 1885, until his death on March 21, 1947, was a son of one of the three founders of the firm and its moving spirit in the first decades of the century. Robert Lehman is his son and successor. Other members of the Lehman family who were partners of the firm at one time or another are Arthur Lehman, Harold M. Lehman and Allan S. Lehman, all three of whom are now deceased, and Herbert H. Lehman, formerly Governor of the State of New York and presently a United States Senator. There were gathered around this family core as partners other men of outstanding ability, who have contributed immensely to the firm's development. Among these other partners were: John M. Hancock, who became a partner on August 1, 1924, and was the first person outside of the Lehman family to be admitted to partnership; Monroe C. Gutman, widely experienced in domestic and international banking, became a partner on January 1, 1927, and has since played an important part in the buying of new issues; he is the only partner of the firm whose deposition was taken by the government in pre-trial proceedings in this action, and was too ill to be crossexamined; Paul M. Mazur, a well known marketing and department store expert, became a partner on July 1, 1927; he had previously done constructive work for various department stores, and is now primarily responsible for the operation of the firm's Industrial Department. Each of these three individuals are partners of the present firm.
Lehman Brothers acts in all capacities for issuers in the handling of negotiated transactions. It has headed and it has participated in underwritten public offerings, and it has acted as agent for the issuer in non-underwritten public offerings, and private placements, and assisted issuers in obtaining term bank loans. It engages in arbitrage transactions and does a commission business on commodities and securities exchanges. It distributes all types of securities, both at wholesale and retail, and it has bought, sold and placed securities for its own account.It distributes also a large volume of municipal securities.
The firm effects the distribution of corporate securities through its Syndicate and Sales Departments. It has a separate Municipal Department which handles all matters with respect to municipal and revenue securities. Another department of significance in this case is its Industrial Department, which includes its New Business Department, and was developed as part of an agressive movement to increase its investment banking business during the series of disputes with Goldman Sachs, hereafter referred to.
Lehman Brothers offers issuers a wide variety of services which go far beyond simply assisting in the raising of capital. The firm attaches great importance, quite apart from investment banking matters, to its role as a counselor to industry. The multiform activities of the Industrial Department typify the scope of the services which Lehman Brothers offers to business enterprises. The Industrial Department, while embracing the characteristics of the "buying department," common to most investment banking firms, includes, in addition, a complex of services which most nearly resembles management or efficiency engineering.
As has been previously pointed out in Part I of this opinion,
commencing with the underwriting of the United Cigar Manufacturers preferred and common stocks in June, 1906, Lehman Brothers conducted its business of heading security issues in an informal partnership with Goldman Sachs.This informal partnership between Lehman Brothers and Goldman Sachs lasted for nearly 20 years and was never reduced to writing. The two firms worked together on the basis of mutual trust. Later the two firms entered into a period of bitter controversy, which is to some extent described in a subsequent part of this opinion,
and, for about two years they split apart, and then came together again.
Long before the ICC required the debt securities of railroads to be sold at public sealed bidding, Lehman Brothers, as head of a bidding account, bid for and won the Cincinnati Union Terminal $12,000,000 bond issue of February 14, 1939. On February 18, 1936, many years prior to promulgation by the SEC of Rule U-50, Lehman Brothers, as head of a bidding account, bid for and won the Connecticut River Power $20,300,000 bond issue, which had been put up for bidding under a local administrative rule. Much earlier, in April, 1926, with Halsey Stuart and Hallgarten, Lehman Brothers bid for and won a $30,000,000 bond issue of Uruguay, and in April, 1928, with Kountze Bros. and Wood Low & Co., won an issue of $2,145,000 equipment trust certificates of Chicago & North Western Railway.
During the period 1941-1949, Lehman Brothers, bidding as either the head or a member of a bidding account, bid for a total of 385 new and secondary issues $1,000,000 and larger of domestic and foreign business corporations (excluding domestic railroad equipment trust certificates). The firm thus bid on 61% of the total of 632 such issues which were sold at public sealed bidding during this period. It bid for 186 issues as the head of a bidding account, winning 35 issues.
5. Glore Forgan & Co.
On March 1, 1920, Charles F. Glore and others formed in Chicago the partnership of Glore, Ward & Co.
On December 29, 1920, Marshall Field, Glore, Ward & Co., a corporation was organized under the laws of Illinois.It continued the business previously conducted by the partnership Glore, Ward & Co. Marshall Field III, who was 26 years of age and who had not been a member of the former partnership, became president of this corporation. He had participated in a student training course in the Chicago office of Lee Higginson & Co. from October 23, 1919 to February 1, 1920.The partners of the former partnership became vice-presidents. On December 31, 1927, the name of this corporation was changed to Field, glore & Co. On September 26, 1929, Field, Glore & Co., Incorporated, was organized under the laws of Delaware, and it continued the business previously conducted by the Illinois corporation, Field Glore & Co.
On March 16, 1931, the partnership of Field, Glore & Co. was formed, and it continued the business previously conducted by the Delaware corporation, Field, Glore & Co., Incorporated. From that day to the present the business has been conducted by a succession of partnerships formed from time to time upon the withdrawal or addition of partners, under the same firm name, which, however, was changed from Field, Glore & Co. to Glore, Forgan & Co. on January 2, 1937. On July 6, 1935 Marshall Field III retired from the then firm.
At the time of the commencement of this action the defendant firm of Glore, Forgan & Co. consisted of eight partners: Charles F. Glore, who died during the trial; John F. Fennelly, Rudolph E. Vogel and James W. Pope, were located in the Chicago office; and J. Russell Forgan, Halstead G. Freeman, Edward F. Hayes and Wright Duryea, in the New York office. The following became partners on August 1, 1950: Hyde Gillette, Charles S. Vrtis, Edwin Cummings Parker, James P. Jamieson and Alfred C. West, in the Chicago office; Charles J. Hodge, Thomas D. Mann and Paris S. Russell, Jr., in the New York office.
This Chicago firm has done a general investment banking and brokerage business; has good distributing facilities, and is interested in managerships and as many participations in desirable issues as it can secure. Its public sealed bidding record is good. There is no successorship problem involved.
6. Kidder Peabody & Co.
The original firm of Kidder Peabody & Co., for many years one of the leading houses, and described throughout the trial as "old" Kidder Peabody, was founded in 1865, to engage in the commercial and investment banking business. In its heyday it did a large and profitable business and was identified with a long series of security issues of the American Telephone & Telegraph Company, acting as New England manager for all negotiated underwritten issues of the Telephone Company and its subsidiaries after about 1899.
During the fall of 1930 the "old" firm ran into financial difficulties, caused by falling prices of securities it owned the withdrawal of large deposits by the Italian Government, and to time deposits which were due or renewable, including a payment to the Bank of International Settlements, said to have amounted to $4,000,000.
Harold Stanley testified:
"J. P. Morgan & Co. had sold the stock of Bank of International Settlements, which looked as if it wouldn't be able to get its money back and have to take a loss unless something were done. If Kidder, Peabody had failed, an old firm -- and it had been a very prominent firm in some ways -- it would have shaken confidence and upset everything."
Accordingly, in an effort to save "old" Kidder Peabody, a $10,000,000 Revolving Fund was raised, of which $2,500,000 each came from J. P. Morgan & Co. and Chase National Bank, $1,250,000 from First National Bank of Boston, $1,000,000 each from Bankers Trust Company and Guaranty Trust Company of New York, $750,000 from Shawmut Bank of Boston, $500,000 from First National Bank of New York and $250,000 each from Merchants National Bank and Second National Bank, both of Boston. The partners of the "old" firm raised an additional $5,000,000.
It soon developed that the condition of the "old" firm was worse than had been supposed. It was thought that the name and some vestige of the repute of the "old" firm might still be salvaged and the advances already made recovered. There is no point in tracing every step of the negotiations. Edwin S. Webster, one of the heads of Stone & Webster, and a man of substance, thought his son, Edwin S. Webster, Jr., who had met with an accident and was then confined to a hospital, might be interested. Young Webster and Albert Gordon had been classmates in the Harvard Business School, both seemed men of promise and they, together with Chandler Hovey, a brother-in-law of Mr. Webster, Sr., who had a brokerage business in Boston, began business as the three partners of the new Kidder Peabody & Co., which is the firm named as a defendant herein, on March 17, 1931. None of the members of the "old" firm remained as partners, three, with the remnants of the "old" firm's staff, remained for a time as employees. Later on in that year, G. Herman Kinnicutt, then in his 60s, became a fourth partner. He had formerly been senior partner of Kissel Kinnicutt & Co., which had gone into liquidation.
The subsequent history of the Revolving Credit and the arrangements made for the repayment of the $5,000,000 loaned as above stated, is developed in great detail but may be passed over. In 1935 the new firm threatened to exercise an option it had to give up the name, and dissolve the firm; and this led to a settlement agreement which was eventually carried out.
By the Bill of Sale as of March 6, 1931, certain securities and assets, including the firm name and good will, leases, stock exchange seats, furniture, fixtures, documents and books, were transferred to the new firm. An agreement of the same date between the old and the new partners, and corporations representing those who had made the advances above referred to, contained a large number of terms, including Article III, Section 2, which provides: "The new firm does not assume directly or indirectly any liabilities of the present firm whether known or unknown, direct or contingent, except the liabilities specifically set forth herein to be assumed by the new firm." These do not appear to have been substantial.
In 1934, when the Glass-Steagall Act took effect, Kidder Peabody took over the lease for office space of the Phildelphia National Company, the securities affiliate of the Philadelphia National Bank; and virtually the entire organization of employees, together with the president, Orus J. Matthews, left the Philadelphia National Company and came with Kidder Peabody. Matthews became a partner some time in 1935.
When Chase Harris Forbes Corporation went out of business, 10 or 15 salesmen from its organization were added to the Kidder Peabody sales staff; other men came over from the Guaranty Company and the National City Company. During 1934 Frederick L. Moore, from the guaranty, became a partner, and Walter V. Moffitt, also from the Guaranty, became a partner in 1935.
Under the leadership of Gordon the affairs of Kidder Peabody prospered; progress was slow at first, but there was steady growth in every phase of its business. The partners and employees went after everything, for managerships if they could be secured, if not for participations and even selling positions.No issue was too small, no participation too insignificant. Offices were opened, first in Chicago, then in Hartford and Albany, in addition to the principal offices in New York, Boston and Philadelphia. By the time this action was commenced, Kidder Peabody maintained a larger selling organization and a larger trading department than at any time in its history, with representatives and correspondents in many leading cities of the United States where it did not have offices, and had moved up from practically no business at all, in 1931 in the depths of the great depression, to a major position in the entire investment banking industry.
The statistical tables are so comprehensive and complete that they accurately reflect the progress and also the competitive pattern of each of the defendant banking firms.Kidder Peabody will serve as an illustration. In the first triennial period, 1935-1937, Kidder Peabody ranked 18th in dollar amount of new negotiated underwritten managements of issues $1,000,000 and larger, and it ranked 25th in number of issues. In the last triennial period, 1947-1949, it ranked 3rd in number of issues and 11th in dollar amount. Its progress in the smaller issues is shown by the tables relating to issues between $100,000 and $1,000,000, and indicates that the whole competitive pattern of the firm was undergoing change, development and growth during the entire period 1935-1949. With reference to these smaller issues, Kidder Peabody had no rank whatever in number of issues, and it stood 200th in dollar amount, in the first triennial. In the last triennial it ranked first both in number of issues and dollar amount. Its progress in public sealed bidding accounts and private placements was substantial.
7. Goldman Sachs & Co.
In 1882, Marcus Goldman and Samuel Sachs formed a partnership to continue a commercial paper business which had been begun by Marcus Goldman in 1869.With the withdrawal of partners or the addition of new partners from time to time, the business has been conducted by a succession of partnerships from 1882 to date, except for the period from January 21, 1922, to December 31, 1926, when the business was conducted as a joint stock association. Beginning in 1885, each of the partnerships and the joint stock association did business under the name of Goldman Sachs & Co. As in the case of Lehman Brothers, the early phases of its development have already been discussed in Part I of this opinion
and will not be narrated here. Similarly, its relationship with Lehman Brothers is described to some extent above in the statement of the origin, organization and personnel of Lehman Brothers
and also in a subsequent part of this opinion.
Goldman Sachs' principal place of business is in New York City; and, in addition, the firm has various branch offices and representatives in other cities. Goldman Sachs not only has a New Business Department, but, as Walter E. Sachs testified on deposition, "Goldman, Sachs & Company is a new business department." In approximately 1935, Goldman Sachs established a Retail Sales Department.Its capital in 1944 was about $6,500,000.
At the date of the commencement of this action, the firm of Goldman Sachs consisted of 13 partners.Among the personnel of Goldman Sachs whose names appear in the record, and who are or have been partners in the firm,are the following: Marcus Goldman, who founded the business in 1869, and who is the grandfather of Walter E. Sachs; Samuel Sachs who joined Marcus Goldman as a partner in 1882, when the business became known as M. Goldman & Sachs, is the father of Walter E. Sachs and an uncle of Howard J. Sachs; Walter E. Sachs, who was first employed by Goldman Sachs in 1905, and who became a partner in 1910, is the only member of the present firm whose deposition was taken by the government; Howard J. Sachs, who became a partner in 1915 and is a member of the present firm, is a cousin of Walter E. Sachs; Henry S. Bowers, also a member of the present firm at the time of the commencement of this action, became a partner in 1915, and was the first partner of the firm who was not related to either the Goldman family or the Sachs family; and Sidney J. Weinberg, who entered the employ of Goldman Sachs in 1907, became a partner in 1927, and is a member of the present firm.
The business now conducted by Goldman Sachs consists in part of: (1) dealing in commercial paper -- the buying of short term promissory notes from merchants and manufacturers and the selling of such notes to banks or institutional investors -- the business which the firm's founder started in 1869; (2) a brokerage business, the firm having been a member of the New York Stock Exchange since the late 1890's, except for the period when it was a joint stock association;and (3) investment banding.
It is not a part of the regular business of the firm to invest its own capital in permanent long term investments in the companies whose securities it underwrites. Since the time that Goldman Sachs first entered the investment banking business in 1906, it has concentrated its underwriting efforts on the security issues of companies engaged in retailing or merchandising or in the manufacturing of consumers' goods. It has never been prominent as an underwriter in the railroad or public utility fields; but it distributes all types of securities both at wholesale and at retail.
The passage of the Glass-Steagall Act, which became effective on June 16, 1934, had no material effect on Goldman Sachs. In the early days of its business, Goldman Sachs did not accept deposits at all.For some years prior to the Glass-Steagall Act, the firm did have some depositors, but this activity was never a very important feature of the firm's business, and after the passage of the Act, the firm discontinued it. The Act did not affect Goldman Sachs' commercial paper business, which continued.
In October, 1929, when the devastating crash in the stock market occurred, Goldman Sachs found itself as an underwriter in the midst of a number of underwritings, and, as Walter E. Sachs testified on deposition, it lost millions of dollars in having to take up securities at the underwritten price at a time when the market price of those securities was greatly depressed. Not only did Goldman Sachs suffer large monetary losses at the time, but because of the losses incurred by investors in securities of the Goldman Sachs Trading Corporation, which Goldman Sachs had sponsored, its reputation as an investment banker was dealt a blow from which it took years to recover.After heading with Hayden Stone the financing for Warner Brothers Pictures on August 25, 1930, Goldman Sachs was not to head another underwriting for almost five years.
In the period 1906-1917, Goldman Sachs had few, if any, underwriting participations in financings headed by others. In the period 1918-1933, it had some modest participations in such financings. There was a further change in the post-Securities Act period. After approximately 1935, when, as has been previously stated, Goldman Sachs established a Retail Sales Department, it began to take substantial participations in issues managed by others.The stipulated data indicate the extent of this change. In the period 1935-1949, Goldman Sachs participated in 570 underwriting syndicates for negotiated issues managed by other investment banking firms, in addition to having participations in 87 such syndicates which it managed or co-managed itself.Another change in this period 1935-1949, and one which resulted from the registration requirements of the Securities Act, was the increased use of private placements by issuers as an alternative method of raising money. The growing importance of this method of financing, in direct competition with other methods, was reflected in the large number of private placements handled by Goldman Sachs in this period, as compared with the previous periods. In the 29 years after 1906, the year it entered the investment banking business, to 1935, Goldman Sachs had handled only 2 private placements. It handled 69 private placements in the 15-year period 1935-1949. Throughout the period 1935-1949, Goldman Sachs continued to solicit the business of heading financings for relatively small concerns which had not previously offered securities to the public, and, during this period, Goldman Sachs headed financings for 28 such issuers.
When Rule U-50 became effective on May 7, 1941, Goldman Sachs, which had had very little experience in the management of public utility issues, did not reorganize its staff or alter the organization of its Buying Department or of any of its other departments in order to enable it to head public sealed bidding accounts for such issues to any large extent. Despite this, however, during the period 1941-1949, Goldman Sachs headed bidding accounts which bid for a total of 24 new and secondary issues $1,000,000 and larger of domestic and foreign business corporations (excluding domestic railroad equipment trust certificates), winning 6 issues. But the firm's record of participating in bidding accounts headed by others tells a different story. In the period 1941-1949, it was a member of bidding accounts which bid for 334, or 53%, of the total of 632 such issues which were sold at public sealed bidding during that period.
8. White Weld & Co.
Established in 1895 under the name of Moffat & White, this partnership changed its name in 1910 to White Weld & Co. and the firm has been in continuous operation under that name ever since. It is not claimed to be "successor" to any institution which was forced to give up investment banking by the terms of the Glass-Steagall Act.
The activities of the firm differ from those of any of the other defendants, and consist of three broad categories, "position" business, commission or brokerage business, and that of managing and distributing security issues. About one-half of the firm capital is devoted to the purchasing of securities of corporations which white Weld is interested in building "from the ground up" and then holding such securities for the long pull and not for resale. One-quarter of the firm capital is employed in its commission business, and only the remaining one-quarter is available for investment banking of the kind with which we are here concerned. As the entire capital of White Weld as of July 6, 1949, was in the neighborhood of $6,500,000, about $1,650,000 was available at that time for underwritings. As of the close of 1945 these figures were much smaller.
White Weld has made a specialty of private placements, as is indicated by the statistics, which show White Weld as agent for the seller in 53 private placements in the period 1935-1947. While opposed to compulsory public sealed bidding on principle, as not being in the best interests of issuers, White Weld's record of public sealed bidding accounts during the same period exceeded its position in negotiated underwritten transactions by a considerable margin. The bulk of its business in the distribution of securities consisted of its participations, as underwriter, in negotiated and public sealed bidding issues managed by others. Thus, despite the relatively small amount of capital allocated to its underwriting activities, White Weld nevertheless ranked high in participations in both public sealed bidding and negotiated issues. Comparing the records of all investment bankers for the fifteen year period, 1935-1949, the statistical tables show that White Weld ranked ninth in number and eleventh in dollar amount of participations in public sealed bidding issues, and that it ranked tenth in number and sixteenth in dollar amount of participations in negotiated issues of $1,000,000 and over.
The partners who exercise the major over-all responsibilities are Alexander M. White, Jr. and Francis Kernan.Harold B. Clark, whose deposition was taken, was then a senior partner. He started with the old firm in 1901, and became a partner in 1907. The older partners who became such in 1901, 1905 and 1912, Harold R. White, Sr., Francis M. Weld, who died during the pendency of the action, and Wm. J. K. Vanston, gradually withdrew from active management of the affairs of the firm, furning things over to the younger men as they came along. The remaining partners, in the order in which they were taken in, are: J. Preston Rice, Jean Cattier, Benjamin S. Clark, David Weld, Harold T. White, Jr., E. Jansen Hunt, William C. Hammond, Jr., J. C. Ransom, Dimitri Yassukovich and Clarence E. Goldsmith.
Relatively speaking, White Weld is a small organization, with its main office in New York, and branch offices in Chicago, Boston, Philadelphia, Buffalo and Cleveland. There is no regularly set up Buying Department, but the firm has a Syndicate Department and a Statistical Department, and its trading activities are considerable.
9. Eastman Dillon & Co.
Founded in 1910 by Herbert Lowell Dillon and Thomas C. Eastman, Eastman Dillon & Co. is a co-partnership engaged in the securities business and in general investment banking.Its existence over the years as a partnership has been continuous and there is no problem of "successorship."
The "Dillon-Eastman era," from 1910 to 1935, shows the firm engaged in a general brokerage business, primarily interested in the Pennsylvania area, where it maintained at various times from three to five branch offices.
After World War I the firm began to grow. By 1925 there were 7 partners, in 1929 the number had increased to 13; and in 1933, it increased to 16 and then dropped to 11. After the return of the senior partners from the service, the firm began to do a certain amount of underwriting, and was active in that field in the period 1924-1929.
The "Gilmour era" began in 1935, when Lloyd Gilmour left Blyth to join Eastman Dillon. He has for some time been the most active partner, is head of the Buying Department and is principally responsible for negotiations with issuers, the obtaining of participations and the general management of the investment banking part of the firm's business.Under Gilmour's leadership, Eastman Dillon took on new vigor and growth. The firm's underwriting activities began to expand, and in 1940, the year which represents Eastman Dillon's emergence as an important managerial house, there was a marked increase in its investment banking business.
Henry L. Bogert, the only senir partner of Eastman Dillon whose deposition was taken by government counsel, was at the time he testified, the managing partner with general supervision of the office management, a position which he had held since 1937. He had come to Eastman Dillon in 1922 from Lee Higginson, where he had been an employee in the syndicate department. After a short period of experience in charge of wholesaling and syndicating, he became inactive in 1929 and ceased to be a partner in 1933, devoting his time for two years to the management of a dairy farm in Virginia. In 1935 he again became a partner, was rather inactive for a few years, and finally became the managing partner.
Eastman Dillon has memberships on several exchanges, carries on an active general brokerage and underwriting business and trades for its own account. The character of its investment banking business is very general, extending to both stocks and debt issues of public utilities, industrial and railroad securities, which it distributes both to institutions and at retail; and it is interested in participations and selling group positions.
In 1943 the firm engaged also in the business of furnishing financial advice to issuers through its Statistical or Investment Research Department, for a fee. This service was discontinued in 1946. Today Dillon and Eastman are limited partners and the firm is primarily under the guidance of Gilmour. There is no evidence in the record concerning the firm's attitude on the subject of competitive bidding.
10. Drexel & Co.
Defendant Drexel & Co., a Philadelphia partnership, is the youngest and one of the smallest of the 17 defendants. It was formed on April 1, 1940, at an initial capitalization of $1,100,000.
As already pointed out
this defendant is not the Drexel & Co. which is mentioned in the Morgan Stanley statement, as the "Philadelphia end of J. P. Morgan & Co." In 1933-1934, J. P. Morgan & Co. (and its Philadelphia branch, Drexel & Co.) in complying with the Glass-Steagall Act, discontinued its investment banking business in New York and Philadelphai, but continued in both cities its commercial banking business, its investment advisory service, its registrar and transfer business, and certain other activities. In 1940, J. P. Morgan & Co., deciding to terminate its Philadelphia activities entirely, organized a trust company in New York under the New York Banking Act, took over the Philadelphia deposits of its branch, Drexel & Co., and withdrew from Philadelphia.
A number of the partners and employees of the old Drexel & Co. thereupon organized the new firm of Drexel & Co., the defendant in this action. The partners of the new Drexel & co. included Edward Hopkinson, Arthur Newbold, Jr., Gates Lloyd, Thomas Gates, Jr., and Edward Starr, Jr. Several new partners have since been added, including Robert H. Lee, William L. Day, Edward Howard York, Jr., Walter H. Steel, Clarence W. Bartow, and William F. Machold. With the exception of Newbold and Day, these men continued to be partners in Drexel & Co. as of March 15, 1950.
In addition to carrying on the business then being conducted by the J. P. Morgan & Co. organization in Philadelphia, with the exception of commercial banking, defendant Drexel & Co. also announced its intention to engage in the investment banking business, from which the Morgan organization had withdrawn some six years previously.
The new firm obtained from J. P. Morgan & Co. the right to use the name Drexel & Co., an important name in Philadelphia financial circles for some one hundred years, and took over the furniture and lease of the old Drexel & Co. office. It also obtained from J. P. Morgan & Co. the books and records connected with the investment advisory service and the registrar and transfer business of the old firm. However, the new Drexel & Co. received nothing in connection with the commercial banking end of the business, which J. P. Morgan & Co. transferred to New York, and nothing with reference to the investment banking business formerly carried on by the old Drexel & Co., since that phase of the J. P. Morgan & Co. -- Drexel business had been discontinued for many years.
No deposition testimony, and little other evidence, was offered against Drexel & Co., and consequently there is no foundation for a discussion of its internal organization or competitive pattern.
11. The First Boston Corporation
The defendant First Boston came into existence as the result of the impact of the Glass-Steagall Act on the securities affiliates of two great banking institutions, The First National Bank of Boston and the Chase National Bank in New York. The legal steps which were taken in order to accomplish this result are complicated and have little relevance to this case, but the background does have a bearing upon the issue of "successorship."
The Harris Forbes organization which later became identified with the Chase Securities Corporation, the securities affiliate of the Chase National Bank, started in 1882 when N.W. Harris, "the father of the modern bond salesman," formed the partnership of N.W. Harris & Co. in Chicago. By 1890 there were offices of N.W. Harris & Co. in Chicago, Boston and New York. In 1907 the assets and business transacted at the Chicago office were transferred to the Harris Trust & Savings Bank, which we shall meet again, in connection with the defendant Harris Hall. In 1911 the New York and Boston offices were each incorporated. In 1922 the stock of each of the two Harris Forbes & Co. corporations thus formed was transferred to a parent company named Harris Forbes Companies. The purpose of this elaborate arrangement was to preserve the name of Harris Forbes as connected with a nationwide organization, but to maintain offices otherwise separate and distinct, in each of the cities above referred to.In August 1930 Chase Securities Corporation, securities affiliate of the Chase National Bank, acquired all the stock of Harris Forbes Companies; and in June 1931 the names of the two corporations known as Harris Forbes & Co. were changed to Chase Harris Forbes Corporation, and thereafter the Chase Securities Corporation conducted no securities business except through these corporations.
Long before the effective date of the Glass-Steagall Act the Chase National Bank decided not to wait but to go out of the investment banking business, even before the Glass-Steagall Act was enacted. Accordingly, in May 1933, Chase Securities Corporation terminated its securities business and, having changed its name to Chase Corporation, proceeded with the liquidation of its two subsidiaries. The two Chase Harris Forbes Corporations made such progress in liqui dating the companies that, by the end of 1933, over 1,000 employees were released from employment, and the number still on the payroll had been reduced to 42.
When the transaction which resulted in the defendant First Boston becoming a publicly owned corporation, completely divorced from the First National Bank of Boston, took place on June 16, 1934, an agreement was made between First Boston, the Chase corporation, and the Chase Harris Forbes Corporations, which, among other things, gave First Boston an option, which it exercised, to have assigned to it
"* * * the name 'Harris Forbes' and the good will thereof incident to the general security business, other than government, state, municipal, political subdivision or governmental instrumentality financing * * *"
together with all of the capital stock of three corporations which were formed in New York, Massachusetts and Canada, "for the purpose of preserving the name 'Harris Forbes.'" In addition, some of the records of the Chase Harris Forbes Corporations and of Chase Securities Corporation, pertaining to corporate financings, were turned over to First Boston.
Eleven of the employees and seven officers of the old Harris Forbes organization found employment with First Boston. The officers were men of great experience and ability and represented the real leadership of the old Harris Forbes organization. They were John R. Macomber, who had been president of the Boston Harris Forbes Corporation, Harry M. Addinsell, who had been president of the New York Harris Forbes Corporation, George D. Woods and Duncan R. Linsley, both of whom had been vice presidents of the New York corporation. The other three were junior officers. The remaining officers of the Chase Harris Forbes Corporations joined a great variety of other firms, including Field Glore and Kidder Peabody. The lesser employees scattered to the winds, some of them to the offices of some of the other defendants herein.
On the First National Bank of Boston side of the picture, the corporate changes of its securities affiliates were intricate, but the net result was that its securities affiliate, First of Boston Corporation, became a publicly held corporation on June 15, 1934. Allan M. Pope, James Coggeshall, Jr., Nevil Ford and William H. Potter, Jr., who as early as 1921 had been officers of the First National Corporation, an earlier securities affiliate of the First National Bank of Boston, together with a substantial number of other officers and employees of First Boston, remained with First Boston.
Allan M. Pope continued as president of First Boston and, as of June 15, 1934, John R. Macomber became chairman of the board and Harry M. Addinsell chairman of the executive committee. In addition, there were 16 vice presidents.Subsequently, 2 of the men above referred to, namely, Woods, Coggeshall, Ford, Linsley and Potter were promoted to executive offices of importance.
In June 1934 First Boston had a capital of $9,000,000; by 1945 its capital was $12,400,000. On July 31, 1946, Mellon Securities Corporation merged with First Boston, 6 of the principal officers of Mellon Securities became associated with First Boston and in 1947, floowing the merger, the capital of First Boston had risen to $25,000,000.
During the period with which we are interested in this case, First Boston was a large and active house with a large personnel, a well coordinated organization and a very large overhead. In June 1934 it had a total of 600 employees, including the clerical and mechanical help.Addinsell's estimate that in January 1949 the whole organization amounted to about 450 people did not take into account the large number of employees in the purely clerical and mechanical departments.
Throughout the period First Boston has had a very active Trading Department and does a large amount of trading for its own account as principal.There is also a Municipal Department, and a Corporate Buying Department which was, at the time Addinsell testified by deposition herein, "a large organization of experts" having 7 vice presidents engaged in oding nothing else and one whole floor of the three floors at 100 Broadway, New York City, devoted to the buying end of the business, which is highly organized and efficient. At the same time, there are limitations upon the capacity of any buying department, and the research and planning essential to the competition for business and the formulation of plans and shaping up issues, is done under the leadership of approximately 8 men, no one of whom can handle more than a limited number of such matters in the course of a year.
The principal offices of First Boston in January, 1949, were located in New York, Boston and Chicago; it also had offices in Pittsburgh, Cleveland, Philadelphia, San Francisco and Springfield, Massachusetts. The annual burden of operating expense is close to $5,000,000.
While opposed to compulsory public sealed bidding in good faith and on principle, First Boston was an early, active and successful manager of public sealed bidding issues. It handles all types of offerings and offers the full range of investment banking services covering any type of investment banking problem, any type of issue, any type of offering and any type of risk. As of December 31, 1947, shortly after the commencement of this action, the principal executive officers of First Boston were Harry M. Addinsell, chairman of the board, James Coggeshall, Jr., president, George D. Woods, chairman of the executive committee, and Duncan R. Linsley and Willaim H. Potter, Jr., executive vice presidents.
12. Dillon Read & Co. Inc.
Dillon Read & Co. Inc. is a New York corporation, having at present only one office, located in New York City.
While deposition evidence of Karl H. Behr was taken by government counsel in the course of the elaborate and prolonged discovery proceedings, none of this was read into evidence at the trial. For this reason, perhaps, there is in the record no more than a bare outline of the history and development of the firm.
On October 11, 1922, Dillon, Read & Co., a New York joint stock association, was formed, with Clarence Dillon as the head of the firm. This in turn became a partnership on January 2, 1942, engaged in a general securities business; the firm became a corporation on March 12, 1945, and has remained such since then, as is indicated by the name above set forth. On May 1, 1951, the stockholders were Clarence Dillon and C. Douglas Dillon. There is accordingly no problem of successorship. Whether or not the firm, prior to the effective date of the Glass-Steagall Act, was engaged in the business of private banking does not appear. If it was, Dillon Reed must have elected to give up such banking activities, as this record shows the firm actively engaged in the investment banking business.
Dillon's experience in the securities business dated from 1913, when he joined the Chicago office of the firm of Wm. A. Read & Co., as a salesman. He moved to the New York office of that firm, and became a member of William A. Read & Co. on April 1, 1916.
In early 1920 Dillon became the senior partner of the old firm of Wm. A. Read & Co. About one year later, in 1921, the name of the partnership firm was changed to Dillon, Read & Co., and thereafter the joint stock association was formed.
In general, the picture is one of a privately owned firm headed by a relatively small group of aggressive individuals, who built Dillon Read up to a position of leadership in the investment banking industry. Among these men were Clarence Dillon, James V. Forrestal, William H. Draper, Jr., Dean Mathey, Ralph Bollard, Karl H. Behr, and, later, C. Douglas Dillon.
Dillon Read is primarily a managerial house. Having no large sales organization, it is not particularly interested in participations in accounts headed by other bankers, but goes after leadership, taking large participations in its own accounts.
While we shall find some evidence that Dillon Read was opposed to compulsory public sealed bidding for security issues, its record of successful public sealed bidding accounts in good. For the 15-year period, 1935-1949, its rank was seventh in dollar volume and eleventh in number of public sealed bidding issues managed. During the same period Dillon Read ranked first in dollar volume of agency private placements.
13. Blyth & Co., Inc.
On or about April 18, 1914, Charles R. Blyth and Dean Witter organized a California corporation known as Blyth Witter & Co., for the purpose of conducting a general investment banking business, with Charles R. Blyth, president; Dean Witter, vice president; Roy L. Shurtleff, vice president; and George Leib, vice president, all of San Francisco.
Blyth Witter & Co. concentrated its efforts in the developing and youthful electric power and light industry of the West Coast and became a specialist in its particular problems. With its main office in San Francisco, it began to enlarge, and opened offices in New Orleans, Los Angeles, Porland and Seattle.
By 1925 Blyth Witter & Co. had opened an office in New York City, thereby bringing to the attention of investment banking houses in the East that there was a market for securities in San Francisco, and the fact that Blyth Wittr & Co. would make a good underwriter and distributor for securities on the West Coast.
The termination of World War I found Blyth Witter & Co. fairly well established as a distributor of the securities of West Coast public utility companies. Of the fourteen issuers from whom Blyth Witter & Co. either as sole offeror or co-offeror, offered securities during the period 1914 through 1923, thirteen were public utility companies. Of the thirteen public utility companies, eleven were West Coast concerns, including two located in closely adjacent areas, the Mountain States Power Co. and the Central Arizona Light & Power Company.
A factor which restricted the market of potential purchasers of California public utility securities was a fear on the part of eastern and midwestern investors that another earthquake would occur in that area, and that the destruction and property loss would be as great as that suffered in the earthquake which occurred in 1906. As the firm specialized in the underwriting and distribution of West Coast public utility financings in West Coast securities markets, the natural consequence was that Blyth Witter & Co. gradually developed into an important and efficient distributing organization on the West Coast. In performing investment banking services for West Coast issuers, Blyth, Leib and Shurtleff placed great stress upon the fact that Blyth Witter & Co. was a California house, and argued that California enterprises should use California underwriters.
In 1924, Dean Witter resigned from Blyth Witter & Co. and formed the copartnership, Dean Witter & Co. Notwithstanding the resignation of Dean Witter, the corporation continued to function under the name of Blyth Witter & Co. until December 31, 1928, when the principal executive officers decided that the organization, in addition to its general investment banking, should go into the general brokerage business. Consequently, the copartnership, Blyth & Co., was then formed on January 1, 1929.
The venture of Blyth & co. into the general brokerage business was shortlived, due principally to the devastating stock market crash of October, 1929. In March of 1930, the copartnership, Blyth & Co., was dissolved, and a new corporation Blyth & Co., Inc., was incorporated under the laws of Delaware on March 10, 1930, to continue the investment banking business previously conducted by the partnership. The firm, in the period 1924-1931, broadened the base of its underwriting and distributing activities from specialization in the underwriting and distribution of the securities of West Coast utilities, to include the underwriting and distribution of issues of nonutility issuers and of non-West Coast issuers.
In the period 1932 through 1935, a number of important changes occurred in the set-up of the Blyth organization. Blyth had built up a very sizable and efficient sales organization throughout the country in order to dispose of those blocks of securities which it acquired through the underwriting of issues and through the operations of its active Trading Department. The Buying Department, however, had not been thoroughly developed. The Blyth buying organization on the West Coast was headed by Roy L. Shurtleff, in the San Francisco office; George Leib, who had started on the West Coast in 1914, was the head of the Eastern organization. His training had been largely in the sales organization.In the Buying Department of the New York office there were two men particularly equipped to analyze the financial structure and requirements of issuers, to develop financing plans, and to follow through on the technique of building an issue and preparing registration statements. These two men were Stewart Hawes and Eugene Bashore. They had assistants who were not then trained to any great extent.
At the end of 1934, Charles R. Blyth wanted to have somebody in the New York office who was trained in buying department activities, to supervise the negotiation of security issue transactions and to head the Buying Department. Charles E. Mitchell turned out to be the man, and on June 17, 1935, Mitchell entered the employ of Blyth as chairman of the board of directors.
Immediately prior to entering the employ of Blyth, Mitchell had his own firm, C.E. Mitchell, Inc., which he had formed in January, 1935.During the period from October 31, 1916, to April 2, 1929, he had served as president of the National City Company, and from April 2, 1929, to February 27, 1933, as chairman of its board of directors. From May 3, 1921, to April 2, 1929, Mitchell had also served as president of the National City Bank of New York, and from April 2, 1929, to February 27, 1933, as chairman of its board of directors. In February and March, 1933, Mitchell resigned all of his directorships and official positions with the National City Company and the National City Bank of New York, and, since that date, has had no direct or indirect connection with either organization. All of those connections had been severed more than two years before he joined Blyth. There was no succession of any kind, either de jure or de factor, from the National City Company to Blyth by reason of the fact that Mitchell joined the Blyth organization, or for any other reason.
In addition to a successful career with the National City Bank, Mitchell brought to the Blyth organization his experience as a director of the Federal Reserve Bank of New York.
Mitchell testified that when he joined Blyth in June, 1935, he endeavored to build the firm into the kind of an investment banking firm, which, with an expert buying organization, a statistical organization, and a distributing organization, could successfully obtain leaderships in underwritings. He started to work with the idea of trying to develop Blyth into a well rounded investment banking organization.
Another step in building up the national Buying Department of Blyth was taken when Eugene M. Stevens entered the employ of Blyth as vice-chairman of the board of directors on April 1, 1936.
He was placed in charge of the buying department of the Blyth organization in Chicago. Prior to entering the employ of Blyth, Stevens had been vice-president of the Federal Reserve Bank of Chicago, and prior thereto had been an officer of the Continental Illinois Bank and Trust Co. of Chicago.
Blyth's principal Buying Department in the East was centered in New York City. In the middle-west it was in Chicago and on the West Coast it was in San Francisco. To head up this nationwide buying organization, there were Blyth and Shurtleff in San Francisco, Mitchell, Leib, Hawes and Bashore in New York, and Stevens in Chicago.
In 1935, Blyth's overhead was approximately $175,000 a month, and its capital in June, 1935, was about $2,500,000. By February 9, 1949, Blyth's capital had increased to between $10,000,000 and $11,000,000.
In February, 1935, Blyth had its own wire and private telephones to Boston, Philadelphia, Cleveland, Chicago, San Francisco, Los Angeles, Portland and Seattle. It had 19 offices and 125 salesmen, and it had a large dealer following, as it traded daily with most of the important dealers throughout the country.The functional organization of Blyth as a leading national distributor required it to have a steady volume of securities to sell. Hence, there was always a vital need for obtaining participations in issues managed by others to supplement what could be supplied to he Blyth sales organization by the security issues managed by Blyth itself. An effort to win at least a substantial participation was a secondary alternative to the primary effort to get leadership.
The static data show that prior to the enactment of Rule U-50 on april 8, 1941, Blyth bid six times for security issues which were offered at public sealed bidding. It bid four times as the manager of a bidding account, and twice as a member in accounts headed by others, winning, however, only once.This was in December, 1940, when an account in which Blyth was a member, and which was managed by First Boston, bid for and won a $53,000,000 Boston Edison Co. bond issue.
During the year 1941, the first year of bidding under Rule U-50, Blyth bid for a total of fourteen issues, two of which were not under Rule U-50. It bid seven times as manager or co-manager of a bidding account, winning once, and seven times as a member in accounts headed by others, winning twice.
Among the public utility companies, whose security issues Blyth bid for in 1941, either as manager or co-manager of the bidding accounts, were the New York State Electric & Gas Corporation and the San Diego Gas & Electric Company. The two issues of New York State Electric & Gas (a preferred stock issue and a bond issue tendered for public sealed bidding at the same time) were the first issues of which bids were opened under Rule U-50.These bids were opened on June 23, 1941. The preferred stock issue was won by the account co-managed by First Boston and Glore Forgan. The bond issue was won by the Equitable Life Assurance Society. The San Diego Gas & Electric issue was a registered secondary offering by the parent company, the Standard Gas & Electric Company, and was the first block of subsidiary common stock offered by a public utility holding company under Rule U-50. This issue was won by the account managed by Blyth, and was offered to the public on July 8, 1941.
Blyth's record in the period 1941-1949 in bidding for new and secondary issues of $1,000,000 and larger of domestic and foreign business corporations (excluding domestic railroad equipment trust certificates) shows that Blyth, bidding as either the head or a member of a bidding account, bid for 462 issues compared with 447 issues for Halsey Stuart.
It bid for 204 issues as the head of a bidding account, winning 51 issues.
In the period 1935-1949, Blyth ranked third, in terms of the number of issues, among all investment banking firms managing or co-managing new and registered secondary issues, $100,000 and larger, won at public sealed bidding. In terms of dollar volume, Blyth ranked fifth, managing or co-managing issues amounting to some $489,500,000
14. Harriman Ripley & Co., Incorporated
Harriman Ripley & Co., Incorporated, was organized on May 29, 1934, under the laws of the State of New York, under the name of Brown Harriman & Co., Incorporated, to engage in the investment banking business, and it commenced business on June 16, 1934. Its name was changed to Harriman Ripley & Co., Incorporated, on January 1, 1939.
The National city company was organized in 1911 under the laws of the State of New York as the securities affiliate of the National City Bank. On June 10, 1933, its name was changed to The City Company of New York, Incorporated, and, on June 4, 1934, it discontinued its securities business and went into liquidation. No legal succession existed as between the National City Company and Harriman Ripley; nor has there been any other kind of succession from one to the other.
Brown Brothers Harriman & Co., a partnership, was formed on January 1, 1931, to carry on the commercial and investment banking activities theretofore engaged in by Brown Brothers & Co., a partnership, by W.A. Harriman & Co., Inc., a New York corporation, and by Harriman Brothers & Co., a partnership. The principal business of Brown Brothers Harriman & Co. has been, and is, commercial banking. From January 1, 1931, to June 16, 1934, it also engaged, to a relatively small extent, in investment banking. On June 16, 1934, Brown Brothers Harriman & Co. ceased doing an investment banking business, which had never been important to it. Brown Brothers Harriman & Co. was and is a private banking partnership, having no legal connection with Harriman Ripley. There has been no succession of any kind from Brown Brothers Harriman & Co. to Harriman Ripley.
When Harriman Ripley commenced business on June 16, 1934, it had twelve officers, seven of whom also comprised its board of directors. Seven of these twelve officers had formerly been officers of the National City Company, and of the remaining five, four had formerly been partners, and one had formerly been manager and attorney in fact, of Brown Brothers Harriman & Co.
The leading personalities in Harriman Ripley are Joseph P. Ripley, who is the chairman, and Pierpont V. Davis, who is the president. Joseph P. Ripley had been an employee and subsequently assistant vice-president of the National City Company from 1925 to 1927, vice-president from 1927 to March 16, 1933, and executive vice-president from March 16, 1933 to June 1934. Pierpont V. Davis had been an employee of the National City Company from 1917 to 1918, and vice-president from 1919 to June 1934. these men were also directors of The City Company of New York, Incorporated, at the time that it discontinued its securities business and went into liquidation.
Harriman Ripley commenced business with paid in capital of $5,000,000, of which $4,900,000 was provided by W. Averell Harriman and E. Roland Harriman, and of which the remaining $100,000 was provided by its officers and directors. W. Averell Harriman and E. Roland Harriman are brothers, and they became general partners of Brown Brothers Harriman & Co. upon its formation on January 1, 1931. W. Averell Harriman has been a limited partner since October 1, 1946, but E. Roland Harriman has been a general partner at all times since January 1, 1931.
From October 24, 1938, to September 27, 1946, inclusive, all of the stock of Harriman Ripley, which was owned directly or indirectly by E. Roland Harriman, W. Averell Harriman, or members of their respective families, being in excess of 90% of the total stock outstanding, was subject to the terms of a voting trust agreement, dated October 24, 1938, under which Joseph P. Ripley was one of the three trustees. Harriman Ripley was recapitalized on October 1, 1946, and the voting trust was dissolved. Since October 4, 1946, its officers have owned the majority of the common stock, being the stock presently entitled to vote for the election of its directors, and E. Roland Harriman, W. Averell Harriman and the members of their respective families have owned directly or indirectly 43% of its voting stock and 97.66% of its non-voting stock.
Harriman Ripley is not only a leading managing underwriter, but it is, in addition, an important distributing organization. It was at the beginning, and has continued to be, a large investment banking house, with a well staffed and aggressive buying, selling and distributing organization. It has offices in a half dozen other cities throughout the country, including Chicago, Philadelphia and Boston. When Harriman Ripley commenced business on June 16, 1934, it had 431 employees, of whom 223 had been employed by Brown Brothers Harriman & Co. immediately prior to their employment by Harriman Ripley, 205 had been employed by The City Company of New York, Incorporated, and three by other employers.
From the time that Harriman Ripley commenced business, it has engaged vigorously in the retail selling of securities. A large part of the volume of Harriman Ripley's business was in municipal securities, and in equipment trust certificates. It began doing business in municipal securities in the year 1934, and it was also active in bidding for public utility issues, during the period prior to the enactment of Rule U-50. The public sealed bidding sheets covering the period January 1, 1935 to December 31, 1940, record twenty-two corporate issues which were offered at public sealed bidding during that period. Harriman Ripley bid, either as a manager or participant, for eleven out of the twenty-two issues, although, in either out of the eleven issues bid for, the bids were not successful. It bid seven times as manager, but won, however, only once; and this was the Androscoggin Electric Corporation bond issue which was offered on May 7, 1935. This issue was Harriman Ripley's first public utility purchase at public sealed bidding. It also participated, under the management of First Boston, in four other accounts which submitted bids, winning two and losing two.
15. Stone & Webster Securities Corporation
Defendant Stone & Webster Securities Corporation, a New York corporation, is a wholly owned subsidiary of Stone & Webster, Incorporated, and is engaged in the investment banking business generally. The parent firm, not a defendant in this case, operated through a number of subsidiaries which offer consulting and engineering, and general advisory services, as well as investment banking facilities.
Organized in 1927, under the name of Stone & Webster and Blodget, Incorporated, this defendant took over the investment banking business which previously had been conducted by the Securities Division of Stone & Webster, Incorporated, and by the investment banking firm of Blodget & Co. In January, 1946, the name of Stone & Webster and Blodget, Incorporated, was changed to Stone and Webster Securities Corporation.
It is not alleged in the complaint that this defendant "succeeded" to the investment banking business of any institution which, pursuant to the Glass-Steagall Act, elected to give up investment banking on June 16, 1934.
Among the personnel of the new corporation were Robert van Deusen, previously an employee of the Securities Division of Stone & Webster, Incorporated, and Edward K. Van Horne, previously an employee of Blodget & Co. Robert van Deusen became an officer and director of the firm upon its formation in 1927; Van Horne became a vice-president of the corporation in 1933, and a director in 1935. At the time the deposition testimony was taken, van Deusen was chairman of the board and Van Horne the president of the corporation, and both directors.
Stone & Webster Securities Corporation engages in a general underwriting business, underwriting and distributing at both wholesale and retail, corporate, government and municipal bonds, as well as preferred and common stocks. It furnishes comprehensive financial services to issuers of securities and to investors. The firm concentrates primarily on utilities financing, but also emphasizes natural gas pipeline, gas distribution company, and power industrial issues. It does not manage public sealed bidding accounts for railroad underwritings, although it occasionally participates in such financing.
The home office of Stone & Webster Securities Corporation is located in New York. It has branch offices in Boston, Chicago, and Philadelphia, and representatives located in Hartford, Providence, and Syracuse.The firm is organized into departments to handle the several aspects of its investment banking business. These divisions include New Business, Municipal, Retail Sales, Syndicate, Accounting, and Wholesale Sales Departments.
On January 3, 1950, the capital of the firm was about $3,000,000.
16. Harris Hall & Company
The background to Harris Hall is interesting. In 1882 N.W. Harris, one of the pioneers in the investment banking business, formed the Chicago partnership of N.W. Harris & Co. Many of those who figure prominently in the evidence in this case were at one time or another connected with N.W. Harris & Co. Harold L. Stuart started his career with this firm in 1895; William Ewing, one of the organizers of Morgan Stanley, worked with "the Harris organization" in Chicago from 1905 to 1916; William Given, later to become president of American Brake Shoe Co., spent a year with this well-known group, beginning about 1908.
In 1907 Harris Trust & Savings Bank was organized in Chicago and N.W. Harris & Co. transferred to it the assets and business of the Chicago office; later the Boston and New York offices followed a course which is to some extent reflected in the thumb-nail sketch of First Boston in this Part II of the present opinion, and we need not follow the details too closely.Suffice it to say that what is sometimes described in this record as the "Harris forbes organization" had its roots in N.W. Harris & Co.
In 1921 Harris Trust & Savings Bank organized the N.W. Harris Company as an affiliate, and a certain amount of investment banking business was also done in the Bond Department of the Bank.But, pursuant to the terms of the Glass-Steagall Act, and on June 16, 1934, the affiliate was dissolved and the Bank elected to discontinue investment banking, except as to the types of securities exempted from the operation of the statute.
In the meantime, as part of an effort to maintain the organization above referred to on a nationwide basis, an agreement was made between the Chicago, Boston and New York houses, which were now in legal contemplation separated, by which each afforded the other an option to participate on original terms, in certain fixed percentages relative to various types of financing, in their respective security purchases. In July, 1930, they agreed to continue this arrangement until December 31, 1932; but it was cancelled in 1931.
The confusion and uncertainty, which everywhere followed in the wake of the Glass-Steagall Act, were naturally evident in Chicago; and it was not until October 30, 1935, that Harris Hall came into existence, organized and incorporated by four of the personnel of the Bond Department of Harris Trust & Savings Bank. Edward B. Hall, who had been with the Bank since 1909, became president of Harris Hall; Norman W. Harris, grandson of the founder of N.W. Harris & Co., became vice-president; Lahman V. Bower became vice-president and treasurer, in charge of the buying activities; and Julien H. Collins became a vice-president. Each of the four was a member of the board of directors.
The capitalization plan envisaged 2500 shares of preferred stock and 60,000 shares of common, or $1,102,000. A proposal was made to the Bank to transfer 12,000 shares of the common stock to the stockholders of the Bank for "the good will of the Harris Trust & Savings Bank heretofore acquired in and pertinent to the purchase and sale of securities"; the proposal was accepted and the transaction consummated. Stockholders of the Bank subscribed for the preferred stock. In 1945, the capital of Harris Hall was $1,291,000.
This small mid-western firm has done a varied and general investment banking business, specializes somewhat in public utility securities and railroad equipment trust certificates; but is interested in managerships in all types of issues and in getting as many participations as it can. It has a surprisingly good record in private placements, considering the size of its organization and its general facilities; its public sealed bidding record is good; and its record of managerships in the various triennials, 1935-1949, has fluctuated widely.
17. Union Securities Corporation
Union Securities Corporation was formed in October, 1938, for the purpose, among others, of continuing the investment banking business of J. & W. Seligman Co. There is no "predecessor-successor" problem with respect to Union, since Union admitted in its answer, and has never questioned, that it was formed to continue the investment banking business of J. & W. Seligman.
J. & W. Seligman Co., a partnership formed prior to 1915, has been engaged in many branches of the banking and securities business, including brokerage, investment counseling, securities underwriting and private banking. the firm discontinued its commercial banking business in about 1933, by reason of the Glass-Steagall Act, and divested itself of its underwriting activities in 1938, at the time Union Securities Corporation was formed.J. & W. Seligman continues today in the business of brokerage, investment counseling and other branches of the securities business other than investment banking. The firm received no consideration for the transfer of its underwriting business to Union.
Union Securities Corporation was organized under the laws of the State of Maryland to engage in the origination, underwriting and distribution of securities and for other purposes. With respect to its investment banking functions, it was organized to continue such business as had theretofore been conducted in that field by J. & W. Seligman Co., and as a subsidiary of two investment companies, Tri-Continental Corporation and Selected Industries Incorporated. The stock of Union was owned in equal proportion by these two investment companies until March 31, 1951. As of that date, Selected Industries Incorporated was merged into Tri-Continental Corporation, and all of the outstanding capital stock of Union is presently held by the latter.
Union Securities Corporation is engaged in the general underwriting business of stocks bonds and municipal securities, and is interested in leadership and participations as well. It is not engaged in the brokerage business, nor does it purchase securities for its own permanent investment. It has on occasion engaged in reorganization or recapitalization plans, involving the purchase of stock, rehabilitation of the company and subsequent disposal of the securities purchased.
Union has various departments to handle the several functions of its investment banking business, including Sales, Syndicate, Buying and Accounting Departments.
Union took over the entire underwriting business of J. & W. Seligman, and part of the personnel engaged in the underwriting and new issue business of the Seligman firm. A number of the men who have been officers and directors of Union Securities since its formation were, and continue to be, partners in J. & W. Seligman Co., and officers and directors of Tri-Continental Corporation and -- until its merger with Tri-Continental -- Selected Industries Incorporated. Included in this group are Henry C. Breck, Cyril J. C. Quinn, and Francis F. Randolph. The latter has been chairman of Union's board of directors since 1940, succeeding to that position upon the death of Earle Bailie. Bailie, who had headed the Union board since the formation of the company, was at the time of his death also a partner in the Seligman firm, and chairman of the boards of both Tri-Continental and Selected Industries.
Randolph, in addition to heading Union's board since 1940, was also president of Union from its organization in 1938, through 1945. He was succeeded in this post by the present incumbent, Joseph H. King, who had come up through the Seligman firm and had been a vice-president of Union.
Although Union was organized to carry on the investment banking business of J. & W. Seligman Co., in actual fact the new company "inherited" practically no business from the old firm. Not only did the Seligman firm give up its commercial banking business after passage of the Banking Act, but also during the depression engaged in very little investment banking activity, managing or comanaging only three issues from the early 1930's up to the time of the formation of Union Securities.
Consequently, Union itself got off to a slow start, the static data indicating that for the first triennial of its existence, 1938-1940, Union managed three negotiated issues (of over one million dollars) and co-managed none.With this record, it ranked 28th among investment banking firms with reference to number of issues managed, and 27th with reference to dollar amount of such issues.
Its progress was still slow in the next triennial, 1941-1943, with two managerships and four co-managerships to its credit, and the firm's rank increased only slightly. But in the next three-year period, 1944-1946, Union took hold, managing twenty issues and co-managing an additional twenty; it rose to 7th in number of issues managed, and 16th in dollar volume of managerships.
While it suffered some decrease in the next triennial, 1947-1949, Union remained an important factor in investment banking activity, ranking 17th in number of issues managed, and remaining 16th in dollar volume of leaderships.
Union now does a wide distributing business also. Its participations in underwritings show a rise similar to that of its managerships. In negotiated issues for the five successive triennials, it ranked in number of issues 25th, tie for 28th, 10th, 14th, and 18th, and in dollar volume 24th, 23rd, 12th, 8th and 13th.
Thus we have the picture of a new firm, organized to continue the almost extinguished investment banking business of J. & W. Seligman, slowly building on this foundation until it became a major underwriting and distributing house.
The static data also reveal some interesting evidence of Union's attitude toward public sealed bidding. At the same time that Union forged ahead in the negotiated field, it began to organize syndicates to bid at public sealed bidding. Thus, while in the period 1944-1946 it managed none and co-managed but two such issues, in the next triennial, 1947-1949, Union managed six and co-managed six public sealed bidding issues, thus ranking 9th among investment banking firms in number of public sealed bidding issues led and 7th in dollar volume of such issues.Its participations in public sealed bidding issues tell a similar story.It commenced to take participations in the second triennial 1938-1940, notwithstanding certain opposition to the Eaton-Young-Stuart campaign for compulsory public sealed bidding, and occupied in successive triennials the rank of tie for 14th, 21st, 16th and 4th. In the last triennial, 1947-1949, it has, in underwriting participations of public sealed bidding issues, been exceeded in terms of dollar amount only by Halsey Stuart, First Boston and Kidder Peabody.
The Syndicate System
During the prolonged pretrial sessions, some of which were of a formal character, in the courtroom and reported, and many others, described as "powwows," were in chambers without the presence of a reporter, and during many months of the trial, the government position relative to the so-called price-fixing phase of the case was strictly in accordance with the charge as formulated in the complaint.No attack was made on the syndicate system as such, but the defendants were said to have abused the system in the course of the formation and operation of the over-all, integrated combination and conspiracy vis-a-vis the hundreds of other firms in the investment banking industry. This system, supposed to have been invented by defendants "and their predecessors" was claimed to be one of the terms of the conspiracy.The government's original position was made too clear for any possible misunderstanding in the course of the clarification process which took so much time and proved in the end so helpful to all concerned.
Thus the following colloquies took place:
"The Court: * * * You say as to such things as this so-called price-fixing arrangement, that these are illegal in and of themselves even if done by one group of underwriters in connection with a particular transaction.
"Mr. Baldridge: Yes, but we are not pressing that position here, your Honor. We are pressing our over-all charge of conspiracy among those who have been named defendants." And again, later:
"The Court: But let us look at it right straight in the eye. Suppose we come out of this and find there was no concert of action between these defendants at all, absolutely none, because that is what they have been contending. If there was no concert of action, no combination, no conspiracy, then I say the whole matter would fall and it would not be left for me to do what I was talking about earlier this morning, namely, find that separate contracts or separate specific underwritten negotiated issues by the syndicate method were illegal. That is right at the point, isn't it, Mr. Whitney?
"Mr. Whitney: Yes, sir.
"Mr. Baldridge: We are not asking for relief, your Honor, outside the over-all conspiracy.
"The Court: I guess that is enough.
"Mr. Baldridge: As I explained this morning, two or three pricefixes are illegal outside the conspiracy, but we are not pressing that.
"The Court: Well, I think we have had a very useful discussion about this matter. But I still would like to have the briefs, just so I can get my legal thinking straight on this matter."
This is what has been described during the trial as the government's first position on the subject of the syndicate system. In the meantime the various discussions and colloquies were making it plain that many of the 10,640 documents which had been, or were in the course of being, authenticated and printed for introduction in evidence as part of the government's case, showed a vigorous state of competition between the seventeen defendant firms and others as well. These documents had been selected out of hundreds of thousands of other documents examined by government investigators because each contained some phrase or clause upon which reliance was placed; and it had not been realized that the balance of many of the documents indicated that a particular defendant or sometimes several of them were doing the various things that government counsel were claiming they had combined and agreed not to do. And so the number of documents intended to be used was cut down by government counsel to about 4,000. As the trial progressed and document after document was placed in evidence it was apparent that government counsel were gradually disproving their own charges. This was especially clear after Harold L. Stuart had on cross-examination furnished the background which was essential to an understanding of the contents of many of the documents.
The result of all this was that finally government counsel attempted to accomplish what they had said in the beginning was not one of their contemplated objectives. Having assured me that the sole issue was the existence or non-existence of the over-all, integrated combination and conspiracy charged in the complaint, they entered upon a series of maneuvers, which, if successful, would have brought into the case two new and additional charges the effect of either of which, if sustained by me, would have been to outlaw many of the clauses customarily used in syndicate agreements by the entire investment banking industry, with the approval and cooperation of the SEC.
Thus it was claimed that the cross-examination by Arthur H. Dean of Harold L. Stuart was a consent, express or implied, to the inclusion in the case of "some other conspiracy" than that charged in the complaint, namely a conspiracy, not by the seventeen against all the rest of the investment banking firms, but one participated in by the industry as a whole. After due consideration, I rejected this contention, as it was clear to me that nothing could have been further from Mr. Dean's intention than any such broadening of the issues.
Then it was asserted that the issue had somehow been in the case all along despite government counsel's disclaimer. Again, after careful examination of the question and a study of the record, I expressed the view that the sole issue was that of the existence or non-existence of the over-all conspiracy.But I agreed to give the matter further consideration after all the government's proofs were in.I have done this, and now decide that the "some other conspiracy" is not before me. The subject will be discussed again in a subsequent portion of this opinion.
At last government counsel did what they should have done as soon as they decided to shift their ground and attack the syndicate system and the entire investment banking industry. It was well known that various clauses of underwriting and selling group agreements containing various types of clauses relative to the public offering price, resale price maintenance, withholding of commissions, uniform concessions and reallowances and stabilization were in common use throughout the industry; the SEC had held that the fixed-price method of issuing new securities gave no offense to the Sherman Act; and the entire process was inextricably interwoven into the texture of a long series of Acts of the Congress and the subject of numerous rules, regulations, releases and memoranda issued by the SEC. No wonder government counsel hesitated to take the responsibility of attempting to tear apart a system which seemed to the Congress and to the SEC to be of such utility to the American economy, and which was the result of over fifty years of gradual growth. But attack it they finally did.
Formal motion papers were served and an application made to amend the complaint. Passing over the intermediate formulations of the new charge, which were so vague as merely to add to the confusion, the motion in end result became one to add to the complaint the following new paragraphs:
"VIII. The Contracts in Restraint of Trade
"47. Since at least January 1, 1942 to date, each defendant has entered into, and threatens to continue to enter into, and unless enjoined by this Court will enter into, contracts with various investment bankers and security dealers in unreasonable restraint of the interstate commerce described in this complaint and in violation of Section 1 of the Sherman Act. These contracts are commonly referred to by defendants as 'Agreements among Underwriters', and 'Selling Agreements' or 'Dealer Offering Letters', and are those employed by defendants as syndicate managers in the merchandising of security issues. Each such contract continues in full force and effect for a stated period of time provided therein. Each purchaser under such a contract purchases, usually severally, a part of the security issue named in the contract and acquires title thereto.Each of these contracts contains, among other things, a fixed schedule of sale and resale prices for the securities named in the contract including
"(a) the public offering price applicable to all retail sales made to the public by members of the buying group or by the syndicate manager as agent for the members of the buying group or by members of the selling group;
"(b) the price applicable to sales made by members of the buying group, acting through the syndicate manager, to selected dealers who are included in the selling group;
"(c) the price applicable to sales made by members of the buying or selling groups, to dealers not members of the selling group.
"48. Each of the defendants, when a party to any of such contracts, has agreed for the period of time provided therein (a) to maintain the fixed schedule of prices, and (b) to authorize the syndicate manager to stabilize the price of the securities named in the contract by making purchases and sales of such securities in the open market or otherwise. Each of the defendants has frequently agreed in such contracts that if the syndicate manager shall so purchase any securities delivered to a member of the buying or selling group, the syndicate manager is authorized to withhold, or if already paid, to obtain the return of a sum of money calculated in accordance with the provisions of the contract as a penalty from such member.
"49. Each of the defendants, when acting as syndicate manager of a buying group or both a buying group and a selling group engaged in merchandising a security issue, has policed the price schedules contained in the contracts relating to that issue and has induced or attempted to induce the members of the buying and selling groups to adhere to the schedule."
After hearing extensive oral argument, studying the numerous memoranda submitted by counsel for various parties and deliberating on the matter for several weeks, I denied the motion.Thereafter counsel for the government urged me to reconsider the matter and I again took it under advisement, with the understanding that I would not decide it until all the government's proofs were in and I had the benefit of the connecting statements to be made pursuant to my Pretrial Order No. 3 and such briefs as might be submitted by counsel in support of and in opposition to the respective motions to dismiss at the end of the government's case.
Thus we come to a consideration of the government's first position.
I. Did the Seventeen Defendant Investment Banking Firms Use the Syndicate System as a Conspiratorial Device in Connection with Any Integrated Over-all Combination?
There are in evidence about 1,300 underwriting papers, colloquially referred to as "syndicate agreements." They cover a period of well upwards of thirty years, some of them much older, and they contain a great variety of provisions relative to price maintenance, the trading account or stabilization, withholding commissions (the so-called "penalty" clauses), uniform concessions and reallowances, authorizations to the manager to act for the group in such matters as group sales, dealer sales, syndicate and price termination, extension or price reduction and so on. I have spent many weeks studying these syndicate agreements and my conclusion, based on the evidence as a whole, is that, in the drafting and use of these agreements these defendant firms acted as separate entities and were motivated solely by normal, ordinary business considerations.These firms played their several parts, just as did other prominent and leading investment banking houses, in the evolution of the syndicate system as described in the preliminary portion of this opinion devoted to the history of the investment banking business. Different firms had different policies, and these are often reflected in the draftsmanship by some of the leading law firms, who sometimes entertained different views on questions of law. At times the forms of agreement used by a single firm on various occasions differ markedly one from another. There is a conspicuous lack of uniformity. Indeed, Morgan Stanley eliminated price maintenance clauses from its underwriting and selling agreements as long ago as 1938; it gave up selling agreements entirely in 1946; and its withholding commissions clause, for failure to place securities with investors, was for a time eliminated from its underwriting agreements and later restored. Price maintenance clauses were omitted from Harriman Ripley agreements in 1943. There is a bewildering variety of clauses used from time to time in their syndicate agreements by the other defendant firms.
Of course there is a certain fundamental similarity in those features which are characteristic of the system. In view of the evolution of the syndicate system over the years how could it be otherwise. The underwriters are formed into a group, broad powers are delegated to the manager, there are provisions for group and dealer sales and with respect to concessions, reallowances and so on.In a moment we shall find that all these similarities and others are reflected in the forms, registration statements, prospectuses and reports required by the SEC pursuant to the authority of the Congress.
But government counsel would have me believe that the very variety of the clauses used by the different defendant firms is some evidence of subtle connivance; that some changes were due to fear engendered by this or that investigation or by the filing of the brief in the PSI
case by the Antitrust Division of the Department of Justice attacking the single-price security offering as violative of the Sherman Act. Doubtless the filing of this brief attacking price maintenance clauses, stabilization clauses and the rest did cause a near-panic among some investment bankers, both defendants and non-defendants.And why not? It is not a very pleasant prospect for a business man, who thinks he has been complying with the law, and who has been following as best he can the directions of the Congress and the SEC, to find himself face to face with a possible indictment and the onerous expense connected with defending oneself against an antitrust charge.But the reaction of the different defendant firms to the filing of that brief was as various and sometimes as contradictory as could well be imagined.Some continued as before, some did not.Even Halsey, Stuart & Co. gave up using price maintenance clauses for a year or so and then came back to them because Stuart thought they could not do business without them.
Finally, I was asked to make a microscopic examination of a long series of clauses in a succession of Morgan Stanley agreements, which were supposed to demonstrate that the abandonment by Morgan Stanley of price maintenance clauses in 1938 was merely colorable. It will suffice to say that I find each and every one of these changes, and other changes made by Harriman Ripley and by other defendants, were made in good faith and for proper reasons, having nothing to do with any other investment banking house or any conspiracy or combination or any attempt at concealment or subterfuge.
The net result of this phase of the government's case is that these defendant firms used the syndicate system, just as did other investment banking houses so far as this record discloses, according to their several and separate views of what was thought by them to be suitable and helpful in connection with each security issue as it came along. There was with reference to the development and use of the syndicate system, no concert of action, no agreement and no conspiracy, integrated, over-all or otherwise.
II. Alternate Claims Belatedly Attempted to Be Asserted against the Investment Banking Industry as a Whole
The government's second position, concerning what government counsel have termed "some other conspiracy," not specifically alleged in the complaint but said to be vaguely included by implication or by conent, and its third position, stated in the papers supporting the motion to amend the complaint, involve alternative claims against the investment banking industry as a whole. In other words, in the event that it should be determined as matter of fact that no such combination or conspiracy as is alleged in the complaint ever existed, government counsel would have two new and additional strings to their bow.
Despite assurances that no attack was being made upon the syndicate system except insofar as it was abused by the operation of the alleged over-all, integrated conspiracy, government counsel ultimately decided, as above stated, that they would, if permitted to do so, ask for an adjudication that the provisions of syndicates relative to the public offering price, resale price maintenance, stabilization and withholding commission clauses, uniform concessions and reallowances, and termination periods for the life of syndicates or the continuance of price restrictions, were illegal per se under the Sherman Act. It needs no argument to demonstrate that these positions are diametrically opposed to the original claim that these seventeen defendant investment banking firms entered into a conspiracy and combination to keep "the cream of the business" for themselves and exclude the rest of the investment banking industry from participation therein.Moreover, there is nothing in the claim that counsel for certain of the defendants consented to the broadening of the issues by reason of his cross-examination of Harold L. Stuart. The evidence thus elicited had a direct bearing upon the history of the syndicate system and completely demolished the government claim that the syndicate system had been invented by defendants "and their predecessors" in or about 1915; other questions related to matters which constituted indispensable background material relative to the nature of the investment banking business. Even though counsel for some defendants at one time urged me to grant the motion to amend and thus broaden the issues and even to adjudicate concerning the "some other conspiracy," counsel for other defendants vigorously opposed the granting of the motion and insisted that the "some other conspiracy" was not an issue legitimately arising out of the state of the pleadings and the proofs. In the end counsel for all defendants aligned themselves in opposition to the inclusion of these two new groups of issues.
It is clear to me that neither of these matters is before me as of right. There are many reasons why, in the exercise of discretion, they should be kept out of the case. Indeed, under the circumstances of this case it might well be an abuse of discretion to treat these issues as justiciable herein and to decide them.
True it is that the questions involved are important to the investment banking industry as a whole; it is stated that these questions have never before been decided by any court; and much time and effort have been expended during this long trial in extensive and scholarly research, the submission of voluminous briefs and in prolonged and helpful argument by counsel.
Buy I question the wisdom of establishing a precedent which may add to the already too-heavy burden of expense resting upon defendants in a sprawling, circumstantial-evidence type of case such as the present one, by permitting the government to shift in mid-trial from one alleged conspiracy to a new and different one. The injustice of thus enlarging the issues in this case is especially manifest when one considers that much additional evidence would in all probability have to be received, despite protestations to the contrary by counsel for the government; and the setting of an integrated, over-all combination and conspiracy case, with its multiplicity of miscellaneous issues, does not seem to me to be an appropriate one in which to determine the legality of a specific underwriting or selling agreement made in connection with an issue of new securities by a particular issuer managed by one of the defendant firms. Indeed, the discussion of "specific agreements" is misleading, as the effect of the procedure urged upon me by government counsel would be to put together large numbers of agreements containing, and not containing, various types of clauses of the character above described, and, out of the general resulting admixture, try to reach some sort of determination of the legality of syndicate agreements in general. This would be highly prejudicial to the defendants.
As I said during the trial, in a colloquy with one of the government counsel:
"It seems to me you keep talking about specific price agreements, but what you are really talking about is a general fog in which hundreds of syndicate agreements, by different parties, over long periods of time, are all put in the pot together and stirred around, making a general stew; and out of such a mess as that I do not believe good law can reasonably be expected to come."
The most satisfactory way to arrive at definitive factual and legal conclusions, which could be tested on appeal and serve as precedents for others in similar circumstances, would be to bring before a court of competent jurisdiction the question of the legality under the Sherman Act of a single group of agreements relating to a specific security issue. In such a case there would necessarily be before the court evidence or appropriate offers of proof of all the attendant circumstances, such as the amount of the issue, the state of the market, the number and relative percentage positions of the underwriting participants, and the amount of their underwriting strength, the selling group or dealer arrangements and a host of other factors such as were considered in the PSI
case by the SEC. The period of completed or actual continuance of they syndicate agreement or maintenance of the public offering price may be too long; other provisions may, under the peculiar circumstances of a given situation, make the entire arrangement in a particular case unreasonable. It seems scarcely likely that such a case could continue to a conclusion, as here, without a single witness to testify to the facts surrounding the making of the syndicate agreements under attack. To proceed in the manner I have just suggested would avoid all the confusion inevitably attendant upon an attempt to decide these questions on a record such as we have in this case, which would furnish counsel for the government with a species of grab-bag out of which they could pick whichever type of clause suited the convenience of the moment as the discussion shifted this way and that. It is difficult for me to see how it would be "in furtherance of justice" to permit this to be done.
Added to all this is the fact that the bringing in of such new issues could hardly fail to prolong the trial, a circumstance of no mean moment in a case which has already covered a period of upwards of three years of trial and pretrial; and the result might be the burden and expense of an appeal which would otherwise not have been prosecuted. One must not be blind to the possibilities of oppression in these overly-long and unduly complicated antitrust cases.
Having in mind the possibility that I may have fallen into error in refusing to entertain and decide these new issues, it seems fitting that I should briefly set forth such views as I have on the subject of the validity of these syndicate agreements in general. The subject is a thorny one and not without a certain fascination. Literally months of my time before and after daily court sessions have been consumed in the study of its various aspects. The following discussion of the questions of law affecting the syndicate system in general, is by way of dictum.
To begin with, the history and development of the syndicate system as set forth in the preliminary portion of this opinion demonstrates that the modern syndicate system in general use today by the investment banking industry is nothing more nor less than a gradual, natural and normal growth or evolution by which an ancient form has been adapted to the needs of those engaged in raising capital. By no stretch of the imagination can it be considered a scheme or plan or device to which investment bankers have from time to time adhered. There is nothing conspiratorial about it; nor, on the record now before me, can these defendant firms or anyone fairly be said to have formed at any time any combination or conspiracy to operate under the syndicate system.
But the Sherman Act applies not alone to conspiracies and combinations but to "agreements" as well, and we are now concerned with written agreements and other contractual arrangements in connection with the underwriting and distribution of security issues. When such agreements contain price maintenance clauses binding on the underwriters, resale price maintenance clauses binding on the selling groups or selected dealers, stabilization and repurchase or withholding commissions clauses, specified and uniform concessions and reallowances and termination provisions of 15, 20 or 30 days, with some powers of extension, or change in the public offering price, under various conditions: do any of these clauses, or any combination of them, constitute per se violations of the Sherman Act?
The group of problems thus propounded suggests a number of pertinent preliminary questions: Has the rule of reason been abandoned to make way for a cliche or rubric to the effect that any agreement relative to price maintenance is taboo, irrespective of whether it fosters and promotes rather than restricts and restrains competition, irrespective of whether it is intended to or does or can affect general market prices, and irrespective of any and all other factors? If there remain some vestiges or at least the hard core or perhaps the integral whole of the rule of reason, should the courts inquire into the substance of the nexus of agreements and relationships as between the various parts of the underwriting and distributing team and the issuer, or look merely at the superficial and formal aspects of the transaction? If the Congress engaged in the elimination of harmful practices, after numerous and prolonged investigations passed a series of statutes into the terms of which the established procedures of investment bankers relative to the public offering price, stabilization and so on have been inextricably interwoven, thus indicating that the members of the Congress were implementing the operation of a system which they regarded as generally legal and proper, what weight should a court give to such attitude on the part of the Congress, in determining whether or not the practices thus implemented are violations of the Sherman Act, in view of the circumstance that no general exemption from the provisions of the Sherman Act is set forth in such legislation? And, finally, if the SEC, organized as an administrative body to supervise the functioning of these Acts of Congress, after careful deliberation and consideration of the views submitted both in writing and by oral argument by the Antitrust Division of the Department of Justice, filed a long and well considered opinion to the effect that the particular agreements in the case before it, which contained price maintenance clauses, resale price maintenance clauses, stabilization and "penalty" clauses and a long period of continuance of the syndicate, were in every respect legal and not per se or any other sort of violations of the Sherman Act, what weight should a court give to this pronouncement by the commissioners, who probably knew more about the practical workings of the syndicate system than any other public body?
Moreover, it is interesting to observe that no one will ever know the extent to which the machinery and apparatus of the syndicate system of today have been moulded into their present state, not merely by the provisions of the Securities and Banking Acts and the amendments thereto and State Blue Sky laws, but by informal conferences between investment bankers and their counsel on the one hand, and SEC, ICC, FPC and various state commissioners and members of their technical staffs on the other, and by the numerous published releases, suggestions and deficiency memoranda issued by one or another of these administrative bodies. No court can turn back the hand of time; and the plain unvarnished truth of the matter is that the intricate, highly sensitive and flexible syndicate system which now serves its purpose so well, is perhaps to a large extent the product of legislation by the Congress and administrative rulings by those functioning under the authority of the Congress. The eggs cannot now be unscrambled. And if they could, cui bono? We must not forget that the law is a living dynamic force at all times responsive to the needs of society, and not a mere game in the playing of which judges move about quotations from earlier cases as one would shift kings and queens on a chess-board.
A. The Rule of Reason
The law is full of perplexities which mystify lawyers and laymen alike. Much of the difficulty is caused by endless and at times futile discussion of decisions rendered in earlier cases, with liberal quotations from opinions intended to apply to particular situations. This in turn leads to discussion of other cases and further quotations and the making of distinctions and explanations. Much of the confusion, expecially in the field of antitrust law, is due to the fact that the breadth and scope of the Sherman Act are so general and so beneficent that lawyers and even judges often fail to heed repeated admonitions that each case must necessarily stand on its own legs, and that the conclusions reached in each depend largely upon the peculiar characteristics of the particular industry involved. That is why discussion of "loose-knit" and "close-knit", "vertical" and "horizontal" combinations, wholesale and retail "merchandizing", and "good intentions", the "elimination of trade abuses", "hardship" and so on is mere mumbo-jumbo which, far from leading to a solution of the questions of law involved, adds to the general confusion. Probably this is just anothr manifestation of how human nature works.Those of ripe experience in any craft rejoice in every opportunity to surround their skills with an air of mystery, by using an esoteric terminology; and lawyers who are specialists in patent, admiralty and antitrust cases are no exception to the general run of mankind.
In any event, plaintiff here relies especially upon general statements about price-fixing in the following cases: United States v. Trenton Potteries, 1927, 273 U.S. 392, 47 S. Ct. 377, 71 L. Ed. 700; United States v. Socony-Vacuum Oil Co., 1940, 310 U.S. 150, 60 S. Ct. 811, 84 L. Ed. 1129; United States v. National Association of Real Estate Boards, 1950, 339 U.S. 485, 70 S. Ct. 711, 94 L. Ed. 1007; Kiefer-Stewart Co. v. Joseph E. Seagram & Sons, 1951, 340 U.S. 211, 71 S. Ct. 259, 95 L. Ed. 219; United States v. Masonite Corp., 1942, 316 U.S. 265, 62 S. Ct. 1070, 86 L. Ed. 1461; Dr. Miles Medical Co. v. John D. Park & Sons Co., 1911, 220 U.S. 373, 31 S. Ct. 376, 55 L. Ed. 502; United States v. Bausch & Lomb Co., 1944, 321 U.S. 707, 64 S. Ct. 805, 88 L. Ed. 1024; and United States v. Paramount Pictures, 1948, 334 U.S. 131, 68 S. Ct. 915, 92 L. Ed. 1260. Many others are referred to in the oral arguments and briefs but these are the ones chiefly relied upon, and the others do no more than apply the same principles to differing sets of facts.
Defendants, on the other hand, quote extensively from: Board of Trade of City of Chicago v. United States, 1918, 246 U.S. 231, 38 S. Ct. 242, 62 L. Ed. 683; United States v. Columbia Steel Co., 1948, 334 U.S. 495, 68 S. Ct. 1107, 92 L. Ed. 1533; Appalachian Coals, Inc. v. United States, 1933, 288 U.S. 344, 53 S. Ct. 471, 77 L. Ed. 825; Prairie Farmer Pub. Co. v. Indiana Farmer's Guide Pbu. Co., 7 Cir., 1937, 88 F.2d 979, certiorari denied, 301 U.S. 696, 57 S. Ct. 925, 81 L. Ed. 1351, rehearing denied, 302 U.S. 773, 58 S. Ct. 5, 82 L. Ed. 599; United States v. New York Coffee and Sugar Exchange, Inc., 1924, 263 U.S 611, 44 S. Ct. 225, 68 L. Ed. 475, and many others, including most or all of those relied on by the government.
I can find nothing in any of these cases which would permit me to conclude that the rule of reason has been abandoned or discarded. Moreover, the basic principles of the Chicago Board of Trade and the Appalachian Coals cases have never been repudiated. Indeed, these cases have been cited by the Supreme Court again and again over the years.
My own opinion is that the situation before me now is sui generis -- none of the cases cited by either side is precisely applicable.Despite all the general condemnation of price-fixing, I find nothing in any of these cases which can be regarded as controlling precedent here or which binds me to hold the clauses of these syndicate agreements now under attack to be illegal per se under the Sherman Act.
We may accordingly, by an original and independent process, apply the rule of reason to the general methods used by the investment banking industry in making an orderly distribution or placement of a new issue of securities on behalf of an issuer.
That the underwriters and the members of the selling group or selected dealers have a certain practical relationship with the issuer, and form a team and act together under the supervision of the manager, is not disputed. Each performs his function or functions in an integrated, unitary transaction. They have a common purpose, they work together toward it, using jointly the efforts, reputation, and experience of all; and their community of endeavor has a value in the practical world which negates any possible inference that their association is a mere cloak for an agreement to fix prices in restraint of trade.
Those who participate as underwriters or dealers are in no sense competitors. When we speak of competitors nothing but confusion will follow unless we first determine what is the "it" for which the competitors are supposed to be competing. Perhaps a few months before the issue under discussion some of the participants were engaged in the underwriting and distribution of a quite different issue of securities, and others of another. But that can have nothing to do with the issue we are talking about. If, as is certainly the case, these participants and dealers are banded together in the enterprise of underwriting and distributing a particular issue, then by very definition they cannot be competitors. The necessary relation that each bears to the issuer makes it clear that they do not and cannot enter the syndicate as competitors, despite the fact that occasionally representatives or agents of one or two of the firms in the team may try to sell the bonds or stocks to the same customer. As SEC Commissioner Robert S. Healey wrote in the PSI
case, which will be more fully discussed later: "Having combined, it was proper for each quasi-partner to agree not to cut his other partners' throat."
The utility and reasonableness of the entire operation, and the fact that functionally it serves a legitimate business and trade-promoting purpose, is amply demonstrated by its unchallenged growth by a gradual process of evolution over a period of a half-century, more or less.
Furthermore, the syndicate system has no effect whatever on general market prices, nor do the participating underwriters and dealers intend it to have any. On the contrary, it is the general market prices of securities of comparable rating and quality which control the public offering price, as explained in the preliminary part of this opinion. Whether by bringing out one issue or many, none of these defendants nor any group of them acting together have ever, so far as appears in this record, been so foolhardy as to attempt to control or in any manner affect general price levels in the securities market. The particular issue, even if a large one, is but an infinitesimal unit of trade in the ocean of security issues running into the billions, which constitutes the general market.
According to plaintiff's claim, the purchase of a security issue from an issuer and its distribution to the public via underwriters and dealers is just the old story of a purchase and resale of commodities or a manufacturer's product with the well-worn scheme of price restrictions all down the line. But is it? In reality the investor either lends money to the issuer, if the issue consists of bonds or debentures, or he makes a continuing investment in the issuer's capital, if the issue is preferred or common stock. The document in the form of a bond or stock certificate, which is "sold" and delivered to the investor, is merely evidence of a relationship which is created, and the relationship survives loss or destruction of the document.
Of even greater significance are the basic underlying characteristics of the relationship between the issuer, the investor and the group of underwriters and dealers, who together serve the issuer in making the single, entire, unitary transaction possible by shaping up the issue, underwriting the risk and planning and carrying out the distribution. Purchases and sales, wholesaling and retailing, of commodities and manufactured products provide no parallel even remotely resembling the complicated and unitary group action necessary to the successful underwriting and distribution of a new and unseasoned security issue.
Defendants advance two arguments on the facts:
(1) "That the function of the investment banker in the capital funds market is not merely to buy and sell as a trader or wholesaler, but to furnish integrated investment banking services to the issuer who is seeking expert assistance in raising capital by a security issue flotation"; and
(2) "that the underwriting syndicate is an ad hoc common enterprise, limited in number of participants, in purpose, and in duration; and it is a reasonable business combination having the purpose and effect of efficiently promoting, rather than restraining, trade."
I agree with both of these contentions, which are amply sustained by the evidence, and I make findings of fact accordingly.
Against this factual background of substance, such a purely fortuitous and incidental feature as the taking of title by the underwriters in severalty, as they now do, because of the changes in the law relative to general liability for material errors in registration statements, and in the amount and incidence of the tax on transfers, as explained in the preliminary part of this opinion on the history of the investment banking business, cannot possibly be controlling. To make it so would indeed make the law an ass. Nor does it make sense to separate the underwriting participants from the selected dealers as one might separate the sheep from the goats, simply because of the formal transfer of title from one to the other. It is axiomatic under the Sherman Act that matters of form must always be subordinated to matters of substance. Basically the underwriting participants and the dealers who constitute the selling group are in the same boat together, pulling in unison toward the same mark.
It matters not whether the members of the team be called "partners," "quasipartners," "joint adventurers" or what not; the significant fact vis-a-vis the Sherman Act is tht they are acting together in a single, integrated, unitary, cooperative enterprise, the purpose of which is not "raising, fixing, pegging, or stabilizing the price" of anything, nor the exercise of any manner of control over general market prices, but solely the distribution of a new security issue in an orderly manner.
It is for these reasons that the classic words of Justice Brandeis in the Chicago Board of Trade case have such pertinency. He wrote:
"But the legality of an agreement or regulation cannot be determined by so simple a test, as whether it restrains competition. Every agreement concerning trade, every regulation of trade, restrains. To bind, to restrain, is of their very essence. The true test of legality is whether the restraint imposed is such as merely regulates and perhaps thereby promotes competition or whether it is such as may suppress or even destroy competition. To determine that question the court must ordinarily consider the facts peculiar to the business to which the restraint is applied; its condition before and after the restraint was imposed; the nature of the restraint and its effect, actual or probable."
The application of the rule of reason in accordance with this simple, fundamental formula does not leave the outcome in doubt on the facts we have before us here. It is upon the basis of these facts, peculiar to the business of raising new capital for issuers, whether by syndicates of underwriters proceeding in negotiated transactions or by public sealed bidding, that the Congress and the SEC evidently arrived at the same conclusion that I arrive at, namely, that the fixed-price type of public offering of new securities viewed in the large, and on the basis of methods now in common use by the investment banking industry, gives no offense to the Sherman Act.
But this is not to say that there may not some day come before the courts a series of underwriting agreements relating to some specific issue of securities in the future which, by virtue of the contemplated or actual period of continuance of price restrictions or the number and underwriting strength of the participants or the existence of other factors or attendant circumstances which we cannot now know, will warrant the courts in making findings of fact from which the conclusion of law will inevitably follow that such agreements are illegal under the Sherman Act. Nor do I say that there has never been any such in the past.
B. The Securities Act of 1933, the Securities Exchange Act of 1934, and the Amendments Thereto; the Rules, Interpretations and Releases of the SEC Thereunder; and the Organization and Functioning of the NASD
I shall not labor the point that the Securities Act of 1933, the Securities Exchange Act of 1934, and the various amendments thereto, including the Maloney Act authorizing the organization and functioning of the NASD in 1938 by adding Section 15A to the 1934 Act, are to be read together as one comprehensive scheme of regulation.Despite the vigorous and oft repeated claims to the contrary by government counsel, I find literally nothing of substance to support the view that the two statutes form separate, air-tight compartments, the 1933 Act applicable to new securities and the 1934 Act to those already issued and outstanding. The textual evidence that the two are to be read together seems in itself conclusive on the point;
and there would appear to be no reason to doubt that the Congress intended this interrelated pattern of regulation to reach all transactions whether on national exchanges or on the over-the-counter securities market. This is the view taken by the SEC; and a contrary view flies in the face of common sense and the objectives of the Congress in formulating and drafting this legislation.
The Securities Act of 1933 recognizes syndicates as a group means of distributing new securities.
Sec. 2(11) "The term 'underwriter' means any person who has purchased from an issuer with a view to, or sells for an issuer in connection with, the distribution of any security, or participates or has a direct or indirect participation in any such undertaking, or participates or has a participation in the direct or indirect underwriting of any such undertaking; but such term shall not include a person whose interest is limited to a commission from an underwriter or dealer not in excess of the usual and customary distributors' or sellers' commission. * * *"
The disclosures required by the 1933 Act are to be incorporated in the registration statement, and no sales or offers to sell are permitted until the registration statement becomes effective, which is "the twentieth day after the filing thereof", 15 U.S.C.A. § 77h(a), with certain allowances for acceleration, which become applicable, for example, when the issuer files a so-called "price amendment" just before the issue comes out.
Sec. 6(a) provides: "A registration statement shall be deemed effective only as to the securities specified therein as proposed to be offered."
Sec. 7 requires the inclusion in the registration statement of information specified in Schedule A, of which subdivision (16) reads:
"(16) the price at which it is proposed that the security shall be offered to the public or the method by which such price is computed and any variation therefrom at which any portion of such security is proposed to be offered to any persons or classes of persons, other than the underwriters, naming them or specifying the class. * * *" 15 U.S.C.A. § 77aa.
Rule 460 of the SEC also requires, within ten days after the security is initially offered to the public, a report on the actual offering price, and an explanation of any variation between the actual price and the proposed public offering price.
Especially in view of the words "any portion" contained in subdivision (16) of Schedule A, the clause "the price at which it is proposed that the security shall be offered to the public" must mean the entire issue. And, if so, the Congress has made specific provision for the fixed-price public offering of a new security issue, in accordance with the mode of floating such issues customarily used by investment bankers for many years. The intent is that the public shall know precisely what it is expected to pay for the security.
Many other provisions of the 1933 Act, and numerous rules and regulations of the SEC, are integrated with this basic clause in subdivision (16) of Schedule A, which is applicable to negotiated underwritten issues, and underwritten public sealed bidding transactions as well, in the field of security issues with which we are concerned in this case. Thus Sec. 6(b) requires the payment of a fee at the time of filing the registration statement "of one one-hundredth of 1 per centum of the maximum aggregate price at which such securities are proposed to be offered". Sec. 11, relative to civil liabilities for material errors or omissions in registration statements, according to the 1934 amendment discussed in the preliminary part of this opinion, is measured as to underwriters by "the total price at which the securities underwritten by him and distributed to the public were offered to the public."
The SEC's Form S-1 requires that the following information be set forth in substantially the following tabular form on the first page of the prospectus:
Price to discounts and Proceeds to
public commissions registrant
This is in accordance with Schedule A (15), (16) and (17) and Sec. 10(a) (1).
The SEC has ruled that these requirements as to "the price at which it is proposed that the security shall be offered to the public" are not complied with unless there is made "bona fide attempt for a reasonable time to distribute the security at no more than such public offering price." This appears in Exchange Act Release No. 3807, April 16, 1946, which criticizes "free riders", who attempt to treat their allotments of securities in the distribution as their own unrestricted property, by holding them for a rise in the market.
That a bona fide public offering of the entire issue at the public offering price is required to be made within a reasonable time is recognized throughout the industry according to Harold L. Stuart. While this may seem to leave the matter somewhat to the conscience of those making the distribution, it is clear that a substantial and genuine effort must be made and anything short of such is apt to get the participating underwriter or dealer, who makes a purely perfunctory and colorable effort, in trouble with the NASD and the SEC.
By express statutory provision, Securities Exchange Act of 1934, Section 15A(n), the Rules of Fair Practice of the NASD are, when approved by the SEC, exempt from the application of the antitrust laws, if in conflict.This is not disputed.
The Board of Governors and the Advisory Council of the NASD have interpreted Rule 1
of Article III of the Rules of Fair Practice as requiring that (NASD Circular, March 13, 1950):
"Members have a moral obligation to make a bona fide public offering of securities acquired in a participation in an initial public offering."
And, fo the purposes of this interpretation the NASD states that:
"* * * the term 'initial public offering' or 'period of original distribution' in intended to mean a sufficient period within which a bona fide public offering can be and has been made to the investing public, and investors have had an opportunity to purchase the issue at the initial public offering price."
While it does not appear that these interpretations have been passed upon by the SEC, they reflect the only meaning that can be reasonably attributed to the statutory language adopted by the Congress. Otherwise, "the price at which it is proposed that the security shall be offered to the public" has no practical meaning whatever.
On this point, as on so many others, the views of counsel for the government have changed radically as the trial progressed. At first they supported a species of "flash" theory, to the effect that there must be a period during which at least a portion of the security issue could be purchased at the public offering price by an investor, but that this period was a merely theoretical or instantaneous one and that no real offers or purchases need be made. When this fantastic view seemed to be pressing the matter too far, counsel receded to the position which as I understand it they take now, namely, that a bona fide attempt, for a reasonable time, to distribute the entire issue must be made, but that the syndicate clauses providing for 15, 20 or 30 days life to a syndicate or to price maintenance are illegal as not being necessarily measured in terms of "a reasonable time". This would seem to take the entire matter out of the category of per se violations of the Sherman Act. Moreover, the government has offered no evidence to show that the prescribed period was in any particular instance in any way unreasonable.
One of the embarrassments under which counsel for the government have been laboring is that they insist that the provisions of the various Acts of Congress, and the various rulings of the SEC in administering these Acts, are in every way lawful and in strict accordance with the letter and spirit of the Sherman Act, whilst at the same time declaring that the basic clauses of the syndicate system constitute per se violations of the Sherman Act. The plain truth of the matter is that the legal questions now under discussion form an area of head-on collision between the SEC on the one hand and the Antitrust Division of the Department of Justice on the other.
We pause for an additional bit of practical background before proceeding to discuss stabilization and uniform concessions and reallowances, and clauses requiring repurchase or loss of commissions for failure to place the securities with investors rather than speculators, traders or "free riders".
In the case of most security issues the public offering price has been established so expertly that the issue is readily absorbed by the investing public at the public offering price.In such cases the statement in bold-face type in the prospectus, required by SEC Rule 426 under the 1933 Act, that stabilization activities may be employed to facilitate the offering of the securities, is commonly used, but means little, even though supplemented by the placing by the manager of an open bid in the market at the public offering price. Where the issue has been priced too low, both the SEC and the NASD require a bona fide offer of the entire issue at the public offering price; and a prompt distribution is inevitable as dealers and underwriters are not allowed to put the securities on their shelves for sale later at prices above the public offering price.Where the issue has been priced too high, however, or where war or the happening of some other catastrophe sends general market prices down, what actually happens? According to the record before me, if the dip in the market is of a minor character or if the issue, while well worth the public offering price in sound value, is for some reason not appealing at the moment, stabilization may help to tide over for a short interval the difficulty of placing a large issue with investors, under not particularly favorable circumstances.
But if there is a general market recession, or the issue has really been priced too high, no sensible manager would waste the funds of the syndicate by pouring them down a stabilization "rathole"; and the syndicate would be promptly terminated or the price lowered or the price restrictions removed entirely, in which event the underwriting participants and the dealers would be free to do whatever they wished with the securities they had taken down. Some might prefer to put the securities "on the shelf"; others might sell them for what they could get. In other words, stabilizing, as thus far sanctioned by the SEC in connection with new security issues, has had nothing to do with price fixing in the sense of the Sherman Act cases, but only as a means of assisting in the placement distribution of such issues in an orderly way. If the stabilization powers were used by way of manipulation in order to raise or fix prices or do anything other than to facilitate an orderly placement of the securities, ther is ample reason to suppose that the SEC, pursuant to its undoubted statutory powers on the subject, would promptly issue a new rule or regulation putting a stop to such manipulation.
After these preliminaries we come to the question of what are the provisions of the statute relative to stabilization?
The long and short of the matter is that the Congress decided not to prohibit such activities, or to include any specific statutory regulation thereof, but left it to the SEC to prescribe appropriate rules and regulations.
The Senate Committee Report of April 17, 1934, reporting on the bill of which Title I became the 1934 Act and Title II the most important amendments yet made to the 1933 Act (No. 792, 73d Cong., 2d Sess., 1934, pp. 8-9) states:
"The impropriety of practices such as 'pegging', or fixing or stabilizing the price of a security has received most careful consideration by the committee. The committee recommends that such practices be not abolished by statute but subjected to regulation by the Commission."
In similar fashion House Report No. 1383 of April 27, 1934, on the same bill, states (p. 10):
"The evidence [as developed by the Senate Committee on Banking and Currency] as to the value of pegging and stabilizing operations, particularly in relation to new issues, is far from conclusive. While abuses are undoubtedly associated with such manipulation, because of the desire of the committee to proceed cautiously such operations have not been forbidden altogether, but have been subjected to such control as the administrative commission may find necessary in the public interest or for the protection of investors."
And (at p. 21):
"Many experts are of the opinion that the artificial stabilization of a security at a given price serves no useful economic function. On the other hand the practice has been widespread on the part of many investment bankers who regard it legitimate, particularly if the public is aware of the plan. Instead of being prohibited, therefore, this practice is left to such regulation by the Commission as it may deem necessary for the prevention of activities detrimental to the interests of investors."
And that is precisely what the Congress proceeded to do by the provisions of Sec. 9(a) (6), which relates to "pegging, fixing, or stabilizing the price" of any listed security. This subdivision of Sec. 9 is not self-operating but contemplates implementation through Commission rules and regulations.
Thus Sec. 9(a) (6) makes it unlawful:
"To effect either alone or with one or more other persons any series of transactions for the purchase and/or sale of any security registered on a national securities exchange for the purpose of pegging, fixing, or stabilizing the price of such security in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors."
And this is supplemented by Sec. 10, relative to manipulative and deceptive devices employed in connection with the purchase or sale, not only of any security registered on a national securities exchange but also of "any security not so registered". So that these sections, together with Sec. 17 of the 1933 Act and Sec. 15(c) (1) of the 1934 Act, added by amendment in 1936, cover every possible loophole and have the general effect of providing that stabilization, a well-known species of manipulation, should not be outlawed but should be subject to such rules and regulations as might be formulated by the SEC.
The language of these various sections is, by reason of the subject matter, technical; but the intent is plain. No distinction is or should be made between securities already outstanding and those currently issued. The scheme of regulation is made broad and general as well as flexible; it includes listed and unlisted securities, those traded on national exchanges and those dealt with in the over-the-counter market. Any other interpretation would be contrary to the whole spirit of the statutory scheme and to the expressions found in the Senate and House Reports above referred to.
The integration of the 1933 Act and the 1934 Act relative to stabilization is reflected in various rules and regulations of the SEC.
Thus, pursuant to authority found in Sec. 17 of the 1933 Act, the SEC adopted Rule 426 (formerly Rule 827) requiring a statement in bold face type "either on the outside front cover page or on the inside front cover page of the prospectus", if "any of the underwriters knows or has reasonable grounds to believe that the price of any security may be stabilized to facilitate the offering * * *." And Rule X-10B-5, issued under Sec. 10(b) of the 1934 Act, and applicable alike to newly issued and already outstanding securities, significantly uses in effect the substantive language of Sec. 17(a) of the 1933 Act.Cf. Rule X-15C1-2; and Items 23(a) and (b) of Form S-1, under the 1933 Act, which require disclosure in the registration statement of prospective stabilizing activities.
Rule X-17A-2 requires that full information be filed with the SEC with respect to all purchases and sales of a security being stabilized by "the manager of the stabilizing syndicate." (Exchange Act Release No. 2008.) See also Form X-9A6-1, relative to the giving of notice of intention to stabilize.
It would serve no useful purpose to discuss in greater detail the various releases issued by the SEC on this subject. Suffice it to say that there is ample evidence of a belief on the part of the SEC that it has the power to promulgate, whenever in its judgment it is necessary or expedient to do so, "in the public interest or for the protection of investors," such rules and regulations concerning the stabilization of new issues of securities as circumstances may require, or even to prohibit such stabilization entirely. (See especially pp. 22-3, 41, of the SEC opinion in the PSI
case, Securities Exchange Act Release No. 3700, quoting from Securities Exchange Act Release No. 2446 and commenting there on.) The fact that it has not done so is perhaps to some extent due to the organization and functioning of the NASD, pursuant to the terms of the Maloney Act, and to the fact that the thousands of reports already on file relative to such stabilizing activities indicate that no such rules or regulations are as yet, in the judgment of the SEC, necessary or desirable. Cf. SEC "Statement" of March 18, 1940; Barrett & Co., 1941, 9 S.E.C. 319, 328; Masland Fernon and Anderson, 1941, 9 S.E.C. 338, 345, 347.
Turning to clauses for repurchase or withholding of commissions, the so-called "penalty clauses", it will be found that such clauses are entirely consistent with SEC registration requirements. That these clauses serve the purpose of orderly distribution and are intended, and often expressly stated, to be applicable where the securities have "not been effectively placed for investment", is reflected in Item 23(c) of Form S-1, the general form for registration of securities under the 1933 Act, which requires a statement concerning any arrangement for "withholding commissions, or otherwise to hold each underwriter or dealer responsible for the distribution of his participation."
In view of what has already been said, it would not seem to be necessary to comment on the uniform selling concessions, discounts and reallowances, except to point out that, in discussing Schedule A(16) and (17) of the 1933 Act the opinion of the SEC in the PSI
"Clearly the fixing of an offering price to the public, and an agreement or understanding as to fixed commissions or discounts, are contemplated by the Securities Act."
The fundamental problem would seem to be the same whether viewed with relation to general uniform price offerings or with relation to uniform concessions, discounts and reallowances.
Do the provisions of the Act of 1933 and the Act of 1934 (except the Maloney Act) amount to an implied exemption, in whole or in part, from the provisions of the Sherman Act? In my opinion they do not.Where it was thought desirable and necessary to do so the Congress made specific provision for such exemption, as in Sec. 15a(n) of the Maloney Amendment to the 1934 Act, where it was thought that the Rules of Fair Practice of the NASD might run afoul of the Sherman Act.
It must be borne in mind that this whole statutory scheme was worked out with the greatest care by members of the Congress thoroughly aware of antitrust problems, often in close contact and cooperation with those who were later to administer the intricate phases of this well articulated and comprehensive plan of regulation of the securities business, and in possession of the fruits of many prolonged and penetrating investigations. They intended no exemption to the Sherman Act; and it is hardly probable that they would inadvertently accomplish such a result. The real point is that all those who worked together on the formulation of this most significant and beneficial legislation went about their task of integrating into the statutoiry pattern the current modes of bringing out new security issues then in common use by investment bankers generally, with complete assurance that no violation of the Sherman Act was even remotely involved.This recognition by the Congress of the legality and utility to the American economy of the general features of the syndicate system cannot lightly be disregarded by any court or judge.
That the so-called Reece Bills, the first of which was introduced in the House on August 22, 1944 (H.R. 5233, 78th Cong., 2d Sess.), shortly after the filing by the Antitrust Division of its brief in the PSI case on February 10, 1944, never came out of committee need cause no surprise.
These Bills were an ill-considered attempt to legalize certain features of the uniform-price offerings of new securities generally, without reference to the attendant circumstances of their use in particular cases, and had little merit. If passed by the Congress the effect could not have been otherwise than to muddy the waters.
C. The Opinion of the SEC in the Public Service Company of Indiana Case
Rule 1 of the Rules of Fair Practice of the NASD, approved by the SEC, provides:
"A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade."
On December 7, 1939, under the management of Halsey Stuart, there was placed on the market an issue of $38,000,000 of First Mortgage 4% Bonds of Public Service Company of Indiana. There were 67 underwriters and 396 selected dealers. The Agreement Among Underwriters and the Selling Agreement contained price maintenance, "penalty", stabilization, uniform concession and reallowance, and other clauses, such as have been attacked here as illegal per se under the Sherman Act. Title to the bonds was taken by the underwriters in severalty and the selected dealers similarly took title to the bonds for which they subscribed and which they took down. The Selling Agreement provided that it would terminate at the close of business on February 7, 1940, but that Halsey Stuart might extend it for not more than 60 days, or terminate it, whether or not extended, without notice. The Agreement Among Underwriters was to terminate 30 days after the termination of the Selling Agreement, except tht it could be extended by Halsey Stuart upon the consent of underwriters who had agreed to buy an aggregate of more than 50% of the bonds, and except that Halsey Stuart could terminate the agreement any day after the date of settlement with the issuer, without notice, whether or not extended.
The issue was "sticky" and there were numerous breaches of the price maintenance provisions of the agreements, both by underwriters and by members of the selling group. Distribution was not substantially completed until March 18, 1940, at which date Halsey Stuart terminated the Selling Agreement. It will be recalled that the invasion of Poland began on September 1, 1939.
Disciplinary action by the NASD for alleged violation of Rule 1 resulted in the imposition of a number of fines on the offending members of the NASD; and in the course of time the proceedings resulting in such disciplinary action came on for review in the SEC under Sec. 15A(n) of the 1934 Act as amended.
WE need not concern ourselves with the elaborate arguments advanced by the parties on the question of whether or not the NASD had power to impose the fines. Suffice it to say that a majority of the SEC found that such action was not warranted and the orders imposing the fines were reversed. But, in the meantime, and at the close of the hearings before the trial examiner, the Antitrust Division of the Department of Justice intervened and, on February 10, 1944, filed a brief attacking the various clauses of the agreements above referred to as per se violations of the Sherman Act. The same position was taken by counsel for the Trading and Exchange Division of the SEC. The filing of the brief by the Antitrust Division fell like a bombshell on the investment banking industry.
The antitrust issue thus raised was given the most careful and exhaustive examination. Having been requested by the Antitrust Division to pass on the legal and factual questions involved, the SEC did so; and illuminating and wellreasoned opinions resulted. Chairman Purcell and Commissioners Pike and Healy agreed that there was no per se violation of the Sherman Act. The concurring opinion of Commissioner McConnaughey does not discuss the merits of the antitrust issue, but there is no indication of disagreement with the other Commissioners thereon.Commissioner Healy agreed with the Chairman and Commissioner Pike on the antitrust phase of the case but thought the NASD had properly interpreted its Rule 1. Much of the factual material in the opinions relating to the history and development of the syndicate system was verified and authenticated by Harold L. Stuart on his cross-examination, and forms a substantial basis for part of the preliminary portion of this opinion. My only disagreement with the SEC is on the subject of implied exemption of stabilizing transactions from the provisions of the Sherman Act. The opinion concurred in by Chairman Purcell and Commissioner Pike appears to consider the various statutory provisions relative to stabilization, which have been discussed supra, as having "removed that problem from the scope of the Sherman Act." Counsel for Morgan Stanley and Harriman Ripley agree with the Commission on this point. I do not.
It will serve no useful purpose to set forth quotations from what the SEC has written on the antitrust questions thus placed before it. The general conclusion, with which I am in complete agreement, is:
"Our views on the application of the antitrust laws to the securities field may be summarized as follows: the mere making of agreements containing provisions for a fixed offering price, price maintenance and stabilization is not per se unlawful. But, like many other contracts, these may be entered into and performed under circumstances that amount to an unlawful suppression of competition."
These views are not binding upon me, or upon any other court or judge; but they are persuasive and helpful, especially as they are those of public officials of ripe experience in dealing with this very subject matter from day to day. Moreover, the very commissioners who expressed these views had been in close cooperation with the members of the Congress who formulated the terms of some of the statutory provisions under consideration. After all, these antitrust problems are largely factual and their true solution depends in the last analysis upon an intimate familiarity with the characteristic features of the particular industry in which these problems arise.
Some Interim Observations
Before leaving the syndicate system and the general subject of the history and development of the investment banking business, it will perhaps be helpful to consider, in a preliminary and tentative fashion, the bearing of such matters upon the charge of an integrated, over-all conspiracy and concert of action between these 17 defendant investment banking firms. If, on the important and fundamental phase of the case which has just been examined, there was no joint action nor any combination by the seventeen acting as a group, lack of such concerted action among them may likewise appear in other phases of the case as well. The process of reasoning by which the use of the syndicate system, the opposition to the campaign for compulsory public sealed bidding, the alleged "Pink" agreement, the so-called infiltration of boards of directors of issuers and a host of other minor issues were brought in to support the "triple concept" charge of "traditional banker", "historical position" and "reciprocity" was that only in such fashion could the alleged conspiracy be proved.there is must to be said in support of this reasongin; but the converse of it is euqlly sound. As each of these several props to the government charge is disproven and thus eliminated, the structure as a whole finds less and less support. The principal factual issue in the case from first to last has been whether or not there was any joint action, combination or conspiracy as between the seventeen defendant firms.
It was only after the connecting statements and oral arguments at the close of plaintiff's case, and after some months of study of the evidence as a whole, that I at last came fully to appreciate why government counsel, and defense counsel as well, had so earnsetly insisted that all the principal phases of the charge must be taken into consideration. At first it seemed to me that the "triple concept" charge could well have been thoroughly examined and the rest eliminated or greatly reduced in scope. But as I proceeded to study the mass of detail it became more and more apparent that counsel for the government had perhaps taken the only course open to them. The basic facts about "reciprocity" and "historical position" were such that it might well in the end be clear that the "traditional banker" part of the "triple concept" could scarcely stand up in isolation and without substantial support from the balance of the alleged conspiratorial scheme. In the final analysis, it might come down factually to one of two possibilities: either the all pervasive, integrated, over-all conspiracy existed or there was no conspiracy at all. Differently expressed, one might be forced by the facts of the case to the conclusion that nothing short of the entire scheme as charged, with its theoretically perfect articulation and symmetry, could have been expected by hard-headed and experienced business men in their sound minds, to have had even the slightest hope of success. In a circumstantial evidence case there must always be the possibility of a negative as well as of a positive answer.
It now appears that counsel for the government have been led astray in connection with their claims relative to the syndicate system by a fundamental factual misconception of the way investment bankers in general function and have functioned for many years. It will soon appear that this same misconception of the basic facts runs through the entire case. The problem of elucidating this mass of evidence and doing so in such fashion as to hold up to view from time to time the framework constructed in the complaint is not easy of solution. It must be constantly kept in mind that we are dealing with a multiplicity of alleged restraints all supposed to be cunningly devised and fitted together by these defendants.
It would put the whole case out of focus and perspective if I proceeded to discuss the "triple concept" of "traditional banker", "historical position" and "reciprocity" without first reviewing the evidence which it is claimed demonstrates that, in other ways, the seventeen defendant investment banking firms combined and conspired together to dominate and control the financial affairs of issuers, so that new issues of the securities of such issuers should be brought out by the negotiated underwritten method in connection with which the "triple concept" could operate, and then be parceled out to the conspiratorial "traditional bankers". For, if issuers were free agents, they could always turn to any one or more of the dozens of other competent and wellequipped investment bankers, said to be eager to get the business but unable to do so because of the operation of the combination and conspiracy of the seventeen. Private placements and agency transactions were always available, too.The fact that certain of the leading firms had, as is alleged, agreed not to compete for business against their coconspirators who were "traditional bankers", would not bind such other leading firms as Halsey Stuart, Merrill Lynch Pierce Fenner & Beane, Salomon Bros. & Hutzler, Lazard Freres, Paine Webber Jackson & Curtis and many others who were admittedly not in the alleged combination or conspiracy. Not amount of judicious parcelling out of occasional participations to these socalled independent firms would suffice to induce them to refrain from competing for the much more lucrative managerships, which carried so much kudos, and were concededly coveted by all investment bankers so staffed as to be able to handle the business. In the absence of substantial domination and control of issuers, as alleged, the "tripe concept" charge may come down to mere dialectics.
Did the Seventeen Defendant Investment Banking Firms Combine for the Purpose of Dominating and Controlling and Did They in Fact Dominate and Control the Financial Affairs of Issuers by Directorships and Solicitation of Proxies?
As with so many other phases of the case the government charge of domination and control of issuers by the 17 defendant firms acting in concert underwent a very considerable shrinking process as the trial proceeded; and substantially all that remained at the close of the case was the "red flag" or "signpost" claim, supplemented by a certain amount of fragmentary material relating to the possible use of confindential information by one or two of the defendant firms and a showing that at times a director who was a partner, officer or employee of one of the defendant firms withdrew from the meeting when the issue was voted on or otherwise showed consciousness of the inconsistency between his position as a director and his interest arising out of the profit his firm might make out of the transaction, and other miscellanea all of which have been carefully considered, but which require no discussion other than as stated herein.
The charge in the complaint as amended is comprehensive and explicit. Paragraph 44 alleges:
"44. The conspiracy has consisted of a continuing agreement and concert of action among the defendants, the substantial terms of which have been that defendants:
* * * * * *
"E. Agree to influence and control the management and financial activities of issuers, among other means --
"(1) By severally securing the appointment or election of directors, officers and members of protective committees, of issuers who, in addition to the performance of their duties, as such, would promote the interests of securing further underwriting business for each of the several defendant banking firms.
"(2) By causing the voting power of large blocks of stock held by investment trusts and others in security issuing companies to be exercised in the interests of securing further underwriting business for the defendant banking firms.
"(3) By inducing and utilizing friendly or allied stockholders of issuers, commercial banks, and other financial institutions serving the financial needs of issuers to influence such issuers to favor defendant banking firms in the sale of security issues.
This is supplemented by the following paragraph.
"45. During the period of time covered by this complaint, and for the purpose of forming and effectuating the conspiracy, the defendants, by agreement and concert of action, have done the things they agreed to do as hereinabove alleged, and, among others, the following acts and things:
"A. Defendants formulated and adopted, subsequently operated and now operate pursuant to, among others, the following restrictive customs and practices:
* * * * * *
"(10) Defendant banking firms maintain and preserve their relationships with issuers by achieving and continuously exercising an effective degree of influence and control over the financial and business affairs of issuers. In many instances, they have severally caused one or more of their partners, officers, or other nominees to be appointed or elected to the board of directors or as an officer of issuers for whom they severally act as financial adviser or from whom they severally purchase security issues. Such appointees thereafter develop, and are in a position to exert, within the issuers' organization, strategic influence against the employment of other investment bankers and against the disposal of security issues by methods or under circumstances not favored by defendant banking firms. * * *."
The charge about "members of protective committees" in subdivision (1) of Paragraph 44E was eliminated; subdivision (2) of Paragraph 44E, together with its counterpart Paragraph 45A (11), was withdrawn in its entirety; the charge in Paragraph 44E(3), as supplemented by Paragraph 45A(12) and (13) relative to utilizing the influence of "commercial banks, and other financial institutions serving the financial needs of issuers" was withdrawn, except as to J.P. Morgan & Co. and the Guaranty Trust Company of New York, and no substantial evidence was offered in support of the charge as thus limited. Further allegations on the subject of domination and control, relating to "securing clearances from * * * issuers before making available to competing business enterprises" the facilities of defendant firms, refusing "to act as advisers or as underwriters for small business concerns," the encouragement and promotion of "consolidations, mergers, expansions, refinancings, and debt refundings," and the alleged agreement "to concentrate the business of purchasing and distributing security issues in a single market," contained in Paragraphs 44F, G and H, were all abandoned and withdrawn. The reference to influence and control of "business" affairs of issuers in Paragraph 45A(10) was deleted.
There were many colloquies on the subject of whether government counsel intended to charge joint or group action by the 17 defendant firms on the subject of directorships. It is plain to me that such is the clear meaning of the allegations above quoted, but counsel for the government seemed reluctant to take this view.
Probably the government position is sufficiently clearly stated in the following:
"The Court: Either this matter of directors goes to the heart of the case or it is just on the periphery, and if it is just on the periphery and relates only to a few defendants and is not something that they agreed to and adhered to togethr, then its importance is certainly less than it would be if it was one of the terms of the alleged agreement.
"Mr. Kramer: The part your Honor read [Paragraph 45A(10)], the government says, is not a term of the conspiracy, but it does relate to each of the defendants."
And, about six months later:
"The Court: I thought the thrust of the directorship was the idea that I was told at the very opening of the trial, a red flag to the other conspirators to hold off. I hadn't understood that it was illegal or any violation of the Sherman Act for a firm, an investment banking firm, to have a man on the Board and to tell him, 'Now, Joe, you go out and get this business. We really want it.'
"Mr Piel: That is right. I don't think Mr. Kramer contends anything different from that.
"The Court: All right.
"Mr. Piel: But he does claim that the alleged conspiracy has as one of its terms that representatives of the defendant conspirators will go on boards of directors not to represent their own firms but to represent the conspiracy to influence and control the affairs of the issuers.
"The Court: That is right.
"Mr. Kramer: That is right, not only to represent their own firms.
"Mr. Piel: That is the other half of his claim on the subject.
"Mr. Kramer: That is very well put."
Throughtout the case government counsel have frankly recognized the fact that the use of a directorship to further competition for investment banking business gives no offense to the Sherman Act. Thus in the closing statements one of the government counsel said:
"If this was a free, open competitive business without a conspiracy operating therein, what conditions would we find?
* * * * * *
"4. You would find a member of an investment banking firm on a board of directors of an issuer, and that aside from the moral or legal question as to whether they are entitled to so act, but you would find that, you Honor, because one of the keenest competitive maneuvers there is in the investment banking business would be to put a director on a board of an issuer; he would be the man the issuer might be looking forward to for financial advice."
And the record discloses many other ways in which having a partner, officer or employee on a board of directors of an issuer may be used competitively.
In fact, as well shall see, there were about as many different policies toward directorships as there are defendant firms in the case.Goldman Sachs and Lehman Brothers, largely influenced by the character of their business and their historical background, had partners and employees on the boards of directors of a large number of issuers, especially in the marketing and merchandising field, but also generally.Earle Bailie, who was Chairman of the Board of Union Securities, wrote to Fitzpatrick of the Chesapeake & Ohio Railway Company in 1938, when Bailie was a director of the C. & O.:
"The ideas I have expressed above are simply my preliminary thoughts on the subject which I am passing on to you for whatever they are worth. I have not discussed them with any other director. I have not, of course, discussed them with any banker. You already know my ideas about the propriety of unauthorized conversations with bankers by directors * * * I do not want my firm to have any financial connections with the Chesapeake & Ohio or any of its affiliated companies as long as I am a director of the Chesapeake & Ohio."
In strong contrast to the course previously followed by J. P. Morgan & Co., Morgan Stanley had and maintained a policy of keeping to a minimum, participation by its partners on the boards of directors of issuing companies. In the entire period 1935-1949, Stone & Webster did not manage a single underwritten new negotiated transaction for an issuer on whose board of directors there was any officer or employee of that defendant firm.
It would serve no useful purpose to attempt to resolve the controversy over whether or not these directors were the "representatives" of their respective firms. It is natural enough that they should sometimes be referred to as "representatives" of this or that investment banking house. But no legal connotation was intended or is to be inferred as a general proposition. Sometimes they were put on for the specific purpose of representing their firms in a limited way; in many instances they were not.
Before proceeding to discuss the evidence it will be well to mention another subject which loomed large in the beginning, but which has now receded into the shadows.One of the "practices" charged against all the defendants in the government's trial brief on the facts, was that of systematically causing a wide distribution of the stock issues of an issuer and then getting "control of the proxy gathering machinery of their issuers so that they could secure votes for perpetuating such a friendly management or for ousting an unfriendly management."
Proof of this phase of the case collapsed entirely; and there was no reference whatever to it in the closing statements of counsel for the government, who assured me: "We haven't left out anything that we think your Honor ought to consider or needs to consider in ruling on the motions to dismiss." This was in accordance with the spirit and intent of my Pretial Order No. 3, so that my consideration of this colossal record should not be made so burdensome as to prevent a determination of the issues within a reasonable period of time.
There was some evidence that Goldman Sachs helped a few issuers in connection with proxy gathering; there are incidental references to the subject in evidence introduced against two or three other defendant firms. As to the rest the record is silent. There is no evidence whatever to support the claim that a wide distribution of stock issues was ever made by any defendant for such a purpose; and the most that can be inferred against Goldman Sachs is that the solicitation of proxies in the few instances where this was done, notably for the B. F. Goodrich Company, was at the request of the management and probably as a service which might ingratiate the firm with the executives of the company and thus give the firm some competitive or other advantage later on. The charge as made is without any foundation in fact.
Were there any domination and control of issuers one would suppose tht numerous witnesses would be available to testify in support of the charge. The documents in evidence bring into shart relief a considerable number of company executives of dynamic and fearless personalities, who were far from being "in the pockets" of the defendant banking firms or any of them. and yet only one financial or executive officer of an issuer was called. Robert R. Young, Chairman of the Board of the Chesapeake & Ohio Railway Company, proved an unfortunate choice. It is difficult for me to picture him as under the influence and control of anyone; and anyone who tried to influence and control him would probably live to regret it. He seemed eager to renew his old controversy with the Guarant Trust Company of New York, which went back to 1938 and 1939, and issued fulminations against what he called "The House of Morgan", composed of J. P. Morgan & Co., Morgan Stanley and the Guaranty Trust Company of New York, and Earle Bailie, Tri-Continental and Selected Industries together as "a Morgan banking satellite"; but such picturesque expressions added little of probative force to the case; and he frankly admitted that he never had any trouble finding investment banking houses, including a number of the defendant firms, to compete for his business.
The government might have called J. Spencer Love, President of Burlington Mills, but it did not. And a scrutiny of the numerous Burlington Mills documents in evidence plainly shows the reasons for not calling him, despite some of the statements in his letters.
It so happens that many letters and memoranda, supplemented by deposition testimony, are in evidence on various phases of the government charge, all having to do with transactions between a number of investment bankers, including several of the defendant firms, and J. Spencer Love, whose career in the textile field is described as "meteoric." As with most of the other documentary evidence, government counsel are interested in detached phrases, sentences or paragraphs, containing language thought to be helpful to the plaintiff's case. But here we have a substantial sequence, enough, taken together with the static data relative to a long series of security issues of Burlington Mills, to give a fairly clear picture of the way investment bankers compete against one another and the shrewd and effective measures taken by corporation executives to get the most out of the investment bankers by way of services, suggestions and prices. This series of documents is of special significance as government counsel rely upon them so heavily and refer to them again and again.
In connection with the charge of domination and control of issuers, some of Love's letters are stressed because he states in one of them, with reference to William J. Hammerslough, a partner of Lehman Brothers, "we didn't elect him on the board to tie ourselves in with Lehman Bros. but because we wanted an outside director and we thought he was a man of ability and skill and that he was interested in us."
In another, Love writes:
"Invariably, when we meet other people who might be people to be helpful to us, we meet with the response that we are a Lehman company and that others aren't going to approach us or be interested in us as long as we are so known.They feel that everything they might propose to us would go right straight to Lehman because of your being on our board."
The letters would indicate that Love was unable to get suggestions from other investment bankers, lacked "a free opportunity to select our own syndicate," and would be better off if he could get Lehman Brothers "in much less of a dominating position." My own conclusion, in the absence of testimony by Love himself, and from the documents and deposition testimony, is that Love was a "tough" and canny trader, who from first to last sat in the driver's seat alone, who took the initiative in the selection of several members of the syndicates and who over the years and from issue to issue had the advice of, and the full benefit of competition by, a number of investment banking firms, defendant and non-defendant, in addition to Lehman Brothers, including Union Securities, Kidder Peabody, Blyth, Commercial Investment Trust and Merrill Lynch. He was also to some extent in touch with Dickson of Greensboro, N. C., where Burlington Mills was located and Wertheim. Far from being "dominated," it was Love who kept the investment bankers constantly on the qui vive and traded them off against one another. Non teneas aurum totum quod splendet ut aurum.
If at times Lehman Brothers told Love "that we considered ourselves to be Burlington's bankers and that we felt he should discuss any new financing with us first," this was merely a competitive maneuver, which, as it turned out, had no effect whatever on Love. Indeed, he turned it to his own advantage in the correspondence which later ensued. and it is not without significance that, in the period 1935-1949, Burlington Mills brought out no less than eight issues of securities by private placement, without using the services of any investment banker.
The negotiated underwritten issues shape up as follows: April 14, 1937, $3,578,000 of common stock, co-managed by Commercial Investment Trust and Lehman Brothers; December 11, 1940, $4,240,000 of convertible preferred stock, managed by Lehman Brothers; September 23, 1942, $2,562,000 of convertible preferred stock managed by Lehman Brothers; March 3, 1943, $6,792,000 of cumulative preferred stock, co-managed by Kidder Peabody and Lehman Brothers; July 3, 1945, $15,600,000 of preferred stock managed by Kidder Peabody alone; and, finally two issues of $5,000,000 and $10,400,000, preferred and convertible second preferred stocks respectively, on February 20, and April 10, 1946, both managed by Kidder Peabody alone.
If the "traditional banker" and "red flag" devices or practices had been functioning Kidder Peabody would have refused to compete for the business.When Love, after the original solicitation of business in 1939 or 1940 by Albert H. Gordon of Kidder Peabody, approached Gordon in December 1942 or January 1943, Gordon made no attempt to get "clearance" from Lehman Brothers.Indeed, Love and Gordon, each with different motives, were careful to keep their negotiations to themselves. Lehman Brothers had no suspicion or intimation of what was going on; but Love was careful to send Gordon a copy of his long complaining letter to Gutman of Lehman Brothers of January 23, 1943. The last paragraph of this letter is a masterpiece of shrewd negotiation. It reads:
"In writing this letter, please do not feel that we are unmindful of the many constructive things that you have done for us and the friendly relationship that has always existed. We hope that we can work things out so that this relationship will not be in any way seriously disturbed and that our future operations can be strengthened and be handled in such way that all of us may ultimately benefit."
This would keep Lehman Brothers on their toes and impress them with the fact that the "friendly relationship" still existed. As a copy went to Kidder Peabody it would be clear to that firm that they might get the business, but would have to give the best possible service and the best possible terms in order to get it. The net result was exactly what Love had hoped for, the issue came out with the dividend rate for which he had been contending, and Kidder Peabody an Lehman Brothers managed the issue together.
But this was the very thing the conspiracy was supposed to have been formed to prevent, according to the claims of government counsel.
To make matters worse, Kidder Peabody succeeded in ousting Lehman Brothers from the co-managership; and one cannot help feeling that the state of mind which led Love, on August 5, 1944, to ask for Hammerslough's resignation as a director of Burlington Mills, had been inspired at least to some extent by the competitive efforts of Kidder Peabody to get Lehman Brothers out of the picture entirely. And when Lehman Brothers tried to hold onto their joint managership by taking the matter up with Love, Gordon testified on deposition, that he told Love "we did not think anything would be served by having them joint manager in the issue; we thought that the company would be better off if it relied on us alone." Ironically, too, Gordon of Kidder Peabody ultimately and in the spring of 1948 became a director of Burlington Mills, despite Love's statement in his letter to Hammerslough of August 5, 1944, that he had reached the conclusion that Burlington Mills ought not to have on its board any "banker or lawyer or efficiency expert, or even an outside textile man" or anyone else who would "likely be doing direct business with us."
What the record shows of the unsuccessful competition of Union Securities and Blyth is in bare outline but, against the background of Love's equivocations and trading proclivities, and in a practical rather than a theoretical business world, it is sufficient to indicate that the first attempt by each of these firms with Love was to get a participation, and the contact thus made was followed by suggestions and other competitive measures, designed to lead to the managership or co-managership of some or all of the securities business of Burlington Mills.
On February 2, 1942, Gutman of Lehman Brothers wrote to Love, acceding to Love's suggestion that Union Securities be given a participation "in any Burlington financing." As early as July, 1941, according to a memorandum of July 30, 1941, by Siff of Lehman Brothers, Love told Siff that "Joe King" of Union Securities "had called him last week." Correspondence with King ensued and King was not only prompt to make suggestions, but was soon talking to Siff in terms of what "we" should do in the matter of formulating a "joint opinion and program for future financing." It was in this connection that Siff in a memorandum to Hammerslough, wrote:
"I would recommend that you do not call King on this, and that in any dealings with Love you take the position that Lehman Brothers are bankers for the company and any discussions regarding additional financing should be carried on through to a conclusion with us before discussions are entered into with Union Securities or anyone else. I believe that we are entitled to take this position in view of the considerable, and I believe effective, work that we have been doing in the way of creating public knowledge and acceptance of the Burlington securities during the past six weeks."
Had the alleged conspiracy been functioning, as charged, Siff would have recommended that Hammerslough call King and remind him of the term of the conspiracy about deferring to the "traditional banker," as there can be no doubt of the "satisfactory relationship" then existing between Lehman Brothers and Burlington Mills; and King would have "deferred" to Lehman Brothers. Moreover, as King must have known that there was a continuing relationship between Lehman Brothers and Burlington Mills, it is difficult to reconcile Siff's fears with the government claim of conspiracy.The whole tenor of Siff's memorandum would seem to refute rather than support the charge.
In the spring of 1945, just as Kidder Peabody was succeeding in ousting Lehman Brothers entirely, George Leib of Blyth called on Love at Greensboro, N. C., and on May 30, 1945, Love wrote Gordon suggesting that Blyth be given a second position in the underwriting. That this visit was designed as the beginnin of a competitive effort to follow in the footsteps of Kidder Peabody, and get the managership, or if possible at least the co-managership, of some or all of the business of Burlington Mills seems probable. As we shall find later, one does not compete for managerships by ringing doorbells or by direct solicitation to company executives.They normally resent this sort of thing. Approaches such as made by King of Union Securities and Leib of Blyth are much more sensible. If one can get a participation in the underwriting of an issue, this may lead to direct contact with the executives; and many officers of issuers are only too glad to talk about their problems and discuss suggestions. This is the sort of competitive effort that gradually builds up a critical attitude on the part of an issuer toward the investment banker who has been bringing out its securities. It is all very subtle, and for that very reason the more effective.
John M. Hancock became a director of Jewel Tea on December 9, 1919, and has remained such over the years. On August 1, 1924, he left the presidency of Jewel Tea and became a partner of Lehman Brothers.On September 6, 1941, Hancock wrote a memorandum for the attention of certain of his partners with reference to a forthcoming issue of securities and mentioned the fact that he had agreed to a form of indemnity clause slightly less favorable to Lehman Brothers than their standard clause.The particular sentence culled from this memorandum by government counsel reads:
"The reason for agreeing to this departure from the standard is the fact that Jewel is particularly open to the charge of being 'banker dominated.'"
I cannot find on the evidence before me tht the financial affairs of Jewel Tea were dominated by Lehman Brothers or anyone else; but it does appear that Goldman Sachs and Lehman Brothers had jointly offered $4,000,000 preferred stock in January, 1916, an issue of $3,500,000 notes in May 1919, and 50,000 shares of 4 1/4% preferred stock in September, 1941. This interval of more than 22 years between issues co-managed by Goldman Sachs and Lehman Brothers can hardly be said to support plaintiff's claim that banker-directors "promote the interests of securing further underwriting business for each of defendant banking firms." In the meantime and in December, 1928, Jewel Tea had offered $4,000,000 of common stock to its security holders without any investment banker.
Henry S. Bowers, a partner of Goldman Sachs, had become a director shortly after the 1916 issue and remained such throughout the period with which we are concerned in this case; and Arthur Lehman, a partner of Lehman Brothers, became a director on February 13, 1918 and remained on the board until his death on May 16, 1936.
What Hancock was probably referring to in the memorandum was his own period of service as president of the company before he became a partner of Lehman Brothers in 1924 and to his position as a director since then. During World War I, Herbert H. Lehman, then a partner of Lehman Brothers, met Hancock, who was at the time a regular Navy officer, who had been in charge of Naval procurement. Because of the favorable impression thus formed, Herbert H. Lehman asked Hancock to go with Jewel Tea, which was in financial difficulties. Hancock became president of Jewel Tea and, with extraordinary resourcefulness and administrative efficiency, he succeeded in putting the company back on its feet. Thinking, not because of any delicacy but to avoid possible criticism, that even the use of the standard Lehman Brothers indemnity clause might appear go give Lehman Brothers some advantage due to Hancock's prior service for and relationship to the company, he agreed to the use of a clause more favorable to the company than that generally used by his firm. This does not support plaintiff's charge, despite the fact that it contains the phrase "banker dominated." The few remaining letters relating to Jewel Tea show a similar concern for the affairs of the company, and they require no further comment. It is also in evidence that, contrary to the advice of counsel, Goldman Sachs and Lehman Brothers loaned money to Jewel Tea during the period of its difficulties.
The Evidence Generally Applicable to Directorships Discloses No Conspiratorial Pattern but Rather the Contrary
From stipulated data set forth in the record, counsel for the government prepared 17 "directorship charts," one for each of the defendants. The chart for each defendant lists every new negotiated underwritten security issue during the 15-year period, 1935-1949, offered by an issuer whose board of directors at the time of the issue included a partner, officer or employee of that defendant. From these charts it appears according to the claim of government counsel "that when a defendant had a director on the board and an issue was done, that that defendant who had the man on the board acted as either manager or co-manager in approximately 86 per cent of the cases." No attempt was made to show the circumstances under which any of these men became directors; the charts do not indicate those instances where a defendant firm was the managing underwriter for the issuer before one of its partners, officers, or employees went on the board, nor which investment banking house managed issues brought out by the issuer after the partner, officer or employee left the board, nor the private placements or offerings to security holders made without the services of any investment banker while such partner, officer or employee was on the board. Moreover, in computing its figure of 86% correlation between directorships and managerships, counsel for the government included a large number of instances in which the defendant firm with a director on the board of an issuer co-managed issues of that issuer together with one or more other investment bankers, either defendants or non-defendants. If the other co-managing firm had no partner, officer or employee on the board of the issuer, and there were many instances of this, it would seem that such issues should not be included in the figures used to arrive at the aggregate of 86%.Nor is any explanation offered for the fact that in numerous instances investment bankers from two or more firms were on the board of the same issuer at the same time.
The charts would seem to add little of real evidentiary value to support the "red flag" or "signpost" theory, in the absence of some proof of attendant circumstances, as it requires little argument to demonstrate that in many cases the men in question were invited by the management to come on the board of directors because a prior relationship with them had demonstrated their ability and usefulness, as with Hammerslough and Burlington Mills, and the mutual confidence reflected in such a relationship would make it probable that the issuer would turn to the director's own investment banking firm when bringing out a new issue of securities, even though there were no conspiracy whatever in operation. Moreover, one must not be blind to the fact that the men who served on these boards in such considerable numbers were in most cases men of wide experience, and of proven competence and judgment, many of whom had in one way or another rendered conspicuous service to the nation; and, in the natural course of events, they were doubtless urged and importuned by company executives to join this or that board of directors, wholly apart from considerations having to do with the raising of capital.
For my own enlightenment I have prepared a chart (subject to a checking of my figures by counsel for the respective parties) and have included therein an enumeration of the total number of issues of new negotiated underwritten security transactions, $100,000 and larger, managed by each of the defendants during the 15-year period, so that a comparison can be made with the government directorship charts. Pro-rating co-managerships, it appears that the defendants managed, in all, a total of 139.7 new negotiated underwritten security issues offered by issuers during the 15-year period, 1935-1949, at a time when a partner, officer or employee of one or more of the defendants was on the board of directors of that issuer. But the defendant firms managed a pro-rated total of 1117.0 of such issues, with or without directorships, during the same period. Thus, only 12.5% of defendants' business in these issues was obtained from issuers upon whose boards there was any partner, officer or employee of a defendant at the time of the issues. And almost half of this "directorship" business was done by three firms, Goldman Sachs, Lehman Brothers and Kuhn Loeb, the older firms who had in the early days become more or less accustomed to have a partner on the board of an issuer because of their sponsorship of the issue, and as a measure of protection for the investors to whom the securities were sold.
The variety of policies of the 17 defendant firms toward directorships are also to some extent reflected in the chart, which follows:
A B C
Number Percentage of
Total Whe n Partner, Director
Number Officer or on Board
of Employee to Total
Managerships a Director Managerships
Blyth 137.2 13.0 9.5%
Dillon Read 87.7 2.1 2.4
Drexel 14.5 2.5 17.2
Eastman Dillon 36.3 5.5 15.2
First Boston 122.4 8.0 6.5
Glore Forgan 47.7 6.3 13.3
Goldman Sachs 49.6 27.5 55.4
Harriman Ripley 54.6 6.5 11.9
Harris Hall 24.0 2.0 8.3
Kidder Peabody 65.8 3.0 4.6
Kuhn Loeb 69.5 19.6 28.2
Lehman Brothers 81.1 19.7 24.2
Morgan Stanley 128.3 4.0 3.1
Smith Barney 88.2 4.5 5.1
Stone & Webster 43.5 -- 0.0
Union Securities 30.7 9.5 30.9
White Weld 35.9 6.0 16.7
Totals 1117.0 139.7 12.5%
The documents relied upon to support the government case make the lack of any conspiratorial pattern all the more apparent.There were 89 such documents in all, in connection with which 17 additional documents were considered on behalf of certain defendants. A large number of the government documents were concentrated in the period 1934-1937; and they were all received against Blyth, Dillon Read, Goldman Sachs, Kuhn Loeb and Lehman Brothers.In the closing statements government counsel in effect conceded that they had practically nothing on directorships against: Eastman Dillon, Drexel, Glore Forgan, Harris Hall, Kidder Peabody, Morgan Stanley, Smith Barney, Stone & Webster and White Weld. a sampling will indicate that there was ample basis for the concession, despite the charts above referred to.
The government chart with reference to Eastman Dillon contains but four issuers. The first directorship complained of was in 1940 and the first issue complained of was in 1944. The complete story about the Eastman Dillon directorships is set forth in a chart prepared by its counsel, based upon the static and stipulated data, in the nature of a brief for the information of the court. It includes all security issues offered during the 15-year period by every issuer which, at any time during that period, had a partner or employee of Eastman Dillon on its board of directors. Of the 25 negotiated underwritten new issues of such issuers, Eastman Dillon was manager or co-manager of, or agent for the seller for, 18 issues. Eastman Dillon was manager or co-manager of, or agent for the seller for, 10 of these 18 issues at a time when Eastman Dillon had no director on the board; and of the remaining eight, four related to Suburban Propane Gas, of which Eastman Dillon was one of the promoters.
The government tabulation with respect to Glore Forgan indicates that there were 12 negotiated new underwritten security issues for 7 different issuers, during the 15-year period, which were offered at a time when a partner of Glore Forgan was on the board of directors of the issuer. Of these, Glore forgan was the sole manager of only 4 and comanaged 7.The remaining issue, which was the only one listed for one of the issuers, was managed alone by Lehman Brothers.And an examination of all the new security issues offered by 13 issuers during this period (except at public sealed bidding), each of such issuers having offered at least one issue during that period while a partner of Glore Forgan served as a director thereof, indicates that of the 34 such issues, 17 were not managed by Glore Forgan. Ten of such issues were offered without the services of any investment banker, and 7 were managed alone by other defendant firms.
Similarly, with respect to Kidder Peabody, of the four issuers who brought out negotiated new underwritten issues during this period at a time when a partner of Kidder Peabody was on the board, the security issues of two of them were managed by other defendant firms. Of the eight issuers represented on the government's Smith Barney chart, Smith Barney managed or co-managed the issues of only four of them.Despite Stone & Webster "representation" on the boards of two issuers, who offered three negotiated new underwritten issues during this period, Stone & Webster neither managed nor co-managed any of them. Proof against others of these nine defendant firms can be analysed in like manner.
As to three of the defendant firms, First Boston, Harriman Ripley, and Union Securities government counsel claims that, despite the absence of documents introduced against these firms on the directorships issue, there is some significance in the static data, or other proof.
Addinsell and Phillips Petroleum
In the connecting statements by government counsel, despite the fact that no documents had been offered against First Boston on the directorships issue, it was insisted that the circumstantial effect of certain letters received against Eastman Dillon indicated that First Boston had adhered to the so-called "practice" of using directorships as a "red flag" or "signpost" to remind other defendant firms that there was a "traditional banker" relationship to which they must defer, in accordance with the terms of the conspiratorial arrangement. These letters were written in 1935 and the one principally relied upon is from Frank Phillips, President of Phillips Petroleum Company to Lloyd S. Gilmour, a partner of Eastman Dillon, of which a copy was sent to First Boston, under date of April 1, 1935. In this letter Phillips wrote:
"We naturally are looking to Mr. Addinsell, Chairman of the Executive Committee of The First Boston Corporation, who is one of our directors and who originally purchased the entire issue."
As the various documents and deposition testimony relative to Phillips Petroleum are heavily relied upon by government counsel on various phases of the case, particularly the so-called "practice" of "giving advice" and the "concept" of "traditional banker," it will be convenient briefly to review the salient facts which concern the relationship between Phillips Petroleum and First Boston. Taken as a whole they prove no adherence to any "practice" or "concept"; nor do they support the allegations of conspiracy and combination. On the contrary, they show a continuing relationship, which had its origin in the twenties and which became stronger over the years due entirely to the ingenuity, skill and integrity of Harry M. Addinsell and his associates.
The Issuer Summaries show an unbroken and continuous relationship with First Boston.In 1935 First Boston acted as agent for the company in connection with a private placement of $14,000,000 Joint Serial Notes; there was an offering to shareholders, without investment banker assistance, in 1936, two private placements wihtout the services of any investment banker in 1937 and 1939; the remaining seven financings were all managed by First Boston and consisted of $25,000,000 of 3% Convertible Debentures in 1938, another of a negotiated underwritten offering to shareholders of $20,000,000 of 1 3/4% Convertible Debentures in 1941, another of 1,007,517, shares of common stock in 1947 and three negotiated underwritten public offerings, two of which came out on January 9, 1941, and the other on February 16, 1944.
There was no reason under the Sherman Act or any other law which should deter First Boston from resorting to every legitimate means in its power to hold on to this business. And it is strange that government counsel should think the following testimony by Addinsell helped plaintiff's case:
"The thing I tried to point out to you this morning, Mr. Stebbins, was that we, under one label or another over a long period of years, had performed services for Phillips Petroleum that they found eminently satisfactory, and I don't think that they were particularly interested in changing to somebody else just as the client of an individual lawyer who may go from one place to another, I mean, from one firm to another, may follow the lawyer."
How this business followed him personally from the old firm of Harris Forbes to First Boston is also used against First Boston. Addinsell testified:
"But, broadly speaking, we have, through that period, established a relationship, and I hope you won't think I am immodest if I say that I think I, in particular, have established a relationship with that company where, strange as it may seem, they value my point of view and value the relationship that they have had with the, first, old firm of Harris Forbes, and then when we, some of us, moved over to the First Boston, with the First Boston. Because, while I don't want to exaggerate my opinion about the value of my services, that has only been possible because I have had a team that could do whatever the job was that was to be done. We had a firm that had the capital, and the standing, and the organization, to do the necessary things for them.
"That is a broad outline of the background.
"In order to get to one point that, of course, you will come to, I would like to say that I think it was in 1932, when I was president of Chase Harris Forbes, Mr. Phillips came to me, entirely unsolicited as far as anybody I know about was ccerned, and said that they would like very much to have me go on the board of directors which, after consulting with my associates in the Chase Bank, I told him I would do. That is a simple statement of the background and facts about it."
When Addinsell testifies that Phillips "is a strong-minded individual * * * he is a rugged individualist * * * he built that company in the face of competition from the old line companies * * * it is a so-called independent company," I believe him. there is ample evidence in this record to support a finding that there was no domination or control of Phillips or Phillips Petroleum asserted or even attempted by Addinsell or by First Boston. Indeed, the very documents relied on by government counsel, supplemented by others offered on behalf of First Boston, show that the services performed by First Boston, under the able leadership of Addinsell, were of a superlative quality, amply justifying the confidence in First Boston which is revealed in the letter to Gilmour of April 1, 1935. The reference to the fact that Addinsell was a director of the company is incidental and has no significance whatever.
To characterize the effective and valuable services performed by First Boston over the years for Phillips Petroleum as an "adherence" to the "practice of giving advice" is unwarranted. As shown in the preliminary part of this opinion on the history and development of the investment banking industry, Addinsell was following the course of competitive effort which had gradually and functionally developed from the early days as a normal and ordinary way of doing the business. Automobile salesmen, plumbers, real estate brokers and innumerable others whose business is fundamentally the rendering of services, all try their best ot establish and hold on to continuing relationships with their customers, by doing a great variety of acts for which they make no separate and specific charge. When a real estate broker works hard getting information for a substantial property owner, attending endless conferences relative to the state of the market, the price to be asked for certain properties, the advertising to be used, and so on, he well knows that he will be compensated only when, as and if he makes a deal.
The bearing of all this on the directorships phase of the case is merely further to weaken another of the supports upon which the government charge of over-all conspiracy rests.
Some of the situations involved were of a special character, such as Cramp Shipbuilding Co., where Harriman Ripley acted as the direct result of a request by the Secretary of the Navy in 1940, to reorganize the corporation so that the shipyards could be reopened for national defense.
United Air Lines
Counsel for the government claim that a telegram of October 27, 1943, from Joseph P. Ripley, then a director of United Air Lines, to W. A. Patterson, the president of the company, supports their charge. It reads:
"You remember advances made by one of our board to Smith Barney Stop Cutler of that firm is now trying to get me and am sure he is going to ask my permission to go to see you and try to get leadership of underwriting Stop Do not wee how I can refuse and hope you will wire me back that am at liberty to tell him to go ahead and see you if he wants to stop am sure you know what my views are as to where it should go."
Emphasis is placed upon the word "permission," which suggests that Ripley's state of mind was such that, because he was a director, Cutler of Smith Barney could not, by reason of the "red flag" or "signpost," approach the issuer without first "clearing" through Ripley.
The explanation is simple. Section 409(b) of the Civil Aeronautics Act of 1938, 49 U.S.C.A. § 489(b), and again hereinafter referred to,
made it impossible for Ripley's firm to manage or participate in any of the financing of United Air Lines while Ripley was a director. At the time the telegram was sent, as appears from the deposition testimony and other exhibits, it was anticipated that he would remain as a director and that the contemplated financing, which was the first made by the company since the passage of the Civil Aeronautics Act of 1938, would be handled by some investment bankers other than Harriman Ripley. In 1940 Patterson had appointed a committee of the board of directors to looking into the matter of financing and this committee consisted of Patterson, Sewall and Ripley. That Patterson had great confidence in Ripley and regarded him highly was matter of public knowledge, as might be inferred from the general relationship between the two men over the years, and also from the fact that in 1942 Patterson had made a speech at the Bond Club of New York in which he publicly referred to Ripley in very favorable terms and praised his handling of United Air Lines' financing. It also appeared that numerous investment banking houses had been pestering the management of the company over this prospective financing and John Newey, one of the executives of the company, had informed Ripley that they had been told to go and see him about any matter pertaining to underwriting. The only firms identified by Newey were F. S. Moseley and First Boston; but Patterson had told Ripley that "he was fed up with having investment bankers coming in to see him." Justin Dart, a director, had discussed the matter with Smith Barney.Some time prior to the sending of the telegram of October 27, 1943, Ripley had recommended to Patterson that the business be given to Blyth and G. M.-P. Murphy as co-managers, evidently because G. M.-P Murphy had a number of aviation experts on its staff and the Blyth wire system was closely identified geographically with the United Air Lines route.
In view of this background it was quite natural that Ripley should think that Cutler was going to ask his "permission" to approach Patterson.
True it is that, when the issue of 105,032 shares of 4 1/2% Convertible Preferred stock came out on December 29, 1943, it was managed by Harriman Ripley.The reason for this is that, after the exchange of telegrams between Ripley and Patterson on October 27, Patterson changed his mind about keeping Ripley on the board, and decided that it was more important to the company to have the services of Harriman Ripley, which would of course include those of Ripley himself, in connection with the financing. Patterson's memorandum to the directors, under date of November 2, 1943, supports Ripley's deposition testimony, and is interesting on the subject of the attitude of issuers toward continuing relationships with investment bankers. thus his memorandum concludes:
"Our management has had many difficulties from the day of the air mail cancellation up to the recent abnormal passenger demand. Thanks to Mr. Ripley and his organization we have never had a financial problem owing to the soundness of the development of our financial structure. It would have been impossible on many occasions to have overcome the obstacles over which we had little control without the sound financial foundation previously established.
"In my opinion there are two ways to go about financing. One is to bargain and drive for the best terms by playing one underwriter against the other. When such transactions do not work out favorably to the underwriter who may get the business on this basis, I think it can be said quite definitely that a relationship that can be counted upon in the future does not exist. The other method is to select bankers who have demonstrated by their past methods and commitments an interest in an organization and its success between intervals of financing.
"I prefer that this company follow the latter policy.This does not mean that we should be careless in the terms we finally negotiate. In the interests of our stockholders, arrangements that are fair and reasonable to both parties to the transaction must be accomplished."
The static data relative to Union Securities is typical of that discussed generally above, and proves just as little. The chart lists 11 issues for 8 issuers; Union Securities managed 10 issues for 7 of these issuers, 9 as sole manager, and one, the only issue for that issuer, as co-manager with Kidder Peabody, which also had a director on the board.
In addition, reliance is placed upon the letter from Bailie to Fitzpatrick of the Chesapeake & Phio Railroad, of June 23, 1938, from which I have already quoted.
This letter advises Fitzpatrick that the Chesapeake & Ohio, in his judgment, should continue with Morgan Stanley and "maintain its existing banking affiliations so long as they are satisfactory." The charge that Morgan Stanley placed Bailie on the board of the Chesapeake & Ohio remains unproven. The writing of this letter under the circumstances seems to me to be thoroughly consistent with Bailie's duties as a conscientious director.
I find no significant difference between Harriman Ripley, First Boston and Union Securities, and the other nine defendant firms with respect to which the government concession was made. Thus, as to 12 of the 17 defendant firms, there is no substantial evidence that any of them used directorships as a "red flag" or "signpost" to others, defendants or non-defendants, or that they deferred to any other firm because one of its partners, officers or employees was a director of an issuer.
Directorship Evidence against Goldman Sachs, Lehman Brothers, Kuhn Loeb, Blyth and Dillon Read
The mass of these documents is so heterogeneous in character as almost to defy description. Of the 89 documents introduced by the government on this issue, 24 were against Goldman Sachs and 35 against Lehman Brothers. As pointed out in Part I of this opinion, these firms were associated with one another over considerable periods of time, and historically they had many directors on the boards of issuers at a time when their sponsorship of new issues, especially of closely owned family affairs or others whose securities had not previously been publicly owned, made the presence of one of their partners on the board more or less essential, in their judgment. It was a matter of policy with them to place partners or employees on the boards of directors of issuers, and there is evidence that they each used the presence of such men on these boards in various ways in support of their competitive efforts, partly to get business but principally to hold on to such business, once it had been secured.
The government chart lists 41 issues by 17 issuers in the 15-year period, offered at a time when a Goldman Sachs partner was on the board of the issuer. Goldman Sachs was sole manager of 15 of these issues, and co-managed 25. Twenty of these 25 co-managerships were with Lehman Brothers.Of the 17 issuers shown on the chart, Goldman Sachs' directorship relations with 14 of them began prior to 1935. Thus, while Goldman Sachs obtained more than half its managerships in negotiated new underwritten security issues, in the period 1935-1949, from issuers on whose boards Goldman Sachs partners were directors, the great majority of these directorship relations were initially established before 1935. On the other hand, the stipulated data show that a Goldman Sachs partners was on the board of directors of only 7 of the 44 issuers for which it first headed financings after the passage of the Securities Act of 1933. For only 3 of these issuers did Goldman Sachs manage underwritings while a partner was on the board: Champion Paper & Fiber Co., Hecht Company and Standard Steel Spring Co.
Of the 24 documents introduced against Goldman Sachs on this phase of the case: 7 had to do with proxies and need no further consideration as the proxy charge has faded out; 13 evidence competitive efforts in respect to May Department Stores, Pillsbury Mills, Endicott-Johnson, B. F. Goodrich and General Foods; 2 concern information possibly of a confidential character, including one which evidently had to do with an attempt to sell the Welch Grape Juice Co. One of the remaining documents will be discussed later in connection with the Pillsbury Mills competition under the heading of "traditional banker."
The last one is a 1942 letter from Hartel of National Dairy to Sidney J. Weinberg a partner of Goldman Sachs, stating that Weinberg had been appointed to the salary committee of the National Dairy board of directors, together with Henry W. Breyer, Jr. and Henry C. Von Elm, who were two of the remaining five "outside" directors eligible to act. No further reference was made to any documents or proof of any kind in the directorships issue against Goldman Sachs in the connecting statements made by government counsel at the close of plaintiff's case, although the stipulated data do show that Charles S. McCain, for many years a director of B. F. Goodrich, later became a partner of Dillon Read, and a 1945 security issue of B. F. Goodrich was jointly managed by Dillon Read and Goldman Sachs.
There is nothing in any of these documents to indicate that Goldman Sachs ever refrained from going after any business because one of the other defendant firms had a director on the board of an issuer.
The government's directorship chart for Lehman Brothers is an extensive one. It includes 35 issues of negotiated new underwritten securities offered by 19 issuers during the 15-year period 1935-1949, at a time when a partner or employee of Lehman Brothers was a member of the issuer's board of directors. Of these issues Lehman Brothers managed 12 and co-managed 17. Seven of the 17 co-managerships were with Goldman Sachs, and one with Goldman Sachs and a nondefendant. Of the 6 issues in which Lehman Brothers had no share in management, Goldman Sachs managed 3. It is interesting to note that Lehman Brothers' directorship relations with more than half of the issuers shown on this chart date from prior to 1935, a further and significant indication that the genesis of investment banker directorships is historical, not conspiratorial.
Lehman Brothers, together with Goldman Sachs, was a leader in the pre-Securities Act period in developing directorship relations with its customers. And, with the development of the Industrial Department of Lehman Brothers, these directorships became an important feature of Lehman Brothers' method of servicing its customers. Elaborate pains were taken to add to its staff some of the foremost experts in the merchandising and marketing fields and others, and some of the very memoranda relied upon by government counsel reveal the stuides made by various partners and employees designed to further the firm's competitive efforts. Two of these memoranda, dated respectively September 15, and 27, 1934, were prepared by H. J. Szold for the attention of Monroe C. Gutman, one of the partners. Another, expressing quite different views of the proper policies to be pursued, was prepared by Hammerslough, one of the partners, on March 25, 1935, and still another, at a much later period by Frank J. Manheim, a recently admitted partner, on June 1, 1946. This last memorandum was apparently offered because one of the lists therein contained was headed "Lehman Brothers' Companies," although Gutman testified on deposition that the companies on the list were not known or described in the firm as "Lehman Brothers' Companies."
The interesting and I think the most significant feature of these frank interoffice memoranda of Lehman Brothers is that there is no direct or indirect reference in any of them to either of the two reasons alleged by government counsel to be the reasons for Lehman Brothers attempting to get directorships: to control financial affairs of issuers, or to serve as a "red flag" to warn off other defendant firms.
Eight of the 35 documents introduced or referred to as against Lehman Brothers on the directorships issue had to do with proxies, 4 related to Burlington Mills, 4 to Jewel Tea, 2 to the possible use of confidential information and 5 to policy statements, including the memoranda just discussed, and some excerpts from Hancock's TNEC testimony in 1940.
In this case I am not concerned with the moral or ethical problem involved in the use of directorships as a means of furthering the competitive efforts of investment bankers to get business and to hold on to it. This is a conspiracy case under the Sherman Act and the more competitive are the policies of a defendant firm the stronger its position vis-a-vis the Sherman Act. This was candidly admitted by government counsel, as stated in the preliminary part of this opinion relating to directorships. What offends the Sherman Act is an agreement, combination or conspiracy not to compete.
And yet one of the documents offered on this phase of the case against Lehman Brothers, is an agreement of January 15, 1940, between the partners of Lehman Brothers, to the effect that Robert LEhman, one of the partners and a director of Pan American Airways, "shall receive or be entitled to receive no interest or share, direct or indirect, in any profits" which might accrue to the firms as a result of the forthcoming new negotiated underwritten public offering of 525,391 shares of Pan American Airways stock, under the joint management of Lehman Brothers and G. M.-P. Murphy. This would seem to be in the same category with evidence that a partner of an investment banking house which is about to manage a forthcoming issue of securities, goes out of the room when the directors vote on the issue and then walks back in again. The agreement was made to get around Section 409(b) of the Civil Aeronautics Act of 1938, 49 U.S.C.A. § 489(b), which provides:
"After this section takes effect it shall be unlawful for any officer or director of any air carrier to receive for his own benefit, directly or indirectly, any money or thing of value in respect of negotiation, hypothecation, or sale of any securities issued or to be issued by such carrier, or to share in any of the proceeds thereof."
I confess that this sort of thing does not sit well with me, as the conflict in interest would seem plainly to require that a director, whose investment banking firm is financially interested in an issue, should refrain entirely from any participation whatever in the negotiations, rather than merely go through the pantomime of walking out of the room when the vote is taken, or make an agreement which may comply with the letter of the law but surely is not consonant with its spirit. But my function is not to pass on incidental questions of propriety or even legality, but to decide the factual and legal issues in this case.
If, on the other hand, as seems not unlikely, the purpose of government counsel is not merely to make insinuations of impropriety, but to anticipate defense argument based on the fact that, after an intervening offering to shareholders without the services of any investment banker in June 1945, the next new negotiated underwritten public offering of securities by Pan American Airways, of $43,930,000 of common stock and purchase warrants on July 3, 1945, was comanaged by Blyth, Kuhn Loeb, Ladenburg Thalmann and Lazard, without the presence of Lehman Brothers as comanager, I can only say that there is no reason to suppose that Lehman Brothers, had they been able to hold on to the Pan American Airways business, would not again have followed the advice of counsel and made a similar agreement, as Robert Lehman was still a Pan American Airways director when the later issue came out. The net result is that we have another instance where the "red flag" or "signpost" part of the alleged conspiracy should have been functioning but was not. Blyth and Kuhn Loeb and their associates evidently took the business away from Lehman Brothers, and they did it despite the fact that Robert Lehman was on the board of directors. And Lehman Brothers, having comanaged the last previous issue with G. M.-P. Murphy, was supposed to be the "traditional banker." Nothing appears in the record to indicate any deterioration in the friendly relations between Lehman Brothers and Pan American Airways in the interval.
The few documents introduced against Lehman Brothers on this phase of the case and relating to Cluett, Peabody & Co. are so fragmentary as to be of little value. They relate to a period in 1937 when, in the course of the fratricidal strife between Goldman Sachs and Lehman Brothers over the business of issuers whose security issues the two firms had co-managed jointly, each was trying to oust the other.In the case of Cluett, Peabody & Co., Goldman Sachs won out and cries of anguish on the part of Hancock of Lehman Brothers are reflected in his letters. What government counsel were evidently interested in was a reference in one of the exhibits to what seems to have been a piece of misinformation transmitted to Hancock, to the effect that Weinberg of Goldman Sachs had threatened to resign from the board of directors if the business were not given to Goldman Sachs alone and Lehman Brothers excluded entirely. As usual there is a word or phrase upon which reliance is placed. Hancock writes that "if" Weinberg threatened to resign, "did he not control the Cluett financing by the threat which the board undoubtedly felt would, if carried out, harm the company." This seems rather farfetched; but Hancock was advancing every argument he could think of. What reduceds all this to mere words is the fact that Hancock knew nothing of the facts concerning the alleged threat to resign, and he testified before the TNEC that he had been told that the rumor, which had been relayed to him about Weinberg's supposed threat to resign, was untrue. The aftermath was that Goldman Sachs got the business and, after the issue came out, Hancock resigned as a director.
A single document, presented wholly without context, relates to Food Fair, Inc., originally known as Union Premier Food Stores, Inc. It is a memorandum of September 11, 1943, by an employee of Lehman Brothers, Lucille Schwartz, who reported a meeting of the employees in the Industrial Department at which no partner was present.The portion of the memorandum relating to Food Fair reads:
"This business came into Lehman Brothers many years ago but was turned down because we had many other relationships in the field and Food Fair was very small at the time. Now this company is expanding dynamically and it is very anxious to do business with us. Eastman Dillon and Wertheim are on the board but nevertheless, the company still wants Lehman Brothers to do the business. We don't want to have any bad relations with either of these investment houses. Therefore, we prefer to have Food Fair go to Wertheim and Eastman Dillon and say that they want LEhman Brothers to be in on the deal."
What action on this suggestion was taken by the partners does not appear; nor do we know the basis or authorization for the statement that Food Fair was "very anxious to do business" with Lehman Brothers. In any event, it is clear that this document does not fit into the alleged conspiratorial scheme, as the last prior issue was one of 55,000 shares of preferred stock in December, 1940, co-managed by Hemphill Noyes and Wertheim. There was also a 1937 issue managed by Childs, Jeffries & Thorndyke, and another in 1938, co-managed by Childs, Jeffries & Thorndyke and Van Alstyne Noel.Wertheim is not claimed to be a co-conspirator; and, accordingly, there was no defendant firm "traditional banker," to whom Lehman Brothers was supposed to defer. The memorandum also shows on its face that some of the employees present at the meeting "are still unknown to the partners." The next issue was brought out by Eastman Dillon alone.
The two documents relating to Allied Stores Corporation, formerly Hahn Department Stores, add little to plaintiff's case.The first of these, suggestive of another of Lehman Brothers' rescue operations, is a memorandum of agreement between the president of the company and Arthur LEhman, a partner of Lehman Brothers, to the effect that Arthur Lehman use his best efforts to assist in the filling of two vacancies in the board of directors by the election of men suggested by the president; Lehman reserves the right to object to one solely on the basis of "something involving that candidate's integrity, moral position or standing in the community" but may object to the other unless he is "a man either of merchandising experience or a man who stands so well in the business world that his counsel will be recognized as being of value to the company," with more to the same effect. The other document is a copy of the minutes of the annual Allied directors meeting on June 29, 1945, which show that Paul M. Mazur and Harold J. Szold, both at the time partners of Lehman Brothers, were elected members of the 11-man Executive Committee, and members of the 5-man Advisory Committee, Szold to be Secretary of each.Mazur was a merchandising expert of outstanding reputation and both he and Szold had much to offer in the way of knowledge and experience; they were each to be paid by the company, $10,000 a year for their services, and concessions by government counsel indicate that they were worth every cent of it.
One document relating to Aviation Corporation, later Avco, is a letter of April 17, 1930, signed by Robert Lehman as chairman of the Executive Committee, to Sanderson & Porter, employing that firm of management engineers to provide the company with an executive head and serve it and its subsidiaries in an advisory capacity, with an option to purchase 50,000 shares of the company's treasury stock. This was a speculative venture, organized a few months before the market crash in 1929, and there were 14 investment bankers on the board, a majority of whom were in no way connected with any of the defendant firms. Other documents concerning Avco relate to proxies and require no discussion.
Only two documents relating to Sears, Roebuck & Co. were introduced against Lehman Brothers on the phase of the case now under discussion, but there is considerable other evidence in the case relating to that mail order house and it will be convenient to treat it all together at this point, especially as the dealings of various of the defendant firms having to do with prospective issues of Sears Roebuck are strongly relied upon by counsel for the government in support of its general charge.
It will be recalled, from Part I of this opinion, on the history and development of the investment banking business, that as early as 1906 Lehman Brothers and Goldman Sachs headed the offering of 90,000 preferred and 45,000 common shares of Sears Roebuck. By reason of their sponsorship of these securities, Philip Lehman became a director on July 2, 1906, and Henry Goldman in 1907. Thereafter a partner of each of the two firms was on the Sears Roebuck board without substantial interruption until at least late 1951. In May and July 1909, Lehman Brothers and Goldman Sachs headed offerings, first of 50,000, and then of 25,000 shares of common stock. There was no further financing until October, 1920, when Chase Securities with Lehman Brothers and Goldman Sachs headed an offering of $50,000,000 of Sears Roebuck notes.
Fourteen years later on June 21, 1934, Burnett Walker, a partner of Edward B. Smith & Co., who had only a few days previously and on June 16, 1934, left the Guaranty Co., by reason of the Glass-Steagall Act, to come with Edward B. Smith & Co., heard a rumor that some Sears Roebuck financing was in prospect and he proceeded to investigate. He tried to get Hancock, of Lehman Brothers, who was a director of Sears Roebuck, on the telephone, but Hancock was out and he spoke to Gutman. We have in evidence the memoranda of this conversation prepared by Gutman, on the one hand, and by Karl Weisheit, then an employee and later a partner of Edward B. Smith & Co., on the other. A true understanding of this conversation will throw considerable light on one of the most important of the contentions advanced by counsel for the government.
Let us first examine the part relied upon by government counsel. It is the following memorandum by Gutman:
"Mr. Burnett Walker of E. B. Smith & Company (formerly Guaranty Trust) called to tell us that they heard rumors of Sears Roebuck Financing and would not of course encroach on this because it was our bailiwick, but, on the other hand would be very glad, if they could in any way pay their way, to have us remember them if any financing takes place.
"I told Mr. Walker that we could not in any way commit ourselves, but that I would make a memorandum of my conversation with him and promised him that we would give the matter consideration at the proper time."
From Walker's standpoint, angling for information, he desired to ascertain: (1) whether financing was really in prospect; (2) whether the old relationship with Sears Roebuck, going back almost thirty years, had in any way deteriorated so as to make it seem worthwhile to go after the leadership of such financing as might be under consideration; and (3) if he found that Lehman Brothers had the situation well in hand, to lay a foundation for obtaining a participation.
From Gutman's standpoint it was desirable to keep his ears open and say as little as possible.Walker merely commented "that he understood that such an issue was being planned," according to the memorandum made by Weisheit. Gutman's attitude evidently convinced Walker "that they did have such an issue in mind" and, thus considering it futile to waste time and effort working on the Sears Roebuck people in an endeavor to get the leadership of the business, it was then and only then that Walker made his remark about not encroaching because the business was in the "bailiwick" of Lehman Brothers. This is an instance of the way a few investment bankers thought it smart to work up to a participation, when they had no reasonable expectation of obtaining the managership; and it explains a number of the documents upon which government counsel lean heavily.
Weisheit's memorandum follows:
"Mr. Montgomery was given to understand by a friend today that Sears, Roebuck & Co. were planning a convertible bond issue. Mr. Walker spoke to the Guaranty Trust Company about this possibility but they said that they knew nothing of it.
"Mr. Walker also telephoned to Lehman Brothers and in the absence of Mr. Hancock (a Director of Sears, Roebuck) spoke to Mr. Gutman. Mr. Walker purposely avoided asking him if they were working on such an issue but said that he understood that such an issue was being planned and from Mr. Gutman's attitude Mr. Walker was convinced that they did have such an issue in mind. Mr. Walker said to Mr. Gutman that we realized this was their business and that we did not wish to interfere in any way but that if there were any place for us in the business on a basis where we 'could pull our own weight' we should appreciate it if they would keep us in mind if and when an issue materialized.
"Mr. Gutman said he would be pleased to make a note of the conversation for consideration at the proper time."
There is no testimony to throw further light on these memoranda; and the record does not tell us whether financing was or was not then under consideration by the management of Sears Roebuck in view of the background. It seems extremely improbable that Walker telephoned Gutman with any real expectation that it would be worthwhile for Edward B. Smith & Co. to attempt to secure leadership. In any event, nearly two years later Weinberg of Goldman Sachs, as indicated by a letter of March 25, 1936, succeeded in ousting Lehman Brothers from its earlier position as co-manager and on December 26, 1936, Goldman Sachs alone managed an offering of 442,560 capital shares to Sears Roebuck shareholders. The Goldman Sachs participation was 15.25%, Lehman Brothers got 10% and Edward B. Smith & Co. only 5%. The letter was offered by government counsel because, as part of his competitive effort to oust Lehman Brothers, Weinberg had written to the president of Sears Roebuck:
"As a matter of fact we always considered that, as the term goes here in the Street, Sears Roebuck was really our issue."
Very likely, had the opportunity to do so arisen, Lehman Brothers would have told the president that they considered that Sears Roebuck was their issue.
Finally, there is a Hancock memorandum of September 22, 1943, indicating that Lehman Brothers did not wish to become interested in financing for a competing concern, Chicago Mail Order House (later named Aldens) if General Wood and Arthur Barrows of Sears Roebuck disapproved, which they did not. This memorandum also makes reference to the appointment of a committee, composed of Hancock as chairman, Weinberg, Humm and Barker, to consider financing in connection with post-war planning and expansion. But there was no post-war financing; in fact there was no further financing whatever.
Cleveland Cliffs Iron Co.
The last four of the documents introduced or referred to in the concluding connecting statement against Lehman Brothers on this phase of the case, have to do with Cleveland-Cliffs Iron Co. This was still another rescue operation, involving the consolidation of Cliffs Corporation and Cleveland Cliffs Company. Due to bad financial management the situation had become difficult; and the loan agreement of December, 1935, with the three banks holding the bank indebtedness, contained a provision that if either William G. Mather or E. B. Greene, who had come into the management after service as an officer of a bank in Cleveland, died or ceased to hold office, their successors should be satisfactory to all the banks. One of the documents is a letter of December 6, 1935, from Greene to Lehman Brothers, Field Glore, Hayden Stone and Kuhn Loeb, who had agreed on December 4, 1935, to purchase $16,500,000 First Mortgage 4 3/4% bonds, that in recognition of their "continuing interest, for the protection of the bondholders, in seeing that the company has a satisfactory management," he confirmed assurances that these underwriters would also be consulted about successors to himself and Mather; and another document merely transmits a copy of this letter and certain other enclosures to Kuhn Loeb.
Of the remaining two, the first evidences the formation of a group consisting of Lehman Brothers, Field Glore, Hayden Stone and Kuhn Loeb on June 28, 1935, to do the financing. The part relied upon is: "Lehman Brothers are to manage the initial business; subsequent leadership is to rotate." But the "rotation" never took place. The $16,500,000 issue was managed by Lehman Brothers and came out on December 10, 1935. In the next two financings Lehman Brothers acted alone, as sole agent for Cleveland-Cliffs, in two private placements in 1939 and one in 1940. In April, 1945, the company placed $5,000,000 of its notes privately without any investment banker.
The last document, a memorandum of December 12, 1935, has to do with compliance with an agreement between the company, Greene and the Adams Express Company, a substantial stockholder, to the effect that Adams Express should have representation on the board. Hayden Stone in some way came into the picture and Gutman had said he preferred an Adams Express man, but if a Hayden Stone man were being thought of he felt someone from Lehman Brothers should be elected rather than someone from Hayden Stone. Steele Michell of Adams Express was elected.
I find as a fact that there is no basis for plaintiff's charge against Lehman Brothers on the "directorships" issue.
The government chart lists 24 issues of negotiated new underwritten securities for 10 issuers during the period 1935-1949, offered at a time when a partner of Kuhn Loeb was on the issuer's board of directors.Of these 24 issues, Kuhn Loeb managed 17 and was co-manager of 6. Kuhn Loeb's directorship relations with half of these issuers were formed before 1935.
Nine documents were offered or referred to against Kuhn Loeb on the phase of the case now under discussion. Six of these were in the 1932-1939 period; the others were in 1944 and referred to Armour & Co.
The evidence fails to support the claim that Kuhn Loeb used any of these directorships as a "red flag" or "signpost" to warn off other defendant firms or that any of the other defendants "recognized" any such signal.
The document chiefly relied upon by government counsel is a memorandum of November 19, 1934, by Benjamin J. Buttenweiser, a partner of Kuhn Loeb, reporting conversations relative to a proposal by a middleman or finder that the firm should interest itself in a secondary offering of all of the common and part of the preferred stock of Franklin Simon & Co., which was owned by the Franklin Simon Estate.
Two partners of the firm of Henrotin, Moss & Lewis, Inc., claimed to represent the Estate and called to see if Kuhn Loeb would be interested. No reason was suggested as to why the Estate did not speak to Kuhn Loeb directly. Buttenweiser remarked that the preferred stock had been brought out by Goldman Sachs and Lehman Brothers, and mentioned incidentally that they were represented on the board, but Henrotin claimed that there had been a resignation. The memorandum constitutes one of the principal pieces of documentary evidence against Kuhn Loeb, as it contains the phrase "Street etiquette." It has little significance on the directorships issue or the alleged domination and control of issuers. Indeed, as it refers to a secondary, there could be no "traditional banker," according to plaintiff's definition.
It may be well to remark in passing, however, that, as will more fully appear hereafter, Kuhn Loeb in 1934 followed a competitive technique which was unique and finds no parallel in the conduct of any of the other defendant firms. It gave wide currency to what appeared on the surface to be a complete and utter refusal to solicit or even accept underwriting business "belonging to some other house" and statements of this attitude by Kuhn Loeb constitute a very considerable part of plaintiff's evidence.The purpose of all this was not eleemosynary, or conspiratorial; on the contrary, this was itself a form of competitive effort, designed to give the impression that Kuhn Loeb was a firm of such prestige and eminence that it was beneath its dignity to run around after business. Otto Kahn called it "his show window." Underneath this facade, however, we shall find shrewd and ingenious methods used to get business of the highest quality, whilst all the time protesting that the firm would never, never take business away from another banker.
This particular document shows the operation of the Otto Kahn-Kuhn Loeb technique, when approached by a finder; and it also shows from another angle the currying of favor for possible future participations, as we have seen done by Edward B. Smith & Co. in its approach to Lehman Brothers, relative to Sears Roebuck. The chronological sequence of events is always important.
A paragraph of the memorandum reads:
"We advised Messrs. Henrotin and Lewis that we appreciated their approaching us in this connection but it was our recollection that Messrs. Goldman, Sachs & Co. and LEhman Brothers had offered Franklin Simon preferred shares and were represented on its board, and that, as Mr. Henrotin knew, we were always scrupulously careful not to intrude in any way on what might be considered other people's business.Mr. Henrotin replied that he was aware of this situation and had anticipated our taking this view, but made clear that, according to his information, the Goldman, Sachs & Co. Lehman Brothers' representative had resigned as a director and consequently he assumed that these two firms were no longer interested in that situation. We then said that we would like to discuss this matter with our other partners and would advise them in due course."
The reasons for this cautious response at once suggest themselves. It would be a mistake even to hint at the possibility of a commitment to a finder who might or might not be in the confidence of the Franklin Simon Estate.More important still, the maintenance of the "show window" of prestige and eminence required that whatever be said or not said at the conference with Henrotin and Lewis be in every respect of such a character that, whatever happened thereafter, the Kuhn Loeb "show window" would remain intact.
The reason for later deciding not to consider this business, as stated in the next paragraph of the memorandum, is not given; it may have been based on the fact that the Estate was selling out not only to raise money to pay taxes but also "because it felt that the management of Franklin Simon & Co. was being adversely affected by continuing disagreements between the late Mr. Simon's son and son-in-law." The reason quite evidently was not that stated to Henrotin and Lewis about not intruding on other people's business. Had that been the reason, the business would have been ejected out of hand at the first conference.
Having decided to reject the business, the partners proceeded to step two. They must make sure that Lehman Brothers was informed of the attitude Kuhn Loeb had taken with Henrotin and Lewis at the first conference. Of course had the decision been the other way, it is highly improbable that Lehman Brothers would have been told anything about the conference with these middlemen.
Accordingly, Buttenweiser suggested that Henrotin convey to Lehman Brothers the information that Kubh Loeb did not wish to intrude, but Henrotin said "he would prefer our discussing the matter with Lehman Brothers." This led to a call to Allan Lehman, because of "the recent discussions which we had with him with regard to our views on similar Street etiquette as it affected the government's holdings of Pennsylvania equipments." But Allan Lehman turned Buttenweiser over to Mazur, who was more familiar with the Franklin Simon situation.When Buttenweiser spoke with Mazur he explained to him "that our only purpose in approaching them was to steer Mr. Lewis their way." This does not appeal to me particularly, but there is no denying the fact that it might well gain some competitive advantage for Buttenweiser and his partners, when the time came for making a close decision relative to a participation in some underwriting in which Kuhn Loeb desired a substantial position. The Lehman Brothers response is interesting too. It was that "they felt that their approach to the business was sufficiently strong that they would rely on it alone without bolstering it up through whatever contact Mr. Lewis may have."
As no secondary sale of Franklin Simon & Co. stock appears in the Issuer Summaries, I cannot remove from my mind the possibility that neither Kuhn Loeb nor Lehman Brothers was really interested. If Kuhn Loeb had been interested, the course of events would have been very different, as we shall see when we come to Armstrong Cork.
All this is matter of inference but that is what a documentary case such as this is about.
Three of the documents refer to the subject of retiring from or not being present at meetings, and a fourth, from one of the Armour officials in 1937, suggests the possibility of Elisha Walker's presence at a board meeting "to help convince some of our directors as to the proper conversion rate and other provisions." In view of what I have already written on the subject of the presence or absence of banker-directors at meetings where security transactions are passed on, there seems to be no reason to discuss it further in connection with these documents.
A memorandum of Lewis L. Strauss, a partner of Kuhn Loeb, makes reference on July 16, 1935, to what seems to be a dispute of no significance between him and Hertz of Lehman Brothers over a suggestion that Mr. Selig, said to be a director of General American Transportation Company, be elected to the Studebaker board. Evidently Stauss had first suggested Dr. Julius Klein, a well known economist and head of an engineering firm, and had withdrawn the suggestion upon objection by Hertz. The gist of the matter is that Strauss said he had asked and obtained Selig's consent to serve and that he would not withdraw his name. As Hertz apparently took the position that he would not serve on the board with Selig, Strauss commented dryly, "I would be willingly resigned to the fact that he [Hertz] would not serve."
Then there is a March 11, 1932 memorandum by Buttenweiser on the subject of directorships. It is argumentative and seems not to represent any firm policy. The principal reason for introducing it was because it lists separately the J. P. Morgan & Co. directorships. Perhaps Buttenweiser thought they should first try to get directors on the boards of issuers where there was a better chance of getting worthwhile financings, than there would be with issuers on whose boards there was a J. P. Morgan & Co. man.
The last two relate to Armour & Co. and are an exchange of letters between Chase Ulman, a director of Armour, and Elisha Walker. Ulman makes various suggestions relative to a forthcoming issue.There is some testimony by Harold L. Stuart to the effect that a previously proposed financial plan, suggested by Armour's chairman, had proved impossible of consummation and that the credit of the company was so weak that it was not practical to resort to competitive bidding, a subject mentioned in Ulman's letter. The sentence selected by government counsel from Walker's reply to Ulman, of August 24, 1944, reads, "As I have said before, my firm intends to give the Company the best terms that it considers advisable." This is claimed to demonstrate an arrogant attitude, suggestive of control. The difficulty with this is that the letter, read as a whole, will bear no such interpretation, nor could it have been viewed in that light by Ulman. In the second paragraph, immediately after the one containing the quoted sentence, Walker adds, "I am very hopeful that the terms we will work out with the management will be satisfactory to you."
The government chart and the potpourri of 18 documents used against Dillon Read on domination and control of issuers and use of directorships are far from impressive. The chart lists only two issuers, CIT Financial Corporation and B. F. Goodrich Co., who offered four negotiated new underwritten security issues during the period 1935-1949, at a time when a Dillon Read officer was on the issuer's board of directors. Dillon Read managed one of these issues alone, and co-managed the other three. Two of the documents referred to proxies.
National Cash Register
Of the other documents, the earliest in point of time is an agreement of January 4, 1926 between the stockholders of the old, privately owned. National Cash Register Company and Dillon Read, relating among other things to the reorganization of the company and to the first public distribution of National Cash Register stock in the history of the company. The stockholders of the old company retained control. Among paragraphs dealing with various matters such as stock options, reimbursement agreements and employee stock, is the part relied on by government counsel, to the effect that Dillon Read is given the right to designate a minority of the directors of the new company. The only fair inference from this, it seems to me, is that in sponsoring such an offering Dillon Read wished to make reasonably sure that the new company had proper management, for the protection of those who bought the securities. For only a short period, after the first year, was there more than one Dillon Read man on the board.
It is interesting to note that in 1935 or 1936, despite the presence of this Dillon Read man on the board, Ripley, upon the invitation of Colonel Deeds, made a trip to Dayton, Ohio, and tried to get the National Cash Register business. When he was told by Colonel Deeds and Mr. Allyn "that they felt that if they did any financing tht they wanted to do it through Dillon Read," Ripley continued to compete and asked if Brown Harriman could not be a joint manager. The "red flag" or "signpost" arrangement did not seem to be functioning.
A letter of January 30, 1926, with certain exhibits attached, constitutes an offer by two stockholders of Amerada Petroleum Corp. to sell common stock to a syndicate to be formed by Dillon Read. The transaction related to the transfer of control from British to American interests. The situation is similar to that of National Cash Register just referred to.Dillon Read is assured that, over a five year period, there will be elected to the board of directors "a majority of the members thereof satisfactory to you." Under these conditions it is understandable that, in offering the shares to the American public, Dillon Read should wish to give some assurance of a capable board for this limited period.
Two documents going back to 1927 and 1928 relate to a piece of patently unattractive business brought to Dillon Read by Freeman, the middleman or finder, whom we shall meet again. In January, 1927, Freeman talked with Van Bibber, of Dillon Read, and said that as the president of the Outlet Company wanted to retire, "any purchaser would have to provide management." On May 22, 1928, Shields of Dillon Read advised Freeman he was "concerned as to the future management". Also that the price was too high. Freeman was persistent, however, and a memorandum of October 26, 1928, contains the phraseology which it is claimed helps plaintiff's case. It reads:
"M. L. Freeman again suggested the possibility of financing for this company or the purchase of control. I told him we would not be interested, partly because of the management and partly due to the fact that the company had their own bankers, Lehman Brothers, who had handled two issues of securities for them and were represented on the board."
This is confirmed by a letter to Freeman of the same date.
I can find nothing here but the exercise of good business judgment on the merits. After an appraisal of the situation Dillon Read gives what seems to me to be entirely adequate business reasons for letting the matter drop.
Beneficial Industrial Loan
There are seven 1931 documents, in series, relative to Beneficial Industrial Loan Corporation. The emphasis is placed upon the following sentence contained in a letter of May 26, 1931, from Willcox of Dillon Read to Alexander Randall of the investment banking house of Mackubin, Goodrich & Co., there being a Dillon Read man on the board at the time:
"More important, I am somewhat troubled by your not approaching the company on this matter through the leaders [Dillon Read] of the investment banking group which was formed to handle the investment banking affairs of the company."
The explanation appears on the face of the letters, read against the background of the static data.
In March, 1931, a security issue of Beneficial Industrial Loan was underwritten by Blyth, H. M. Byllesby, Dillon Read and Mackubin Goodrich, Dillon Read leading and handling the business. Of $10,000,000 6% convertible debentures, $7,000,000 were offered March 11, 1931, and there was an option on the remaining $3,000,000. It is this option feature of the 1931 financing which was the subject of the approach of Randall to the executives of the company.There is no doubt that any plan in which Bleyth, Byllesby, Dillon Read and Mackubin Goodrich were jointly interested, by reason of their percentages of Dillon Read, 47.50%, Blyth, 23.75%, Byllesby, 23.75% and Mackubin Goodrich, 5%, should have been presented by Dillon Read; and Willcox, on May 26, 1931, wrote to O. W. Caspersen, Vice President of Beneficial Industrial Loan, substantially repeating what he had written on the same day to Randall.
Government counsel treats these letters as warning off a potential competitor, but such was not the case. They were all in the deal together, and Caspersen's reply to Wilcox, of May 29, explains Randall's "approach," as follows:
"Mr. Randall wanted to discuss the matter with you, but as you were absent he asked us not to do anything about it until you returned and had the opportunity to pass on it."
A memorandum of Willcox in this series dated September 10, 1931, suggests that Dillon Read ask George Franklin to go on the board of Beneficial Industrial Loan. The phrase selected here follows a reference to two lawyers on the board, and is "both of whom speak our language." But the ue of this common phrase would not seem to justify an invidious interpretation.
Part of the correspondence is between Warner of Byllesby and Willcox to the effect that Byllesby feels that it is entitled to have a "representative" on the board. Wilcox puts it up to Byllesby to work out with Blyth, so that there may not be "three representatives of the banking group," in view of the willingness of the company to have two. But Byllesby and Blyth could not agree and the purchase contract accordingly only called for one. The emphasis here is placed by government counsel on the following sentence in the last letter by Willcox:
"The Company has taken a very firm position on this subject, and it seems to us hardly proper to put pressure on it to change the agreement."
Whatever "pressure" may have been suggested, however, was suggested by Byllesby, and not by Dillon Read.
By way of sequel, it appears by the deposition testimony of Bogert, of Eastman Dillon, that Eastman Dillon took the business away from Dillon Read, and the next negotiated underwritten offerings of Beneficial Industrial Loan, starting in December, 1938, came out under Eastman Dillon management.
A letter from W. S. Charnley to Robert E. Christie, Jr., both of Dillon Read, dated July 20, 1931, mentions recommending Wilbur DuBois, "one of our men," to be named as a director of Union Oil Company Pantapec Liquidating Corporation. The sentence selected by government counsel here is:
"I am very glad that you agreed to this request as in view of the possible future circumstances it is, I think, very necessary that we put the Union Oil under every obligation possible."
Charnley was a director of Union Oil Company of California from before July 26, 1933, until after he left Dillon Read on March 10, 1934. Except for one issue in June, 1923, the pre-Securities Act Issuer Summary Sheet shows Dillon Read as "offeror" or as being in "privity of contract," either alone or with others, with respect to all underwritten offerings between 1922 and 1930. All underwritten issues since 1935 have been managed by Dillon Read, and private placements in 1947 and 1949 were handled by Lehman and Dillon Read respectively.
That the reference to DuBois was merely part of Dillon Read's competitive effort to get or keep business, by taking advantage of an opportunity to be of service to the company, seems apparent. It was only intended that he should serve "during the period of division of properties of Union National Petroleum Company." Gregg of Union Oil, in a letter to DuBois, refers to "the very limited services which you will be called upon to perform"; and DuBois resigned as a director after serving less than two months.
Commercial Investment Trust
A single document of February 28, 1941, is a combined notice of annual meeting of stockholders and proxy statement of Commercial Investment Trust Corporation, which merely states:
"Mr. Bolland (an officer of Dillon, Read & Co.) was originally elected in 1929, and Mr. Altschul (a partner of Lazard Freres & Co.) in 1930 and Mr. Strauss (a partner of Kuhn, Loeb & Co.) in 1936 were without formal action designated as candidates, by the Boards of Directors then in office because of their affiliation with underwriters of the Corporation's securities."
Finally, there are three Dillon Read memoranda relating to Rheem Manufacturing Company in March and April of 1944. The last previous negotiated underwritten issue had been managed by Blyth, followed by a private placement without the services of any investment banker in 1943. The first memorandum, dated March 23, 1944, gives a summary of miscellaneous information about the company, probably prepared for the purpoe of going after the business, and the part relied on by government counsel notes, concerning the board of directors, that it "is an entirely employee board with the exception of A. E. Ponting, Coast representative of Blyth." The second, from Behr to McCain, both of Dillon Read, indicates that Keplinger who "was connected with Dillon, Read & Company before he was connected with Rheem," was still of the opinion that Rheem desired "to do business with us instead of Blyth," and would like to bring the president of Rheem in to see Dillon Read, to dispel any impression that Keplinger had misinformed them of the company's position in the matter. The last memorandum, of April 20, 1944, without details notes a talk between Mr. Rheem and Keplinger with Mitchell of Blyth, a subsequent talk between Mr. Rheem and Keplinger with McCain of Dillon Read and concludes with the statement that "Blyth & Company is now working on a debenture issue for this company." Strange to relate, government counsel seem to think these memoranda indicate that Dillon Read started after the business, had a good chance to get it and then stopped competing because Blyth was the "traditional banker" and because of the "red flag" shown by the presence of Ponting on the board.
All the inferences are to the contrary. To begin with, as Dillon Read knew that Blyth had brought out the last previous negotiated underwritten security issue it should not have gone after the business at all, if the alleged conspiracy was in operation. No "red flag" was necessary. The significant thing is that they did compete for the business and they lost out partly because Blyth was evidently in a strong competitive position and Keplinger, in his efforts to help his old firm to get the business, overplayed his hand. Mitchell of Blyth was a formidable opponent and more than a match for Keplinger. Moreover, Mr. Rheem evidently preferred to do business with Blyth. It would be interesting to hear what took place at the conversation between Mr. Rheem, Keplinger and Mitchell shortly prior to the decision to count Dillon Read out. This is not a case of deferring, but of the very sort of active competition that the operation of the conspiracy was supposed to be designed to prevent. There is nothing whatever to indicate that Keplinger's efforts were frustrated by the presence of Ponting on the board.
I find as a fact that there is no basis for plaintiff's charge against Dillon Read on the "directorships" issue.
The government chart shows that Blyth had directors on the boards of 8 issuers, who offered 14 issus of negotiated new underwritten securities during the 15-year period. Of these 14 issues, Blyth managed all but one, the sole issue for one of the issuers. It appeared, however, that Blyth or Blyth Witter had handled financing for 6 of the remaining 7 issuers before its man was made a directorf and all 8 are West Coast companies. Blyth never had any general policy of placing directors as a means of competing for business; but where continuing relationships existed in particular instances these may well have been improved and fostered by the presence of a Blyth officer on the board of directors.
In addition to the Dillon Read documents relating to Rheem, which have jut been discussed, government counsel introduced only three documents on this phase of the case against Blyth, and one other, received against Lehman Brothers, was referred to in the connecting statements.
The Lehman Brothers document is a letter from Robert Lehman to Donald N. McDonnell of Blyth, dated October 6, 1943, asking for an underwriting position in a possible financing by Rayonier, Inc. The statement "with two associates on the board of directors, I presume your firm must know the whole story," is supposed to illustrate the power or advantage that a directorship gives an investment banker over potential competitors. But Lehman Brothers had no reason to suppose that it was in a position successfully to compete for the business nor does it appear that Lehman Brothers even contemplated doing so.
Pan American Airways
A letter from George Leib to Charles E. Driver, both of Blyth, dated June 1, 1937, indicates that Leib is after a participation and has not been able to make any progress with Lehman Brothers, which, Leib appears to have had some reason to believe, was about to manage a Pan American Airways issue. The letter comments, "Representatives of several investment banking houses are on the board -- particularly Lehman," and goes on to suggest that "if they have an underwriting" about the only was Blyth could be included in the group was by an approach through Lew Manning, representing Aviation Corporation, one of the largest stockholders of Pan American.
Far from helping the government because of the phrase "particularly Lehman," the significance of the document seems to be that it was one of the early steps in a competitive effort which finally succeeded in getting the business away from Lehman Brothers, as is shown in the discussion of Pan American Airways financings under the sub-title of Lehman Brothers, on the phase of the case now under discussion.
Another feature of the Pan American Airways financing tends to refute a contention of government counsel which seems to rest on no more substantial foundation than pure assertion. It is claimed that one of the features of the conspiratorial scheme is that, if a defendant investment banking house once has an underwriting position or participation in a financing managed by another defendant, this precludes the participant from competition for the management of future financings of the issuer whose securities are under consideration. But Blyth had participated in the 1940 issue of Pan American Airways, co-managed by Lehman Brothers; and this did not deter Blyth from joining with Kuhn Loeb, Lazard and Ladenburg Thalmann in seeking the leadership of the 1945 issue. There are numerous other instances of the same thing and I shall not mention the subject again. An appropriate finding of fact relative thereto may be submitted in due course.
Mitchell, of Blyth, when with the National City Company, had for many years worked on Anaconda financings, which in the pre-Securities Act period were handled by the National City Company and the Guaranty Company. Mitchell had been a director of Anaconda for a long time, having been invited by John F. Ryan, then President of Anaconda, to become a director in 1929. During the summer of 1935, Anaconda became interested in a proposed financing which was to be the first substantial new money issue after the Bank Holiday of 1933.Blyth worked out a financing plan and Mitchell testified extensively by deposition concerning the details of what was done. Swan of Edward B. Smith & Co., Stanley Russell of Lazard and others were also after this business. It was only natural that the men who had previously handled Anaconda financings at the National City and Guaranty companies should be found competing against one another for this business after they had been forced to make new connections by the operation of the Glass-Steagall Act.
Despite all this, government counsel claimed, in connection with the "successorship" phase of the case, that the business of Anaconda had "fravitated" to Blyth by reason of a conspiratorial agreement among the defendants to the effect that "part" of the business of National City should be "inherited" by Blyth. As a matter of fact I find that Blyth got this business due to the competitive efforts of Blyth, under the able guidance of Mitchell; and, when cornelius F. Kelley of Anaconda wrote Mitchell on August 2, 1935, that if National City Company and Guaranty Company were permitted by pending legislation to resume their investment banking activities, "inasmuch as they have always been the principal bankers of the Company, they would be entitled to lead in the financing if they so desired," Kelley was merely exercising the prerogative of an issuer to select its own investment bankers according to its own free choice.The pending legislation did not pass, however, and the $55,000,000 issue of debentures came out on October 15, 1935, under the management of Blyth.
This is all leading up to a document introduced against Blyth on "directorships," which is a letter from Mitchell to Kelley of August 21, 1935, tendering his resignation as a director of Anaconda, "in order that there may be no conflict of interests in my position as Chairman of Blyth & Co. and in my holding a Directorship in the Anaconda Copper Mining Company, with respect to consideration of the financial program of your Company." Mitchell testified that this was a "matter of judgment" in this "particular case." He never came back on the board.
The final document against Blyth on directorships is a letter from T. H. Banfield, president of Iron Fireman Manufacturing Co., to Shurtleff of Blyth with reference to a vacancy on the board of directors and among the voting trustees of the company, caused by the death of Mansel Griffiths, manager of Blyth's Portland office. The part relied upon reads:
"When Blyth & Co. purchased part of the Iron Fireman Manufacturing Company's holdings and put the same on the market to the public, there was an understanding that Blyth & Co. would have two directors on the Iron fireman Manufacturing Company's board.
"During the life of this agreement, we have been very happy with the association of both Manse Griffiths and Henry Boyd and it goes without saying that we regret very much the loss of Manse Griffiths.
* * * * * *
"The other Voting Trustees and Directors would welcome you to become a member of the Voting Trustees and also a member of the Board of Directors of Iron Fireman if same would meet with your pleasure. I understand that this is quite satisfactory to Charley Blyth."
There is no evidence that Blyth sought to have any of its officers or employees selected as voting trustees or directors; and I do not see why it is not a reasonable inference that those who served as voting trustees or directors did so at the request of the stockholders or the management and for good business reasons.
With respect to Blyth I find the facts on the "directorships" issue to be the same as with reference to the other defendants. There was no adherence to any "red flag" or "signpost" term of any agreement, and no domination or control over any issuer.
Some Further Interim Observations
It is because the allegation of domination and control of issuers presents one of the fundamental and crucial controverted issues of fact in the case, that I have gone to such pains to review the evidence in detail and in this comprehensive fashion. After all the talk about domination and control of issuers which is to be found in the TNEC hearings, and in the course of other investigations by numerous public officials over the years, it was to be expected that substantial evidence would be produced at this trial in support of the specific and detailed allegations in the complaint on this subject. Certainly there was nothing to prevent government counsel from having access to every living witness and every shred of documentary evidence in existence.Partners, officers and employees of investment banking houses were subject to subpoena before the Grand Jury, which considered these issues for many months but found no indictment against any of the defendants. While I was adamant in refusing to permit any prying into the proceedings before the Grand Jury, and would take the same position if I were to go through this whole weary process again, there is ample indication in the long record now before me to indicate that truckloads of documents were produced before the Grand Jury. The precise number of the hundreds of thousands of documents, from the fields of issuers and defendant and non-defendant investment banking houses, which were examined, tabulated and photostated by government investigators, will probably never be known. The intimate and confidential character of hundreds of the documents in evidence would seem to indicate that there was no suppression of evidence whatever by anyone.
And yet, as is shown by the detailed summary just concluded, the result is nothing but a hodge-podge of confusion. Mons parturibat deinde murem prodidit. No judge or court possibly make a finding of domination and control of the financial affairs of issuers, by defendants or anyone else, on the basis of such proofs. The myth of domination and control of issuers by investment bankers, at least in the post-Securities Act period with which we are principally here concerned, which was fostered by the ex parte TNEC proceedings and blown up by the long continued propaganda in favor of compulsory public sealed bidding should, perhaps, be given a decent burial and quietly laid to rest.
There is further significance, however, in this discussion of the evidence on directorships. It illustrates the method pursued, and the strategy and tactics employed, in a documentary case such as this. Mere fragments are culled from a host of miscellaneous documents, in complete disregard of the transactions revealed by the context in whcih these words or phrases are used. But mere "words" are as empty air. The facts concerning the transactions in the course of which these "words" are used must constitute the building materials out of which court judgments are constructed.
Moreover, the same clear indication of the lack of any combination or concert of action by and between the seventeen defendant firms, which appeared in connection with the consideration of the evidence on the so-called price-fixing phase of the case and the operation of the syndicate system, is found again in the proofs relating to alleged domination and control of the financial affairs of issuers and the use of directorships and proxies. In a circumstantial evidence case of this character the lack of such joint action on these important and basic issues cannot fail to be matter of grave consequence.