Despite the statements that the purpose of the Trading Corporation was to trade securities, one month after the IPO, Catchings approached Ralph Jonas again to try to negotiate a merger between the two trusts. The idea of the merger, he later testified, was for Goldman to get its hands on the large equity stakes that Jonas had acquired in his trust and to “build them up” through “trading” and then to “resell a large proportion of such stock at a profit after the earnings of the companies had increased as a result of the efforts of The Goldman Sachs Trading Corporation and of Goldman, Sachs & Co.”
Investigators, though, had their doubts that this was Catchings’s sole motivation for merging with Financial and Industrial. They suspected that Goldman coveted the controlling stakes in the banks and insurance companies in Financial and Industrial’s portfolio because they were large buyers of the debt and equity securities that Goldman was in the business of underwriting and selling. Why not, the logic went, get control of companies that bought an awful lot of what Goldman manufactured? While in his later testimony Catchings conceded that Manufacturers Trust “might possibly at times have been a large buyer of securities” and that insurance companies “are what you would call ‘big purchasers’ of securities,” he denied that getting access to them was the motivating factor for his second approach to Jonas in January 1929. He testified such an idea “was not even remotely” in his and his partners’ thinking. (Unfortunately, the facts did not support Catchings’s contention. In 1929, after Goldman did get control of Financial and Industrial, the companies in the portfolio—Manufacturers Trust, National Liberty Insurance Company, Baltimore American Insurance Company, and People’s National Fire Insurance Company—were regular buyers of the securities Goldman sold during the year, in the amount of approximately $20 million. At the beginning of 1929, the investment portfolios of Liberty Insurance and Baltimore American consisted primarily of the stock of Manufacturers Trust Company. By the end of 1929, these two insurance companies had bought the securities of twenty-four companies who were also banking clients of Goldman.)
In January 1929, the negotiations between Catchings and Jonas once again foundered—as merger discussions often do—over the matter of price. After more than three years as a public company, including impressive earnings along the way of around $60 million, Financial and Industrial traded—understandably—at a higher multiple to the underlying value of the stocks in the portfolio than did Goldman’s trust, which had been in business all of two months and had yet to have a public report of its financial performance. (Why holding companies whose assets are shares in other companies trade at a premium to the value of those underlying shares remains a bit of an ongoing mystery but can be explained, in part as Catchings did, by the chance to invest alongside other supposedly more savvy investors, much the way people today invest in Berkshire Hathaway to get Warren Buffett.)
In January 1929, Goldman’s Trading Corporation stock was trading at around $136 per share (up from $104 at the IPO) and the underlying assets were worth around $108 per share, a multiple of 1.26. Financial and Industrial, on the other hand, was trading at around $143 per share and had an asset value of around $80 per share, a market trading multiple equal to 1.78 times its asset value. Constructing a stock-for-stock merger based upon the public trading of the two stocks—which is normally how it is done—would have worked to Jonas’s advantage since Financial and Industrial’s stock traded at a premium to Goldman’s stock. Catchings wanted no part of that deal and insisted, instead, that the negotiations for the merger—in effect who controlled the resulting company and how many shares of the new company their respective shareholders owned—would have to be “predicated upon asset values” rather than market values, a measure that would favor Goldman over Jonas.
The discussions broke off again over whether to value the companies based on market trading or based on underlying asset values. But by the end of January 1929, Jonas had caved. “[A]fter discussing the matter with my associates,” Jonas said, “we felt that it would be desirable even on the basis of an asset position to make a combination of interests” between the two companies. Part of his logic for moving forward on Goldman’s terms was Jonas’s belief—severely ill-placed, it turned out—that Goldman Sachs would “materially aid the growth and profits” of both Manufacturers Trust and the National Liberty group of insurance companies, which, if true, would benefit the shareholders of Financial and Industrial, of which Jonas was by far the largest individual shareholder. The other part of the logic stemmed from Jonas’s ebbing enthusiasm for continuing to manage his business and a desire to secure a new management team to do it. In addition, other members of Jonas’s small, overtaxed management team appeared to be in ill health. “Two of my associates have broken down under the strain,” Jonas wrote to his shareholders in February 1929 to explain his decision to sell the company to Goldman. “A third is now ill and I myself have not had a day’s vacation in two and a half years. It is not prudent to trust new associates with large responsibilities until they have been tried. Under these circumstances it seemed easier to combine with some existing organization of standing and tried and trusted ability and success.” Goldman Sachs Trading Corporation was all of three months old at that moment and its management “untried,” according to the subsequent report about the 1929 Crash.
After less than a week of negotiations, on February 3, 1929, Jonas and Goldman Sachs reached a “tentative oral agreement” to merge the two trusts. Under the February 3 plan, Goldman would end up owning 4.4 percent of the stock of the combined company and Jonas, the largest shareholder, would own 16.6 percent of the combined company. Despite this obvious discrepancy, Goldman would be running the show. It entered into a new management agreement for ten years, and of the seven directors of the new company, six would be Goldman’s partners—including Catchings and Weinberg—and the final director’s seat would belong to Jonas. Given that Jonas had agreed to sell his company to the Trading Corporation, his shareholders would have to vote to approve the deal.
Catchings admitted that this would be new territory for him and his Goldman partners. Although he said Goldman had “done a great deal of business” that was “very similar to commercial banking,” Catchings agreed that except for the “iron business” and “a few other businesses” he had “never actually been in any other kind of business, [but] I have been combating the point of view that you are presenting to me for a great many years, and I have discovered that in the shoe business, in the iron business and the department store business, the executive problems are very much the same.” For his part, Jonas explained that he didn’t know much about Goldman’s business and instead was relying on Catchings’s feeling that Goldman’s “prestige and standing and fifty years of existence … at least equaled or offset the good will that we had in Financial and Industrial.”
Still, Jonas faced a problem with his own shareholders, who, under the February 3 agreement, were to get one Trading Corporation share worth around $68 per share (accounting for the two-for-one split) for each of their Financial and Industrial shares, then worth $145 a share. This would certainly be a tough sell once the deal was announced.
Meanwhile, to help insure the likelihood that the remaining non-Goldman shareholders of the Trading Corporation voted for the merger, in the days after the handshake with Jonas, but before any public announcement of the deal, Goldman Sachs—through a new partnership that it controlled—set about aggressively and systematically buying the shares of the Trading Corporation, effectively driving up the shares’ price and rewarding existing Trading Corporation shareholders for just holding on. An increase in the Trading Corporation share price would also, presumably, make a merger of equals between the Trading Corporation and Financial and Industrial more palatable to Financial and Industrial shareholders—once it was announced—if Trading Corporation’s stock was not trading at such a discount to Financial and Industrial’s stock. Goldman and Jonas quickly concluded that an increase in the Trading Corporatio
n’s share price would make the merger far more likely to be approved by both sets of shareholders.
As part of the February 3 agreement—documented on February 4, still before any public announcement had been made—an account was created to trade in the stocks of both Trading Corporation and Financial and Industrial. The owners of the account were the Goldman Sachs Trading Corporation (controlled by Goldman Sachs) and Delmar Capital Corporation (controlled by Ralph Jonas). According to the agreement between the two, “in connection with the proposed acquisition by Goldman Sachs Trading Corporation of the assets of Financial and Industrial Securities Corporation, this is to confirm our understanding that we both deem it expedient to arbitrage in the stock of these two companies.” The account would be operative for thirty days, with all the profits and losses from the account accruing to the Trading Corporation. If the deal had not closed after thirty days, the account would continue to function with the profits and losses shared equally by the two companies. Goldman would manage the account and “in its uncontrolled discretion” would have full power to buy, sell, and trade in the two stocks. (In the end, the deal closed within thirty days and all the stock in the account went to Goldman.)
In fact, during the weeks the account was open, no arbitrage of the stocks—buying one stock and selling the other to lock in the spread between them—occurred. Rather, all that happened was that Goldman bought the shares of Trading Corporation in a thinly concealed effort to drive the stock price higher and higher in order to make the deal more palatable to the shareholders of both companies. Most of this trading by Goldman in the joint account was done prior to any public announcement about the deal. On February 2, 1929, the Trading Corporation’s stock closed at $136.50. The next day, the two firms set up the joint trading account. On February 4, a “leak” from an undisclosed source about the combination of the two companies created “a tremendous hullabaloo” in the market.
The Trading Corporation’s stock did not open until 11:00 a.m., and the indications were that it would open at $175 per share, up nearly 40 points from the previous close. Instead of selling at these prices—a big increase—Goldman, acting for the joint account of which Goldman was the beneficiary, put in a buy order for 53,000 shares of its own stock, or 54 percent of the total trading for the day. The stock closed at $178 per share. The next day, Goldman bought another 42,300 shares, or 76 percent of the total volume, and the stock closed at $179.625. Goldman sold no shares of Trading Corporation stock that day. This continued for the next few days, until the price of Trading Corporation’s stock closed at $221 per share, up from $136.50 in less than a week. Goldman spent $33,325,000 buying Trading Corporation’s stock—constituting 64 percent of the total volume during those four days—raising the price of the stock to double the value of the underlying assets and on par with the premium placed on Financial and Industrial’s stock. With the extraordinary increase in the shares of Trading Corporation, the plan Catchings and Jonas reached on February 3—and still not disclosed publicly—was abandoned since the original ratio of one stock to the other no longer made sense. Instead, in effect, the stocks were exchanged based on equal market value as well as equal asset value (after a dividend of $4.5 million was made to the Trading Corporation’s shareholders so that each company’s assets would be $117.5 million).
On February 7, Catchings and Jonas recut their deal, and it was announced publicly four days later, on February 11. Goldman Sachs Trading Corporation agreed to issue 1.125 million new shares to the holders of Financial and Industrial, with shareholders’ meetings set for February 21 to vote on the deal—in the case of Goldman’s shareholders, the vote would authorize the new shares to be issued; in the case of the Financial and Industrial shareholders, they would vote to sell the company to Goldman. The revised deal was made possible through the extensive buying of the Trading Corporation’s stock in the secret account that had driven the price of the stock dramatically higher than it had been a week earlier. “[I]t is apparent that the Goldman Sachs Trading Corporation’s activities in its own stock were the substantial factor in the establishment and maintenance of the market value of its shares at a price equal to the market value of the shares of Financial and Industrial Securities Corporation on the basis of the ratio in which the shares of the two companies were to be exchanged under the final plan for the combination of the two companies,” according to the Crash report. “However, in none of the public announcements of the impending combination of the two companies was there any reference either to the existence of, or to the trading activities in the stock of both companies conducted by the joint account.”
The report went on to criticize Jonas for not disclosing in a letter to his own shareholders—a minority of whom were vociferously opposed to the combination with Goldman Sachs Trading Corporation—that by the terms of the joint-account agreement, his overriding incentive was to make sure his shareholders voted for the deal at the shareholders meeting on February 21. By around this time, the joint account had spent close to $50 million—a substantial sum at the time—buying the stocks of the two merger partners; if the shareholders did not approve the merger, Jonas would have been on the hook for half—$25 million—of the cost of the stock that had been bought. “Mr. Jonas thus possessed a special pecuniary interest in facilitating the sale,” the report observed. In Jonas’s letter to his shareholders he made the affirmative statement—albeit untruthful—that “I have never personally owned nor has anyone owned for me, a single share of Goldman Sachs Trading Corporation.” Under later “interrogation,” Jonas justified his decidedly misleading statement by claiming his obligation would only kick in had the merger not been approved. “I never regarded that we had a commitment except the one commitment on the merger not going through,” he said.
On February 21, both sets of shareholders approved the merger, and the Trading Corporation issued 2.25 million shares of its own stock, valued at $235 million, to the holders of the Financial and Industrial Securities Corporation, which had assets of $117.5 million. Goldman paid this premium using its own stock, which it had inflated through its robust purchases during the previous weeks. “The market value for its own stock … was almost exclusively the creation of the Goldman Sachs Trading Corporation itself,” the subsequent report concluded. When asked about the manipulation later, Weinberg conceded that “buying actually improves the market, we know that,” but little else.
As for Catchings, he was even more dishonest than Weinberg.
“I tell you with great positiveness,” he testified, “that the account was not formed for the purpose of putting up stock and that it was not formed for the sake of manipulating the market but was formed for the purpose of being active in the market during the time until the stock reached its natural level,” which Catchings believed would be $220 per share “by the mere force of the agreement of the two companies to combine.”
With tongue in cheek, Galbraith took note of all this activity at Goldman. “The spring and early summer were relatively quiet for Goldman, Sachs, but it was a period of preparation,” he wrote. With the Financial and Industrial deal closed, in April 1929, Catchings and his editorial sidekick, William Trufant Foster, lashed out at the Federal Reserve Board in a statement printed in the New York Times, claiming that it “had gone outside its legitimate functions” in seeking to regulate the flow of credit into the stock market. Instead of accommodating business, they declared, the board had kept business in a “state of growing uncertainty and apprehension.” The pair warned the Fed not to try to thwart the “confidence in the soundness of American business,” a confidence that was “warranted by the facts.” Not for the first time would a Wall Street figure guilty of rank speculation—and possibly insider trading—attack the government, even the weak government of the time, for trying to protect the public.
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ON JULY 26, Catchings decided to ratchet up Goldman’s exposure to its high-flying investment trust. Together with another sponsor, Goldman launched the Shen
andoah Corporation by selling $102.5 million of securities to the public. The deal was said to be seven times oversubscribed and included layers of additional leverage that the original Goldman Sachs Trading Corporation did not have. The Trading Corporation bought 2 million of the 5 million Shenandoah shares offered, and Goldman partners took seats on its board. Goldman sold through a public offering the Shenandoah stock at $17.50 and it closed at $36 per share at the end of its first day of trading, up more than 100 percent on the day. Some twenty-five days later, Catchings struck again, this time selling $142 million of shares in yet another trust, the Blue Ridge Corporation—the board for which was identical to Shenandoah’s. Of the 7.25 million shares Blue Ridge offered to the public, Shenandoah bought all but 1 million of them. “Goldman Sachs by now was applying leverage with a vengeance,” Galbraith observed.
And why not? At the time of the Blue Ridge offering, according to the New York Times, Goldman Sachs Trading Corporation was worth $500 million, up fivefold in nine months, and Shenandoah had doubled in value in less than a month. Blue Ridge had the additional financial innovation that it allowed investors to exchange shares in a select group of twenty-one other blue-chip New York Stock Exchange companies—among them AT&T and General Electric—at fixed prices for shares in Blue Ridge. Why anyone would want to do this was not made clear, of course, especially if the fixed price offered for, say, a share of General Electric by Blue Ridge was less than where GE was trading in the market. It is often the case that Wall Street’s shenanigans are not readily apparent. After the Blue Ridge deal, Goldman Sachs had created well over $1 billion in market value—actually $1.7 billion—in about nine months, as impressive an act of financial alchemy as had ever been achieved. “[T]he nearly simultaneous promotion of Shenandoah and Blue Ridge was to stand as the pinnacle of new era finance,” Galbraith wrote. “It is difficult not to marvel at the imagination which was implicit in this gargantuan insanity. If there must be madness something may be said for having it on a heroic scale.”
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