Pecora had a far more precise plan for his confrontation with Whitney. The only entity capable of policing the exchange was the exchange, and Pecora wanted to know how vigilantly it was walking its beat. Asking Whitney whether the federal government needed to regulate the exchange would elicit a sure negative response. So, instead of asking the question directly Pecora began with a laundry list of precautions and disciplinary actions the exchange never took. The exchange, he asked, never audited the companies that sought to be listed there? No, Whitney replied, but a year earlier it had begun requiring new listings to have an independent audit, although it was unwilling to impose that mandate on existing listings. Did the exchange examine the “character” of a company’s officers and directors? Yes, when it was first listed. “And don’t you think it would be just as advisable to exercise that same kind of supervision by inquiry even after a corporation had succeeded in having its securities listed?” Pecora asked. Whitney agreed, but explained that at that point the officers and directors were “entirely beyond” the exchange’s control. It had no power to remove them; its only power was to remove the company from trading on the exchange, but it almost never did that.
In truth, the New York Stock Exchange’s listing standards were the highest in the country. The bigger problems were with other exchanges, where issuers could list their securities without these kinds of disclosures. But even the New York Stock Exchange radically reduced the effectiveness of its required disclosures through its inability or unwillingness to investigate applications for listing. “So lax was the ‘self-regulation’ of the Exchange authorities,” Pecora wrote, “that even the formally condemned abuses were actually detected and punished only on the most infrequent occasions.”9
Reporters described the confrontation between the two men as “fencing,” but it was more like surgery. Pecora’s careful cataloging of the limits of exchange enforcement was far more effective than trying to wring either an admission of wrongdoing out of Whitney or a concession that outside regulation was necessary. Whitney, to be sure, tried to argue that no one could stop those bent on outright fraud, not even the federal government. But Pecora, who had little tolerance for Whitney’s evasions, was able to show that the exchange failed to take even the most rudimentary steps to police listed companies.
“Mr. Pecora,” Whitney explained, “naturally if people wish to be crooked and to make false statements, they may get away with it with any agency or institution.”
“But does the New York Stock Exchange take any steps to confirm the statements made by officers of a corporation seeking to list its securities on your exchange?” countered Pecora, who was not buying the impossibility argument.
Whitney said he couldn’t answer Pecora’s question without referring to some internal exchange documents. An increasingly weary Pecora remained polite but insistent that he wanted Whitney’s “own knowledge” as to what really happened, not some canned answer about the exchange’s formal procedures.
“My dear sir,” Pecora continued, “you have been a member of the exchange for twenty-one years. You have been its president for nearly three years.”
“Yes, sir.”
“Can’t you tell me, from the wealth of knowledge and experience that must have come to you during those years”—Whitney tried to cut in, but Pecora just talked right over him—“whether or not the exchange affirmatively takes any action seeking to check up or to confirm the statements made to it by corporation officers seeking to have their securities listed?”
Whitney admitted that there was no check. “In other words,” Pecora continued, “the exchange proceeds upon the assumption that nobody lies to it, does it?”
“The exchange,” Whitney insisted, “has got to take people at their face value and that they are honest until they are proved otherwise.”
“The presumption is all in favor of the person who makes applications as to honesty and integrity? Is that what you mean?”
“Yes; if you wish it that way.”
At no point did Pecora ask Whitney to admit that the exchange was aware of wrongdoing. Pecora surely knew that the self-righteous exchange leader would never do that. But each time Whitney admitted that the exchange could not or did not oversee its listed firms he was making the case that self-regulation was not enough.10
Whitney still clung to his belief that the exchange never erred, that it maintained a perfectly “free and open market” in securities. But, given its lackadaisical methods and the pervasive wrongdoing Pecora had already shown, Whitney’s denials were no longer convincing. Pecora, for example, asked him whether he now thought that verifying company information was important. Whitney seemed appalled that Pecora wanted him to question the integrity of the gentlemen who listed their stock on the exchange—verifying information would mean “the presumption of dishonesty rather than honesty.”
“In other words, you would rather discover the dishonesty after it has come to light or after its evil effects have been manifested, than prevent the dishonesty beforehand?”
“But that has not happened, Mr. Pecora.”
“How do you know it has not happened?”
The answer was self-evident, Whitney replied; because the exchange never found any evidence of problems, they must not exist.11
When the exchange did take a look at various types of speculative activity going on in its midst, it appeared to have a rather idiosyncratic definition of what it meant to maintain a “free and open” market. Whitney admitted that stock pools were allowed under exchange rules, but also claimed that the exchange existed for only one purpose—“to allow the ready action of the law of supply and demand.”
Pecora could not see how those two statements were compatible. The whole point of a pool was to move prices away from the price the market had set under normal buying and selling conditions. A free and open market, Pecora asked, was not one that was controlled in this way, was it? Whitney said he didn’t know what a controlled market was, to which Pecora sarcastically replied, “Well, Mr. Whitney, I am trying to use words that are simple in their meaning, but if I am using words that you do not understand I will try to change them.”
Whitney was indignant, no doubt appalled that this immigrant, a former criminal prosecutor far below him on the social scale, would dare speak to him in such an impolite fashion.
“I understand the word ‘controlled’ completely, Mr. Pecora,” he haughtily replied.
Well, if he understood what control meant, Pecora said, then he should be able to say whether it was possible for a pool “to exercise temporarily . . . a control of the market price”?
Whitney said that a pool could exercise that kind of control over price as “long as the stock and their money hold out.”
“Now,” Pecora asked, “what steps, if any, does the exchange take to prevent that kind of control?”
“I do not know of any, Mr. Pecora.”
“When such a pool is operating and effecting such a control, it is restricting a free and open market where honest values can be obtained, is it not?”
“No, sir.”
Whitney’s denial was simply not credible, and so Pecora asked again, “Is it not?”
“No, sir,” the exchange leader repeated.12
To be sure, Pecora’s naïveté about how stock markets worked was still very much in evidence. The investigator chastised Whitney for not being able to see in 1928 and 1929 that prices were wildly inflated, but it was hardly a fair charge. Bubbles are easy to spot, but usually only after they have burst. “Mr. Pecora,” Whitney complained, “you are talking about [the] judgment of hindsight. We did not have it then, nor did but very few, if any, have it then.” Pecora remained unconvinced: “Mr. Whitney, don’t you think . . . the New York Stock Exchange . . . owes some measure of responsibility to the public to watch those prices and when they get out of line to sound some kind of public warning?”
Whitney was, understandably, incredulous. “If you will tell me, Mr. Pecora, how I, as presid
ent of the New York Stock Exchange, might do that I will be glad to have you do so, and will endeavor to act accordingly. But I will say that if the president of the New York Stock Exchange at that time had issued such warnings . . . he would have been laughed at.” Whitney was right when he told Pecora that the exchange did not have “either the facility or the ability to be the oracle as to how prices should fluctuate, or to set forth whether a price is too high or too low.” It could not be the “dictator of what prices should be” on a daily basis.13
Still, Pecora’s careful examination of the exchange president was far more successful than the committee’s awkward encounter a year earlier. By the end of the day, the picture Pecora painted was not, as Whitney claimed, of a forum in which the forces of supply and demand met freely to determine prices. Pecora saw a darker purpose to the exchange. The exchange “was in reality neither more nor less than a glorified gambling casino where the odds were heavily weighted against the eager outsiders.” Pool accounts were rampant. “The public who bought these stocks at dizzily mounting prices,” Pecora wrote in his memoirs, “did not do so merely because of impersonal market forces; they were the victims of a determined, organized group of market-wise operators, armed with special information and special facilities and backed generously with bankers’ credits.”
For his part, Whitney decried such gambling while still trying to defend speculation. Whitney granted that there was a “delicate” line distinguishing the two which turned only on the impossible task of divining the intent of the trader. He insisted that legitimate speculation predominated on the exchange, but in the end even that assertion crumbled in the face of Pecora’s skilled questioning.
“So that it is all a matter of intent which controls?” Pecora asked the exchange president.
“It seems to me so, yes.”
So, Pecora wanted to know, how did Whitney determine whether a trader intended to speculate or gamble?
Whitney, of course, said that he had no way of divining intent. “Then how are you able to recognize any line that distinguishes an honest or proper kind of speculative trading from an improper kind or gambling kind, if you have no way of ascertaining the intent?” Pecora asked. “[A]s far as you know to the contrary the majority of the speculative buying might be of the gambling variety, might it not?”
In the end, Whitney could resort to nothing but haughty ipse dixit. “I say I do not think so,” he replied. “I do not say that it is not. I do not think so.”14
Federal regulation was needed, Pecora concluded, because Whitney and the other leaders of the New York Stock Exchange were doing nothing about the gambling or the manipulations. Everyone in the country seemed to know that there was a pool in R.C.A. stock organized in March 1929 by Michael Meehan, a specialist and member of the New York Stock Exchange. The pool netted its participants $5 million in one week, but the exchange didn’t see the need to investigate it until the summer of 1932, after testimony about it in the Banking and Currency Committee that spring. Three years on, many of the relevant documents were destroyed. The exchange found no wrongdoing. Since pools didn’t violate stock exchange rules, the exchange would have certainly reached the same conclusion if they examined every scrap of paper. It was, to Whitney, just the operation of the free and open market.15
With those manipulations and the exchange’s hands-off approach, Pecora simply couldn’t see that the market performed a legitimate function. But his view was a little too jaundiced. By creating a place where investors could easily sell securities, the market lowered the costs of raising capital for American businesses. Whitney was right—speculation in securities was an essential part of the American economy. All Pecora saw was that this “glorified gambling casino” was unregulated. Pecora had shown that the exchange did not vigorously exercise its regulatory prerogatives and that its prices were not solely the product of supply and demand. To make the case for federal regulation he only needed to underscore the importance of the exchange to the United States economy. Didn’t the New York Stock Exchange constitute “the greatest market for securities in this country, if not in the world?” Weren’t its quotations accepted “as substantial evidence of the value of securities to which they relate?” Securities were often accepted as collateral for bank loans and, in fact, were more readily accepted because of the active market the exchange created, correct? Whitney, naturally, had no choice but to accept all those propositions.
Well, if all that was true, Pecora continued, then the operation of the stock exchange was “of interest to the entire country,” wasn’t it? Again, Whitney had no choice but to agree—he had, after all, just proclaimed that speculation on the exchange had built the United States.
Despite the exchange’s crucial place in the American economy, Pecora continued, it was “subject to no official regulatory power”? Whitney conceded that there was none. The only logical question after nine days of testimony was, why not?16
Chapter 16
DAY TEN: THE END OF AN ERA
When Pecora recalled the City Bank hearings in his memoirs, his count was off by a full day. “It lasted . . . just nine days,” he wrote in 1939, “but in those nine days a whole era of American financial life passed away.” Perhaps it was unsurprising that this last day slipped from Pecora’s otherwise infallible memory. It was, for the most part, mundane. The investigator’s questions were largely perfunctory, and he let his assistants take a good deal of the testimony. In an ideal world, Pecora’s flair for the dramatic would no doubt have led him to a more fitting ending. Perhaps the climax could have been Edgar Brown, the personification of the hapless middle-class investor who trusted in City Bank’s sterling reputation. Richard Whitney’s inveterate self-importance and righteous certitude would also have made a fitting conclusion. Unfortunately, the real world does not come so neatly packaged. Pecora had to tie up some loose ends and was forced to conclude the hearings with a whimper rather than a bang.
Day ten started the same way as day one—with Charles Mitchell. On Sunday evening, when Pecora learned of Mitchell’s resignation, he insisted that Mitchell remained under subpoena and that his presence in Washington was crucial. But to anyone watching the hearings, Mitchell now seemed little more than an afterthought. For the last three days the deposed banker had sat in the spectators’ row—Pecora didn’t call him to the stand once. Instead, Mitchell was forced to sit through hours of testimony about City Bank’s South American follies and about the squirrelly loan charged to the Port Authority account. He listened to Edgar Brown’s tale of ruin after Brown’s encounter with his former financial institution.
After that parade of indiscretions, if not sins, Mitchell continued to look abashed, or at least that was the way it seemed to Pecora. “It was one thing,” Pecora wrote in his memoirs, “to manipulate great blocks of stock on the Exchange, to float great bond issues, dealing only with impersonal financial machinery, or professional dealers. It was quite another to be brought face to face with responsibility for the ultimate damage to individual human beings.”1
On Thursday morning, the last day of the hearings, Pecora was ready to question Mitchell again, but there was no dramatic confrontation between the two men, no Perry Mason moment when Mitchell admitted the error of his ways. Pecora asked Mitchell a few housekeeping questions about when the banker first saw the Lehmann opinion, the opinion by the solicitor general that found securities affiliates violated the National Banking Act. Mitchell could not recall clearly. That was it. Mitchell left the stand in a matter of minutes. So why did Pecora insist that Mitchell remain in Washington? Most likely, he was just being careful. He could not be sure how any of the remaining witnesses would testify. If subsequent testimony implicated Mitchell, Pecora wanted him available. That didn’t happen, and now it appeared that Pecora, having insisted that Mitchell remain in Washington, needed to put him briefly on the stand in order to justify his decision.2
Over the previous nine days, Pecora had presented nearly all the examples he identified in h
is investigation “of how a bank should not conduct a stock-selling and stock-speculation business.” Now, with that work out of the way, most of the last day was consumed with testimony that Norbeck had wanted the City Bank hearings to address. In the scheme of things, this testimony was not terribly important. There was the consolidation of three farm-equipment manufacturers into a company called Oliver Farm Equipment. National City made a nice profit when it arranged the merger, and there was some unseemly squabbling between it and another Wall Street firm about precisely how those profits should be divided, but there was nothing terribly scandalous in the transaction. The same was largely true of the Lautaro Nitrate Company, a Chilean corporation controlled by the Guggenheim family. When National City offered its securities it never disclosed to prospective investors the profits it would make and it never disclosed substantial risks inherent in the company’s business. They were, to be sure, valid points to raise at the hearing, but they were points Pecora had already made several times with the other offerings. Day ten’s testimony was simply more of the same.
Pecora wanted to share some of the remaining limelight with his assistants who had worked so hard over the previous six weeks, so Julius Silver handled most of this questioning. Silver was a smart and competent lawyer (he would eventually become the CEO of Polaroid), but only a few minutes after he took the floor, it was clear why the press was so captivated by Pecora. Silver was clinical and dispassionate—he asked the right questions, but there was nothing memorable in his examination.
The Hellhound of Wall Street Page 32