Pecora’s take was somewhat more colorful. He viewed the affiliates as an attempt to take profitable business away from private investment banks like J.P. Morgan rather than as a way of competing with trust companies and state banks. Commercial banks, he wrote, “looked with hungry eyes upon the savory meats that had hitherto been the virtual monopoly of the private investment banker, and they decided to share more liberally in the feast.”
This idea was not original to Vanderlip; he modeled City Bank’s affiliate on the First Security Company that George Baker of First National Bank had formed in 1903. By the time City Bank got around to forming its own affiliate, there were more than two hundred bank affiliates in existence. The key to business success was to ensure that the executives of the bank completely controlled the affiliate without actually owning it, which would violate federal law. National banks turned to their Wall Street lawyers, who came up with an ingenious solution. The shareholders of the bank formed a separate corporation; in City Bank’s case it was called the National City Company. Rather than retaining control of those shares, however, the bank’s shareholders agreed to place their shares with three trustees, all officers or directors of City Bank, who had the ability to vote on any matters that would normally be submitted to the company’s shareholders, including electing the board that would run the company. The trustees also agreed to distribute through the bank any dividends the company declared. Legally, the affiliate was a separate corporation in which the bank had no ownership interest. In reality, however, because the bank and the affiliate had precisely the same management, this structure was the functional equivalent of the bank forming a wholly owned subsidiary to pursue these business ventures. Indeed, City Bank was literally inseparable from the company—National City’s stock was printed on the reverse side of the stock certificate for the bank.7
Pecora read that history and concluded that the structure effectively nullified the restrictions built into the National Banking Act. “Surely,” he wrote, “the suave legerdemain of the corporation lawyer in the service of high finance has scarcely, if ever, achieved a more hairsplitting triumph!” Now with Mitchell back in the hot seat, he wanted to drive that conclusion home with the loans the bank made to finance purchases of City Bank stock. “Wasn’t that a species of trading by the bank in its own stock?” the lawyer asked.
Mitchell remained adamant; the bank and the affiliate were separate legal entities. That was true, Pecora pressed, but shouldn’t we look past those formalities? The company, he insisted, “is inseparably interwoven with the bank, is it not? . . . It is like one body with two heads, isn’t it? It has the same body; it has the same blood, meaning the capital derived from the sale of the capital stock of the bank. . . . But instead of having one head it has two heads, and the two heads seem to be the one head in your personality. You were the chairman of both institutions. But in form it had two heads, didn’t it?”
It was not Pecora’s most elegant question, but it made the essential point: any real separation between City Bank and the National City Company was illusory—a mere legal fiction—because Mitchell was the driving force behind both companies. Even Mitchell had to concede that the two were hardly distinct; they were one “institutional entity.”8
When Hugh Baker resumed the stand in the afternoon, Pecora switched gears from the independence of the National City Company to its operation during the 1920s. Just what were the consequences of allowing national banks to use these legal expedients to engage in what would otherwise be prohibited activities? It quickly became apparent that Mitchell (and his fellow executives) really did believe that securities could be sold like coffee or vacuum cleaners. Like any other sales organization, National City used financial incentives to drive its salesmen. If some stock or bond “was considered more difficult to sell” or if the company “desired to accelerate sales of any particular issue,” the company would suddenly offer premium commissions, sometimes a third higher than its standard commissions. The premiums were always, of course, for the securities the company sponsored or for the stock of City Bank.
For a firm that had pitched its “unquestioned reliability” to magazine readers across the country for years, it was a jarring disconnect. At the turn of the century, when trust companies began hawking securities for the first time, many industry observers began to worry about the inherent conflict of interest they faced between giving disinterested investment advice and promoting their own interests. Those concerns were frequently dismissed; the honesty and integrity of bankers, it was widely thought, would be enough to prevent abuses. Perhaps that faith and confidence had been misplaced.9
Those promotions went out to the affiliate’s scattered offices in flashes sent over its 11,000 miles of private wires, but this was only the mildest means used to spur on the sales staff. The company liked “to keep the salesmen on their toes” with sales contests, an innovation for which Mr. Baker claimed credit. “I suppose our sales organization,” he testified, “is like all other sales organizations. There are times when they seem to slow down and are tired. In order to inject new life into the organization we would develop what we called sales contests, to add some competition.” There were any number of contests that Pecora could have questioned Baker on, but he chose one that was announced on September 27, 1929, just one month before the crash. Pecora’s choice was not subtle, but it was an effective way to link that calamity to those hard-sell efforts.10
One of Baker’s 350 salesmen was Julian Sherrod, the man who had written the tell-all book about the company two years earlier and whom Pecora unsuccessfully tried to enlist as an assistant in the investigation. Sherrod’s name never came up in the hearings, but Baker’s testimony on Friday afternoon seemed to confirm everything he had revealed. Sherrod’s experience seemed typical. Like a Fuller Brush man, Sherrod started by selling securities door to door. He called on customers early in the morning and late at night when they were not at work and he even made sure to visit certain churches on Sunday to maximize the number of potential clients he could pitch. Despite attending the affiliate’s bond class, he was ill-prepared, and he found a population that seemed equally ignorant about investments. “He did not know what he was buying and I did not know what I was selling,” Sherrod wrote afterward, “I was just merchandising.” It didn’t matter; Sherrod was successful anyway. He sold nearly $700,000 in bonds in his first six months. The key was not to focus on what he was selling but to focus on the reliability and integrity of City Bank. “I had mastered the gospel and talked so much about the greatness of our Bank,” Sherrod wrote, “that a man would finally give up and say ‘all right, send me some.’”11
But inside the securities affiliate, the harried employees weren’t simply dispassionately and clinically analyzing the quality of bonds and securities. The scene Sherrod described in his book and Baker described at the hearing was a 1920s version of Glengarry Glen Ross; precisely, Pecora noted, “like that of any nonbanking large-scale sales organization.” The first order of business was generating the pool of potential customers. The company had an entire department dedicated to drumming up new leads—culled primarily from voter lists and automobile registrations—leads that were constantly fed to the salesmen. Of course, the company also had a ready-made list of new securities customers—the depositors of City Bank. The bank, after all, had started its personal loan department and had begun accepting tiny deposits from customers not just for the positive public relations it generated, but because these “small but developing capitalists” were potential stock and bond customers.
Just a day earlier, Rentschler testified that the bank wanted to create a broader base of potential clients for the affiliate. On Friday, however, Baker seemed squeamish about admitting that reality. He denied ever seeing a list of depositors, but even his testimony showed National City and the Bank working closely together. It was the inseparably interwoven single enterprise that Mitchell had testified to earlier in the day, and it left, to Pecora’s way of thinking, the
se “prospects” with their guard down. The company’s salesmen, he reasoned, “came to them clothed with all the authority and prestige of the magic name ‘National City.’”12
“Would it surprise you to know,” Pecora asked Baker, “that many of the bank’s depositors who never before had had any business with the company were approached directly by the salesmen or representatives of the company and greeted with the remark that the salesmen knew that they were depositors of the bank?”
Baker did “not dispute that at all,” but he insisted that the bank did not simply hand a list of its depositors over to the company. It would, however, transmit the names of customers interested in investments to the company and the company would immediately contact that depositor.
Pecora realized at once that the close connection Baker had just revealed gave him an opening to reexplore the conflict of interest that existed between the bank and the investment company, and he quickly took advantage of it. “And if that depositor or customer then followed up that suggestion by calling upon the National City Co. for advice as to his investments, it was not an unusual thing for the National City Co. to suggest investment in securities that the company was sponsoring, was it?” Pecora asked.
Unlike the day before, Baker was caught off guard on this issue: “That is right.”
“In fact, it was the usual thing, wasn’t it?”
Baker realized what he had admitted and tried to back away. “That is right. But he did not recommend—”
Pecora never gave him the chance to finish that justification. “And do you consider, as a director of the bank, that that was a disinterested and unselfish way for the bank to advise a depositor concerning the making of investments generally?”
Even with his testimony about promotions and sales contests, Baker was unwilling to admit that either the bank or the company had done anything improper. He, like Mitchell in his first day of testimony before the committee, relied on the company’s internal “yardstick” for measuring investment quality; the one that Mitchell claimed would never be shortened while he was in charge in order to meet the business needs of the bank. The National City Company, Baker insisted, had “facilities . . . for study of investments, and based upon that we made our recommendations.” Pecora wasn’t quite ready to challenge that claim about the quality of the affiliate’s offerings. There was still next week.13
Instead, Pecora continued to paint a picture of a company that never overlooked an opportunity to make a sale, no matter how small. A memorandum sent to salesmen entitled “Loaves from Crumbs” discussed the problem of small cash differences in favor of customers that sometimes occurred when trading stock. Those cash balances, the executive who wrote the memorandum worried, often went “into the customer’s bank account to be lost sight of or spent.” With the lower cost of City Bank stock as a result of its split, the memorandum advised salesmen that they “should make it a point to see that the crumbs resulting from an exchange of securities go at once into one or more shares of the stock. If the amount is insufficient to buy one share you can have the customer put up the remaining cash.” Buying City Bank stock “ties the customer in closer than ever.” The memorandum recognized what Baker seemed loath to admit—broadening the stockholder base would create new customers for the affiliate. “By using the crumbs of cash resulting from exchanges to buy new stock of the National City Bank . . . you will work these crumbs into a loaf of substantial size with consequent advantages to the client, the National City Co., and yourself.”14
There were some lighter moments during the day, such as when Pecora’s notes incorrectly transcribed a flash sent to the sales staff. “We necessarily will deal recklessly,” Pecora quoted from his notes, “in executing orders—”
Uncharacteristically, Baker interrupted him: “I did not say ‘recklessly.’”
“What did you say?”
“Ruthlessly,” Baker replied.
“Ruthlessly?”
“Yes.”
Pecora was more than willing to admit his mistake. “We have it ‘recklessly,’” he said, “but we will adopt your term ‘ruthless.’” Laughter rippled through Room 301. “Thanks for the correction.”
“I like that much better,” Baker offered.
“So do I,” Pecora agreed.15
With all the pressure to sell, the pace in the affiliate’s offices was grueling and relentless. The former National City salesman Julian Sherrod gave a taste of it in his memoirs:All day long our private wire was busy. All day long the message was the same—hurry up, hurry up, hurry up—send some orders—send in some orders—send in some orders. . . . When things slowed up a little, some genius would hatch up a contest of some kind and then we would be under extra pressure from every direction sometimes for weeks.
Top salesmen were rewarded, everyone else was shamed. With the threat of dismissal constantly hanging over their heads for lackluster performance, the salesmen lived in fear of the dictatorial Mitchell. A typical internal memorandum noted dryly, “I should hate to think there is any man in our sales crowd who would confess to his inability to sell at least some of any issue of either bonds or preferred stocks that we think good enough to offer. In fact, this would be an impossible situation and, in the interest of all concerned, one which we would not permit to continue.” One legend claimed that Mitchell fired a young employee who had the temerity to tell the world-renowned banker that his pants were unbuttoned. “In those days,” wrote the critic Edmund Wilson, “the trousers of Charles E. Mitchell could no more be unbuttoned than Louis the Fourteenth’s grammar could be at fault.” All in all, it was hardly the kind of probity, rigor, and “unquestioned reliability” that the company had tried so hard to project for so many years.16
How could the bank engage in and even control these activities indirectly when it was prohibited from doing so directly? Hadn’t federal banking examiners been able to see through this patently transparent artifice? Apparently, they had, or at least someone in the federal government had. Pecora asked Mitchell if he was familiar with an opinion written in 1911 by the solicitor general of the United States, Frederick Lehmann, to the then attorney general, George W. Wickersham. Mitchell had read it “many, many years” earlier and he did not remember the details. Pecora was more than happy to remind him.
The opinion was lengthy, but Pecora hit the highlights, reading a series of excerpts into the record. In 1911 President Taft requested an opinion on “the legality of the agreements and arrangements existing between” City Bank and the National City Company. The Lehmann opinion was a full explanation for the decision that Wickersham and Lehmann had already reached and conveyed to Taft—the bank and the affiliate were in violation of the law. Lehmann (whom Wickersham considered “one of the most intelligent men I know”) discussed the affiliate’s participation in general investment banking business, pointing out that the affiliate “has no independence of action” and was controlled entirely by the bank’s executives. “The temptation to the speculative use of the funds of the banks,” Lehmann wrote, “will prove to be irresistible.”17
The main point of contention, however, was not these generalized investment banking activities. Other national banks had already formed investment banking affiliates. City Bank’s was the largest, but it stood out for a different reason. Several of the bank’s shareholders transferred shares they owned in other banks and trust companies to the National City Company, instantaneously transforming the affiliate into the nation’s first bank holding company. The National City Company was a nascent interstate banking chain, and its existence immediately riled those who were constitutionally opposed to large concentrations of economic power. Wickersham thought that holding companies should be prohibited, so it was not terribly surprising when Lehmann concluded that “the National City Co. in its holding of national-bank stocks is in usurpation of Federal authority and in violation of Federal law.”
With all the testimony over the last several days describing the affiliate’s sales practices
and the bank’s financing of its operations, Norbeck was convinced that Lehmann was a “prophet.” Pecora tried to put a more nefarious cast on the opinion. The lawyer could only submit a carbon copy as an exhibit, he said, because the original was “not to be found among the files of the Department of Justice.” In his memoirs six years later, Pecora wrote that the opinion had been “buried,” the result, no doubt, of a political conspiracy or, at the very least, “the complaisance of governmental authorities toward powerful financial and business groups during the lamented pre-New Deal era.” Lehmann’s opinion “had disappeared—spurlos versenkt [sunk without a trace], to borrow a wartime phrase—leaving only a carbon copy as a ghost to haunt the conscience of the Bank.”18
Mitchell was silent in the face of these suggestions, but his lawyer James Covington was not. The sixty-two-year-old former congressman from Maryland and former judge was one of the best known lawyers in Washington and a founder of one of the city’s largest law firms. Covington demanded to be heard, and he and Pecora immediately got into a rancorous debate about just what the Lehmann opinion signified. This was, Covington argued, just an opinion. If “so high-minded a man” as George Wickersham never pressed charges against City Bank, then “he must have differed with it.” Pecora thought it was a “gratuitous assumption,” to which Covington immediately responded, “Not so much a gratuitous assumption as some that you have made from time to time.” Covington got an immediate rebuke from Norbeck, who told him, “We want no more of that.”
The Hellhound of Wall Street Page 24