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September 2002

Caveat vendor


US business leaders fear a heavy-handed legal and regulatory response to accounting scandals. The same fear was widespread in the 1930s. But the much hated laws and regulations laid down then set the foundations for a vibrant financial sector.




       
Franklin D Roosevelt announces
addresses Congress in 1933, saying
that companies must tell the truth.
"It should give impetus to honest dealing
in securities," he said.
There are few things that corporate America in general and Wall Street in particular loathe more than the intrusion of government into their affairs. In such invasiveness, they detect the long arm of the reddest-hued socialism. They did so in the 1930s, when one congressman described the passage of the Securities Act of 1933 and the National Securities of 1934, as legislation designed to "Russianize everything worthwhile".
Some are hinting at that again today, with Intel's chairman, Andrew Grove, telling the Washington Post in July that today's anti-business atmosphere in the US reminds him of the Hungary he left in the mid 1950s.
That may be an extreme view of the legislative reform that has been rushed through Congress in a bid to restore confidence in the US corporate sector. But judging from the snail-like speed with which US companies with a turnover of more than $1.2 billion moved to fall in line with the new guidelines, most appear to believe that the Sarbanes-Oxley Act is an outrageous imposition.
The objections are twofold. First, it is felt that the legislation will load an unnecessary administrative burden on to corporate America; second, and much more important, that it may leave innocent CEOs and CFOs vulnerable, in extremis, to 25-year jail sentences for signing off accounts that are not "truly presented".
Those who object to these new constraints might pause to think about the longer-term benefits of the reforms of the 1930s. Those were based on the simple notion that companies must tell the truth about their businesses, the securities they are selling, and the risks involved in investing. As president Franklin D Roosevelt told Congress in May 1933: "There is an obligation upon us to insist that every issue of new securities to be sold in interstate commerce shall be accompanied by full publicity and information, and that no essentially important element attending the issue shall be concealed from the buying public."
He added: "This proposal adds to the ancient rule of caveat emptor the further doctrine 'let the seller also beware'. It puts the burden of telling the whole truth on the seller. It should give impetus to honest dealing in securities and thereby bring back public confidence."
While the public may have cheered, Wall Street and the US corporate sector fought tooth and nail against legislative change which, they claimed, would be so draconian as to destroy the US capital market and, as a result, strangle economic recovery as birth.
       
Whitney testifying before Congress:
before being jailed for fraud he warned
of the dire consequences of
tighter regulation
The strongest of motives for resisting regulation
The most energetic broadsides against the Roosevelt administration came from within the financial services sector itself. Charles Collins, president of the Boston Stock Exchange, foresaw the closure of hundreds of brokers' outlets throughout New England as a direct consequence of the legislation and, with it, the wholesale withdrawal from the US stock market of the small investor.
The price of seats on the NYSE collapsed. In 1933, these had been changing hands for up to $250,000. By February 1934 the going rate was closer to $190,000, and the following month seats were being sold for not much more than $100,000. Nobody lobbied against the government's meddlesome approach to Wall Street with quite the same forcefulness as Richard Whitney, president of the NYSE.
In February 1934, he wrote to the presidents of 850 of the largest listed companies in the US warning them of the dire consequences of the "sweeping and drastic provisions" built into the proposed National Securities Act. The following month, Whitney told members of the Senate banking and currency committee that rather than regulate exchanges, the bill laid before them would put his members out of business. The proposed changes, he warned, would bring with them "the end of liquidity in our markets"; it would "hamstring and freeze the security markets of the United States", and it would probably "lead to another panic".
Whitney had plenty of strong personal reasons for objecting with such inexhaustible passion to the proposals for increased regulatory surveillance. An incurable speculator, by the mid 1930s he was attempting to cover his own losses by embezzling funds to the tune of about $1 million from, among others, the New York Yacht Club. This earned him an unenviable entry into the history books as the first former president of the exchange to serve time in prison.
After a spell in Sing Sing, Whitney became mute on market regulation. He had already said more than enough: he probably delivered more power to the Securities&Exchange Commission than its founders had ever imagined would be possible.
But furious opposition to the new laws of the 1930s was by no means the sole preserve of Wall Streeters, straight and crooked alike. Gerard Swope, president of General Electric, signed a letter submitted by the Business Advisory and Planning Council, which he chaired, apparently voicing the view of American industry that the reform amounted to "a national calamity" and "a disaster".
In the academic world, a prominent NYSE member firm polled US finance professors for their views on federal regulation early in 1934. Of these, 39 opposed the measures, arguing that they would hamper economic recovery. Only four expressed support for them.
From the specialist financial press, too, there came howls of disapproval. "The process of extending the reach and grasp of government direction is endless, or appears to be," said Barron's in September 1933, adding the following March that the efforts of the reformers amounted to "a grandiose experiment in broad social control under the guise of stock exchange regulation".
In its darkest moments of 1934, Barron's was even penning premature obituaries for scores of brokers as well as for the entire new-issue market. Its "With the Editor" column of February 10 1934 pointed to some of the more alarming likely by-products of the perceived emergence of America's new "centrally-controlled economy". "Unfortunately," it warned in one of its more apocalyptic prognostications, "the provisions of the Act make it unlikely that there will be any new securities."
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