TWO
SANCTUARY

30

As you drive the interstate highways of the United States and pass from one state to another, you typically are welcomed by a sign announcing L· M. the fact that you are crossing the border into new territory. The sign usually radiates local pride, proclaiming the state’s nickname or its motto, depicting its emblematic animal or flower. Entering New York you are welcomed to “The Empire State.” Heading south, New Jersey announces that you are in “The Garden State.” Maryland warmly implores you to “Enjoy Your Visit.” Drive along Interstate 95, and whether you cross the Delaware Memorial Bridge or come from the south, tiny Delaware, “The First State,” “Little Wonder,” greets you with another sign, a smallish blue sign with white lettering that is nevertheless hard to miss: “Home of Tax Free Shopping.” How does such a small state, with little industry to speak of, obtain the revenues to eliminate sales tax?¹

The answer is that Delaware gets rich from the revenue it rakes in from chartering and taxing corporations. Along with this money comes the taxable wealth of the substantial industry of lawyers and corporation service companies that has grown up to assist them, together with the rest of the professional infrastructure necessary to maintain the corporate law business. And corporate law is big business in Delaware. In 2005, Delaware’s total tax revenues were $2.7 billion. Nine percent of this came from corporate income taxes, that is, from taxes paid by corporations earning money in the state. But $700 million—almost 26 percent—came from corporate licensing fees paid by corporations that buy into Delaware law and operate throughout the rest of the world. Take away the business of DuPont, the chicken farms, tourism in the Brandywine Valley and the lovely beaches, and Delaware’s main industrial product is corporations. Corporations that have their legal pied-à-terre in Delaware pay the bills that keep the population free from taxes.²

It was not always so. Delaware was an also-ran at the end of the nineteenth century. The state was not even among the top five states of incorporation. At the end of that century, the empire of corporate law was New Jersey. Known by muckrakers as “the traitor state,” “the mother of trusts” and a variety of other less printable epithets, New Jersey presided over the degradation of corporate integrity from 1889 until 1913. Only then did Woodrow Wilson, on his way to the White House, persuade New Jersey’s legislature to toughen up its corporate laws. The legislature took it back after Wilson was safely in Washington. But it was too late.³31

Wilson’s legacy to New Jersey was a corporate exodus to the promised land. As if crossing a corporate Red Sea, guided by a pillar of cloud by day and fire by night, New Jersey’s companies made a beeline across the Delaware River to a land where they were welcomed with open arms and have lived happily ever after. Perhaps this is New Jersey’s most important legacy to the nation, or at least to its corporations. But the important story for now is not the present; it is how New Jersey changed the face of American corporate capitalism.

New Jersey did not create the giant modern corporation. But, saddled with debt and politically controlled by its own railroads that refused to pay it taxes, its politicians sensed an entrepreneurial opportunity in marketing corporate charters. The state provided laws that made it easy to cooperate by combination, and the charters it sold allowed corporations to solve the problem of destructive competition. Competitors that previously had to work at the margins of the law through trusts, pooling arrangements, or communities of interest now could legally combine operations under a single corporation that owned all their stock. The structure that resulted looked almost exactly like the outlawed trusts. But New Jersey inscribed that structure into its corporate law. The trust structure was no longer a subterfuge. The holding company transformed it into a perfectly legal device.

New Jersey made it easy for corporations to take advantage of these holding companies. The law provided a financing technique that allowed promoters and bankers to put the combinations together without having to use cash. It gave them a financial printing press that let them create vast amounts of new stock to pay the owners of the corporations coming into the combinations. Promoters could also take that stock as their pay and then dump it on the market, to be scooped up by an emerging middle class eager to participate in the new business world. When J. P. Morgan’s syndicate had finished creating the New Jersey holding company that was U.S. Steel, it paid itself 1.3 million shares of Steel stock. It promptly sold that stock to the public for $62.5 million (almost $1.5 billion in 2006 dollars) in order to cash in on its enormous fee. New Jersey provided the magic words that allowed financial wizards to conjure up the giant modern corporation.32

New Jersey solved the problem of corporate cooperation even as it created problems for American finance, law and society, problems that would persist long after Delaware had taken the lead. New Jersey is not solely to blame for the dilemmas that confronted all Americans, whether Granger, Populist, Progressive, Socialist or Conservative, as they struggled to deal with the giant corporation. But the Garden State’s role in the development of American corporate law and the troubles it created for the entire nation were pivotal. And so my story of the giant modern corporation continues in New Jersey.

THE POWER OF THE STATES

Corporation law—the law that governs the creation, financing and management of corporations—has always been left to the states. The members of the Constitutional Convention refused to delegate the power to create that law to the federal government. James Madison saw the future better than most. He wanted the Constitution to give the federal government the power “to grant charters of incorporation in cases where the Public good may require them, and the authority of a single State may be incompetent.” When might the “authority of a single State” be incompetent? When corporations were engaged in interstate commerce. And it was the federal government that had the power to regulate interstate commerce. Madison had some supporters. He pushed the issue several times. But the Framers’ fear of monopoly privileges that had long been associated with corporations and their even greater fear of concentrating economic power in the federal government won the day. The creation and regulation of corporations stayed in state hands.⁴

The states granted corporate charters the way they had been granted in Britain. Corporate charters were granted by special act of the legislature, as in Britain they had been granted by the Crown. Because each was granted separately, it was tailor-made to suit the needs of the particular corporation. This meant that these charters contained whatever rights and powers the incorporators could negotiate with the state. That might include more freedom or less, depending on the project and the promoter’s relationships with legislators.⁵

The point is important because it laid the foundation for an eventual revolution in the way that American state charters were granted. Special legislative favors, like corporate charters, were undemocratic. And many state legislatures granted monopoly privileges in corporate charters just as the Crown had done in England, and just as undemocratically. Even when a monopoly was not explicit, the idea of the corporate charter was frequently thought to convey it. The issue was joined in the 1837 Charles River Bridge case, where the United States Supreme Court held that a corporate charter did not imply a monopoly in the business for which it was granted. The Court would revisit this issue under various constitutional provisions through almost the end of the century. The fear of corporate monopoly power and other “undemocratic” privileges stirred up general anticorporate sentiment that reached its peak in the democratic maelstrom of Jacksonian America. But corporations were useful, even though their real utility was not to be realized until the development of the railroads and the age of industrialization. So state legislatures granted charters and created corporations.⁶33

This practice of legislative chartering could not survive in the land of equality. In order to make the corporate form fit with the equality promised by democracy, states—starting with New York in 1811—slowly began to develop general incorporation laws. These laws allowed anybody to form a corporation simply by following the proper procedures. Most states had adopted some form of general incorporation law by the middle of the nineteenth century.

General incorporation laws were democratic. But the advantages of tailoring a charter to a corporation’s needs sustained the practice of special chartering, even after general incorporation laws were commonplace. For example, a special legislative charter could loosen tight statutory restrictions on the amount of capital a corporation could have and the nature of its business. Special charters, like any other statute passed by a legislature, could more or less contain whatever terms the legislature chose to include. So a charter could include privileges beyond those included in general incorporation laws.

There was another, somewhat darker, advantage to special charters. They could have a certain attraction for the poorly paid lawmakers themselves. Legislators could get by with a little help from their friends as those friends showed appreciation for the special privileges put in their corporate charters. So most states continued to allow special legislative incorporation along with these general incorporation laws until the 1870s, when they began to outlaw the practice. It was special incorporation in the age of Jackson that got New Jersey into the financial mess that its late-century corporate law was designed to fix.⁷

WHY NEW JERSEY?

New Jersey identified itself with corporate interests early in its statehood. The state’s first significant attempt to attract corporate business was realized in Alexander Hamilton’s Society for the Establishment of Useful Manufactures, which planned to develop an industrial city alongside the Passaic Falls. The state was so eager to establish its importance in business that it gave the corporation some of its own sovereign powers, including the power to take private property for the corporation’s use. It also made the corporation’s profits exempt from taxes. These privileges, modified a bit, became common in many state railroad charters, but New Jersey mastered the practice of delegating its power to corporations.34

After the failure of the Society for the Establishment of Useful Manufactures, New Jersey tried again. It gave these powers, and more, to two corporations that would join together to dominate its business and government until the Panic of 1873. These were the Delaware and Raritan Canal Company and the Camden and Amboy Railroad Company.⁸

The State of Camden and Amboy

New Jersey’s story really began as the legislature created the Delaware and Raritan and the Camden and Amboy. The War of 1812 had painfully showed up the inadequacies of existing transportation and communication facilities between New York and Philadelphia. New transportation routes were needed. Canal promoters started clamoring for a charter to build a cross-state canal as they came to see New Jersey’s transportation potential. They soon found themselves competing with railroad promoters who also wanted to grab the New York-to-Philadelphia connection. Each group wanted the kind of monopoly charter that had characterized Robert Fulton and Robert Livingston’s steamship monopoly of New York Harbor. Both were granted their wishes in a legislative compromise. On February 4, 1830, the corporate twins, the Delaware and Raritan Canal Company and the Camden and Amboy Railroad Company, were born.⁹

Their charters were similar but, because the Camden and Amboy is the name by which the monopoly was best known, I will focus on that charter. According to one account, “the monopoly of the Delaware and Raritan canal and Camden and Amboy railroad companies was unique in American history.” The Camden and Amboy’s corporate charter protected it from competing lines built within three miles of its track for nine years. But far more significant was the fact that it also made the corporation completely exempt from taxes. Tax exemption, usually for a limited period of time, was characteristic of many of the early railroad charters. The Amboy’s was permanent. It did have to charge a modest transit tax of ten cents for each passenger and fifteen cents for each ton of shipped materials. But this applied only to passengers and freight traveling across the entire state. The Amboy was exempt from the transit tax for New Jersey residents who traveled and shipped within the state. And the transit tax would disappear completely if the New Jersey legislature chartered another railroad that ran within three miles of the Amboy’s terminal points. This was unlikely to happen because, only a year later, the legislature amended the Amboy’s charter to give it a truly extraordinary privilege—veto power over the grant of additional railroad charters. The Amboy held these powers until 1868, when the two companies surrendered their charters, and 1869, when the legislature eliminated both the transit tax and the railroad’s unique privileges.¹⁰35

The Camden and Amboy, under the control of the extraordinary Stevens family of Hoboken, was almost immediately successful. The canal company failed. But success was at hand. Captain Robert Field Stockton, a young man not yet thirty who had earned his stripes in the War of 1812, returned home to New Jersey after military exploits in Europe and Africa. He quickly involved himself in New Jersey politics. He also persuaded his wealthy father-in-law to invest heavily in the canal company. At this point, just to cover his bases, he asked the Trenton legislature to amend its charter to allow it to run a railroad line right alongside the canal.

This was not as daft an idea as it seems. Railroads in that time before dawn were pokey, unreliable things. They were mostly used to supplement other forms of transportation, and the idea of running a railroad along a canal would be helpful to its business. Stockton got his railroad amendment despite the Camden and Amboy’s resistance. This threatened the Amboy enterprise. Stockton was hardly guaranteed success either, although the canal had grown profitable. Competition between the canal and the Amboy would hurt them both. So Stockton accepted Stevens’s offer to combine the Delaware and Raritan Canal Company with the Camden and Amboy. Thus it was that their capital, their assets, their routes, their management and their boards of directors were joined together under the “Marriage Act” of February 15, 1831. The new “Joint Companies” controlled the fledgling Jersey transportation industry, with the canal eventually running from New Brunswick to Trenton and the railroad from South Amboy to Camden. Just to secure its position with the Trenton government, the Joint Companies gave the state one thousand shares of stock (the Amboy had already given it one thousand), to be paid for out of their joint revenues.

The legislature gave the Camden and Amboy complete veto power over grants of all railroad charters for about $30,000 in anticipated dividends and transit taxes. The corporation had begun its control of state policy. New Jersey rapidly became known as the State of Camden and Amboy. So important was the railroad to New Jersey history that at the 1893 Columbian Exposition in Chicago, the fabled “White City,” New Jersey’s contribution was the original Camden and Amboy train that had begun its run in 1834.¹¹36

Eighteen thirty-two saw the birth of another railroad company, the New Jersey Railroad and Transportation Company. The Camden and Amboy exercised its veto power. Evidently the incorporators of the New Jersey Railroad had good friends in the legislature, because the legislature ignored the Amboy and granted the charter. The New Jersey Railroad successfully began to operate a line between Jersey City and New Brunswick. This gave it quicker access to New York by way of the ferry from Jersey City than from the Amboy’s own terminal farther to the south. Legal fights followed. The rulings looked bad for the Amboy. In order to stop the litigation and save the Joint Companies, Stockton bought control of the New Jersey Railroad. He pulled the plug on the litigation and gave his control to the Amboy. But there was one final battle before the Amboy’s empire was secure. The Pennsylvania-incorporated Philadelphia and Trenton Railroad threatened to run a line along the Straight Turnpike between the Philadelphia ferry landing at Trenton and the New York ferry at New Brunswick. The Amboy bought control of this line, too.¹²

The Camden and Amboy, now operating under the corporate name the United Railroads and Canal Companies, controlled New Jersey’s rail lines, its shore line and its access to New York. Passage from Philadelphia to New York—at least rapid passage—required paying tribute to the Amboy. And the Amboy was not shy about exacting its tribute. It charged extortionate rates to through-passengers and consistently cheated the state out of its transit tax, the only revenue (besides returns on its stock) that the state could expect from it. It was easy to cheat. Accounting was still on the far side of primitive and the Amboy could keep its books any way it chose—and it chose to keep them dishonestly. By 1871 the Amboy controlled 456 miles of track, including the principal New York-to-Philadelphia lines, and 65 miles of canal.¹³

The crumbs from the Amboy’s table were enough to keep the state going for a time. As New Jersey’s nineteenth-century historian John Raum described it:

It was the duties paid by these companies [the Camden & Amboy and later the United Companies] that built our State Prison and Lunatic Asylums, of which structures our State may well feel proud; also, our beautiful State House, which a late writer in Massachusetts observes, “is not surpassed by any in the United States;” and in fact the means for all our internal improvements, as well as a large amount towards the support of our magnificent system of public schools, is derived from this source, thereby saving our citizens from an enormous yearly tax, which must have accrued through our extensive internal improvements, did we not have some other means of meeting these expenditures.37

The Amboy was in control. The Amboy more or less picked New Jersey’s legislators and its governor. It was able to produce a complete whitewash of two investigations authorized by the state in 1848 and 1849, brought to investigate charges by the famous economist Henry C. Carey, writing anonymously as “A Citizen of Burlington,” that the Amboy was cheating the state and its own stockholders. The Amboy continued to buy up tax-free land at the same time that it continued to refuse to pay the state what it was due. The tax burden fell squarely on the cities and towns.

What little the Amboy provided was enough for New Jersey through the Civil War. But while the state had been beyond the range of physical destruction during that conflict, financial destruction was another matter. It had accumulated crushing Civil War debt, crushing, at least, if it lacked the revenue to pay it back. At the same time, it continued to provide the substantial public services demanded by its citizens, including upkeep on that “beautiful State House” and the “State Prison and Lunatic Asylums.” The New Jersey legislature did not want to suffer the political heat of imposing property taxes, and much of the taxable property was owned by the Amboy anyway. Local officials complained bitterly about the amount of property taxes they had to assess in order to provide public services that they believed the state should provide. And while some state tax revenue came in from other corporations, it was not much.¹⁴

Finally, desperate for funds and pressured by would-be competitors, New Jersey broke the Amboy’s monopoly by passing a general railroad incorporation act. But the Amboy had already, in June 1871, leased its lines to the Pennsylvania Railroad for 999 years. Following an unsuccessful shareholder suit to enjoin the lease, the Amboy transferred its property to the Pennsylvania at the stroke of midnight between November 30 and December 1, 1871. Somewhat desperate, the state finally taxed the United Companies itself. So the Amboy paid New Jersey approximately $298,000 in 1876 on combined earnings of $5 million, a rather modest 5.9 percent. New Jersey’s awakening was too little and too late. The state was desperate for cash. The solution lay in corporate law.¹⁵38

Despite the Amboy’s control, New Jersey’s general corporation law was frequently amended between 1846 and 1886 to resemble a responsible corporation law, similar to that of most states. But responsibility was expensive, especially if you were a New Jersey legislator. Special chartering continued to be a highly popular form of incorporation until the 1870s, at least for those with money and influence.¹⁶

Other states were tightening their corporation laws. This became particularly true in the 1880s as businesses grew following the depression of the previous decade. The first of the large trusts appeared in order to combine in a manner that evaded corporate law restrictions. Standard Oil made everybody nervous, and the growth of several other large trusts during the 1880s, including the American Cotton Oil Trust, the National Lead Trust and the Sugar Trust provoked a general awakening to the coming changes in the American industrial and financial landscape. In response several states, including Kansas, Michigan, Missouri, Nebraska, North Carolina, Tennessee and Texas, passed relatively strong antitrust measures by 1891. The Sherman Act of 1890 became federal law. Public policy, not yet adjusted to the new realities, continued to oppose corporate cooperation. But business was desperate for a new legal form that would control competition for survival and profit. It was New Jersey—poor and accustomed to submitting to the demands of corporations—that in 1889 was poised to give birth to the giant modern corporation.¹⁷

New Jersey Finds Its Fortune

It is fair to say that in 1889 pretty much every sentient being in America was watching what was happening in the business world. A few states, sensing an opportunity to help facilitate business cooperation, had liberalized their corporate laws. They hoped that the congenial homes they created would lead to revenue from franchise fees and taxes. Delaware and West Virginia decked out their laws to attract needy businesses. And in order to make the most of it, they sometimes took to the road. In 1888, the secretary of state of West Virginia set up a table at New York’s Fifth Avenue Hotel, “the social center of the financial world,” where he displayed the seal of the state proudly beside him and explained the advantages of West Virginia law, selling charters to all who cared to buy one.¹⁸

Recall that it was about this time that the New Jersey legislature was facing huge deficits because of the state’s unpaid Civil War debt and its unwillingness to tax its corporations seriously. While the incorporation business had been profitable for politicians, the pressure to solve the state’s financial problems had become irresistible. The stage was set for an uphill battle waged by New Jersey to tax the previously untaxed or undertaxed railroads. So in 1882 the state swept away all tax exemptions from corporate charters. Tax legislation was passed. The railroads became taxpayers. The Amboy continued to cheat. Taxes went largely unpaid and the state’s treasury remained unfilled. In order to try to make some money, the New Jersey legislature imposed a franchise tax on corporations in 1884.¹⁹39

And then James B. Dill rode into town. Dill was a New York lawyer who lived in the Garden State. John Wayne with a briefcase, Dill went to Trenton to rescue New Jersey from its financial woes. In so doing, he helped to change the face of American corporate capitalism.

Dill was, as his friend and critic Lincoln Steffens put it, “a masterpiece.” Although a young man at the time, he eventually became, according to Upton Sinclair, the highest-paid lawyer in New York. Born in 1854, by the time he was forty-six he had reportedly been paid $1 million, “the largest fee ever paid to an attorney in the United States,” for mediating negotiations between Andrew Carnegie and Pierpont Morgan that led to the creation of U.S. Steel. A year later, he was described in Frank Leslie’s Popular Monthly as “the greatest trust lawyer in the United States.” By 1898 he had written the first of his several treatises on New Jersey corporate law. By 1899 he had testified as an authority on New Jersey corporation law before the United States Industrial Commission and regularly attended meetings of the American Economic Association. By 1902 he had given a speech to the Seminary in Economics at Harvard, in which he advocated the creation of a national incorporation law that would deal with the problem of the irresponsible state corporate laws he had helped to create. And in 1905 he became a member of New Jersey’s highest court, the Court of Errors and Appeals. There was no commission of the government, no conference of academics, no gathering of experts, no major newspaper, which failed to call upon him for testimony, speeches or comments. Everybody knew James B. Dill. And this is how he was referred to. One could speak of (although not to) Morgan as “J. P.,” but Dill was universally referred to as “James B. Dill” or, at the very least, “Mr. Dill.” By the time of his death in 1910, Mr. Dill’s opinion on virtually every aspect of the modern corporation was given the greatest deference.²⁰

Dill was hugely successful. But he was a bit of a misfit among his powerful and famous contemporaries. One account described him as follows:

In appearance he suggests none of the traditions of the ideals of the lawyer who has been successful beyond the most rosy dream. He has none of the suave dignity that distinguished Evarts; none of that genial and yet, after all, reserved quality that made Choate both admired and feared. There is not an expression or a mannerism that suggests a profound student…. To see Dill hurrying through Wall Street one would surmise that he was the Clearing House or Stock Exchange representative of some one of the greater financial institutions … muttering to … [himself] in a manner which in a more secluded environment would cause … [his] mental balance to be suspected.40

This, then, was one of the most respected and best paid lawyers of his day. But in the late 1880s, Dill was a relatively young man on the make. He observed West Virginia’s and Delaware’s attempts to attract corporate business and, so watching, came up with a plan. He presented this plan in New York, whose corporate laws were of the generally more respectable type. But New York was not interested. According to Lincoln Steffens’s entertaining account of the matter, Dill naively failed to explain to the New York political bosses how they could personally benefit from the plan. So he crossed the Hudson to his home state.²¹

Dill explained his plan to Governor Leon Abbett, a reformer who twice became governor despite crossing New Jersey’s political machine. Abbett was trying his best to obtain control over New Jersey’s chaotic finances. So he listened. As Dill explained it, the plan came in two parts. First, the legislature would build on its holding company act and corporate finance laws to pass the most liberal corporation law in the country. But the mere passage of new laws would not bring New Jersey the business it sought. After all, other states had lax laws, too.²²

The second part of the plan revealed Dill’s real genius. This was to create a corporation to advertise New Jersey’s paper bounty. The Corporation Trust Company of New Jersey was born. Its job was to sing the praises of the New Jersey corporation to businessmen throughout the land. It would do all of the necessary work to incorporate, service and maintain these companies which, under New Jersey law, would not have to do a penny of business in their new legal home. But the Corporation Trust Company of New Jersey was hardly a public service company. Its founding stockholders included not only James B. Dill himself, but also Secretary of State Henry Kelsey, Allan L. McDermott, clerk of the Chancery Court, United States District Attorney Henry S. White, Charles B. Thurston, secretary of the successor corporation to Hamilton’s Society for the Establishment of Useful Manufactures (which had been acquired by the Amboy and now was controlled by the Pennsylvania Railroad), and Governor Leon Abbett himself.²³41

Here is how the company worked. Anybody who was interested in incorporating in New Jersey had only to write to the Secretary of State. That functionary would send in return a treatise on New Jersey law which carefully explained the latitude it gave corporate managers and directors in structuring and financing their corporations. The Secretary of State would then refer the inquiry to the Corporation Trust Company or one of its later competitors, which would service the client, sending the necessary legal forms and offering to complete the entire incorporation process for the promoter, all at a modest fee.

The New Jersey approach was later widely imitated, sometimes even more blatantly. The Secretary of State of South Dakota, for example, referred interested parties both to that state’s corporation trust companies and also to the librarian of the State Supreme Court. This devoted public servant offered promoters his own personal incorporation services for $10 by letters written on the court’s official letterhead. No matter how brazen the efforts of the also-rans, New Jersey had such a head start that, by 1904, 170 of 318 industrial trusts studied by John Moody, including all of the largest trusts, had incorporated in New Jersey.²⁴

The eight years that it took New Jersey to refine its laws did not damage the plan. Eighteen ninety-three was a year of major panic, followed by a serious four-year depression. By the time recovery slowly began in 1896 and the merger wave broke with a fantastic return to prosperity in 1897, New Jersey was poised to jump out in front, and jump out in front it did. The revenue from New Jersey’s new business in corporate franchises paid off the state’s debt within a decade. The number of New Jersey incorporations grew from 567 in 1888 to 1,155 in 1891 and 1,212 in 1892, dropping into the 800s and 900s during each of the depression years of 1893 to 1896, and exploding from 1,118 and 1,104 in 1897 and 1898, respectively, to 2,186 in 1899, 1,995 in 1900, and 2,353, 2,255 and 2,035 in each of 1901, 1902 and 1903. By contrast, New York did not show anything close to a comparable number of incorporations until 1901 and Delaware did not even get out of the hundreds until 1909.²⁵

Dill’s marketing plan spoke more or less for itself—the proof was in the dramatic increase in the number of New Jersey corporations and Trenton’s rapidly filling treasury. But what exactly made New Jersey law so attractive?

In order to understand what was meant by the liberalization of corporate law, it helps to have some idea of what corporate statutes that were considered to be responsible looked like. Take, as an example, the law of Massachusetts. Its citizens were proud of the fact that their corporation law probably was the most demanding in the nation. The powers of directors and officers were limited. Stockholders had to approve all conveyances, mortgages, long-term real estate leases and business expansion. Directors could only issue stock after business had started by offering it at par to existing shareholders, regardless of the actual value of the stock. Stock could be issued for cash or property but a majority of the directors as well as the officers had to make a sworn statement that described and valued the property and the Commissioner of Corporations had to certify that, in his opinion, the valuation was reasonable. Directors and officers were personally liable for certain actions that damaged creditors, like paying dividends when such payment would make the corporation insolvent, issuing debt in excess of capital and watering stock. Massachusetts corporate law would not look like that of other states until 1903, when the legislature amended it in a futile attempt to catch up with New Jersey. Here is how New Jersey’s law was different.²⁶42

THE LEGAL FOUNDATION OF THE GIANT CORPORATION

The transformation of New Jersey law came in stages. Historians generally mark the passage of the 1889 holding company act as the most important reform. That law reversed the old common-law rule by allowing New Jersey corporations to buy and hold stock in other corporations. But, as I will show, the holding company act was not the essential development, although it was useful. Rather, the critically important change was the law that allowed corporations to buy shares in other corporations with their own stock, leaving the matter of price entirely within the discretion of corporate directors. This development was perfected in 1896, the year before the merger wave began.²⁷

The Holding Company

The traditional rule in the various states, including New Jersey, was that corporations were generally not allowed to own stock in other corporations. The law was particularly stringent with respect to stock purchases made by one corporation for the purpose of controlling another. Rare exceptions were made when a corporation had express legal permission or the purchase was incidentally necessary to its business. While a small handful of states took the opposite approach, this rule had long been entrenched in American and British law and continued as the law in most states even after New Jersey had authorized the holding company.

Courts provided several justifications for this rule. First, a corporation was only allowed to engage in the specific activities described in its charter. There was good reason for this. Nineteenth-century Americans were not entirely comfortable with corporations. Their acceptance—or tolerance—of corporations depended upon the states’ willingness to keep them under control. One of the best methods of preventing corporations from running amok was to limit their activities.43

A second, relatively ancient, reason for the rule was that courts presumed that stockholders of a particular corporation were investing their money in that particular corporation conducting those particular activities allowed by its charter with its particular management. In the language of modern economics, stockholders chose only the risk of a given business, not any other business the corporation might buy into.

A final reason, which started to appear frequently in the early 1880s as the antitrust debate heated up, was that a corporation buying the stock of other corporations, especially in the same business, was the mark of monopoly. Courts enforced the rule, and the treatise writers through the late 1880s expressed it as black letter law.²⁸

New Jersey’s holding company act was important. It paved the yellow brick road from competition to cooperation. But it took a few tries for the lawmakers to get it right. The 1889 holding company act allowed corporations “of this state, or any other state, doing business in this state and authorized by law to own and hold shares of stock and bonds of corporations of other states [emphasis added]” to do so, and to do so “with all the rights, powers and privileges of individual owners of shares.” The statute served its purpose as an opening salvo. But it was not enough. The 1889 law applied only to corporations otherwise legally entitled to hold stock in other corporations. Only a handful of states allowed this under almost any circumstances, and even the New Jersey law itself was not an outright license for New Jersey companies to own stock in other companies—they had to have express permission in their charters. Courts differed in their interpretations of what corporations owning stock with the rights of “individuals” meant and, in particular, whether a corporation owning stock in another corporation had the right to vote that stock unless that right was expressly stated in the charter.²⁹

So on March 14, 1893, the law was improved in a way that would induce promoters to incorporate in New Jersey. It now provided that “any corporation” created under the New Jersey corporation act could own stock in corporations of any state and specifically provided that the rights of individual owners included “the right to vote thereon, which natural persons, being the owners of such stock, might, could, or would exercise [emphasis added].” The legislature could not have been much clearer in permitting corporations to vote the shares they owned to control their subsidiaries.³⁰

But there was more. Evidently the meaning of the rights of “natural persons” exercising rights they “might, could, or would” exercise was not clear enough. So, in 1896, the statute was amended one more time to eliminate the phrase “natural persons” and “might, could, and would.” Now it simply allowed a corporation, “while owner of such stock” to “exercise all the rights, powers, and privileges of ownership, including the right to vote thereon.” Finally, in 1899, the law achieved its final form. A holding company was allowed to exist as a finance company alone, to exist solely for the purpose of owning another corporation’s stock. In a complete perversion of the nineteenth-century view of the corporation, the twentieth century dawned with corporations that had no specific businesses of their own.³¹44

The promoters of New Jersey corporations could buy all the stock of competing corporations in any state, adding them to the corporate structure in the same way that an individual stockholder added stock to his portfolio. Since most states, including New Jersey until 1918, prohibited mergers of corporations across state lines, the holding company could have been the Holy Grail of cooperative business.³²

But most combinations were not holding companies until the last few years of the merger wave. The dominant form of transaction appears to have been what was sometimes known as “fusion,” in which the assets and liabilities of the constituent corporations were directly absorbed by the new combination in exchange for stock or, occasionally, cash. This left the constituent corporations in place with no other assets than the new company’s stock or cash. The old corporations then dissolved and distributed the consideration to the shareholders of the selling corporations. If a constituent corporation had taken stock for its assets, its shareholders then became shareholders of the combination.³³

Why was the simpler holding company form not more widely used? One reason is fear of the unknown. Lawyers then, as now, were conservative in counseling clients. The holding company act, and the holding company itself, were untested both as a corporate law matter and as an antitrust matter. Holding companies looked almost exactly like trusts except that a corporation held the stock instead of trustees. Lawyers and their clients were afraid that holding companies would be treated like trusts, exposing them to prosecution under the Sherman Act as the Supreme Court then applied it. Many were emboldened by Standard Oil’s reorganization as a New Jersey holding company in 1899, which significantly increased the use of the holding company during the final years of the merger wave. But their fears were confirmed by the Supreme Court’s ruling in the 1904 Northern Securities case that holding companies were subject to the Sherman Act. Only with the 1911 decisions in the Standard Oil and American Tobacco cases did the Supreme Court make it clear that the Sherman Act applied to single consolidated corporations too, thus making the choice of form less consequential than its behavior from an antitrust perspective. The holding company only reached its full potential, and that as a control device, in the 1920s.³⁴45

The holding company was important as the first apparently unassailably legal form of combination. It was a symbol of New Jersey’s willingness to accommodate corporate combinations when most other states were clearly hostile. It was also an invitation, quite express if you consider the role of the Corporation Trust Company, for promoters to come to New Jersey with the implicit assurance that nobody would bother them as they put together their combined corporations. Seen this way, the holding company served a transitional purpose, as a bridge between the trust form of organization and combinations of assets within a single giant corporation.

Selling Stock for Property

New Jersey’s more critically important contribution both to the growth of the giant modern corporation and the American stock market was made in 1896. It was then that the state amended its corporation law to allow corporations to buy stock for property in a manner that gave the directors the exclusive right to value the property, and thus its price in stock. This development was determinative for the success of the merger wave because it allowed promoters to pay as much as they wanted for corporations with the stock of the new combination. They did not need cash.

In one sense, there was not as much new about this law as there had been about the holding company act. New Jersey law, like the laws of other states, had long allowed corporations to buy stock for property. The key difference was that the earlier rules did not give the directors’ valuation the finality of the 1896 New Jersey act. Under the old law, directors could be liable to creditors and sometimes shareholders if their valuation was wrong, and shareholders could be liable to creditors, too. Under the new statute, the directors had no liability to creditors or shareholders (or anyone else) if they turned out to be wrong unless their valuation of the property was clearly fraudulent. And fraud was a technical legal concept that was very hard to prove.

The old law also said that property had to be bought for the full value of the stock. It is unclear from the statute what “full value” meant, although New Jersey courts would provide the surprising answer. The 1896 amendment left no statutory question—it was up to the directors alone to decide whether or not full value had been paid.

This standard was the real key to creating the giant combinations. And New Jersey’s lawmakers knew it. In their introduction to the 1896 revision of New Jersey’s corporation laws, the commissioners noted that “a few substantial changes have been made, but they are generally only the insertion of the well settled decisions of the court. For instance, in Section 49 … we have provided that in paying for property purchased by the issue of stock, the judgment of the directors as to the value of the property, shall, in the absence of actual fraud, be conclusive.” The assertion that this provision merely reflected well-settled law was misleading, as I will discuss below, but the important point to note is that this was the only provision of the entire act that the commissioners separately discussed. They did not mention the holding company act except as part of a broad overview of the revised statute.³⁵46

The Corporation Trust Company gave the same prominence to the stock-for-property act in its brochure describing the advantages of New Jersey law, and repeated the same misrepresentation. After describing the process of incorporation, the brochure laid out the benefits of New Jersey law. As one of seventeen briefly mentioned points, it noted the power of corporations to own stock. But after setting out these seventeen points, it went on to discuss one special feature:

A most important example calls for special mention. In that section which authorizes the issuance of stock for property, the statement that the judgment of the directors as to the value of property is absolutely final in the absence of fraud was first flatly stated in the law in 1896, but the Courts for many years previous to this laid down the same principle and had repeatedly affirmed it. Since the Courts and Legislature thus supplement each other’s efforts, every provision of the law is the rational result of long experience.

Thus, among all of the statutory provisions that the Corporation Trust Company identified as important, the most prominence was given to the stock-for-property provision. Together with the Report of the Commissioners and the observation by the Industrial Commission that stock of a combination was the most frequent form of payment to the sellers, this almost certainly clinches the argument that at least New Jersey’s lawmakers and lawyers believed the stock-for-property provision was the most important of New Jersey’s “reforms.”³⁶

A proper understanding of the development of the giant modern corporation also supports this conclusion. It is extremely difficult to appraise the value of property. In one sense, value is whatever a willing buyer will pay a willing seller. But what if there are only a few buyers or only one buyer? And what if the property is unique? Take an easy case like real estate. In most populated markets today, valuing a piece of real estate is relatively simple. A house in a suburban housing development, where most houses are fairly similar, will sell for a price that is somewhere in the range of what the last house in the development sold for (holding constant for variables like the condition of the house, interest rates, the frequency of sales and the like). A two-bedroom coop apartment on West End Avenue in Manhattan will sell within some range of the last one sold in the same building, assuming roughly the same condition and the same layout. Bic pens will sell within pennies of one another from one city to the next. Shares of Microsoft stock trading on the New York Stock Exchange move by tiny fractions based on immediate supply and demand. Value is relatively predictable.47

But what about an oil refinery in Philadelphia in 1870? What about a Pittsburgh steel mill in 1890? What about a Chicago slaughterhouse, a trunk line between Cleveland and New York, a flour mill in Minnesota? Each of these, for a variety of reasons, was unique—its location, the quality and cost of railroad service or other shipping, the reliability of its customer base, the goodwill of its name and the quality and stability of its suppliers. Properties like these were swept up into the new giant corporations in the corporate combinations of the 1890s. While some of their owners insisted on cash, most were happy to take all or part of the purchase price in stock of the new combination as long as the price was high enough.

When these new corporations were formed by combining existing corporations into a new corporation or under a holding company, their promoters and financiers had to decide upon a capitalization, a financial structure consisting of some combination of bonds, preferred stock and common stock. They had to determine how much to issue and to assign a value to each of these different types of securities. Together these values would make up the capitalization of the corporation. And the value had to be based upon something. But what?

Promoters had almost irresistible incentives to put high values on the assets they were buying. The more they valued the assets, the higher the amount of capital they could justify and the more stock they could issue. The more stock they could issue, the more stock they could take for themselves. And the more stock they could take for themselves, the more they could sell in the market for cash. Promoters were not the only greedy ones. Sellers had to be given attractive prices to persuade them to sell their properties, all the more so if the promoters expected them to take untested stock. So promoters had every incentive to make the initial volume of shares—the capitalization—as big as possible.

The New Jersey amendment pretty much allowed the directors to assign the properties any value they chose. As a result, it allowed them to capitalize the new corporations at whatever values they chose and to issue as much stock as they wanted. The New Jersey courts, vainly attempting to uphold their state’s honor, did the best they could to eviscerate the statute. Nobody cared.³⁷48

THE NEW JERSEY COURTS—A FUTILE ATTEMPT TO MAINTAIN INTEGRITY

The New Jersey law revision commission did not completely lie. The stock-for-property provision did develop out of common law, and New Jersey even had various statutory forms of the rule that well predated the 1896 revision. The lie was in the implication that directors had long had virtually absolute discretion in valuation. The truth was otherwise. This rule had been judicially adopted only in 1890 and, without much additional litigation, remained somewhat ambiguous.

The original rule was grounded in democracy even as its later statutory revision enabled the creation of plutocracy. Courts reasoned that it allowed people with little cash, but valuable assets, to have the chance to participate in corporations. But this rationale limited the discretion directors had to determine the value of the property. While courts wanted to provide opportunity, they also had to protect corporate creditors who could rely only upon the corporation’s assets for repayment in the event of failure. And stock that was issued for property worth less than the face amount of the stock would mislead creditors as to the value of the corporation’s assets.

Corporate laws that protected creditors were a tradeoff for the relatively new general privilege of limited shareholder liability, as New Jersey’s highest court explained in 1882 in Wetherbee v. Baker. Limited liability meant that stockholders had to pay the corporation only the par value of their stock. Creditors could not come after their individual assets. The rule for partners was different. All of the partners were liable for the business’s debts, even if payment had to come from their personal assets. The law that stock had to be fully paid was a way of compensating creditors for protecting shareholders with limited liability.

Besides, as the Wetherbee court saw it, the statute did not really change anything about this creditor-protective rule. All it did was create a different way for shareholders to pay for their stock. It certainly did not provide a different method of valuing that payment. Property given for stock was expected to have a cash value something close to the par value of the stock in order to be considered “fully paid.” Only then would limited liability attach. While creditors of a bankrupt corporation could not go after shareholders’ personal assets when the shares were fully paid, at least they had the comfort of knowing that the shareholders had paid what they promised.³⁸49

There were limits to how much stock you could sell for property under the common law and early statutes. These limits largely grew out of what was known as the “trust fund doctrine.” This doctrine treated the amount stockholders paid to the corporation in par value as a trust fund to be held for the benefit of creditors. The trust fund included money that shareholders owed for the stock but had not yet paid. Now note the problem. If “fully paid” stock was issued for property that was worth less than the stock, the creditors’ protection was largely meaningless—the trust fund would be empty, or relatively so. So in Wetherbee, the New Jersey court held that it was not enough for the directors of a corporation to make a good-faith attempt to value the property being purchased. That value had to be a “fair bona fide valuation” in “what may fairly be considered as money’s worth.” This was known as the “true-value” rule. Unless the property met this standard, the stock was considered to be a fraud upon the corporation’s creditors. Shareholders (who in these cases were usually the promoters and directors) would have to pay the difference between the true value of the property and the unpaid portion of their stock until the creditors were paid off. The rule of Wetherbee gave the directors no real discretion. It held them almost to a form of strict liability.³⁹

The true value rule began to bend. The United States Supreme Court, relying both on common law and New York’s 1880 move from the true-value rule to a “good-faith” rule, held in 1886 that shareholders would be liable to the corporation’s creditors for unpaid subscriptions (which included the difference between the true value and the overvalued property) only if the directors or shareholders had engaged in “actual fraud.” If “the shareholders honestly and in good faith put in property instead of money in payment of their subscriptions, third parties have no ground of complaint.”⁴⁰

In 1890, New Jersey’s equity court again addressed the issue. In Bickley v. Schlag, the corporation’s authority to issue stock for property came not from a statute but from a provision in the corporation’s charter that was almost identical to the statutory language. The distinction between charter provision and statute did not matter to the court, which adopted the good-faith rule articulated by the United States Supreme Court. New Jersey law had just been judicially amended and, before the dust settled, would be amended again.⁴¹

The problem with the New Jersey statute up to this point was that it authorized the issuance of stock for property “to the value thereof.” Whose valuation mattered—directors or courts? While courts ordinarily would defer to the judgment of the corporation’s directors under the good-faith rule, their judgment still was subject to the chance that a court would hold that the property was not worth what the directors said it was.50

The moment of truth came in Donald v. American Smelting and Refining, the first case to be decided under the 1896 revision. This revision had added the language “and in the absence of actual fraud in the transaction the judgment of the directors as to the value of the property purchased shall be conclusive.” This language was vitally important. It was the language the Corporation Trust Company touted and said the courts supported. Unlike the good-faith rule, and certainly unlike the true-value rule, it did not leave room for judicial valuation. But that did not stop the court. It used the Donald case to read this new language out of the statute.

Donald is interesting for several reasons. It was the first case under the new statute, and the first that involved a corporate combination of the type that characterized the merger wave. It is also interesting because counsel for the defendants, Samuel Untermyer, was one of the best-known and highest paid corporate lawyers in the country. Like his contemporary, Louis Brandeis, he would forsake his origin as corporate lawyer and trust promoter (again, like Brandeis, after he had become very wealthy), to redeem himself by making the national case against the abuses of trusts, corporate law and the stock market. Untermyer’s most prominent and public role would be as counsel for the Pujo Committee in 1912 and 1913, and as an advocate for stock market regulation. We will meet him again in this role in Chapter Nine.

American Smelting bought various Guggenheim properties, including smelting and refining plants. (The Guggenheims, who made their money in mining, were among New York’s Jewish aristocracy. But although they were among the richest of “our crowd” they were of a slightly lower social standing than Schiffs and Kuhns and Warburgs and Lehmans. Not only were they considered nouveau riche in that crowd, but mining was also considered socially inferior to banking as a way of making money.) American Smelting would pay for the Guggenheim properties with $6 million in cash and $45 million in its own stock, and increase its capitalization from $65 million to $100 million to finance the deal. Shareholders of American Smelting sued to prevent it, and the court agreed.⁴²

The court found the language of section 49 “explicit.” “To the value of the property” meant that the property’s value “must at least equal the face value of the stock,” specifically citing the old true-value rule of Wetherbee, which the statute was designed to overrule. The court noted that the judgment of the directors was entitled to “considerable weight,” although the court claimed the right to determine the value for itself in complete disregard of the new statute. And it loosened the meaning of the statute’s language, “actual fraud.” Actual fraud was a precise legal concept with clearly established meaning. But the court said that if the directors had not engaged in “due examination” of the property’s value, or if they included other “assets” that were not really property (apparently goodwill and capitalized future earnings), or if their judgment was “plainly warped by self-interest,” that would be fraud enough. None of these behaviors even approached the legal test for actual fraud.51

What about the new language that made the directors’ decision final, the new language that was designed to attract the promoters? The court effectively rewrote the statute. When a deal involved valuation before the stock was issued, as the American Smelting deal did, the court held that its version of the true-value rule applied. The statute only applied as written if a stockholder or creditor brought a case after the stock had been issued. The court’s policy goal was clear. Promoters who capitalized the new combinations for their own benefit were not to be trusted. Only shareholders who later bought the stock were to be protected. While the court’s reading had logical force, it was not what the statute said.⁴³

The press followed the case closely and applauded the court’s decision. The New York Times reported that “[t]he decision is looked upon here as one of great significance with respect to the incorporation of companies under New Jersey laws in the future.” Fear was expressed that corporations would flee from the state, although others thought that fear was overstated. There was no flight from New Jersey.⁴⁴

Nobody left New Jersey because everybody ignored the court. Its ruling in Donald did not even matter to the parties themselves. The plaintiffs did not care about protecting creditors or shareholders at all. Leonard Lewisohn and H. H. Rogers, who both resigned from the American Smelting board in protest of the deal, were worried that the Guggenheim deal would wind up cutting their own United Metals Selling Company out of its role as selling agent for American Smelting. On March 30, 1901, the day after the court’s decision, the parties negotiated a settlement. The Guggenheim deal would proceed as planned and United Metals would continue as the Smelting Company’s selling agent. Who cared if New Jersey’s highest court said the directors’ valuation of the deal was a lie?⁴⁵

New Jersey’s courts did their best to stymie the legislature in its attempt to sell New Jersey’s dignity. While Donald represents the judicial interpretation of the 1896 act, there is one more case worth discussing which, although decided five years after Donald, relied upon the 1889 act. Although the acts had somewhat different language, the differences appear to have been entirely irrelevant to contemporaneous commentators and almost entirely irrelevant to the New Jersey courts. See v. Heppenheimer is a classic of the era and provides the most thoughtful and carefully reasoned discussion of the entire issue.⁴⁶52

The case again involved Untermyer. This time he was serving as a principal in the deal, a promoter as well as lawyer for the allegedly fraudulently valued Columbia Straw Paper Company. The business was formed in 1892 explicitly to monopolize the straw paper industry. It was bankrupt by 1895. The court relied on Donald, disregarding the fact that a different statute applied. Again it ignored the words “actual fraud” and adopted the constructive fraud rule.

The deal in See was in some respects even worse than that in Donald. The whole purpose of the Untermyer scheme was to promote and organize the corporation, capitalize it with overvalued property, get it running, and dump the stock on the public. The deal was meant to be accomplished by means of a misleading public prospectus drafted by Untermyer, whom the court called “the managing genius of the whole transaction,” and a privately circulated “confidential” prospectus. Without mincing words, the court called this whole operation an “intrinsic” fraud.

Untermyer had a defense. The promoters had, in fact, carefully valued the property. But they did so, wrote the court, on the basis of anticipated monopoly power. That meant that the value the directors assigned the property included future profits which the court in Donald had said was not “property” at all. The question of corporate valuation was squarely raised, but for now the important question was what the courts would accept as value, regardless of what businessmen and economists might think. Could the board value the corporation’s property on the basis of “prospective profits”? The answer was no. Only tangible assets could be used.

The court was more financially sophisticated than might appear from this conclusion. Prospective profits could not be used as value, but the court did say that the directors could use goodwill in valuing the property bought with stock. The court was, with good reason, rather unclear in describing the difference between prospective profits and goodwill. But it did not matter in this case, because the new corporation had not done any business. It had no goodwill, however one defined it, and as far as the court was concerned the goodwill of the constituent corporations was already included in their purchase prices.⁴⁷

See v. Heppenheimer was embraced by commentators. Where Donald had damaged one of the principal attractions of New Jersey corporate law, the valuation methodology approved by the See court completely destroyed it. Yet corporations continued to flock to New Jersey after Donald and See, and the previously formed giant New Jersey corporations did not run away. Why?⁴⁸53

The See court’s own language provides an answer worth quoting at length:

But the defendants say the practice of so valuing property under our statute has been indulged in frequently before, and numerous corporations have been organized and have existed upon such a basis, so that, they argue, the practice has become well nigh crystallized and sanctioned by long usage.

I am sorry to feel constrained to admit that this practice has been frequently indulged in, and, further, that it has brought obloquy upon our state and its legislation. But I am happy to be able to assert, with confidence, that such practice is entirely unwarranted by anything either in our statute or in the decisions of our courts, and whenever it has been indulged in it has involved a clear infringement of, if not fraud upon, the plain letter and spirit of our legislation.

“Frequently indulged in” indeed. By hundreds of corporations, including almost all of the largest corporations in the United States. But in order for a corporation to be held liable under the court’s revision of the statute, it had to be sued by creditors after the corporation had run out of money to pay them or by stockholders diluted by the promoters’ stock. These suits almost never materialized. The court rose to protect the maiden’s honor. But the maiden had willingly gone astray and the court’s efforts were far too little and far too late.⁴⁹

New Jersey’s courts could try to cover the state’s shame. But Dill’s legislation was ultimately what mattered, and what continued to pay the tax bills. Writing in 1909, Taft’s attorney general, George Wickersham, complained about the confusion created by the New Jersey courts and proposed instead a mandatory corporate disclosure law to allow shareholders to figure out corporate value on their own. At the same time, he noted that if the rule of See v. Heppenheimer “should be applied to all the corporations organized under the laws of New Jersey during the past ten or fifteen years, a very considerable number would no doubt be found to have their capital stock not fully paid, and the stockholders, to their great surprise, liable in the event of insolvency for the debts of the corporation.” While Wickersham was right, there really was little to worry about. New Jersey remained safe for corporate plutocracy.⁵⁰54

This entire discussion raises the vitally important question of how the stock of a giant corporation was to be valued. While I have just touched upon the topic here, I will discuss the matter at greater length in the next chapter. Meanwhile, there were a few other advantages to incorporating in New Jersey.

YOU NEVER HAVE TO LIVE IN JERSEY AND OTHER FEATURES

New Jersey law acquired some other attractive features in the 1896 Act. Included among these were the corporation’s right to incorporate “for any lawful purpose.” This was a dramatic liberalization of the restrictions placed on the scope of corporate business by legislative charters and other general incorporation laws. New Jersey corporations also were given the power to amend the corporate charter at will (in order, among other things, to alter its capital stock and to create different classes of stock), and to pay minimal taxes for the privilege.⁵¹

With these reforms in place came perhaps the crowning glory. Companies could incorporate in New Jersey and never have to conduct any business there at all. It was enough that they maintained a registered office in the state. And the corporation service companies were ready to do all the work for a modest fee. Testifying before the United States Industrial Commission in October 1899, Howard K. Wood, assistant secretary of the Corporation Trust Company, told the commission that his corporation served as the registered New Jersey office of, and represented, six to seven hundred companies. How could the Corporation Trust Company accommodate so many different corporate offices in one building? It did not. Complying with the letter of New Jersey law, it covered the outer walls of the building with plaques, each stating the name of a corporation and noting that the building contained the corporation’s registered office. Thus all six to seven hundred corporations whose plaques were on the wall were present and had a registered office in the state.⁵²

And there was more. New Jersey actively defended its corporate citizens against the resentments and retaliations of other states. In 1894, New Jersey passed a law that taxed every corporation of other states operating in New Jersey at the same rate that those states taxed New Jersey corporations operating in their states. This precluded other more responsible or ambitious states from retaliating against New Jersey through taxation.

In 1897 the legislature passed a law that protected stockholders, directors and officers of New Jersey corporations from any criminal or civil action brought in New Jersey courts under the laws of any other state. The law was not the result of a random thought. It was passed eighteen hours after being introduced for the purpose of protecting the officers of the Sugar Trust who were about to find themselves in big trouble in New York. As Lincoln Steffens described it:55

The Albany legislature appointed a committee to investigate all Jersey trusts that were operating in New York, and that committee came down to New York City after the Sugar Trust. But the Sugar Trust put its books on a boat and rushed them over to Jersey, and Jersey, under the guidance of her New York corporation lawyers, drew up and rushed through the Trenton legislature a bill to protect her own.

With the passage of the new legislation, New Jersey’s “conquest” was complete.⁵³

WHERE WERE THE OTHER STATES?

New Jersey prospered. Other states howled with indignation, and perhaps some envy, at New Jersey’s crass and selfish takeover of corporate America. But the other states were not powerless, and one might well ask why they did not use their own corporation laws to combat New Jersey’s profligacy. Why, for example, did Nebraska not prohibit the stock of a Nebraska corporation from being owned by another corporation, or at least a corporation from another state? If all of the states had enacted such laws, New Jersey’s holding companies would have been of little use. And states could have prohibited New Jersey corporations from raising money by selling watered stock in their states. (That was not to happen for more than a decade.) New Jersey corporations would only have been able to grow in New Jersey.

There are several answers to the question of why the other states did not retaliate. In the first place, attacking New Jersey would be counterproductive. Restrictions against New Jersey corporations would simply induce all corporations that wanted to combine to reincorporate in New Jersey, thus taking away any control over them by their home states, and relying either on local finance or help from residents of states that failed to retaliate. Moreover, these other states imposed franchise taxes on foreign corporations, revenues they were unwilling to lose by antagonizing New Jersey. Besides, New Jersey corporations could simply use their stock to buy the assets of corporations in other states rather than the corporations themselves, so it would have been ineffective for states to retaliate by restricting what their corporations could do.56

If this were not enough to discourage state self-protection, there was the collective action problem of one state retaliating against New Jersey, uncertain of what other states would do. If all states had retaliated, they could have contained New Jersey’s apostasy. But one or a few states, challenging New Jersey by themselves, would suffer. It was not long before more than half of the nation’s largest corporations were incorporated in New Jersey. U.S. Steel was a vital employer in Pennsylvania and much of the Midwest, as was Standard Oil from Cleveland to Baltimore. It was the same as if all states today prohibited Delaware corporations from having subsidiaries or doing business in their states—economic devastation for most. So there was little to be gained and much to be lost for a state at the turn of the century to retaliate against New Jersey. Although officials from nine states in the Mississippi Valley met in St. Louis in 1899 to develop a set of uniform laws, they ultimately failed with a “ludicrous fizzle” because the delegates could not agree on a policy toward trusts and, I suspect, states were unwilling to suffer the economic consequences of bucking the trend New Jersey had begun.⁵⁴

The attitude that resulted was, if you can’t beat ‘em, join ‘em. New York passed its own holding company act in 1892. And, before long, other states followed and even outdid New Jersey’s liberality. The entire complexion of American corporate law changed. Even Massachusetts, the bastion of corporate integrity, rather resentfully joined along in 1903. But despite (or perhaps because of) the domino effect created by New Jersey, the new situation did not go unchallenged.”⁵⁵

The federal government did not rise to its modern prominence in domestic matters until the New Deal. But it was during the Progressive Era that it began to lay the theories and create the models upon which federal regulation was based. The corporations question more than any other issue helped it set that groundwork. Even as the federal government tried to regulate trusts, the multiple problems created by corporate combination in New Jersey confused regulatory attempts. This was especially true of corporate overcapitalization, which resulted in promoters dumping huge numbers of questionable shares on the market. The issue of overcapitalization became the regulatory centerpiece of everything from antitrust reform to railroad rate regulation and eventually led to the first federal efforts to enact securities legislation. But before examining this regulatory history, it is important to see how New Jersey law combined with economic circumstances to create the merger wave, to make the business of America into the business of finance, and, in the process, to transform the American stock market.