Unfortunately, there was more to it than that. Focusing specifically on the second $8 million bond offering, Pecora asked Byrnes whether he knew that nearly half the offering was instead being “used to pay off existing short-term obligations held by the National City Co.” National City was paying itself with the money it raised from investors and, yet again, not telling them anything about it. Byrnes was clearly nervous. He slowly and carefully examined the company’s documents, which were piled in front of him on the mahogany table, and then he asked to speak to Pecora “off the record.” After a few moments of whispered conversation, in which Byrnes seemed to be worried about his own legal liability, he did his best to distance himself from the offering. It was, he said, “four years ago” and National City got opinions from Shearman & Sterling and from its Brazilian counsel “as to the legality of the issue.”
Byrnes also tried to argue that the prospectus had indeed disclosed the relevant information. If an investor turned to the inside pages, he would find a sentence that said that the proceeds were to be used “as provided in law No. 1061,” passed in Brazil about a month before the bond offering. The prospectus then listed a few projects that were consistent with the economic development disclosure Pecora had read into the record, investments in the region’s railroad, the power company, and the like. But Byrnes pulled a translation of law No. 1061 out of the company’s files. That law, it soon became apparent, was not nearly as limited as the prospectus suggested. It said that the government could also use the proceeds to pay back any short-term loans it had outstanding.
When Pecora tried to determine whether the company knew about the contents of that law when it wrote the prospectus, Byrnes made a remarkable pronouncement: “I am informed here that our counsel wrote the law, so to speak, so that I am assuming that would give me greater confidence that it was legally issued.”
Pecora was taken aback, unsure of what he had just heard: “You mean that Shearman and Sterling wrote the law for the state of Minas Geraes?”
“No,” Byrnes replied, retreating as quickly as he could, “I would hardly say that. I think rather that Momsen and Torres, who were our counsel down there, that they drafted the law, which would be a better way of putting it, than that they wrote the law.”
Pecora was unconvinced. “And you might be right in both instances.”
“Well,” Byrnes conceded, “that would be rather extraordinary to say the least.” It was indeed “extraordinary.” No matter how delicately Byrnes tried to couch it, the company had dictated the content of a Minas Geraes law in order to ensure the legality of paying itself back with the proceeds of the bonds the company was offering to American investors.4
Byrnes continued to insist that this disclosure—an obscure reference to a Brazilian state law with no discussion whatsoever of paying back existing indebtedness—was adequate. It was a losing battle. “Read the information that you say is contained in that circular which informs the public that a substantial part of the proceeds of that loan was to be used to pay back those short-term advances,” Pecora demanded. The best the banker could muster was a lame suggestion that the information was “inherent” in the phrase “the proceeds of the loan will be utilized as provided in law 1061.”
Eventually, after a good deal of hounding from Pecora, Byrnes reluctantly conceded that the prospectus didn’t precisely “contain the direct statement,” but he insisted that to include all those details “would have made such prospectus so inordinately long that there would have been no chance that the investor would have read it.” Besides, he added, everybody assumed that these loans were used to repay the kind of short-term advances the National City Company had made.
No one seemed to care for that answer. Senator Brookhart pointed out that “it would not have taken much space” to set out the company’s interests. Pecora focused on Byrnes’s assumption. “Why do you say it is assumed by everybody?” he asked. Byrnes retreated again; perhaps he didn’t “know much that is in the mind of the investing public.”
Wasn’t it true, Pecora continued, that Byrnes only knew about the “trained and sophisticated bond buyer?” Certainly Byrnes wasn’t telling the committee “that the mass of the investing public” was aware of these kinds of details? Byrnes again tried to pin some of the blame on the lawyers, but in doing so he, quite conveniently, reiterated one of Pecora’s central themes—the reliance the company’s customers placed on its advice, expertise, and integrity. “Naturally,” Byrnes explained, customers “depend upon the bankers to see that the issue is properly made, and the bankers in turn must depend on counsel to see that the necessary legal formalities are set up.”
Pecora saw his opening and he did not let it go to waste: “The average investor, the average bond buyer, does not look into these things, does he?”
Byrnes still seemed to think he was pinning the blame on the lawyers, but his answer fit Pecora’s needs perfectly. “He depends, first,” he repeated, “upon the banker, and they in turn must depend upon their counsel as to the matter of legality.”
“And the bond buyer relies considerably upon the prestige of the offering and distributing house, doesn’t he?”
“Why, certainly he does,” Byrnes replied, not appearing to notice he was hammering one more nail into the coffin of unregulated investment bankers, “not only here but anywhere else that I know of.”5
How Minas Geraes would use the proceeds of the bond offering was not the only misrepresentation in the prospectus. Pecora put George Train, the man who originally urged National City to underwrite these bonds, on the stand. Train, it seemed, was willing to play fast and loose with other crucial facts in order to get the deal done. In 1927, analyzing Minas Geraes’s history of bond offerings in Europe, Train was amazed at the shoddy way that the government had handled its obligations. The “laxness of the State authorities,” he wrote in an internal company memorandum, “borders on the fantastic.” His review of Minas Geraes’s history “shows the complete ignorance, carelessness and negligence of the former State officials in respect to external long-term borrowing.” It would, he wrote, “be hard to find anywhere a sadder confession of inefficiency and ineptitude than that displayed by the various State officials.” Despite those conclusions, Train wrote in the prospectuses for the bond offerings, “Prudent and careful management of the State’s finances has been characteristic of successive administrations in Minas Geraes.”6
How, Pecora wanted to know, could Train possibly square those statements? Train squirmed and behind him Victor Schoepperle whispered tips, frantically trying to help his colleague. Pecora had no interest in letting Train out of his difficult spot.
“Do you want the help of Mr. Schoepperle in making your answer?” Pecora asked.
Train said that he did not need any help, leading Pecora to announce, “Well, please tell that to Mr. Schoepperle, who seems to think that you do.”
Train actually needed quite a bit of help, because the answers he came up with on his own didn’t convince anybody. First he tried to explain that his criticisms referred to earlier state administrations, not the ones in power when the bonds were sold. Pecora, who couldn’t have had a much easier time with a witness, immediately pointed out that the prospectus referred to “successive administrations.” Train quickly switched gears; he only meant to refer to the state’s handling of its internal budget matters and not to how the state handled its external finances. But Pecora was again ready for him, turning to the copies he had made from the company’s files. Did Train remember, the lawyer asked, a letter from one of his colleagues, which criticized this very language of the draft prospectus? Didn’t that colleague point out that this language was problematic “in view of the extremely loose way in which the external debt of the State was managed”? Apparently, even Train’s colleagues hadn’t bought the argument, although their criticisms were insufficient to get the firm to modify the prospectus’s language. Unable to come up with another answer, Train decided to blame it on Rio.
/> “I was in Brazil and perhaps became, as one often does in that country, a little overenthusiastic with respect to the merits of the particular credit I was investigating,” he told Pecora.
Pecora was unwilling to accept that answer either. If it was Train’s intention to refer merely to internal finances, why didn’t he just say that? Like other witnesses who had painted themselves into corners, Train tried to parse words exceedingly finely. It was straight out of Alice in Wonderland.
“Well, of course,” Train replied, “it would rest on an interpretation of the word ‘finances.’”
Pecora dismissed Train’s parsing. “But if you wanted to make a favorable comment on the administration of the internal finances of the State, would it not have been extremely simple to have inserted the word ‘internal’ before the word ‘finances’?”
“I think,” Train conceded, “it would have been more accurate.”
“And if you wanted to convey to the investing public through the medium of this prospectus what you had learned concerning the ‘careless, inefficient, and inept and loose way of the State’s management of its external finances,’” Pecora continued, “you would have said so too, would you not, in the prospectus?”
Train continued to squirm, now choosing to blame everything on the citizens of Minas Geraes: “These people in Minas were back-country people, and they had shown, as I stated in my letter, ineptitude in handling—”
Pecora interrupted Train; he was growing impatient with all the evasions and hedging. “Will you answer my question now?” he demanded.
Train insisted that he thought the problems he outlined in his earlier memos involved only “past administrations.”
So, Pecora summarized, the company and Train chose to disclose only so much as would make the offering look as good as possible? “You did not go back,” he said, “to the point where the administration was loose and inefficient in its handling of its external finances, did you?” Schoepperle was still frantically trying to whisper advice into Train’s ear, earning a sharp rebuke from Pecora: “Now, Mr. Schoepperle, he said he did not need your help. . . . Now, what is the answer to that question?”
Train hesitated: “In this prospectus?”
“Of course, in the prospectus.”
“No,” Train finally admitted, “we did not go back to that point. I did not go back to that point.”
Train and Schoepperle were now furiously arguing with each other, leading Pecora to finally interject, “All right. Mr. Train—when you are through quarreling with Mr. Schoepperle, I will ask you a question.”7
Train’s testimony also explained why the company was so eager to advance money to Minas Geraes. It seemed that after the first bond offering two rival investment banks, Kuhn Loeb and Lee Higginson, approached officials there about underwriting a bond offering for the state, a fact that both surprised and perturbed National City. The National City Company, Train explained, “hoped to establish the general relationship, and it was . . . rather disconcerting to find that . . . someone else would come in and have some future financing.” The company thought that Lee Higginson was trying to “chisel in.”
Pecora was delighted with that phrase. “Chisel in,” he exclaimed, “that is not a banker’s term, is it?” No, Train conceded to general laughter throughout the room; it was “just an expression.” In earlier times, the old-line investment banking firms lived by a strict moral code—it was under most circumstances considered unseemly to poach another firm’s clients. Such civilities had long since faded in the hurly-burly of the late 1920s, particularly where foreign bonds were concerned. Thomas Lamont’s complaint about the violent competition among investment banks for this business seemed as much a lament for that fading code as a warning for American investors. Code or no code, National City was not happy.8
“Naturally,” Pecora inquired, “the National City Co. and its co-underwriters in that first loan were unwilling to have these other banking houses ‘chisel in,’ were they not?”
Train clearly was ruing that he used the phrase, and he demurred: “I would say that they did not like the idea.”
Pecora would not be put off, because now it was clear why City Bank had been so insistent on lending to the Brazilian state. “Was it not,” Pecora asked, “in order to retain the good will and the favor of the authorities of the State of Minas Geraes that these short-term unsecured advances were made?”
Train would not admit that motivation, but it certainly seemed to be the case. Indeed, the company had all but forced the second bond offering on the state to recoup those advances. State officials insisted that the bond markets were so unsettled at the time the company wanted to make the offering they feared “a new loan would not prove a success.” Failure would have been devastating to the state if it ever wanted to go back to the credit markets again. Investors were already wary of Minas Geraes because the bonds from the first offering were trading for less than the offering price. National City insisted on the loan anyway. When one of its executives and the company’s lawyers wanted to include language in the prospectus disclosing that the proceeds of the bond offering would be used to repay the company, the company apparently vetoed that suggestion. Byrnes had insisted earlier in the day that “no investor would be in the slightest interested nor his investment in the least affected” by these details. Few of the people in Room 301, certainly not Pecora, seemed to agree.9
The highlight of the day, and perhaps of the entire second week of the City Bank hearings, was the appearance of Edgar D. Brown of Pottsville, Pennsylvania. Brown was brought in to personalize the consequences of the stock market practices Pecora uncovered. He was just forty, but he was not well; although Pecora was ten years his senior, the lawyer was in far better shape. Brown had tuberculosis, was nearly deaf, and although he once had a successful career as a theater owner, he was now destitute, scraping by working as a clerk for the local “poor board” to support his family. Brown described himself as a “shorn lamb,” but he was unwilling to take his plight or the plight of any helpless victims meekly. He appears to have been one of Father Cox’s Army, the unemployed marchers who descended on Washington from Pennsylvania in January 1932. Just before he arrived for the hearing, a Pottsville grand jury refused to indict him for breaking into the local school in order to shelter a group of students from some nasty weather.10
The story Brown was about to tell was heartbreaking. He was a dream witness—earnest, good-humored, and dignified. Pecora knew when to get out of the way, and he asked Brown to tell that story in his own words. In 1927, Brown decided to move to California because of his poor health. He sold his theater chain and with a portfolio of $100,000 in cash and mostly United States government bonds in hand, he came across a City Bank advertisement that seemed perfectly suited to his needs. “Heading out on a long trip?” the bank ad asked. If so, you should contact City Bank, which could help when you were away from “the advice of your local banker.” Brown was a successful businessman but, like many Americans at the time, an investment neophyte, and he took the bait.
The close working relationship between City Bank and its securities affiliate was never better demonstrated. Brown was sure that he wrote to City Bank, but he received a reply from a salesman in the National City Company’s Philadelphia office named Fred Rummel. Rummel told Brown that his bonds “were all wrong.” He should sell the United States government bonds, borrow two or three times the $100,000 he had, and then invest in a wide variety of securities the company recommended.
Brown took the company’s advice, insisting only that he wanted bonds instead of stock. Other than that Brown trusted the company implicitly. “I would never buy or sell anything without their sanction and would always act upon any suggestions which they might make.” Pecora, especially after all the letters he read from former customers, was not surprised by Brown’s faith in the company. “After all,” Pecora wrote, “he was not dealing with some fly by night bucket shop or itinerant gold-mining stock peddler, but
with the greatest and soundest bank in the world.” A bank like this one—at the time the largest in the country—“was supposed to occupy a fiduciary relationship and to protect its clients, not to lead them into dubious ventures; to offer sound, conservative investment advice, not a salesman’s puffing patter.”11
Over the next year a welter of bonds came in and out of Brown’s portfolio. There were railroad bonds, utility bonds, and industrial bonds. Brown’s foreign bond holdings spanned the globe—Peruvian and Chilean bonds; bonds from the State of Rio Grande do Sul in Brazil; Vienna and Budapest bonds, the bonds of the Belgian National Railroad, Norwegian Hydro, German General Electric, and the Saxon Public Works; Greek, Italian, and Irish bonds. They seemed to have only one thing in common—they all went down in value.
When Brown complained at the end of 1928, Rummel told him, “Well, that is your fault for insisting upon bonds. Why don’t you let me sell you some stock?” Brown, like most everyone else, thought the stock market was “continually moving up. So then I took hook, line and sinker and said ‘Very well. Buy stock.’” The witness was so deaf that Pecora shouted into Brown’s cupped ear, “Did he buy stocks then for your account?” Even Brown laughed, as he tossed a two-inch-thick pile of confirmations onto the mahogany table, replying to the delight of those gathered in Room 301, who roared with laughter, “Might I answer that facetiously—Did he buy stocks?” Brown never knew what he was buying. “I bought,” he testified, “thousands of shares of stock on their suggestion which I did not know whether the companies they represented made cake, candy, or automobiles.” All he could do was to follow the company’s advice; it was, he thought, “the only safe thing to do.”12
The Hellhound of Wall Street Page 30
