(Image: Zen Buddha Silence by Marilyn Barbone.)
September 22, 2019
John Brooks is one of the best business writers of all time. Business Adventures may be his best book, but Once in Golconda, The Go-Go Years, and The Games Players are also worth reading.
I wrote about Business Adventures here: http://boolefund.com/business-adventures/
Today’s blog post deals with The Go-Go Years.
Here’s a brief outline:
- Climax: The Day Henry Ross Perot Lost $450 million
- Fair Exchange: The Year the Amex Delisted the Old Guard Romans
- The Last Gatsby: Recessional for Edward M. Gilbert
- Palmy Days and Low Rumblings: Early Warnings Along Wall Street
- Northern Exposure: Early Warnings Along Bay Street
- The Birth of Go-Go: The Rise of a Proper Chinese Bostonian
- The Conglomerateurs: Corporate Chutzpah and Creative Accounting
- The Enormous Back Room: Drugs, Fails, and Chaos Among the Clerks
- Go-Go at High Noon: The View from Trinity Church
- Confrontation: Steinberg/Leasco vs. Renchard/Chemical Bank
Henry Ross Perot from Dallas, Texas, was one of the top six richest people in America on April 22, 1970. That day, he suffered a stock market loss of $450 million, still leaving him with a billion dollars worth of stock. Brooks writes that Perot lost more than the assets of any charitable foundation in the country outside of the top five. Brooks adds:
It was also quite possibly more in actual purchasing power than any man had ever lost in a single day since the Industrial Revolution brought large private accumulations of money into being.
On May 8, 1970, schools were closed in protest of Vietnam. One of the antiwar demonstrations by students took place at Wall Street. This particular demonstration was noticeably nonviolent. Unfortunately, right before noon, a group of construction workers—carrying construction tools and wearing heavy boots—attacked the student demonstrators. Fifty (out of a thousand) students needed first-aid treatment, and twenty-three of those were hospitalized.
Brooks explains that workers on Wall Street sided with the students:
Perhaps out of common humanity, or perhaps out of class feeling, the bulls and bears felt more kinship with the doves than with the hawks. At Exchange Place, Robert A. Bernhard, a partner in the aristocratic firm of Lehman Brothers, was himself assaulted and severely cut in the head by a construction worker’s heavy pliers, after he had tried to protect a youth who was being beaten. A few blocks north, a young Wall Street lawyer was knocked down, kicked, and beaten when he protested against hardhats who were yelling, ‘Kill the Commie bastards!’
However, many on Wall Street took no part in the struggle. Brooks continues:
…there is an all too symbolic aspect to professional Wall Street’s role that day as a bystander, sympathizing, unmistakeably, with the underdogs, the unarmed, the peace-lovers, but keeping its hands clean—watching with fascination and horror from its windows…
Did it make sense any more to live—and live at the top of the heap—by playing games with paper while children screamed under the window?
Although Perot understood that Wall Street—where a company could be taken public—was the source of his wealth, he nonetheless still believed in the West—and the “frontier”—not the East. Brooks:
He believed that all things were possible in America for the man of enterprise and that the natural habitat of the man of enterprise was the “frontier.”
Perot graduated from the Naval Academy in 1953, where he was class president. After four years of active Navy duty, he went to work as a salesman on commission for IBM.
Perot was earning so much money at IBM that the company cut his commissions by 80 percent and they gave him a quota for the year, past which he wouldn’t earn anything. In 1962, Perot hit his quota on January 19, which made him essentially unemployed for the rest of the year.
Perot’s solution was to start his own company—Electronic Data Systems Corp., designers, installers, and operators of computer systems. The new company struggled for some time. Finally in 1965, federal Medicare legislation was passed. E.D.S. soon had subcontracts to administer Medicare or Medicaid in eleven states.
All told, by 1968 E.D.S. had twenty-three contracts for computer systems, 323 full-time employees, about $10 million in assets, annual net profits of over $1.5 million, and a growth curve so fantastic as to make investment bankers’ mouths water.
By early 1970, having beaten every city slicker he encountered, Perot was worth $1.5 billion. (This was a few years after E.D.S. went public.)
Perot proceeded to become what Brooks calls a “moral billionaire.” He pledged to give away nearly all of his fortune to improve people’s lives. Early on, when he started making charitable donations, he refused to take a tax write-off because he felt he owed tax money to a country that had given him such great opportunities.
Regarding the one-day stock market loss of $450 million, Brooks says:
The way Perot received the news of his monumental setback on April 22 was casual to the point of comedy.
Perot thought, correctly, that the $1.5 billion he had made over eight years wasn’t entirely real because it couldn’t be turned easily into cash. Moreover, he had plenty of money, including a billion dollars in E.D.S. stock post-crash. The bottom line, notes Brooks, was that Perot viewed the one-day swing as a non-event.
Brooks writes that E.D.S. was experiencing outstanding financial results at the time. So the stock swoon wasn’t related to company fundamentals. Many other stocks had fallen far more on a percentage basis than E.D.S. would fall on April 22, 1970.
At any rate, since the vast majority of stocks had already fallen, whereas E.D.S. stock hadn’t fallen at all, it seemed to make sense that E.D.S. stock would finally experience some downward volatility. (Brooks notes that University Computing, a stock in E.D.S’s industry, was 80 percent below its peak before E.D.S. even started falling.) Furthermore, it appeared that there was a bear raid on E.D.S. stock—the stock was vulnerable precisely because it was near its all-time highs, whereas so many other stocks were far lower than their all-time highs.
Nor is it without symbolic importance that the larger market calamity of which E.D.S. was a part resembled in so many respects what had happened forty years before—what wise men had said, for more than a generation, over and over again as if by way of incantation, could never happen again. It had happened again, as history will; but (as history will) it had happened differently.
Brooks tells the stories of two swindlers, Lowell McAfee Birrell and Alexander Guterma. Brooks writes:
Birrell, like Richard Whitney before him, was apparently a scoundrel as much by choice as by necessity. The son of a small-town Presbyterian minister, a graduate of Syracuse University and Michigan law school, a handsome, brilliant, and charming man who began his career with the aristocratic Wall Street law firm of Cadwalader, Wickersham and Taft and soon belonged to the Union League and Metropolitan Clubs, Birrell, if he had not been Birrell, might easily have become the modern-day equivalent of a Morgan partner—above the battle and beyond reproach.
Birrell issued himself tons of unauthorized stock in corporations he controlled, and then illegally sold the shares. The S.E.C. was after Birrell in 1957. To escape prosecution, Birrell fled to Brazil.
Guterma was in the mold of the traditional international cheat of spy stories—an elusive man of uncertain national origin whose speech accent sometimes suggested Old Russia, sometimes the Lower East Side of New York, sometimes the American Deep South.
Guterma made his first fortune in the Phillipines during World War II. He ran a gambling casino that catered to occupying Japanese serviceman.
In 1950, Guterma married an American woman and moved to the United States. Brooks:
During the succeeding decade he controlled, and systematically looted, more than a dozen substantial American companies…
In September 1959, Guterma was indicted for fraud, stock manipulation, violation of federal banking laws, and failure to register as the agent of a foreign government.
Brooks mentioned Birrell and Guterma as background to a story in 1961 that involved Gerard A. (Jerry) Re and his son, Gerard F. Re. The Re’s formed the Amex’s largest firm of stock specialists. (At that time, specialists maintained orderly markets in various stocks.) One problem was that specialists often have inside information about specific stocks from which they could profit. Brooks comments:
Pushed in one direction by prudent self-interest, in the other by sense of duty or fear of punishment, a specialist at such times faces a dilemma more appropriate to a hero in Corneille or Racine than to a simple businessman brought up on classic Adam Smith and the comfortable theory of the socially beneficent marketplace.
The S.E.C. finally took notice. Brooks:
Over a period of at least six years, the S.E.C. charged, the father and son had abused their fiduciary duties in just about every conceivable way, repeating a personal profit of something like $3 million. They had made special deals with unethical company heads—Lowell Birrell in particular—to distribute unregistered stock to the public in violation of the law. In order to manipulate the prices of those stocks for their private benefit and that of the executives they were in league with, they had bribed the press, given false tips by word of mouth, paid kickbacks to brokers, generated false public interest by arranging for fictitious trades to be recorded on the tape—the whole, infamous old panoply of sharp stock-jobbing practices.
Ralph S. Saul, the S.E.C.’s young assistant director of the Division of Trading and Exchanges, led the investigation against the Res. After only two hours of oral arguments, the S.E.C. permanently banned the Res from the securities business.
It turned out that the president of the Amex, Edward T. McCormick, was on the S.E.C.’s list of Re associates. This implied that the Amex, or at least its chief, knew what was going on all along.
McCormick, who held a master’s degree from the University of California and a PhD from Duke, had started working for the S.E.C. in 1934. In 1951, he left his post as S.E.C. commissioner to become head of the Amex. Brooks notes that this sort of talent drain had been the bane of the S.E.C. from its beginnings. Brooks says:
The scholar and bureaucrat had turned out to be a born salesman. But with the Amex’s growth, it began to appear toward the end of the decade, a certain laxness of administration had crept in. Restless at his desk, Ted McCormick was always out selling up-and-coming companies on listing their shares on the Amex, and while he was in Florida or at the Stork Club drumming up trade, sloppy practices were flourishing back at Trinity Place.
Many didn’t notice the Res’ misdeeds. And it seemed that those who knew didn’t care. However, a father-and-son-in-law team, David S. Jackson and Andrew Segal, were greatly disturbed.
Jackson had seen McCormick change over the years:
…Jackson had watched McCormick gradually changing from a quiet, reflective man into a wheeler-dealer who loved to be invited by big businessmen to White Sulphur Springs for golf, and the change worried him. “Ted,” he would say, when they were at dinner at one or the other’s house, “why don’t you read any more?”
“I haven’t got time,” McCormick would reply.
“But you’ll lose your perspective,” Jackson would protest, shaking his head.
Jackson and Segal eventually concluded that McCormick was not fit to be the president of Amex. Jackson met with McCormick to tell him he should resign. McCormick reacted violently, picking up a stack of papers and slamming them on to his desk, and then punching a wall of his office.
McCormick told Jackson that he had never done anything dishonest.
“No, I don’t think you have,” Jackson said, his voice shaking. “But you’ve been indiscreet.”
Roughly a dozen members of Amex, mostly under forty and nicknamed the Young Turks, sided with Jackson and Segal in calling for McCormick’s resignation. However, they were greatly outnumbered and they were harrassed and threatened.
One Young Turk, for example, was pointedly reminded of a questionable stock transaction in which he had been involved some years earlier, and of how easily the matter could be called to the S.E.C.’s attention; to another it was suggested that certain evidence at hand, if revealed, could make a shambles of his pending suit for divorce; and so on.
Soon Jackson and Segal were practically alone. Then something strange happened. The S.E.C. chose to question Jackson about an incident in which one of Jackson’s assistants, years earlier, had done a bad job of specializing. The S.E.C. was led by its top investigators, Ralph Saul, David Silver, and Edward Jaegerman. They questioned Jackson for hours with what seemed to be hostility, scorn, and sarcasm.
Jackson went home and started writing a letter to send to various public officials to complain about his poor treatment by the S.E.C. Jackson read the letter aloud over the phone to Ralph Saul, who was horrified. Saul apologized, asked Jackson not to send the letter, and said that amends would be made.
The S.E.C. sent a team to watch the Jackson and Segal operation, trade by trade. The S.E.C. concluded that Jackson and Segal were honest and asked them to become allies in the reform of the Amex. Jackson and Segal agreed.
McCormick eventually was forced to resign.
THE LAST GATSBY
Brooks tells the story of Edward M. Gilbert:
From the first, he was a bright but lazy student with a particular aptitude for mathematics, a talented and fanatical athlete, and something of a spoiled darling…
Matriculating at Cornell in the early stages of World War II, he made a name for himself in tennis and boxing, won the chess championship of his dormitory, and earned a reputation as a prankster, but went on neglecting his studies.
Gilbert enlisted in the Army Air Force and worked for Army newspapers. He demonstrated a talent for acquiring foreign languages.
After the war, Gilbert joined his father’s company.
During this period of his business apprenticeship he embarked on a series of personal ventures that were uniformly unsuccessful. He backed a prizefighter who turned out to be a dud. He was co-producer of a Broadway play, How Long Till Summer? that starred the black folksinger Josh White’s son… [but the play] got disastrous notices and closed [after a week.] Gilbert also dabbled in the stock market without any notable success.
Edward Gilbert’s father, Harry Gilbert, became a multi-millionaire when his company, Empire Millwork, sold stock to the public. Brooks:
He was ever ready to use his money to indulge his son, and over the years he would do so again and again… Never a corporate rainmaker, Harry Gilbert, humanly enough, yearned to appear vital, enterprising, and interesting to his friends and colleagues. The son’s deals and the electric office atmosphere they created were made possible by the father’s money. Doubtless the father on occasion did not even understand the intricate transactions his son was forever proposing—debentures and takeovers and the like. But to admit it would be to lose face… And so, again and again, he put up the money. Harry Gilbert bought commercial glamour from his son.
Brooks explains that, in 1948, Eddie Gilbert began dreaming of enlarging Empire Millwork through mergers. In 1951, he asked his father for a directorship. But Harry Gilbert turned him down. So Eddie quit and entered the hardwood-floor business on his own.
There were two versions of what happened next. In one version, Eddie Gilbert was successful and Empire bought him out in 1962. In the other version, Eddie tried and failed to corner the hardwood-floor market, and Harry bought him out to bury the big mistake. Brooks writes:
At any rate, in 1955 Eddie returned to Empire with new power and freedom to act.
Eddie wanted to buy E. L. Bruce and Company, the country’s leading hardwood-floor company.
With net sales of around $25 million a year, Bruce was considerably larger than Empire, but it was a staid firm, conservatively managed and in languid family control, of the sort that is the classic prey for an ambitious raider. In 1955, Eddie Gilbert persuaded his father to commit much of his own and the company’s resources in an attempt to take over Bruce.
Now Eddie came into his own at last. He began to make important friends in Wall Street—brokers impressed with his dash and daring, and delighted to have the considerable commissions he generated. Some of his friends came from the highest and most rarified levels of finance.
In his early thirties, a short, compact man with pale blue eyes and a sort of ferret face under thinning hair, Gilbert had a direct personal charm that compensated for his vanity and extreme competitiveness. Sometimes his newfound friends patronized him behind his back, laughing at his social pretensions and his love of ostentation, but they continued going to his parties and, above all, following his market tips. Some accused him of being a habitual liar; they forgave him because he seemed genuinely to believe his lies, especially those about himself and his past. He was a compulsive gambler—but, endearingly, a very bad one; on lucky streaks he would double bets until he lost all his winnings, or draw to inside straights for huge sums at poker, or go for broke on losing streaks; yet at all times he seemed to take large losses in the best of humor.
Eddie urged his new friends as well as his family to buy Bruce stock, which was selling around $25 a share.
All that spring, the Gilberts and their relatives and Eddie’s friends accumulated the stock, until in June it had reached the seventies and was bouncing up and down from day to day and hour to hour in an alarming way. What was in the process of developing in Bruce stock was the classically dangerous, sometimes disastrous situation called a corner.
Bruce family management had realized that a raid was developing, so they were buying as much stock as they could. At the same time, speculators began shorting the stock on the belief that the stock price would fall. Shorting involved borrowing shares and selling them, and later buying them back. The short sellers would profit if they bought it back at a price lower than where they sold it. However, they would lose money if they bought it back at a price higher than where they sold it.
The problem for short sellers was that Eddie’s friends and family, and Bruce family management, ended up owning all available shares of stock. Brooks:
The short sellers were squeezed; if called upon to deliver the stock they had borrowed and then sold, they could not do so, and those who owned it were in a position to force them to buy back what they owed at a highly inflated price.
Short sellers bought what little stock was available, sending the price up to 188.
Eddie Gilbert, coming out of the fray in the fall of 1958, seemed to have arrived at last—apparently paper-rich from his huge holdings of high-priced Bruce stock, rich in the esteem of his society backers, nationally famous from the publicity attendant on the corner he had brought about.
Gilbert was self-indulgent with his new wealth, for instance, keeping a regular Monday box at the Metropolitan Opera. Brooks:
He acquired a huge Fifth Avenue apartment and, when and as he could, filled it with French antiques, a fortune in generally almost-first-rate paintings, and a staff of six. Sometimes he lived in a mansion at Palm Beach, epitome of Real Society in faded turn-of-the-century photographs. He took an immense villa at Cap Martin on the French Riviera, where he mingled when he could with Maria Callas and Aristotle Onassis and their like, and gave huge outdoor parties with an orchestra playing beside an Olympic-size swimming pool.
Brooks explains that Gilbert was not genuinely rich:
His paper profits were built on borrowing, and he was always mortgaged right up to the hilt; to be thus mortgaged, and to remain so, was all but an article of faith with him… He was habitually so pressed for cash that on each January first he would draw his entire $50,000 empire salary for the coming year in a lump sum in advance. By the summer of 1960 he was in bad financial trouble. Empire National stock was down, Gilbert’s brokers were calling for additional margin, and Gilbert was already in debt all over New York. He owed large sums to dozens of art dealers… But he hung on gamely; when friends advised him at least to liquidate the art collection, he refused. To sell it, he explained, would be to lose face.
However, Gilbert was saved when Bruce stock increased sharply. This led Gilbert to want to have Bruce acquire Celotex Corporation, a large manufacturer of building-insulation materials. Gilbert acquired as much Celotex stock as he could. He put his friends and family into Celotex. Even his old enemies the Bruce family authorized Gilbert’s use of $1.4 million of the company’s money to buy Celotex shares.
But then Gilbert’s fortunes reversed again. The stock market started to go sour. Moreover, Gilbert’s marriage was on the rocks. Gilbert moved to Las Vegas in order to stay there the 6-week period required for a Nevada divorce.
Gilbert kept his residence in Las Vegas as much of a secret as he could. The few people from Bruce who were allowed to know where Gilbert was were sworn to secrecy.
While in Vegas, Gilbert would be up at dawn, since the markets opened at 7:00 A.M. Nevada time. In the afternoons, Gilbert went to the casinos to gamble. He later admitted that his gambling losses were heavy.
Meanwhile, the stock market continued to decline. Eddie Gilbert was in trouble. Most of Eddie’s friends—who held Celotex on margin—were also in trouble.
Gilbert himself had all but exhausted his borrowing power. His debts to brokers, to friends, to Swiss bankers, to New York loan sharks on the fringes of the underworld, all loomed over him, and the market betrayed him daily by dropping even more.
The third week of May became for Gilbert a nightmare of thwarted pleas by telephone—pleas to lenders for new loans, pleas to brokers to be patient and not sell him out, pleas with friends to stick with him just a little longer. But it was all in vain, and in desperation that same week Gilbert took the old, familiar, bad-gambler’s last bad gamble—to avoid the certainty of bankruptcy he risked the possibility of criminal charges. Gilbert ordered an official of Bruce to make out checks drawn on the Bruce treasury to a couple of companies called Rhodes Enterprises and Empire Hardwood Flooring, which were actually dummies for Gilbert himself, and he used the proceeds to shore up his personal margin calls. The checks amounted to not quite $2 million; the act amounted to grand larceny.
Gilbert hoped that the prices of Bruce and Celotex would rise, allowing him to repay Bruce for the improper loan. But Gilbert had a premonition that the stock prices of Bruce and Celotex were about to tumble more. Gilbert later told The New York Times:
“I suddenly knew that I couldn’t get through this without getting hurt and getting innocent people hurt.”
Gilbert was right, as the prices of Bruce and Celotex collapsed on what turned out to be Blue Monday, the Stock Exchange’s second worse day of the century thus far. Bruce fell to 23, down 9 3/8, while Celotex fell to 25, down 6. In total, Gilbert lost $5 million on Blue Monday. Furthermore, many of Gilbert’s friends who’d followed his advice also had huge losses.
Gilbert realized that if he could find a block buyer for his Celotex shares, that might allow him to repay loans, especially the improper loan from Bruce. But Gilbert was unable to find such a buyer. So Eddie did the last thing he felt he could—he fled to Brazil, which had no effective extradition treaty with the United States.
Suddenly Gilbert returned to the United States, despite federal and state charges against him that carried penalties adding up to 194 years in prison. Gilbert’s father had hired Arnold Bauman, a New York criminal lawyer, who had told Gilbert that he could return to the U.S. if he promised to implicate other wrongdoers. Gilbert never fulfilled these promises, however, and he ended up spending a bit over two years in prison.
Before going to prison, Gilbert was free on bail for four and a half years. During that time, with more money form his father, Gilbert started and ran a new business, the Northerlin Company, flooring brokers. He was successful for a time, allowing him to begin repaying loans. But again he was too aggressive, and he had to sell the Northerlin Company for a tax loss.
PALMY DAYS AND LOW RUMBLINGS
Brooks explains how William Lucius Cary came to be appointed as chairman of the S.E.C.:
A strong Report on Regulatory Agencies to the President Elect, commissioned by the President-elect himself and written late in 1960 by James M. Landis, who had been an S.E.C. chairman in New Deal days, showed that Kennedy was bent on bringing the S.E.C. back to life, and it set the stage for the Cary regime. Landis called for more funds as well as greater regulatory zeal, and Kennedy and Congress implemented the Landis conclusions with practical backing; between 1960 and 1964, the S.E.C.’s annual appropriation increased from $9.5 million to almost $14 million and its payroll from fewer than one thousand persons to almost fifteen hundred. But the change was not only quantitative. Cary concentrated on recruiting talented and enthusiastic lawyers, devoting perhaps a third of his time to the task. His base supply naturally enough consisted of his former students and their friends; the atmosphere… soon changed from one of bureaucratic somnolence to one of academic liberal activism.
Brooks gives background on Cary:
Cary in 1962 was a lawyer of fifty-one with the gentlemanly manner and the pixyish countenance of a New England professor. A late-starting family man, he had two children who were still tots; his wife, Katherine, was a great-great-granddaughter of America’s first world-famous novelist, James Fenimore Cooper. His reputation among his colleagues of the bar was, as one of them put it, for “sweetness of temperament combined with fundamental toughness of fibre.”…He had grown up in and around Columbus, the son of a lawyer and president of a small utility company; he had graduated from Yale and then from Yale Law, practiced law a couple of years in Cleveland, then done a long stretch in federal government—first as a young S.E.C. assistant counsel, later as an assistant attorney general in the tax division of the Justice Department, then as an Office of Strategic Services cloak-and-dagger functionary in wartime Roumania and Yugoslavia. In 1947 he had entered academic life, teaching law thereafter, first at Northwestern and later at Columbia. He was in the latter post, taking one day a week off to go downtown to the “real world” of Wall Street and practice law with the firm of Patterson, Belknap and Webb, when John F. Kennedy appointed him S.E.C. chairman soon after assuming the Presidency in January 1961.
Brooks then states:
Two actions during his first year in office gave the financial district an inkling of Cary’s mettle and the S.E.C.’s new mood.
The first case was In the Matter of Cady, Roberts and Co., which related to events that occurred two years before. A young broker of Cady, Roberts and Co., Robert M. Gintel, had received information that Curtiss-Wright Corporation was about to seriously cut its quarterly dividend. Gintel immediately sold 7,000 shares for his firm’s customers. This violated Rule 10B-5 of the S.E.C. against trading based on privileged information. Gintel was suspended from trading for twenty days. It seemed like a light sentence.
But so firmly entrenched was the Wall Street tradition of taking unfair advantage of the larger investing public, and so lax the S.E.C.’s administration of that particular part of the law between 1942 and 1961, that not a single stockbroker had ever been prosecuted for improper use of privileged information during those two decades.
The second action led by Cary involved a two-year Special Study of the securities markets. The study was released in three parts.
Specifically, the first installment said that insider-trading rules should be tightened; standards of character and competence for stockbrokers should be raised; further curbs should be put on the new-issues market; and S.E.C. surveillance should be extended to the thousands of small-company stocks traded over the counter that had previously been free of federal regulation…
The second part of the study… concentrated on stock-exchange operations, recommending that brokers’ commissions on trades be lowered, that the freedom of action of specialists be drastically curtailed, and that floor traders—those exchange members who play the market with their own money on the floor itself, deriving from their membership the unique advantages over nonmembers of being at the scene of action and of paying no commissions to brokers—be legislated right out of existence through the interdiction of their activities.
The third and final part… was probably the harshest of the three—and in view of political realities the most quixotic. Turning its attention to the wildly growing mutual-fund business, the S.E.C. now recommended outlawing of the kind of contract, called “front-end load,” under which mutual-fund buyers agreed (and still agree) to pay large sales commissions off the top of their investment. It also accused the New York Stock Exchange of leaning toward “tenderness rather than severity” in disciplining those of its members who have broken its rules.
All in all, the Special Study was a blueprint for a fair and orderly securities market, certainly the most comprehensive such blueprint ever drawn up, and if all of its recommendations had been promptly put into effect, what follows in this chronicle’s later chapters would be a different tale. But, of course, they were not.
The law that was finally passed—the Securities Acts Amendments of 1964—had two main sections, one extending S.E.C. jurisdiction to include some twenty-five hundred over-the-counter stocks (about as many as were traded on the New York and American exchanges combined), and the other giving the government authority to set standards and qualifications for securities firms and their employees.
As far as it went, it was a good law, a landmark law, a signal achievement for Cary and his egghead crew. But it fell far short of what the Special Study had asked for. Not a word, for example, about mutual-fund abuses; no new restrictions on the activities of specialists; and nothing to alter the Stock Exchange’s habit of “tenderness” toward its erring members. Those items had been edited out in the course of the political compromises that had made passage of the bill possible.
The “bitterest pill of all,” writes Brooks, was that the floor traders continued to be allowed to trade for their own accounts using privileged or inside information. The Special Study had asked that such trading be outlawed. But there were very strong objections from the Stock Exchange and then from business in general. Their arguments referred to the freedom of the marketplace and also the welfare of the investing public. The Stock Exchange commissioned the management firm of Cresap, McCormick and Paget to study the issue and determine if floor trading served the public or not.
Built into this situation was one of those moral absurdities that are so dismayingly common in American business life. The Stock Exchange, largely run by floor traders and their allies, had a vested interest in finding that floor traders serve a socially useful purpose. Cresap, McCormick and Paget, being on the Exchange payroll, had a vested interest in pleasing the Exchange…
Cresap, McCormick and Paget labored mightily. One may imagine the Exchange’s gratification when the report, finished at last, concluded that abolition of floor trading would decrease liquidity and thereby introduce a dangerous new volatility into Stock Exchange trading, doing “irreparable farm” to the free and fair operation of the auction market. But perhaps the Exchange’s gratification was less than complete. The magisterial authority of the report was somewhat sullied when James Dowd, head of the Cresap team that had compiled it, stated publicly that his actual finding had been that floor trading was far from an unmixed blessing for the public, and accused the Stock Exchange of having tampered with the report before publishing it… Cary wanted to hold S.E.C. hearings on the matter, but was voted down by his fellow commissioners.
At all events, the report as finally published did not seem to be a triumph of logical thought.
Thus frustrated, Cary’s S.E.C. came to achieve through administration much of what it had failed to achieve through legislation.
In August 1964, the S.E.C. issued strict new rules requiring Stock Exchange members to pass an exam before being permitted to be floor traders. As well, each floor trader had to submit daily a detailed report of his or her transactions.
Shortly after imposition of the new rules, the number of floor traders on the Stock Exchange dropped from three hundred to thirty. As an important factor in the market, floor trading was finished. Cary had won through indirection.
There were hardly any blacks or women on Wall Street in the 1960’s. Brooks:
Emancipated, highly competent and successful women in other fields—the arts, publishing, real estate, retail trade—still found it consistent with their self-esteem to affect a coy bewilderment when conversation turned to the stock market or the intricacies of finance.
Liberal Democrats, many of them Jewish, were about as common as conservative Republicans in the positions of power; now, one of them, Howard Stein of Dreyfus Corporation, would be the chief fund-raiser for Eugene McCarthy’s 1968 presidential campaign…
Many of the men putting together the stock market’s new darlings, the conglomerates, were liberals—and, of course, it didn’t hurt a Wall Street analyst or salesman to be on close and sympathetic terms with such men. There were even former Communists high in the financial game.
Between 1930 and 1951, very few young people went to work on Wall Street. Brooks writes:
Indeed, by 1969, half of Wall Street’s salesmen and analysts would be persons who had come into the business since 1962, and consequently had never seen a bad market break. Probably the prototypical portfolio hotshot of 1968 entered Wall Street precisely in 1965… Portfolio management had the appeal of sports—that one cleanly wins or loses, the results are measurable in numbers; if one’s portfolio was up 30 or 50 percent for a given year one was a certified winner, so recognized and so compensated regardless of whether he was popular with his colleagues or had come from the right ancestry or the right side of the tracks.
It was open season now on Anglo-Saxon Protestants even when they stayed plausibly close to the straight and narrow. Their sins, or alleged sins, which had once been so sedulously covered up by press and even government, were now good politics for their opponents. They had become useful as scapegoats—as was perhaps shown in the poignant personal tragedy of Thomas S. Lamont. Son of Thomas W. Lamont, the Morgan partner who may well have been the most powerful man in the nation in the nineteen twenties, “Tommy” Lamont was an amiable, easygoing man. He was a high officer of the Morgan Guaranty Trust Company and a director of Texas Gulf Sulphur Company, and on the morning—April 16, 1964—when Texas Gulf publicly announced its great Timmins ore strike, he notified one of his banking colleagues of the good news at a moment when, although he had reason to believe that it was public knowledge, by the S.E.C.’s lights in fact it was not. The colleague acted quickly and forcefully on Lamont’s tip, on behalf of some of the bank’s clients; then, almost two hours later, when news of the mine was unquestionably public, Lamont bought Texas Gulf stock for himself and his family.
Lamont had known for several days earlier, and had done nothing. And when he informed his colleague about the Timmins ore strike, he believed that the information was already public knowledge. According to the S.E.C., however, the insider trading rule also required one to wait “a reasonable amount of time,” so that the news could be digested. Brooks:
In so doing, it lumped [Lamont] with flagrant violators, some Texas Gulf geologists and executives who had bought stock on the strength of their knowledge of Timmins days and months earlier, and who made up the bulk of the S.E.C.’s landmark insider case of 1966.
Could it be, then, that the S.E.C. knew well enough that it had a weak case against Lamont, and dragged him into the suit purely for the publicity value of his name? The outlandishness of the charge against him, and the frequency with which his name appeared in newspaper headlines about the case, suggest such a conclusion.
In the end, all charges against Lamont were dropped, while virtually no charges against the other defendants were dropped. Unfortunately, before this happened, Lamont’s health had declined and he had passed away.
The Texas Gulf ore strike at Timmins in early 1964 had dramatically shown Canada to United States investors as the new Golconda. Here was a great, undeveloped land with rich veins of dear metals lying almost untouched under its often-frozen soil; with stocks in companies that might soon be worth millions selling for nickels or dimes on Bay Street, the Wall Street of Toronto; and with no inconvenient Securities and Exchange Commission on hand to monitor the impulsiveness of promoters or cool the enthusiasm of investors. American money flowed to Bay Street in a torrent in 1964 and early in 1965, sending trading volume there to record heights and severely overtaxing the facilities of the Toronto Stock Exchange. Copies of The Northern Miner, authoritative gossip sheet of the Canadian mining industry, vanished from south-of-the-border newsstands within minutes of their arrival; some Wall Street brokers, unwilling to wait for their copies, had correspondents in Toronto telephone them the Miner‘s juicier items the moment it was off the press. And why not? Small fortunes were being made almost every week by quick-acting U.S. investors on new Canadian ore strikes, or even on rumors of strikes. It was as if the vanished western frontier, with its infinite possibilities both spiritual and material had magically reappeared, with a new orientation ninety degrees to the right of the old one.
The Canadian economy in general was growing fast along with the exploitation of the nation’s mineral resources, and among the Canadian firms that had attracted the favorable attention of U.S. investors, long before 1964, was Atlantic Acceptance Corporation, Ltd., a credit firm, specializing in real-estate and automobile loans, headed by one Campbell Powell Morgan, a former accountant with International Silver Company of Canada, with an affable manner, a vast fund of ambition, and, it would appear later, a marked weakness for shady promoters and a fatal tendency toward compulsive gambling.
In 1955, two years after founding Atlantic, Morgan sought to raise money from Wall Street at a time when some on Wall Street thought they could make profits in Toronto. Morgan knew Alan T. Christie, another Canadian. Christie was a partner in “the small but rising Wall Street concern of Lambert and Company.”
At Christie’s recommendation, Lambert and Company in 1954 put $300,000 into Atlantic Acceptance, thereby becoming Atlantic’s principal U.S. investor and chief booster in Wall Street and other points south.
The years passed and Atlantic seemed to do well, its annual profits steadily mounting along with its volume of loans. Naturally, it constantly needed new money to finance its continuing expansion. Lambert and Company undertook to find the money in the coffers of U.S. investing institutions; and Jean Lambert, backed by Christie, had just the air of European elegance and respectability, spiced with a dash of mystery, to make him perfectly adapted for the task of impressing the authorities of such institutions.
Christie first contacted Harvey E. Mole, Jr., head of the U.S. Steel and Carnegie Pension Fund. Brooks:
Christie made the pitch for Steel to invest in Atlantic. Mole, born in France but out of Lawrenceville and Princeton, was no ramrod-stiff traditional trustee type; rather, he fancied himself, not without reason, as a money manager with a component of dash and daring. Atlantic Acceptance was just the kind of relatively far-out, yet apparently intrinsically sound, investment that appealed to Mole’s Continental sporting blood. The Steel fund took a bundle of Atlantic securities, including subordinate notes, convertible preferred stock, and common stock, amounting to nearly $3 million.
The following year, Lambert and Company convinced the Ford Foundation to invest in Atlantic Acceptance. Brooks comments:
After that, it was easy. With the kings of U.S. institutional investing taken into camp, the courtiers could be induced to surrender virtually without a fight. Now Lambert and Company could say to the fund managers, “If this is good enough for U.S. Steel and the Ford Foundation, how can you lose?” “We were all sheep,” one of them would admit, sheepishly, years later. Before the promotion was finished, the list of U.S. investors in Atlantic had become a kind of Burke’s Peerage of American investing institutions: the Morgan Guaranty and First National City Banks; the Chesapeake and Ohio Railway; the General Council of Congregational Churches; Pennsylvania and Princeton Universities (perhaps not coincidentally, the man in charge of Princeton’s investment program was Harvey Mole); and Kuhn, Loeb and Company, which, to the delight of Lambert, gave the enterprise its valuable imprimatur by taking over as agent for the sale of Atlantic securities in the United States. Perhaps the final turn of the screw, as the matter appears in hindsight, is the fact that the list of Atlantic investors eventually included Moody’s Investors Service, whose function is to produce statistics and reports designed specifically to help people avoid investment pitfalls of the sort of which Atlantic would turn out to be an absolutely classic case.
In the early 1960’s, Atlantic’s sales were increasing nearly 100 percent per year. It seemed that the company was exceeding what anyone could have expected. Of course, in the loan business, you can increase volumes significantly by making bad loans that are unlikely to be repaid. Brooks:
In fact, that was precisely what Atlantic was doing, intentionally and systematically.
However, having such investors as the Steel fund, the Ford Foundation, etc., made it easy to dismiss critics.
Late in 1964, Atlantic, hungry for capital as always, sold more stock; and early in 1965, Kuhn, Loeb helped place $8.5 million more in Atlantic long-term debt with U.S. institutional investors. By this time, Lambert and Company’s stake in Atlantic amounted to $7.5 million. The firm’s commitment was a do-or-die matter; it would stand or fall with Atlantic. Moreover, it is now clear that by this time Morgan and his associates were engaged in conducting a systematic fraud on a pattern not wholly dissimilar to that of Ponzi or Ivar Kreuger. Atlantic would use the new capital flowing from Wall Street to make new loans that its major officers knew to be unsound; the unsoundness would be deliberately camouflaged in the company’s reports, in order to mislead investors; the spurious growth represented by the ever-increasing loans would lure in new investment money, with which further unsound loans would be made; and so on and on. Morgan had taken to intervening personally each year in the work of his firm’s accountants—some of whom were willing enough to commit fraud at their client’s request—to ensure that a satisfactory rise in profits was shown through overstatement of assets and understatement of allowances for bad debts. For 1964, it would come out later, Atlantic’s announced $1.4 million profit, under proper accounting procedure, should have been reported as a loss of $16.6 million.
The game, like all such games, could not go on forever. By early 1965, suspicion of Atlantic’s operations was in the wind. In April, the New York Hanseatic Corporation, a $12-million investor in Atlantic paper, asked the Toronto-Dominion Bank for a credit check on Atlantic. The response—which in retrospect appears dumbfounding—was favorable. In fact, if the bank had been able to penetrate the mystifications of Powell’s accountants, it would have discovered that Atlantic was by that time actually insolvent. For several years, at the instigation of some of the various international schemers for whom Morgan had a fatal affinity, the firm had been increasingly involved in a desperate and doomed plunge in a shaky venture far from home: between 1963 and early 1965 it had committed more than $11 million to the Lucayan Beach, a hotel with a gambling casino attached, on balmy, distant Grand Bahama Island. A Royal Commission would later describe the investment as “the last throw of the dice to retrieve all the losses created by years of imprudence and impropriety.” But the Lucayan Beach venture, managed incompetently and fraudulently, did not flourish, and the losses were not to be retrieved.
On June 15, Atlantic went into default. It needed $25 million to cure the situation. “Of course, it neither had not could raise such a sum.” Brooks comments:
The Old Establishment of U.S. investing had fallen for its own fading mystique. Believing, with tribal faith that can only be called touching, that no member of the club could make a serious mistake, the members had followed each other blindly into the crudest of traps, and had paid the price for their folly.
Brooks concludes: “…the Atlantic episode neatly divides Wall Street’s drama of the decade, ending the first act, and beginning the second and climactic one.”
THE BIRTH OF GO-GO
Brooks defines the term “go-go” as a method of investing:
The method was characterized by rapid in-and-out trading of huge blocks of stock, with an eye to large profits taken very quickly, and the term was used specifically to apply to the operation of certain mutual funds, none of which had previously operated in anything like such a free, fast, or lively manner.
The mood and the method seem to have started, of all places, in Boston, the home of the Yankee trustee. The handling of other people’s money in the United States began in Boston, the nation’s financial center until after the Civil War. Trusteeship is by its nature conservative—its primary purpose being to conserve capital—and so indeed was the type of man it attracted in Boston. Exquisitely memorialized in the novels of John P. Marquand, for a century the Boston trustee was the very height of unassailable probity and sobriety: his white hair neatly but not too neatly combed; his blue Yankee eyes untwinkling, at least during business hours; the lines in his cheeks running from his nose to the corners of his mouth forming a reassuringly geometric isoceles triangle; his lips touching liquor only at precisely set times each day, and then in precise therapeutic dosage; his grooming impeccable (his wildest sartorial extravagance a small, neat bow tie) with a single notable exception—that he wore the same battered gray hat through his entire adult life, which, so life-preserving was his curriculum, seldom ended before he was eighty-five or ninety.
Brooks writes about the Boston-born “prudent man rule.” In 1830, Justice Samuel Putnam of the Supreme Judicial Court of Massachusetts wrote in a famous opinion:
All that can be required of a Trustee to invest is that he conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion, and intelligence manage their own affairs, not in regard to speculation, but in regard to permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.
Brooks then writes that Boston, in 1924, was the location of “another epoch-making innovation in American money management, the founding of the first two mutual funds, Massachusetts Investors Trust and State Street Investing Company.” Later, after World War II, “the go-go cult quietly originated hard by Beacon Hill under the unlikely sponsorship of a Boston Yankee named Edward Crosby Johnson II.” Brooks describes Johnson:
Although never a trustee by profession, Johnson was almost the Boston-trustee type personified.
The market bug first bit him in 1924 when he read a serialization in the old Saturday Evening Post of Edwin Lefevre’s “Reminiscences of a Stock Market Operator,” the story of the career of the famous speculator Jesse Livermore. “I’ll never forget the thrill,” he told a friend almost a half century later. “Everything was there, or else implied. Here was the picture of a world in which it was every man for himself, no favors asked or given. You were what you were, not because you were a friend of somebody, but for yourself. And Livermore—what a man, always betting his whole wad! A sure system for losing, of course, but the point was how much he loved it. Operating in the market, he was like Drake sitting on the poop of his vessel in a cannonade. Glorious!”
Eventually Johnson was asked to take over Fidelity Fund, a mutual fund with only $3 million under management. Brooks comments:
Edward Crosby Johnson II, for all of his trustee-like ways, clearly had a speculative background and temperament; after all, his stock-market idol was one of the master speculators.
What this meant in practice was that Fidelity was willing to trade in and out of stocks, often fairly rapidly, rather than buy and hold.
Then in 1952, Johnson met Gerald Tsai, Jr. Johnson, liking the young man’s looks, first hired Tsai as a junior stock analyst. Tsai was born in Shanghai in 1928 to Westernized Chinese parents. Tsai’s father had been educated at the University of Michigan, and was Shanghai district manager for the Ford Motor Company. Tsai himself got a BA and MA in economics from Boston University. Brooks:
“I liked the market,” he would explain years later. “I felt that being a foreigner I didn’t have a competitive disadvantage there, when I might somewhere else. If you buy GM at forty and it goes to fifty, whether you are an Oriental, a Korean, or a Buddhist doesn’t make any difference.”
Tsai’s reasons for liking the market were similar to Johnson’s reasons: “you were what you were not because you were a friend of somebody, but for yourself.” Brooks continues:
At Fidelity, Tsai was not long in making his mark. Always impeccably groomed, his moon face as impassive as a Buddha, he showed himself to be a shrewd and decisive picker of stocks for shot-term appreciation…
Tsai explained later that Johnson gave you your head—a chance to work on your own rather than as part of a committee—but he simultaneously gave you your rope, saying “God ahead and hang yourself with it.” Tsai also quoted Johnson as saying, “Do it by yourself. Two men can’t play a violin.”
Soon Tsai asked Johnson if he could launch a speculative growth fund. Johnson said yes in the space of an hour, saying, “Go ahead. Here’s your rope.”
Tsai’s rope was called Fidelity Capital Fund, and it was the company’s first frankly speculative public growth fund. Right from the start, he operated it in a way that was at the time considered almost out-and-out gambling. He concentrated Fidelity Capital’s money in a few stock that were then thought to be outrageously speculative and unseasoned for a mutual fund (Polaroid, Xerox, and Litton Industries among them).
As once “Jesse Livermore is buying it!” had been the signal for a general stampede into any stock, so now it was “Gerry Tsai is buying it!” Like Livermore’s, his prophecies by force of his reputation came to be to a certain extent self-fulfilling.
Brooks also writes about the invention of the “hedge fund,” so named because, unlike a mutual fund, a hedge fund could operate on margin and make short sales. Brooks describes the man who invented the hedge fund:
He was Alfred Winslow Jones, no sideburned gunslinger but a rather shy, scholarly journalist trained in sociology and devoted to good works. Born in Australia at the turn of the century to American parents posted there by General Electric, he graduated from Harvard in 1923, got a Ph.D. in sociology from Columbia, served in the foreign service in Berlin during the thirties, and became a writer for Time-Life in the forties.
In 1949, Winslow got the idea for a hedge fund. He raised $100,000 in investment capital, $40,000 of it his. The first hedge fund did well, even in the bad market of 1962 because of its capacity to sell short. Its clients were mainly writers, teachers, scholars, social workers. (One client was Sam Stayman, the bridge expert.) Winslow’s fund showed a five-year gain of 325 percent and a ten-year gain of more than twice that amount. The fund took 20 percent of profits as an annual fee.
Alfred Jones, in his own middle sixties, had made so much money out of A. W. Jones and Company’s annual 20 percents that he could well afford to indulge his predilections. Spending less and less time at his office on Broad Street, he devoted himself more and more to a personal dream of ending all poverty. Considering material deprivation in the land of affluence to be a national disgrace, he set up a personal foundation devoted to mobilizing available social skills against it… Jones could afford to go the way of the aristocrat, treating money-making as something too simple to be taken very seriously, and putting his most profound efforts into work not in the cause of profit but in that of humanity.
In late 1965, Tsai left Fidelity and formed his own mutual fund, the Manhattan Fund. Tsai set out to raise $25 million, but he ended up raising $247 million. The only problem for Tsai was that the bull market had peaked. Investors expected Tsai to make 50 percent a year, but he could only do so if the bull market continued. Brooks comments:
But if Tsai no longer seemed to know when to cash in the investments he made for others, he knew when to cash in his own. In August, 1968, he sold Tsai Management and Research to C.N.A. Financial Corporation, an insurance holding company, in exchange for a high executive post with C.N.A. and C.N.A. stock worth in the neighborhood of $30 million.
Brooks defines the term:
Derived from the Latin word glomus, meaning wax, the word suggests a sort of apotheosis of the old Madison Avenue cliche “a big ball of wax,” and is no doubt apt enough; but right from the start, the heads of conglomerate companies objected to it. Each of them felt that his company was a mesh of corporate and managerial genius in which diverse lines of endeavor—producing, say, ice cream, cement, and flagpoles—were subtly welded together by some abstruse metaphysical principle so refined as to be invisible to the vulgar eye. Other diversified companies, each such genius acknowledged, were conglomerates; but not his own.
In 1968, 26 of the country’s 500 biggest companies disappeared through conglomerate merger. Some of the largest targets were acquired by companies much smaller than themselves. Moreover, enthusiasts were saying that eventually 200 super-conglomerates would be doing most of the national business. There would only be a handful of non-conglomerates left. Brooks observes:
The movement was new and yet old. In the nineteenth century, few companies diversified their activities very widely by acquiring other companies or by any other means. There is, on the face of it, no basic reason for believing that a man who can successfully run an ice cream business should not be able to successfully run an ice-cream-and-cement business, or even an ice-cream-cement-and-flagpole business. On the other hand, there is no reason for believing that he should be able to do so. In the Puritan and craft ethic that for the most part ruled nineteenth-century America, one of the cardinal precepts was that the shoemaker should stick to his last.
Brooks notes that it was during the 1950’s that “really uninhibited diversification first appeared. Brooks:
During that decade, National Power and Light, as a result of its purchase of another company, found itself chiefly engaged in peddling soft drinks; Borg-Warner, formerly a maker of automotive parts, got into refrigerators, other consumer products; and companies like Penn-Texas and Merritt Chapman and Scott, under the leadership of corporate wild men like David Carr and Louis E. Wolfson, took to ingesting whatever companies swam within reach. Among the first companies to be called conglomerates were Litton, which in 1958 began to augment its established electronics business with office calculators and computers and later branched out into typewriters, cash registers, packaged foods, conveyor belts, oceangoing ships, solder, teaching aids, and aircraft guidance systems, and Textron, once a placid and single-minded New England textile company, and eventually a purveyor of zippers, pens, snowmobiles, eyeglass frames, silverware, golf carts, metalwork machinery, helicopters, rocket engines, ball bearings, and gas meters.
Brooks lists the factors involved in the conglomerate explosion:
- corporate affluence
- a decline of the stick-to-your-last philosophy among businessmen
- a decline of the stick-to-anything philosophy among almost everyone else
- a rise in the influence of graduate business schools, led by Harvard, which in the 1960’s were trying to enshrine business as a profession, and often taught that managerial ability was an absolute quality, not limited by the type of business being managed
- federal antitrust laws, which forbade most mergers between large companies in the same line of business
One additional factor was that many investors focused on just one metric: the price-to-earnings (P/E) ratio. Brooks clarifies why this isn’t a reliable guide when investing in a conglomerate: when a company with a high P/E buys a company with a low P/E, earnings per share increases. Brooks:
There is an apparent growth in earnings that is entirely an optical illusion. Moreover, under accounting procedures of the late nineteen sixties, a merger could generally be recorded in either of two ways—as a purchase of one company by another, or as a simple pooling of the combined resources. In many cases, the current earnings of the combined company came out quite differently under the two methods, and it was understandable that the company’s accountants were inclined to choose arbitrarily the method that gave the more cheerful result. Indeed, the accountant, through this choice and others as his disposal, was often able to write for the surviving company practically any current earnings figure he chose—a situation that impelled one leading investment-advisory service to issue a derisive bulletin entitled, “Accounting as a Creative Art.”
The conglomerate game tended to become a form of pyramiding… The accountant evaluating the results of a conglomerate merger would apply his creative resources by writing an earnings figure that looked good to investors; they, reacting to the artistry, would buy the company’s stock, thereby forcing its market price up to a high multiple again; the company would then make the new merger, write new higher earnings, and so on.
THE ENORMOUS BACKROOM
Nineteen sixty-eight was to be the year when speculation spread like a prairie fire—when the nation, sick and disgusted with itself, seemed to try to drown its guilt in a frenetic quest for quick and easy money. “The great garbage market,” Richard Jenrette called it—a market in which the “leaders” were neither old blue chips like General Motors and American Telephone nor newer solid starts like Polaroid and Xerox, but stock with names like Four Seasons Nursing Centers, Kentucky Fried Chicken, United Convalescent Homes, and Applied Logic. The fad, as in 1961, was for taking short, profitable rides on hot new issues.
As trading volume increased, back-office troubles erupted. Brooks:
The main barometric measuring-device for the seriousness of back-office trouble was the amount of what Wall Street calls “fails.” A fail, which might more bluntly be called a default, occurs when on the normal settlement date for any stock trade–five days after the transaction–the seller’s broker for some reason does not physically deliver the actual sold stock certificates to the buyer’s broker, or the buyer’s broker for some reason fails to receive it.
The reasons for fails typically are that either the selling broker can’t find the certificates being sold, the buying broker misplaces them, or one side or the other makes a mistake in record-keeping by saying that the stock certificates have not been delivered when in fact they have been.
Lehman Brothers, in particular, was experiencing a high level of fails.
Stock discrepancies at the firm, by the end of May, ran into hundreds of millions of dollars. Lehman reacted by eliminating a few accounts, ceasing the make markets in over-the-counter stocks, and refusing further orders for low-priced securities; it did not augment these comparatively mild measures with drastic ones—the institution of a crash program costing half a million dollars to eliminate stock record errors—until August, when the S.E.C. threatened to suspend Lehman’s registration as a broker-dealer and thus effectively put it out of business. Lehman’s reluctance to act promptly to save its customers’ skins, and ultimately its own, was all too characteristic of Wall Street’s attitude toward its troubles in 1968.
Where were the counsels of restraint, not to say common sense, in both Washington and on Wall Street? The answer seems to lie in the conclusion that in America, with its deeply imprinted business ethic, no inherent stabilizer, moral or practical, is sufficiently strong in and of itself to support the turning away of new business when competitors are taking it on. As a people, we would rather face chaos making potsfull of short-term money than maintain long-term order and sanity by profiting less.
GO-GO AT HIGH NOON
Brooks on New York City in 1968:
Almost all of the great cultural centers of history have first been financial centers. This generalization, for which New York City provides a classic example, is one to be used for purposes of point-proving only with the greatest caution. To conclude from it that financial centers naturally engender culture would be to fall into the most celebrated of logical fallacies. It is nonetheless a suggestive fact, and particularly so in the light of 1968 Wall Street, standing as it was on the toe of the same rock that supported Broadway, off-Broadway, Lincoln Center, the Metropolitan Museum, the Museum of Modern Art, and Greenwich Village.
Brooks then writes about changes on Wall Street:
Begin with the old social edifices that survived more or less intact. In many instances they were Wall Street’s worst and most dispensable; for example, its long-held prejudices, mitigated only by tokenism, against women and blacks.
A few women—but not many—were reaching important positions. Meanwhile, for blacks, Wall Street “had advanced the miniscule distance from the no-tokenism of 1965 to tokenism at the end of the decade.”
Spring of 1969—a time that now seems in some ways part of another, and a more romantic, era—was in the business world a time of Davids and Goliaths: of threatened takeovers of venerable Pan American World Airways by upstart Resorts International, for example, and of venerable Goodrich Tire and Rubber by upstart Northwest Industries… Undoubtedly, though, the David-and-Goliath act of early 1969 that most caught the popular imagination was an attempt upon the century-and-a-half-old Chemical Bank New York Trust Company (assets a grand $9 billion) by the eight-year-old Leasco Data Processing Equipment Corporation of Great Neck, Long Island (assets a mere $400 million), a company entirely unknown to almost everyone in the larger business community without a special interest in either computer leasing, Leasco’s principal business until 1968, or in the securities market, in which its stock was a star performer. In that takeover contest, the roles of Goliath and David were played, with exceptional spirit, by William Shryock Renchard of the Chemical and Saul Phillip Steinberg of Leasco.
Renchard was from Trenton, New Jersey, and although he attended Princeton, he probably was not expected to amount to much. That is, he didn’t stand out at all at Princeton and his senior yearbook said, “Renchard is undecided as to his future occupation.”
By 1946, at the age of thirty-eight, Renchard was a vice president of Chemical Bank and Trust Company. In 1955, he became executive vice president; in 1960, he was made president; and in 1966, he was made chairman of the board of what was now called Chemical Bank New York Trust Company. By that time, the bank had $9 billion in assets and was the country’s six largest commercial bank.
Saul Phillip Steinberg was from Brooklyn and was a full generation younger than Renchard. Steinberg was unexceptional, although he did develop an early habit of reading The Wall Street Journal. He attended the Wharton School of Finance and Commerce at the University of Pennsylvania.
Steinberg researched I.B.M., expecting to find negative things. Instead, he learned that I.B.M. was a brilliantly run company. He also concluded that I.B.M.’s industrial computers would last longer than was assumed. So he started a business whereby he purchased I.B.M. computers and then leased them out for longer terms and for lower rates than I.B.M. itself was offering.
In 1964, two years after launching his business—Ideal Leasing Company—earnings were $255,000 and revenues were $8 million. Steinberg then decided to go public, and the company’s name was changed to Leasco Data Processing Equipment Corporation. Public sale of Leasco stock brought in $750,000. Leasco’s profits skyrocketed: 1967 profits were more than eight times 1966 profits. Brooks:
As might be expected of a young company with ambition, a voracious need for cash, and a high price-to-earnings multiple, Leasco became acquisition-minded… In 1966 and 1967, Leasco increased its corporate muscle by buying several small companies in fields more or less related to computers or to leasing… These acquisitions left the company with $74 million in assets, more than eight hundred employees, larger new headquarters in Great Neck, Long Island, and a vast appetite for further growth through mergers.
Diversified companies learned that if they acquired or merged with a fire-and-casualty company, then the otherwise restricted cash reserves—”redundant capital”—of the fire-and-casualty company could be put to use. Thus, Leasco got the idea of acquiring Reliance Insurance Company, a Philadelphia-based fire-and-casualty underwriter “with more than five thousand employees, almost $350 million in annual revenues, and a fund of more than $100 million in redundant capital.” Brooks writes:
Truly—to change the metaphor—it was a case of the minnow swallowing the whale; Reliance was nearly ten times Leasco’s size, and Leasco, as the surviving company, found itself suddenly more than 80 percent in the insurance business and less than 20 percent in the computer-leasing business.
[Leasco] suddenly had assets of $400 million instead of $74 million, net annual income of $27 million instead of $1.4 million, and 8,500 employees doing business in fifty countries instead of 800 doing business in only one.
Brooks notes that Leasco’s stock had, over the previous five years, increased 5,410 percent making Leasco “the undisputed king of all the go-go stocks.” Now comes the story of Leasco and Chemical Bank.
Leasco had gotten interested in acquiring a bank. Banks often sold at low price-to-earnings ratio’s, giving Leasco leverage in a takeover. Also, Steinberg thought “that it would be advantageous to anchor Leasco’s diversified financial services to a New York money-center bank with international connections.” By the fall of 1968, Leasco was zeroing in on Renchard’s $9-billion Chemical Bank.
Leasco had begun buying shares in Chemical and had prepared a hypothetical tender offer involving warrants and convertible debentures when Chemical learned of Leasco’s intended takeover. Brooks:
…Renchard was in no doubt as to Chemical’s response. He and his bank were going to fight Leasco with all their strength. True enough, a merger, as in the Reliance case, would result in immediate financial benefit to the stockholders of both companies. But it seemed to Renchard and his colleagues that more than immediate stockholder profit was involved. The century-and-a-half-old Chemical Bank a mere division of an unseasoned upstart called Leasco?
Renchard organized an eleven-man task force to come up with a strategy for fighting off any takeover attempt. Renchard commented later:
“We were guessing that they would offer stuff with a market value of around $110 for each share of our stock, which was then selling at $72. So we knew well enough it would be tough going persuading our stockholders not to accept.”
First, Renchard leaked the story to The New York Times. The Times published a piece that included the following:
Can a Johnny-come-lately on the business scene move in on the Establishment and knock off one of the biggest prizes in sight?
Is Chemical in the bag? Hardly. William S. Renchard, chairman of the Chemical Bank, sounded like a Marine Corps colonel in presenting his battle plan…
One strategy Chemical came up with was to attack the value of Leasco stock by selling it or shorting it. This approach was discussed at a February 6 strategy meeting, but no one afterwards was ever willing to admit it. Brooks:
The striking and undeniable fact is, however, that on that very day, Leasco stock, which had been hovering in the stratosphere at around 140, abruptly began to fall in price on large trading volume. By the close the following day Leasco was down almost seven points, and over the following three weeks it would drop inexorably below 100.
Chemical planned a full-scale strategy meeting:
At the Chemical strategy meeting—which was attended, this time, not only by Chemical’s in-house task force, but by invitees from other powerful Wall Street institutions sympathetic to the Chemical cause, including First Boston, Kuhn Loeb, and Hornblower Weeks—a whole array of defensive measures were taken up and thrashed out, among them the organizing of telephone teams to contact Chemical stockholders; the retaining of the leading proxy-soliciting firms solely to deny their services to Leasco; and the possibility of getting state and federal legislation introduced through the bankers’ friends in Albany and Washington in order to make a Leasco takeover of Chemical illegal. Despite the availability of such weapons, the opinion of those present seemed to be that Leasco’s venture had an excellent chance of success.
Finally, Renchard and Steinberg met for lunch. Brooks writes:
One may imagine the first reactions of the antagonists to each other. One was lean, iron-gray, of distinctly military bearing; a North Shore estate owner, very conscious of the entrenched power of the nation standing behind him, very much a man of few and incisive words. The other was round-faced, easy-smiling, a man of many words who looked preposterously younger than his already preposterous twenty-nine years, and given, as he talked, to making windmill gestures with his arms and suddenly jumping galvanically up from his chair; a South Shore estate owner…; a young man bubbling with energy and joy in living.
During the meeting, Steinberg said he wanted it to be a friendly takeover. Renchard seemed to be open to that possibility. At the same time, Renchard said that he was “a pretty good gutter fighter,” to which Steinberg replied that his own record as a gutter fighter “was considered to be pretty good, too.”
A second meeting was held. This time, Renchard and Steinberg brought their chief aides. Steinberg put more emphasis on his friendly intentions, and he conceded that he would be willing to not be the chief executive of the merged entity. Renchard said they had lots to consider and would get back in touch shortly.
Then Chemical held another full-scale battle meeting at which they considered several possible options. They thought about changing their company’s charter to make a Leasco takeover legally difficult if not impossible. They floated the idea of buying a fire-and-casualty company to create an antitrust conflict with Leasco’s ownership of Reliance. They even talked about arranging to have a giant insurance company take over Chemical. Brooks notes:
Probably the most effective of Chemical’s various salvos was on the legislative front… Richard Simmons of the Cravath law firm, on retainer from Chemical, began devoting full time to the Leasco affair, concentrating his attention on the drafting of laws specifically designed to prevent or make difficult the takeover of banks similar to Chemical by companies that resembled Leasco, and getting these drafts introduced as bills in the State Legislature in Albany and the Congress in Washington.
Simmons’ anti-bank-takeover bill was introduced in Albany and was passed. Moreover, a Wall Street Journal article questioned Leasco’s earnings prospects. As well, the Department of Justice sent a letter to Leasco raising the possibility that the proposed takeover might violate antitrust laws. In truth, the proposed takeover did not violate antitrust laws. How the Justice Department came to send such a letter has never been explained, observes Brooks.
At this point, Steinberg decided to abandon the effort to merge with Chemical. Brooks quotes Steinberg:
“Nobody was objective… bankers and businessmen I’d never met kept calling up out of the blue and attacking us for merely thinking about taking over a big bank. Some of the attacks were pretty funny—responsible investment bankers taking as if we were using Mafia tactics.. Months after we’d abandoned our plans, executives of major corporations were still calling up and ranting, ‘I feel it was so wrong, what you tried to do—’ And yet they could never say why… I still don’t know exactly what it was.”
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