SEVEN
PANIC AND PROGRESS

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The Panic of 1907 was a watershed event for currency regulation, banking regulation and securities regulation. It was the first serious economic panic to occur after the creation of the giant modern corporation had brought significant numbers of ordinary Americans into the stock market and demonstrated the impact that the new market could have on American business and the overall economy. It led Roosevelt, who was blamed by conservatives for causing the panic by attempted overregulation, to make a final unsuccessful push for federal incorporation. The seeds of federal securities regulation that had been planted in the antitrust debate began to grow out of both that effort and the various investigations that followed. Federal securities regulation started to receive distinct attention in its own right as the antitrust phase of securities regulation gave way to the antispeculation phase. These earliest attempts at securities regulation were notable for their halting efforts to address the consequences of the dominance of finance over industry created by the merger wave and the rapidly developing speculation economy. All of them failed.¹

The new generation of individual investors that had recently entered the market created its own set of problems. Uneducated and uninformed individuals put too much money into speculative securities. While a few might get rich, the best they could do for the most part was to see their wealth diminish in a bursting bubble. Or they could lose their investments in worthless stock. While this troubled some lawmakers and the president, its importance as a public concern remained minimal during an age in which caveat emptor still had some currency. And while the number of individual investors was increasing, the absolute numbers were not large enough to create a constituency for change. This was especially true when the executive and both houses of Congress were Republican and remained there in substantial part by the grace of business.167

Concern over the tie between bank stability and speculation was also an outgrowth of the Panic, branching off from the antitrust debate’s focus on overcapitalization. As early as the turn of the century, elastic state laws and federal convenience in an age of decentralized currency liberated banks, insurance companies and, especially, trust companies to increase their profits by becoming big investors in speculative securities. But until the Panic, the problem of banking stability, like the issue of investor protection, remained subjugated to antitrust concerns.²

The unstable banking system created by banks’ and trust companies’ increasing direct and indirect investments in corporate securities presented a new federal problem as the first decade wore on. Some looked to the stock exchanges to help stabilize the financial markets. The stock exchanges, including the single most important one—the NYSE—were private associations, answerable only to themselves. The NYSE sometimes adopted new rules to stave off federal regulation, as it would in 1913 following the Hughes Committee report on speculation and in the middle of the Pujo investigations of the Money Trust. But enforcement of these often ambiguous rules was entirely discretionary with the Exchange, which persisted in doing little to regulate itself. In fact the only violation that could get a member permanently expelled from the NYSE was sharing or cutting commissions. Fraud, stock manipulation and other forms of cheating customers could only be punished with brief suspensions. As with its members, so with the corporations it listed. The Exchange did little to enforce its disclosure laws. The New York state government also showed little appetite for exchange regulation.

THE PANIC OF 1907

The Dow doubled between 1904 and 1906. Old-style speculation was pervasive. Mining stocks were the driving force, as they would be the catalyst of the panic. But the winter of 1907 brought a rude if brief awakening. The money market tightened and credit increasingly was hard to come by, not least for brokerage houses. Railroads had been put under severe monetary pressure the previous year. Some brokerages closed up shop. Now a March stock panic crushed prices on the NYSE, wiping out $2 billion in market value.³

U.S. Steel’s resumption of dividends and an increase in Union Pacific dividends brought temporary relief. But the Egyptian and Tokyo exchanges collapsed in April. The summer brought more bad news. New York failed to attract buyers for two bond issues, and San Francisco repeated New York’s failure. The New York street railway combination went into receivership, as did Westinghouse Electric Company in October, just as the panic was getting under way. U.S. Steel announced lower earnings. J. P. Morgan’s ambitious and poorly conceived shipping trust failed. Judge Kenesaw Mountain Landis ruled that Standard Oil had violated the Elkins Act and stuck it with a $29 million fine in the fall. Standard’s stock price dropped 10 percent.168

Crises on the Hamburg and Amsterdam exchanges in early October created an outflow of U.S. gold to Europe. Problems on the Montreal Exchange soon followed. An attempted corner of United Copper stock by F. Augustus Heinze and Charles W. Morse collapsed. Several important banks and trust companies were involved in financing their effort, and the result was the looming insolvency of some of them. A bank panic was at hand.

The trust companies had caught the speculative fever without keeping sufficient reserves to protect their obligations to depositors. Among these were the banks involved in the United Copper play. One clearinghouse, the National Bank of Commerce, announced that it no longer would perform clearing operations for New York’s third-largest trust company, the Knickerbocker, which had been involved in the copper scheme. Trust companies like the Knickerbocker were not clearinghouse members and had to rely on member banks like the National to complete their banking transactions. The National Bank of Commerce’s action meant certain death for the Knickerbocker. It failed in mid-October after shutting its doors because it could not meet the run on its deposits. The real Panic of 1907—a bank panic—had begun.

The panic was a bank panic, but the banks’ losses that led to runs on their deposits were caused at least in part by bank speculation in securities. The Aldrich-Vreeland Act of 1908, the Federal Reserve Act of 1913 and finally the Glass-Steagall Act of 1933 were designed to respond to this irresponsible banking environment. At the time, though, no effective federal mechanism existed to control the banks.

The intervention was led by the nation’s de facto central banker, J. P. Morgan, asked by the administration to save the American money supply as he had during the gold crisis of 1895. Treasury Secretary George Cortel-you went to New York, where he deposited $25 million from the Treasury to be loaned for the most part as Morgan saw fit—mostly to bail out failing brokerage firms. The story is well known: Morgan’s hasty return from an Episcopal retreat in Richmond, Virginia, and the all-night meetings at the Morgan mansion on Madison Avenue, attended by George Baker of the First National Bank, James Stillman of the National City Bank, E. H. Harriman and other financial luminaries. Morgan demanded the infusion of additional funds by each of the attendees in order to shore up the failing trusts. (Morgan refused to support the Knickerbocker because of its particularly bad behavior and heavy demands. Its president, Charles T. Barney, committed suicide, but almost every account of the story suggests that perhaps Mr. Barney had not been his own executioner.)⁴169

The panic continued and Morgan’s circle of financial deputies widened. He invited more than fifty New York bank and trust company presidents to his library. He locked the door. He opened it again only when each had agreed to kick in their respective shares of the $25 million needed to prevent the bankruptcies of more than sixty brokerage houses and the ruin of their customers as well. John D. Rockefeller put in a share, and deposited $10 million with Stillman’s bank. Morgan bailed out New York City from its impending bankruptcy by uniting with Baker and Stillman to issue bonds to keep it afloat. He bought up bills of exchange to force the flow of gold from Europe to the United States.

In a tarnished last-minute deal, he saved a large brokerage firm, Moore & Schley, which was on the verge of ruin. The arrangement was for Morgan-controlled U.S. Steel to buy Moore & Schley’s principal collateral. This was the stock of the Tennessee Coal, Iron & Railroad Company, one of U.S. Steel’s major competitors. The deal was made only after Morgan received personal, if perfunctory, approval from Teddy Roosevelt. Morgan’s bailout was probably overkill in terms of what Moore & Schley needed to keep it afloat. U.S. Steel’s acquisition of Tennessee Coal almost certainly violated the Sherman Act, which let Roosevelt in for a lot of public criticism and ultimately resulted in his testifying as a witness in the investigations that led up to the Taft administration’s antitrust suit against U.S. Steel. The panic drew to a close in November and a thirteen-month industrial depression followed.⁵

One result of the Panic of 1907 was seven more or less lean years in America. But as Chapter Eight will show, it was a time when individual investors rapidly expanded their presence in the market.

ROOSEVELT’S LAST CHANCE—FEDERAL INCORPORATION, THE HEPBURN BILL AND THE FAINT BEGINNINGS OF INVESTOR PROTECTION

The federal incorporation debate continued despite the failure of the Little-field bill and the Bureau of Corporations’ federal licensing proposal. Congressmen regularly introduced new bills and Roosevelt renewed his attempts to secure federal incorporation under his control after he took a postelection break to focus on railroad regulation with the Hepburn Act of 1906. The Hepburn bill, which was different from the Hepburn Act, was introduced in the House on March 23, 1908. It was Roosevelt’s last chance to achieve federal incorporation. It was also the last chance for Littlefield, who chaired the subcommittee that conducted hearings on the bill in his final year in Congress.170

The bill was drafted by the National Civic Federation. As presented to Roosevelt by its president, Seth Low, the bill was an antitrust reform measure, far more limited in scope than a federal incorporation or licensing proposal. By the time it was ready to present to Congress, it had been transformed by the administration into its most potent federal incorporation effort.

The bill came into being rather modestly as an amendment to the Sherman Act. But Roosevelt diverted it from the initial goals of the National Civic Federation and reshaped it in his own regulatory image. Perhaps frustrated with the modesty of his achievements in trust regulation and stung by the blame he had taken for the Panic, Roosevelt increasingly came to see trust regulation as a crusade. He concluded a letter on the subject to Charles Bonaparte by quoting the last paragraph of Lincoln’s Second Inaugural Address and closed a January 1908 Special Message to Congress with the same words. Although Roosevelt blamed business for his failures, he retained his appreciation of the value of the giant modern corporation and wanted to bring it under sensible regulation. But Roosevelt was not Lincoln and the trust battle was not the Civil War. Despite his use of the latter’s immortal words of healing, Roosevelt continued to prosecute his case in increasingly hot rhetorical terms in a vain effort to attain the control over business that had eluded him. The Hepburn bill was condemned to failure for the same reasons that Roosevelt’s earlier power grabs had failed. Its importance was that, coming as it did upon the background of the Panic of 1907, the bill and the congressional debates over it introduced the issue of federal securities regulation in its own right, independent of antitrust concerns, as well as the first serious calls for investor protection.⁶

The Need for Certainty

The Hepburn bill was a different kind of federal incorporation measure despite its continued focus on trust reform. It would have permitted interstate corporations to register with the Commissioner of Corporations to give them the privilege of advance review of their contracts or combinations in restraint of trade. The Commissioner then would have had the power to determine whether they were reasonable and, if so, to exempt the registrant from federal prosecution unless the government decided that conditions had changed. Corporations that did not register continued their business practices at their legal peril.171

Business had been clamoring for certainty. The Bureau of Corporations’ files contain a raft of letters from businessmen around the country inquiring as to whether they could federally incorporate or, more frequently, whether the Bureau would give them advance guidance or approval of their plans, a matter which Garfield and his successor, Herbert Knox Smith, regularly had to reply was beyond their authority. Ralph Hill of Mount Vernon, Iowa, wrote to Smith asking flat out whether the Bureau had jurisdiction to advise a corporation “how it may change its policies or organization so as to conform to the Sherman Anti-trust Act.” More plaintively, the Bain Wagon Company of Kenosha, Wisconsin, sent Smith a letter claiming that only the merger of a number of wagon makers could save many of them from bankruptcy and asking for the Bureau’s sanction of their combination. In 1907, an agent of the Traveler’s Insurance Company wrote to Smith enclosing a newspaper article attacking the Bureau for creating such great uncertainty that entrepreneurs found it difficult or impossible to raise capital:

I fear you do not begin to realize the great amount of trouble and financial distress you are helping to bring about by the methods you are pursuing in the management of your Department. It is affecting many lines of business and causing anxiety in many homes. If you want Harriman or Rockefeller, why not go out and lasso them instead of disturbing all the smaller business interests, and thus disturbing the whole country.

A number of trade associations like the Building Material Men’s Exchange of Jefferson County, Alabama, the National Petroleum Association, the Wisconsin Retail Lumber Dealers’ Association and the Bituminous Coal Trade Association wanted advice or assurance from the Commissioner that they were in compliance with the antitrust laws. In one unusual letter, Charles W. Chase of Chicago wrote on behalf of his client, the Chicago-New York Electric Air Line Railroad Company, asking if it could provide all of its relevant corporate and financial information to the Bureau so that the Bureau could publicly release it and reassure potential investors as to the soundness of the enterprise. This Garfield refused to do and Smith, then his deputy, suggested that the company simply wanted to use the Bureau both as a shill and a stamp of approval.

These inquiries reflected a growing mood of uncertainty and anxiety about antitrust concerns among businessmen of all types and in all regions of the country. Many businessmen were generally in favor of the Hepburn bill. Others opposed it because they wanted clear rules as to the legality of specific types of combinations and restraints of trade instead of regulatory guidance on a case-by-case basis. Some small businessmen worried that the bill’s regulatory process would end up legalizing trusts to their competitive disadvantage. Most small businessmen opposed the way the bill effectively made labor boycotts lawful under the Sherman Act. There was much for some people to like in the Hepburn bill, but reading the hearings suggests that there was something for everyone to loathe.⁷172

The Provenance of the Hepburn Bill

The Hepburn bill itself was the product of the NCF’s Chicago Conference on Trusts and Combinations, held from October 22 to 25, 1907, as the panic in New York was raging. Among its final recommendations was that Congress create a nonpartisan commission to study ways of easing the effects of the Sherman Act on big business, specifically to create a system of federal incorporation or licensing that would distinguish between those trusts that served the public and those that damaged it, and also to ease the crunch of the Sherman Act on organized labor. It also recommended that Congress expand the role of the Department of Commerce and Labor to require the disclosure of corporate information.

A final amendment to the recommendations asked outgoing NCF President Nicholas Murray Butler to appoint a delegation to present its ideas to Congress and the president. The delegates met with congressional leaders in late January 1908. Aldrich evidently told NCF executive director Ralph Easley that trust legislation was unlikely to be considered during that congressional session but that the NCF ought to create a commission to investigate changes along the lines of the conference resolution.⁸

The story of the bill’s origin, development and hijacking by Roosevelt, comprehensively detailed by Martin Sklar, is long and complex. What started as an outgrowth of the trust conference was taken over by the NCF in the wake of the recent Danbury Hatters’ case. There the Supreme Court unanimously ruled that the Sherman Act applied to combinations of labor, a ruling that galvanized labor leaders and supporters from Gompers to Bryan to seek outright amendment of the Sherman Act to protect the unions instead of the indeterminate process of committee investigation that had been resolved upon by the conference.

NCF President Seth Low was a former president of Columbia University and mayor of New York. Conservative and open-minded, he supported organized labor. Low testified that the legislators had asked him to draft a proposed bill while he was in the process of contacting representatives Jenkins and Hepburn to arrange the presentation of the conference’s thoughts to Congress. The conference had not authorized such action, so the NCF took over, although Low assured the committee that nothing in the bill was inconsistent with the Chicago resolutions.⁹173

Low set up the committee. Despite the rich variety in its membership, by this time the NCF was largely dominated by the business and financial members who “carefully controlled” participation in the 1907 Conference. Its principal participants included August Belmont, Elbert Gary, Henry Lee Higginson and Isaac Seligman, together with a few labor leaders like Samuel Gompers and John Mitchell. Rounding out the committee were two eminent corporation lawyers, Victor Morawetz, counsel to the Atchison, Topeka and Santa Fe Railroad, formerly a partner in the prominent Cravath firm and the author of perhaps the first modern American treatise on corporate law, and Francis Lynde Stetson, who drafted the bill.¹⁰

The Hepburn Bill

While the individual eminence of its members gave the NCF access to all levels of government, the organization historically had little legislative influence or broad public support. It had begun this new project hoping to cooperate with the administration on its development. It worked closely with Roosevelt, who repaid the NCF by seizing the chance to transform the measure from Sherman Act amendments to an elaborate registration and regulatory scheme that would have put the power over American industry that he wanted in the president’s hands.¹¹

The bill that was ultimately introduced in the House, from which it never emerged, was an extreme expression of Roosevelt’s vision of the presidency. While it followed his policy of publicity, allowing corporations to register with the Commissioner of Corporations, the real power of publicity would lie with the president. The president, not the commissioner, would be given direct rulemaking power over the initial application requirements. And this power was broad:

[T]he President shall have power to make, alter, and revoke, and from time to time, in his discretion, he shall make, alter, and revoke, regulations prescribing what facts shall be set forth in the statements to be filed with the Commissioner of Corporations … and what information thereafter shall be furnished by such corporations and associations so registered, and he may prescribe the manner of registration and of cancellation of registration.174

The importance of the Hepburn bill to my story is that it served as a bridge between the antitrust-based federal incorporation debate and the rising public concern with securities speculation and stock market regulation brought on by the panic. This is partly reflected in the different requirements the bill would have imposed on business corporations and not-for-profit corporations and partly in direct testimony during the hearings. The not-for-profits that the bill contemplated primarily were labor unions. The influence of the growing stock market was evident in the provisions that would have applied to business corporations.

Business corporations would have had to file their organizational materials and all of their contracts, statements of financial condition and corporate proceedings under regulations “made by the President.” Not-for-profits would only have to file their charters and bylaws, the addresses of their principal offices and the names and addresses of officers, directors and members of standing committees.

The periodic filing requirements were different, too. The president would be given authority to create regulations for periodic filings by business corporations that presumably would include significant financial information, while not-for-profits were not required to file anything beyond the registration materials, except for updated registrations as required by the Commissioner of Corporations. As a trade-off, not-for-profits were unable to take advantage of the Commissioner’s rulings on the reasonableness of their contracts. But the bill’s attempt to exempt labor boycotts from the Sherman Act would hardly have made this a problem.¹²

Why the difference? Low, testifying in favor of the bill, explained. “Corporations for profit appeal to investors for their money; corporations not for profit do not.” Corporations that sought money from investors were obliged to provide the kind of financial information that would allow investors to make reasoned decisions.

Low’s view of “the large measure of publicity” of corporate information that would be released if the bill passed was sophisticated and anticipated the New Deal acts in policy as well as philosophy. He identified the “advantages of publicity [as] two sided. Men whose corporate activities, within proper limits, are to be matter of public record are likely to be careful not to do anything they are not willing the public should know.” By the same token, appeasing business interests, he noted that much of the public criticism of corporations came from ignorance, and disclosure would bring understanding that would portray corporate dealings in a better light. While not so obviously shareholder-related, the first reason was aimed at controlling corporate misbehavior and the second at assuring investors that American corporations were safe places to invest their money. Under the Hepburn bill they would presumably limit the formation of illegal trusts.¹³175

The strongest hint of investor protection came relatively early in the extensive hearings, during an interchange between Littlefield, Low and Jeremiah Jenks. Littlefield had been questioning Jenks on the federal government’s power to require interstate corporations to disclose information of the type contemplated by the bill, including capitalization and financial information. Jenks, despite his regular protestations that he was not a lawyer, did not hesitate much in giving his legal opinions. The use of publicity for investor protection emerged from the use of publicity to control trusts.

Low focused the discussion on trust concerns. Referring to interstate corporations that sought financing from the public, he asked: “Is it not a perfectly legitimate thing to ask that corporation, it if wants to do interstate commerce on the basis of all sorts of stocks and bonds, for the benefit of the investor whose money is to be engaged in interstate commerce, to state the conditions upon which that money is to be used in interstate commerce?” Low clearly meant to suggest that publicity would alert potential investors to the possibly illegal use of their money and thus allow them to decide whether to invest. But Littlefield redirected the question. “That comes right down to the question as to whether, under our power to regulate commerce, we have any power to protect the investing public as a part of the regulation of commerce.” Jenks demurred and Littlefield became even more specific. “Do we have any power, under the power to regulate commerce, to so regulate it as to protect the security or value of the investing public’s investments?” To this Jenks answered in the affirmative.¹⁴

While such a brief and seemingly off-the-point exchange in over seven hundred pages of hearings hardly proves a major development in federal thinking, it does provide an important illustration of the beginning of legislative attention to the securities market. The Panic of 1907 was the elephant in the antitrust hearing room. Jenks testified again, this time on the relationship between trusts, securities and overcapitalization, and approvingly introduced into evidence the British Companies Act of 1900 with its detailed prospectus requirement for the protection of investors. Under Littlefield’s questioning, he also gave particular attention to the relationship between overcapitalization and speculation.¹⁵

The Hepburn bill was not securities regulation. But the connections between the creation of the giant trusts, monopoly, speculation and investor fraud were becoming clearer. Clarification allowed lawmakers to begin to understand and address each problem on its own distinct terms while keeping the whole of the corporations problem in view. One can see the way a growing stock market and concern with speculation began to manifest itself in legislative proposals to protect investors in the last federal incorporation gasp of the Roosevelt administration.176

Roosevelt himself had begun to speak out more widely on the subject of investor protection, although he was firm in his insistence that the shareholders of illegal trusts, rather than the officers, should bear the brunt of the penalties. “Nothing is sillier than this outcry on behalf of the ‘innocent shareholders’ in the corporations,” he wrote Bonaparte. The shareholders controlled the corporations, after all. Shareholders hurt by overcapitalization were different, and Roosevelt believed that it was necessary to protect them in their purchases by disclosure, although his legislative efforts had at best an indirect influence on investor protection. But once the stockholder owned shares, the corporation’s misbehavior was his responsibility, even if the corporation was dominated by a controlling interest. “That stockholder is not innocent who voluntarily purchases stock in a corporation whose methods and management he knows to be corrupt; and stockholders are bound to try to secure honest management, or else are estopped from complaining about” the government’s enforcement of the laws against the corporation. Roosevelt saw a clear difference between defrauding investors by selling them watered stock and the responsibilities that came with stockholding. It was at almost precisely this time that securities regulation took off as a legislative project in its own right.¹⁶

THE ROOTS OF SECURITIES REGULATION

Overcapitalization, federal incorporation and the trust question largely remained consumer pricing issues through the Panic of 1907. Those who made law and policy did not entirely ignore investors, and calls for securities regulation were common. But securities regulation was not the subject of legislative activity except to the extent lawmakers thought it was necessary to remedy trust abuses. The investing class was not yet a major constituency for anybody except perhaps politicians from New York, and their most influential constituents were getting rich from securities just the way they were. The antitrust stage of securities regulation was important to the development of securities law mostly because it focused lawmakers on the various consequences of widely held corporate stock. Yet while the middle class was entering the market in larger numbers, the idea of securities regulation as consumer protection (treating securities as consumer goods) in contrast to securities regulation for consumer protection (to reduce monopoly prices caused by corporate finance) had only limited acceptance and was not yet embraced as a federal responsibility.177

Arising as they did in the aftermath of the Panic of 1907, proposals for securities regulation through the beginning of the war were designed to control speculation and thus stabilize the economy. But while economic stability was the focus, the interests of investors were also starting to matter more as the middle class increasingly turned not only to securities in general but also to common stock more specifically. The antispeculation and consumer protection stages of securities regulation began together, although the former dominated. The antispeculation stage would end in failure, but some of its concerns would be addressed with the creation of the Federal Reserve System in 1913, whose evolution largely paralleled this second stage. It was the consumer protection stage that would result in effective regulation and help to legitimate the speculation economy.

Four important governmental efforts at the end of the long decade show the progress of these developments. The investigation by the Hughes Committee in 1908, the debate over the Mann-Elkins Act in 1910, the Report of the Railroad Securities Commission in 1911 and the Pujo Committee investigations of 1912 and 1913 spanned the antispeculation stage of securities regulation. It began in New York, the site of the Panic, before migrating to the federal government.¹⁷

The Hughes Committee

Governor Charles Evans Hughes of New York, the scene of the debacle, appointed the Governor’s Committee on Speculation in Securities and Commodities in 1908. It was charged with determining “what changes, if any, are advisable in the laws of the State bearing upon speculation in securities and commodities, or relating to the protection of investors, or with regard to the instrumentalities and organizations used in dealings in securities and commodities which are the subject of speculation.” While the Committee focused on the broad economic effects of speculation, investor protection was present as a reform theme. Despite its asserted aims, the Committee is widely understood to have been created largely for the purpose of forestalling more serious federal regulation.¹⁸

The Committee delivered its report on June 7, 1909, after slightly more than six months of work. Its efforts have received scholarly attention, with some historians noting the extent to which it lashed out at the New York Stock Exchange. In fact it did nothing of the sort. Its Report is probably best characterized as gentlemen calling the attention of other gentlemen to the disagreeable fact that there were a few scoundrels in their midst who needed a good thrashing.178

The Committee’s composition made its conclusions predictable. Horace White, who chaired the Committee, had impeccable Republican credentials. Born in 1834, White worked as a reporter for the Chicago Daily Tribune. He covered the Lincoln-Douglas debates, befriending Lincoln and eventually serving as his paper’s Washington correspondent during the Civil War. An ardent abolitionist, he spent time in the 1850s funneling money, arms and supplies as assistant secretary of the National Kansas Commission to the Free State pioneers. After brief service with his friend Henry Villard on the Kansas-Pacific Railroad and the Oregon Railway & Navigation Company, he moved to the New York Evening Post and the Nation, along with Carl Schurz and E. L. Godkin and, later, Villard’s son Oswald, taking over financial and economic reporting for the two journals. Eventually White became editor-in-chief of the Post, from which he retired in 1903. His young associate and fellow mugwump, Oswald Garrison Villard, described him as ranking “as a great economic conservative,” “blind to much that was going on about him in our economic life” and particularly the depredations of Wall Street. This attitude is illustrated by his refusal to believe that the Panic of 1907 had anything to do with stock speculation.¹⁹

Charles Sprague Smith, an educator, romantic and idealist, founded the People’s Institute at Cooper Union and revitalized Cooper Union itself. Also a member of the Committee was David Leventritt, a New York lawyer whose nomination to the New York State Supreme Court was unsuccessfully opposed by the elite—and anti-Semitic—Association of the Bar of the City of New York, in an attack led by Elihu Root, which catalyzed the creation of the founding of the more pluralistic New York County Lawyers’ Association. Despite the progressive ideals of some of its members, the Committee’s conclusions toed the Republican Party line. Dissent was voiced only outside the context of the Committee report. Committee member John Bates Clark wrote a separate letter to the governor, cosigned by only one colleague, urging stringent regulation, and David Leventritt, believing state regulation to be impractical, suggested that the governor should ask Congress to pass federal legislation.²⁰

It is worth noting, in light of the Committee’s conclusions, that White expressed an understanding of the purpose of the market that gave pride of place to its function as a forum where investors could gain liquidity rather than as a mechanism for allocating capital to industry: “The very raison d’être of the stock exchange is to supply a market where invested capital can be quickly turned into cash, and vice versa.” Thus it is unsurprising that the Committee found that speculation which, in contrast to gambling, was legal in New York, was not all bad. In fact, it helped to stabilize prices. But speculation had started to get out of control and threatened to destroy the economic service performed by the NYSE. “It is unquestionable that only a small part of the transactions upon the Exchange is of an investment character; a substantial part may be characterized as virtually gambling.” Gambling should be stopped.²¹179

The trouble for the Committee was that distinguishing good speculation from bad speculation, or gambling, was really impossible. The Committee’s principal speculative concern was futures trading, and the forms and methods of futures trading that were legitimate and gambling were indistinguishable. The Committee also studied the speculative effects of short selling, which had been outlawed by New York in 1812 and restored in 1858. Again the Committee demurred, largely because of the serious financial problems Germany had experienced after trying to regulate the practice. The Committee did urge brokers to require higher margins to dampen the speculative effects of margin trading. It also criticized other speculative practices. Price manipulation, wash sales and matched orders were not mere speculation but more like fraud. These, it was “convinced,” could be controlled by the Exchange.²²

Exchange self-regulation was the Committee’s principal solution, although the Exchange had been notoriously unwilling to regulate its members. The Exchange pretty much ignored the Committee until, under attack by the Pujo Committee in 1913, it adopted several vague and perfunctory rules against the most obviously fraudulent kinds of manipulation.

The Committee also expressed some concern for investor protection in addition to its primary focus on speculation. It considered and rejected the idea of a mandatory registration and disclosure system like that embodied in the British Companies Act of 1900. Two problems precluded this logical step. The Committee was afraid that New York might lose business to states that did not adopt such regulations. It also expressed its concern that state registration might lead investors to think the state had actually evaluated the quality of the securities. The former concern was implausible in light of New York’s towering dominance in financial matters. The latter concern often came up in debates over securities regulation and became more credible in the next few years as state blue-sky laws did precisely that.

The Committee suggested some pallid legislation, in particular a sort of antifraud law for advertising. It would have required that any person placing an ad for securities had to sign a statement accepting responsibility for it with the newspaper’s publisher. But this was the extent of its willingness to impose legal requirements.180

So much for a consumer-oriented disclosure law. Perhaps, the Committee suggested, the Exchange ought to verify corporations’ listing information. But this, too, it rejected, arguing again that the public would rely too heavily upon the required audit as state verification of the quality of the security. The Committee instead recommended that the Exchange should require more detailed information in its listing requirements and that “means should be adopted for holding those making the statements responsible for the truth thereof.”

The Committee was especially critical of fraudulent and misleading securities advertising. But here, too, it was reluctant to suggest that anybody bear any obligation for anything. Again it displayed perhaps an unjustifiable (and ultimately unjustified) faith in human nature by choosing to forgo law and recommend that investors trust in the fact that bankers and brokers of good reputation naturally would protect that reputation by refusing to advertise in papers that accepted such “swindling advertisements.” Directors, too, should have the character to pay attention to the accuracy of their companies’ publicity. In the end, the Committee, putting its faith in the NYSE, did little more than to ask the Exchange itself to pay a little more attention to the miscreants.²³

That organization, still characterized by all of the trappings of a private club, more or less ignored the Committee. The market largely remained as it was.

Brief Interlude—Taft and Investor Protection

Roosevelt’s hand-picked successor, William Howard Taft, continued the advance of securities regulation as an antitrust issue, especially with respect to the railroads, but also began to articulate it as an issue of investor protection and the health of American industry. Taft unsuccessfully pursued securities regulation both in the Taft-Wickersham federal incorporation bill of 1910 and in his attempt to regulate the issuance of railroad securities with the Mann-Elkins Act. He did not care much about the fates of individual investors. But he was keenly sensitive to the fact that the continued success of the American economy required individuals to remain willing to invest their money in industrial development. He believed that in order to attract investors, industrial development required capital to be used for the growth of business, not for the enrichment of promoters.

The Panic of 1907 had its influence on Taft as on everybody else, but his interest in the relationship between investor and industrial well-being had been formulated well before Americans became buyers of common stock. Early-formed opinions were important for Taft. As the editor of Taft’s speeches put it, “it is hard to avoid the sense that Taft’s political character, political opinions, political prejudices even, were formed early and thoughtfully and thereafter changed little.” One of his most deeply held convictions was the sanctity of private property and its relationship to liberty. It was this belief in property rights that underlay his concern, however limited, for investors.²⁴181

As early as 1895 Taft, who was then a federal circuit judge, saw overcapitalization both as a fraud on bondholders, whom he viewed as the true owners, and a hindrance to the advance of industry. In a speech before the American Bar Association in Detroit on August 28, 1895, he criticized state corporate law for allowing promoters and managers to water corporate stock that they then issued to themselves, giving themselves control over the corporation, which, by virtue of the watered stock, could only be mismanaged and was mismanaged for their benefit.

The real owners, the bondholders, are at the mercy of this irresponsible management until insolvency comes. The reckless business methods which such an irresponsibility and lack of supervision invite create an unhealthy and feverish competition in every market, wholly unrestrained by the natural caution which the real owner of a business must feel. The concern is kept going with no hope of legitimate profit, but simply to pay large salaries or to favor unduly some other enterprise in which the managers have a real interest.

Only after making this observation did he proceed to assert a “distrust of corporate methods” in their use of large amounts of capital “to monopolize and control particular industries.”²⁵

Taft’s deep belief in the sanctity of private property as necessary for liberty drove his interest in investor protection, less for the sake of the investors themselves than for the safety of the American industrial system. Campaigning during the midterm elections of 1906, he argued that the use of capital to reproduce itself was “a virtue.” It was the corporation that made this possible “and the incident of the transfer of shares of stock is what enables so many millions of people to have an interest in these immense corporations which they have helped to build up by contributing their modest savings.” The prosperity of all of the people depended upon the institution of stock to permit the distribution of corporate wealth.²⁶ Taft was primarily interested in securities regulation for the sake of industrial health and growth. In Columbus, Ohio, in August 1907, he made his concerns plain, noting “recent revelations” of railroad overcapitalization that bilked “innocent investors.” This was not a federal problem, according to Taft. What was a federal problem and had to be dealt with was the manner in which overcapitalization “has a tendency to divert the money paid by the public for the stock and bonds which ought to be expended in [railroad improvements and maintenance] into the pockets of the dishonest manipulators and thus to pile such an unprofitable debt upon a railway as to make bankruptcy” likely. He extended this view to industrial corporations generally following the Panic of 1907, demanding federal supervision of securities issues as a means of improving corporate management and with it public confidence in corporate America. Finance had to be made to serve industry rather than the other way around.²⁷182

Taft was happy to leave antitrust regulation of industrial corporations primarily to the courts at the beginning of his term, subject to a Sherman Act amendment clarifying when combinations were illegal, but overcapitalization, and especially railroad overcapitalization, was a problem that required legislative and administrative action. His first concern was the way promoters used watered stock to obtain control of railroads with other people’s money, but it gradually shifted until he was fighting against watered stock both as a fraud on investors and as destroying the railroads by encouraging the financial mismanagement of a vitally important commercial facility. By 1910 he had returned to the idea of federal incorporation, proposing the extensive Taft-Wickersham bill. This measure would have, among other things, imposed strict federal administrative control over corporate securities issues, including federal determination of the fair value of stock issued for property. Taft’s clear purpose continued to be to ensure that money raised by corporations was invested in those corporations for business health and stability. He continued to push for federal incorporation until almost the end of his term.²⁸

Investors were not irrelevant. His early concern for bondholders now included stockholders as well. The only purpose of watering stock, he said, was to deceive investors into paying too much for it. These investor concerns were manageable with disclosure. Indeed, one of the principal benefits he saw in corporate taxation was the fact that reporting corporations would be disclosing far more information than ever they had before, aiding investors in evaluating a corporation’s stock as well as the government in collecting taxes. His concern both with the sanctity of private property and with maintaining a healthy investor base had grown and he warned that proposed amendments to the Interstate Commerce Act should avoid damaging the interests of railroad shareholders and maintain a healthy market for their stock.²⁹183

Taft was not particularly focused on the investor as investor. In fact, one biographer suggested that Teddy Roosevelt had to coach him to show concern for the small investor during the 1908 campaign. But he helped to highlight and publicize the need for securities regulation in the context of his broader concerns for the protection of the American industrial economy from irresponsible finance.³⁰

CAPITAL VERSUS THE CONSUMER: SECURITIES REGULATION THROUGH THE RAILROADS

Congress devoted a significant amount of attention to the securities of common carriers for antitrust purposes. Overcapitalization made it difficult for the issuers to earn enough money to meet the stated dividends on their watered stock. To ameliorate the problem, they overcharged consumers.

By the end of the first decade of the twentieth century, many economists and public actors had come to accept as a matter of economic reality that competitive markets would eliminate the possibility of overcharging consumers. Manufacturers and retailers had to set their prices to meet the competition that increased when prices rose and made industries attractive to new entrants. Only in a few industries that could sustain monopolies did overcapitalization remain an intractable problem, both for the consumer and for the uninformed stock buyer. Railroads, especially the new urban rail and streetcar lines, and public utilities often were natural monopolies. They could charge monopoly prices, and overcapitalization added the necessity of meeting dividend payments to their other incentives to overcharge consumers for a service which had no real alternatives. Thus securities regulation remained a central focus in railroad and utility regulation as the broader antitrust debate that had begun in the 1880s moved toward its conclusion during the second decade. Again the focus was the relationship between watered stock and monopoly. But consumer legislation for securities investors became an increasingly frequent issue in the debate as the general public continued to enter the market. In this context, too, it played second fiddle to the issue of banking and economic stability.

The Hepburn Act of 1906

Investors were not the object of concern when Congress passed the Hepburn Act of 1906. The Hepburn Act, which enlarged and strengthened the Interstate Commerce Commission and gave it real power to prohibit excessive rates, was introduced as an antitrust measure, ensuring that rates charged by common carriers would be “just and reasonable” and giving the Commission the express authority to set maximum rates. The Act did require substantial and detailed financial reporting by all common carriers to the Commission, but this requirement was designed to keep the Commission itself informed, not investors.184

Shareholders’ interests were not completely missing from the debate. Democratic Senator Benjamin Tillman of South Carolina, who supported the bill, submitted a lengthy statement. Overcapitalization, while occupying only a small portion of his analysis, was a problem he stressed, and he stressed it on behalf of shareholders:

[I]t is impossible not to reach the conclusion that there has been an immense amount of overcapitalization deliberately planned and carried out for a specific purpose; and that purpose can be no other than the foisting on the people of railroad securities which have no actual value and the only motive for whose creation and sale was to add to the gains of a coterie of multimillionaires, whose energies are now directed toward compelling the business interests of the country to “make good” by increasing the earnings of the roads with a view to paying dividends upon this fictitious valuation of the properties.

Tillman remarked that the proceeds of the inflated securities, while allegedly needed for improvements to the roads, were mostly pocketed by the controlling interests. His concerns were threefold—railroad performance, consumer overcharging in order to make dividend payments and shareholder protection. But shareholders were the least of it. By far the greater problem was excessive rates. The senator was particularly concerned with the section of the statute that allowed the Commission to determine the “just and reasonable and fairly remunerative rate.” “Fairly remunerative” on what? The watered capitalization or the value of the tangible property?

There can be no justice in compelling the people as a whole to pay dividends on watered stock primarily for the purpose of increasing the fortunes of men already too rich. The poor dupes who have been led to invest their savings in such stocks can better afford to lose them than to have the labor of the country saddled with the burden of paying perpetual tribute in the shape of dividends on dishonest valuations….

All issues of railroad securities in the future … should be under the control of the Interstate Commerce Commission and there should be a speedy readjustment of capitalized values… while protecting, as far as possible, the innocent holders of watered stock. It may be that these can not be protected under the law and that the holders of first-mortgage bonds and of preferred stock, who will be found in the end to be the multimillionaires who have perpetrated the scheme of injustice, will retain their advantage, while the poor dupes who have been led to buy the products of railway printing presses will lose what they have invested.185

Tillman might have been concerned about shareholders, but not nearly so much as he was with the consumers and railroad patrons who were his constituents. As with the legislative proposals on federal incorporation, the seeds of stockholder concern were present in the Hepburn Act debate, but it decidedly remained a side issue.³¹

The Mann-Elkins Act of 1910

The Hepburn Act was not effective enough, so Congress passed the Mann-Elkins Act in 1910 at Taft’s request. Originating in the Roosevelt administration, and indeed outlined in detail in Roosevelt’s March 1907 letter to the ICC, it was drafted, in Rooseveltian style and to congressional consternation, by Attorney General George Wickersham. The Republican platform of 1908 promised new legislation to restrain railroad rate abuses. Although the Republicans still controlled both houses, the Act’s passage was ensured only by a combination of progressive Republicans and progressive Democrats.³²

Most of the Mann-Elkins Act is unimportant in explaining the evolution of securities regulation. The part that matters is the one that was amended out of the bill, which addressed the domination of finance over the railroad industry through the medium of securities. All new securities to be issued by railroads had to be paid at par value, in cash and, if in services or property, at fair value to be determined by the Interstate Commerce Commission. Like some federal incorporation measures of these years, the draft prohibited railroads from issuing securities until they had received Commission approval after the Commission had determined that all of the proceeds were to go to finance the railroad and not into the pockets of shareholders or promoters. All railroad combinations had to receive Commission approval. The Commission also had the authority to approve the capital structures of reorganizing railroads.186

Investor protection was not the purpose of this capital regulation, as it might appear at first blush. Rather, it was to prevent the kind of overcapitalization that diverted wealth from industry and led railroads to overcharge customers in order to make high dividend payments. Like virtually all other business regulation during this period, the debates leave no room for doubt that the regulation was largely about monopoly. Yet it clearly addressed what its supporters saw as the distortion of industry to serve finance through the use of watered stock.

The corporate finance provisions of the bill were fiercely debated before they were defeated. The debate reveals one reason why securities regulation for investor protection had not previously received much attention. As Tillman demonstrated during the Hepburn Act debate, congressmen from regions other than the Northeast were not particularly sympathetic to the suppliers of capital, no matter how modest their means, when returns on that capital were reaped from the fields of their constituents. The House minority report clarified these concerns: “The apparent purpose of this proposed drastic and unprecedented legislation is to protect and guarantee the owners of capital stock of a railroad that has engaged in overcapitalization.” This was a theme repeated throughout the debate. As William Adamson of Georgia put it, the only reason for the corporate finance provisions was to protect already existing railroad monopolies and the value of the securities held by their owners: “Their evident purpose is to anticipate and set up by indirection, for the advantage of present security holders, the impossible federal incorporation act… to take control of the subject of investments and look after securities in speculation. If that is a good purpose, it should find manifestation in an honest effort to enforce the antitrust law instead of trying to invent means to nullify it.”

Were these provisions to pass, he continued, Southern and Western railroads would be unable to raise capital and transportation throughout the country would be controlled by existing monopolies. If overcapitalization and corporate mismanagement were problems, he said, the states and not the federal government ought to assert responsibility over them.³³

In response, James Mann of Illinois, House sponsor of the bill, argued that it would help to create economic opportunity for railroad entrepreneurs and work to the industry’s benefit. After noting that the purpose of the provisions was to ensure only reasonable returns on railroad securities in order to keep rates down, he said: “[The corporate finance provisions] will protect the public; it will give to an unknown corporation which has no market value for its stock or its bonds, in a new part of the country … an opportunity to obtain money from the issuance of its stocks and bonds on such reasonable terms as may be allowed.” The securities regulation provisions would help railroads raise capital by ensuring the integrity of their securities. They would create opportunities and foster competition, not limit them.³⁴187

The Senate debate was largely along the same lines as that in the House. After Albert Cummins of Iowa noted that he favored legislation regulating the corporate finance of all businesses, not just railroads, he too attacked the proposed bill on the ground that it perpetuated the status quo and left wealthy promoters and monopolists in charge.³⁵

The dominant concern remained monopoly, the target high rates and the battle between capital and the consumer. The centrality of this point is brought home by Cummins’s objection to a section in the corporate finance provisions that sustained the validity of securities of overcapitalized corporations as long as they were in the hands of “innocent purchasers.” All purchasers would fit this category, he said, and the wealth they held was illegitimate because it was born of fraud and monopoly. More important, the purpose of the statute was to prevent overcharging consumers, and this purpose would be defeated if corporations were permitted to continue paying dividends on watered securities, no matter how innocent the purchaser.

The corporate finance provisions were eliminated and the bill passed with substantial majorities in both houses. All that was left of them was a provision authorizing the president to appoint a commission to investigate railroad securities.

The debate over the corporate finance provisions of the Mann-Elkins Act illustrates an important turning point in the development of federal securities regulation, despite its otherwise conventional concern with monopoly. For what this debate, along with the Hepburn hearings and the Hughes Committee, shows is the growth of a new branch of the trust debate, a branch with two prongs. The new branch grew out of regulatory concern with securities from a business standpoint, an antitrust concern over competition, opportunity and consumer pricing. It grew into public concern about regulating securities as securities, about regulating securities from an investor’s standpoint, with a particular goal of reining in finance to serve the purposes of industry that had been perverted by the creation of the giant combinations. This branch of the debate would have worked to ensure that finance served the needs of business and not the financiers.

The faster-growing prong of this new branch focused on a particular category of investor, banks and financial institutions, whose stability and support of the economy were affected by their investments in corporate securities. The other prong focused on securities regulation for the protection of investors. Significant evidence of this appears in the report of the Railroad Securities Commission, whose creation had been authorized by the Mann-Elkins Act.³⁶188

The Hadley Commission—Protecting Investors

The Railroad Securities Commission was chaired by Arthur Hadley. Hadley’s eminence as an economist put his appointment beyond question. But he was a perfect choice to chair the commission if the goal were to preserve the status quo. Hadley had been an economist for over thirty years at the time of his appointment, most famous for his 1896 book, Economics. He was also expert on the subject of railroads. One reviewer approvingly noted of Economics that “The work is a long argument for the general rightness of what is.” Another observer wrote of the book that it was “as intelligent an apologia and as judicious a defense of the economic institutions of the day as the American literature contains.” His son and biographer, Morris Hadley, agreed with this, noting that “Hadley did believe that the economic institutions of the day, with all their faults, were a better basis for future development than any of the rival schemes proposed by socialists or others.” It is notable that his appointment came at a time when Taft was in the process of abandoning Roosevelt’s interventionist approach to regulation in favor of a more conservative attack on the trusts through the courts.³⁷

Hadley was not a great believer in regulation. In an 1890 speech in Denver he argued that misbehaving corporate executives should be socially shunned rather than punished by law, because this was clearly an “all-powerful remedy.” As early as 1885, while serving as Connecticut’s Commissioner of Labor Statistics he had, on more practical grounds, suggested only mild legislative reform, “believing that it would be quite hard enough to enforce [the reforms he suggested] and out of the question to enforce more sweeping ones.”³⁸

Hadley had a long history of opposing securities regulation in particular. In his 1885 book, Railroad Transportation, he dismissed the idea of regulation while acknowledging the distorting effects of speculation on business: “Legislation against commercial crises is about as effective as legislation against chills and fever.” Legislation against speculation, even if it were a good idea, would be impossible, Hadley wrote, because there was no way to distinguish between “good speculation” and “bad speculation.” These words would echo throughout the Commission’s Report. If Taft wanted to prevent regulation, he had chosen the right man.³⁹

Hadley exercised tight control not only over the Commission but also over its purpose. He responded to Taft’s invitation to chair the Commission with a letter exploring the different forms a special commission could take. A commission that took testimony “and on the basis of this testimony … draft a statute which shall represent intelligent public opinion and have the force of intelligent opinion behind it” held no interest for him. He was, however, quite willing to chair a commission of “experts, selected for their knowledge of the specific matters involved,” to advise the government on the basis of their expertise as to what reforms might be “practicable.”189

While a commission of experts was appointed, their deliberations were not always easy. Hadley wrote to his wife after one meeting that “‘Sessions of the Commission were squally, but interesting. How we are ever going to agree on a report is more than I can see.’” But the final report was unanimous, a point in which Hadley took special pride. While he noted that he had to make concessions to achieve this result, the Report reads more or less exactly as one would have predicted based on his earlier work.⁴⁰

Despite Hadley’s distaste for hearings, the Commission did hold public hearings in New York, Chicago and Washington, where it took testimony from thirty-four witnesses. It received hundreds of letters commenting on railroad securities regulation and studied the literature on the subject as well as the congressional debates over the Mann-Elkins Act. The Commission submitted its Report to the President on November 1, 1911.⁴¹

The Mann-Elkins Act had been designed as progressive legislation to assert more aggressive federal control over the railroads. The Report and its recommendations with respect to securities regulation were a model of conservatism. Most telling was the Commission’s reliance upon disclosure as the device best calculated to control overcapitalization and financial manipulation in the railroad industry. We have seen that disclosure up until this time was almost entirely regulatory in function, designed to give the government information to enable it to enforce the law. Disclosure as a remedy, to ensure investor protection, was mentioned from time to time, as it was by scholars and other prominent thinkers and activists, but it had never been a central part of the regulatory agenda.

Disclosure for the protection of investors took center stage in the Report. The Commission identified two ways that overcapitalization could damage the public. The first, now familiar, way was to induce common carriers (and other businesses) to pay dividends that were, in effect, “an unnecessary tax on interstate commerce.” But, and quite outside the scope of its charge, the Commission identified a second evil, one that hearkened all the way back to a reason for par value itself. This was the deception of bondholders by overcapitalization, leading them to believe that their bonds had a meaningful equity cushion when in truth they were floating on water. The Commission showed little sympathy for the individual bond holder, suggesting that state law and his own intelligence could protect him. But it did see that systemic overcapitalization could shake the confidence of creditors generally and thus result in higher borrowing costs for railroads that legitimately needed the funds.190

Perhaps the most interesting thing about the Report is the extraordinary skill with which the Commission transformed this last concern, which was a matter of broad economic regulation, a matter of ensuring the financial viability of common carriers, into an investor concern and, at the same time, introduced modern financial thought into the regulatory debate.

The Commission recommended that common carriers report the actual funds they received in relation to nominal capital to the Interstate Commerce Commission. And this was not just for the purpose of discovering monopolistic practices. Managers should do what they wanted in terms of financing, “but they must make it plain to the investor today and to the public tomorrow” how much cash lay behind stated capital.

This conservative form of regulation would eventually serve as the federal model that developed through the Wilson administration. Management’s discretion to finance the corporation as it saw fit should not be circumscribed by the federal government; state corporate law should not be superseded. It was regulation enough to ensure that every stockholder was informed of the facts. Publicity was the answer. Publicity alone should be the federal remedy. All of a corporation’s financial information should be disclosed to the ICC, the ICC should have authority to investigate the corporation in order to determine the accuracy of the information, the ICC itself should have the power to set accounting rules and corporate directors should disclose all of their personal interests in the corporation.

At the same time, the Report reflected the Commission’s more modern economic sophistication. Some degree of stock watering could be tolerated as long as it had a business purpose. The Commission specifically noted that it was financially legitimate for a corporation to offer its existing shareholders stock at a par value below the market value as long as management disclosed that fact. Such an issuance would dilute the market value of the stock, but the Commission acknowledged the demands of financial reality in recognizing its occasional necessity.

This was the second transformative aspect of the Report, its introduction of modern financial thinking into the debate over federal corporate regulation. I described in the preceding paragraph the Commission’s acceptance of the necessity of market value dilution for a distressed railroad in need of cash. The public’s failure to understand the difference between stock and bonds was another issue the Commission identified as a serious impediment to appropriate finance. This misunderstanding was natural in light of the fact that stock, especially common stock, had only recently come into popular use as an investment vehicle. But it was compounded by the standard practice of identifying common stock at its par value, typically $100. A bond with a stated par value of $1,000 represented a promise to repay that money to the bondholder, but common stock with a stated par of $100 represented no such thing. “It has at best only a historical importance, as showing property was or purported to be worth at time of incorporation.” It was par value that created the problem with overcapitalization, not necessarily the overcapitalization itself. If investors knew the actual value of the corporation’s assets and income, they would be able to assess for themselves the worth of the stock. “[T]he investor must depend upon his own intelligence to protect him from loss. The function of the government is to see that correct information is available.”191

Throughout its report, the Commission sounded the theme of share value based on capitalized earnings, recognizing that common stockholders could not rely upon the promised dividend for their return but rather on the profits actually realized by the roads. This was not the same thing as accepting capitalized earnings as a valuation method for the roads’ initial capitalizations, but instead an understanding of the financial reality of the limited use of stated capital as an assurance of returns. In thirty brief pages, the Report focused governmental attention on the factors that determined the value of common stock. Future profit, not historical cost, was the true determinant. It was a lesson that the public would absorb only too well during the 1920s.

The Report was presented to President Taft. Nothing was done. Yet even as investigations continued, the middle class entered the market in ever-larger numbers, for the first time becoming a phenomenon to be reckoned with.