United States v. Morgan

TOPICAL ARRANGEMENT OF OPINION

Introduction.

The Offense as Charged in the Complaint.

Certain Alleged Unifying Elements Abandoned or Disproved.

The Applicable Law Relative to Conspiracy.

Part I:

The Investment Banking Business.

I. Prior to the First World War.

II. Between World War I and the Securities Act of 1933.

III. Further Developments 1933-1949.

IV. How the Investment Banker Functions.

Part II:

The Seventeen Defendant Investment Banking Firms.

1. Morgan Stanley & Co.

2. Kuhn Loeb & Co.

3. Smith Barney & Co.

4. Lehman Brothers.

5. Glore Forgan & Co.

6. Kidder Peabody & Co.

7. Goldman Sachs & Co.

8. White Weld & Co.

9. Eastman Dillon & Co.

10. Drexel & Co.

11. The First Boston Corporation.

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12. Dillon Read & Co. Inc.

13. Blyth & Co., Inc.

14. Harriman Ripley & Co., Incorporated.

15. Stone

&

Webster Securities Corporation.

16. Harris Hall & Company (Incorporated).

17. Union Securities Corporation

Part III:

The Syndicate System.

I. Did the Seventeen Defendant Investment Banking Firms Use the Syndicate System as a Conspiratorial Device in Connection with Any Integrated Over-all Combination?

II. Alternate Claims Belatedly Attempted to Be Asserted against the Investment Banking Industry as a Whole.

A. The Rule of Reason.

B. The Securities Act of 1933, the Securities Exchange Act of 1934, and the Amendments Thereto; the Rules, Interpretations and Releases of the SEC Thereunder; and the Organization and Functioning of the NASD.

C. The Opinion of the SEC in the Public Service Company of Indiana Case.

Some Interim Observations.

Part IV:

Did the Seventeen Defendant Investment Banking Firms Combine for the Purpose of Dominating and Controlling and Did They in Fact Dominate and Control the Financial Affairs of Issuers by Directorships and Solicitation of Proxies?

Proxies.

Burlington Mills.

Jewel Tea.

The Evidence Generally Applicable to Directorships Discloses No Conspiratorial Pattern but Rather the Contrary.

First Boston.

Addinsell and Phillips Petroleum.

Harriman Ripley.

United Air Lines.

Union Securities.

Directorship Evidence against Goldman Sachs, Lehman Brothers, Kuhn Loeb, Dillon Read and Blyth.

Goldman Sachs.

Lehman Brothers.

Cluett Peabody.

Food Fair.

Allied Stores.

Aviation Corporation.

Sears Roebuck.

Cleveland Cliffs Iron Co.

Kuhn Loeb.

Franklin Simon.

Miscellanea.

Dillon Read.

National Cash Register.

Amerada Petroleum.

Outlet Company.

Beneficial Industrial Loan.

Union Oil.

Commercial Investment Trust.

Rheem.

Blyth.

Rayonier.

Pan American Airways.

Anaconda Copper.

Iron Fireman.

Some Further Interim Observations.

Part V:

The “Triple Concept”.

Semantics.

“Historical Position”.

Chicago Union Station.

The Alleged “Practice” of “Traditional Banker” and “Successor-ships”.

1. Morgan Stanley.

The “Master Mind”.

The Telephone Business.

Consumers Power.

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,The Alleged “Caretaker” Situations.

Dayton Power & Light.

Atlantic Coast Line, Toledo & Ohio Central, Chicago & Western Indiana, Nypano (New York, Pennsylvania & Ohio) and Dominion of Canada.

2. Kuhn Loeb.

The Otto H. Kahn “Show Window”.

Bulgaria.

Commonwealth of Australia.

Armstrong Cork.

Bethlehem Steel.

R. H. Macy & Co.

Crucible Steel.

General Cable.

S. Smith Barney (Edward B. Smith & Co.).

What Is Now Taking Shape Is Not a Static “Mosaic” of Conspiracy but a Constantly Changing Panorama of Competition Among the Seventeen Defendant Firms.

Wilson & Co.

Rochester Gas & Electric.

A. E. Staley Manufacturing Co.

Aluminum Koppers, Jones & Laughlin, Lone Star Gas, Gulf Oil.

Southern Pacific.

Standard Oil of New Jersey.

4. Lehman Brothers.

Crown Zellerbach.

Giannini Interests.

The So-Called “Treaties” Between Lehman Brothers and Goldman Sachs.

National Dairy Products.

Butler Bros., Associated Gas & Electric, Indianapolis Power & Light and Tidewater Associated Oil.

5. Glore Forgan.

Indianapolis Power & Light.

6. Kidder Peabody.

Pennsylvania Power & Light.

7. Goldman Sachs.

Pillsbury.

8. White Weld.

9. Eastman Dillon.

10. Drexel.

11. First Boston.

Province of Cordoba, Androscoggin Electric Corp., and Central Maine Power.

12. Dillon Read.

Scovill Manufacturing Co., Scripps, Porto Rican American Tobacco Co., Argentine Government, American Radiator and Grand Trunk Western.

United Drug.

Shell Union Oil.

13. Blyth.

Pacific Gas & Electric.

Competition for Leadership 1934-1936.

.The Alleged Overly-Large Syndicate Formed By Blyth in Connection with the $80,000,000 Issue of March 27, 1945.

The Sale in 1945 of 700,-000 Shares of Common Stock of Pacific Gas & Electric Held by North American.

14. Harriman Ripley.

Scandinavian Financings.

15. 16 and 17. Stone & Webster, Harris Hall and Union Securities.

Part VI:

Alleged Conspiratorial Opposition of the Seventeen Defendant Banking Firms to “Shopping Around,” and to the Campaign for Compulsory Public Sealed Bidding; and the Alleged Adoption of Devices to Sabotage SEC Rule U-50 , and Compulsory Public Sealed Bidding in General.

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General Views on Competitive Bidding and the Advantages to Issuers Arising Out of Continuing Banker Relationships.

The Eaton — Young—Halsey Stuart Campaign.

Responses to Requests from SEC to Express Views Relative to Proposed Rule U-50 and Further Amendments to Rule U-12F-2.

Alleged Overly-Large Syndicates and Other “Devices” to Sabotage Public Sealed Bidding.

Part VII:

The “Insurance Agreement,” Alleged to Have Been Made on December 5, 1941, and “Approved” on May 5, 1942.

Part VIII:

Conclusion.

Administrative Features and Statistics of the Trial

Summary, Rulings on Motions and Dismissal.

Appendix:

Summary Description of Statistical Compilations, Tables and Charts.

MEDINA, Circuit Judge.

Introduction

This is a civil action in equity to restrain the continuance of certain alleged violations of Sections 1 and 2 of the Sherman Act, Act of Congress of July 2, 1890, c. 647, 26 Stat. 209 , 15 U.S.C. §§ 1 , 2, 4. It is charged that defendants entered into a combination, conspiracy and agreement to restrain and monopolize the securities business of the United States and that such business was thereby unreasonably restrained and in part monopolized.

The “securities business” which is the subject of these charges is defined in the complaint in terms that are uncertain and in part contradictory. In the ■clarifying process of pretrial hearings and trial, however, counsel for plaintiff receded in part from the allegations of the complaint. As finally re-defined, plaintiff’s position is that the “security issues” to which the charges of the complaint should be understood to relate are intended to include new issues, and secondary offerings registered with the Securities and Exchange Commission under the Securities Act of 1933, 15 U.S. C.A. § 77a et seq., of securities of domestic and foreign business corporations and foreign governmental units and foreign municipalities, offered to or placed with investors in the United States, but to exclude domestic railroad equipment trust certificates, all notes and serial notes representing term loans by commercial banks, all general and revenue obligations of domestic governmental units and domestic municipalities, and all unregistered secondary offerings of any securities.

The combination, conspiracy and agreement to restrain and to monopolize and the actual restraint effected thereby are claimed to have embraced every method and type of transaction by which issues of the above-defined securities have been transferred from the issuers (or from sellers of blocks of such securities in registered secondary offerings) to the hands of investors, whether underwritten by investment bankers or non-underwritten, whether privately placed or publicly offered to existing security-holders or the general public, and whether in negotiated transactions or at public sealed bidding, with the exception, however, of direct offerings by issuers to their security-holders in which investment bankers are not employed as agents or underwriters. The part of the securities business which is charged to have been monopolized by the defendants in the course of and through the operation of the conspiracy is claimed to have consisted of all new issues of the above-defined securities, and all registered secondary offerings thereof, which have been underwritten by investment bankers in negotiated transactions and publicly offered to existing security-holders or to the general public.

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The Offense as Charged in the Complaint

The complaint charges an integrated, over-all conspiracy and combination formed “in or about 1915” and in continuous operation thereafter, by which the defendants as a group “developed a system” to eliminate competition and monopolize “the cream of the business” of investment banking. The prolixity of the complaint and its various involutions are such that it will be convenient to summarize and paraphrase its contents, as was done in the trial brief submitted at the opening of the trial by counsel for the government. The mortar to cement together the various parts of this extraordinary document is provided by a series of definitions, many of which bear little resemblance to the meaning of the various words or phrases used in the business.

The central theme is what has been referred to throughout the case as “the triple concept” of “traditional banker,” “historical position” and “reciprocity.” To quote from the brief above referred to:

“Under the traditional banker concept that banker who first manages an underwriting for a particular issuer is deemed entitled to manage in the future all additional security issues offered by such issuer. * * * Under the concept of historical position once a banker participates as a member of a buying group in the purchase of the securities of a particular issuer, such banker is deemed entitled to participate on substantially the same terms as a member of the buying group in all future issues offered by such issuer. Under the concept of reciprocity the defendant banking firms recognize a mutual obligation to exchange participations with one another in the buying groups which they respectively manage.”

In this connection the complaint specifically charges that:

“Each defendant banking firm keeps a reciprocity record to show the business it has given to each of the other defendant banking firms and the business it has received from each of such firms.”

And that:

“Over a period of time, the amount of gross spreads which one of such firms enables another to earn by selecting it for participation in buying groups is substantially equivalent (with due allowance for differentials in prestige and underwriting strength) to the amount of gross spreads it has earned in the same period of time as a participant in buying groups formed and managed by such other firm.”

As it is evident that no such parcel-ling out of the investment banking business could function so long as the management of issuers was free to choose and deal with any investment banking house it wished, there is alleged in the complaint as one of the terms agreed upon by the defendants, and as part of the conspiracy and combination, that there should be a species of control over issuers so as to “preserve and enhance their control over the business of merchandising securities:”

“(1) by securing control over the financial and business affairs of issuers, by giving free financial advice to issuers, by infiltrating the boards of directors of issuers, by selecting officers of issuers who were friendly to them, by utilizing their influence with commercial banks with whom issuers do business.”

One of the terms of the agreement said to have been made by the members of the combination and conspiracy is that when a “representative” of one of the 17 defendant banking houses becomes a director of an issuer, this is understood by all the rest to be the equivalent of “raising a red flag,” and thus warning the others to keep off.

As a measure of combined control over issuers and the several hundred other investment banking houses

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against whom the conspiracy was to operate, it is charged in the complaint that in 1915 “the modern syndicate method of distributing securities was invented by defendant banking firms and their predecessors,” and that defendants agreed that with certain modifications this method should be utilized by defendants to stabilize the business “by fixing and controlling the prices, terms, and conditions of purchase, sale and resale of securities.” This “device” is said to be manipulated by defendants in various ways, all as part of the general plan or scheme. For example, it is alleged that defendants as managers of such syndicates not only further the ends of the combination or conspiracy by dealings among themselves, but that they sometimes exclude other firms from participations or selling group positions, and sometimes include such firms “which might otherwise attempt to compete with defendant banking firms;” and that by means of this “device” defendants “agree among themselves upon a uniform, non-competitive price” which, having thus been “fixed” by them, is foisted upon issuers, by what can only euphemistically be called “negotiation,” in view of the domination and control exercised or attempted to be exercised over the issuers by defendants. It is worthy of note that the allegations with reference to the syndicate system and its so-called price-fixing features are made solely in reference to the charge of the integrated, over-all combination and conspiracy.

Certain statutory and regulatory provisions of great significance, which became effective in 1934, 1941 and 1944 are reflected in other phases of the combination and conspiracy as charged.

In 1933 the Congress passed the Glass-Steagall Act,

1

pursuant to the terms of which commercial banks and their security affiliates were required to go out of the investment banking business, if the banks desired to continue taking deposits and performing their other banking functions. The deadline was June 16, 1934. The affiliates were accordingly dissolved; and such banking houses as had bond departments or otherwise engaged directly in the investment banking business, with very few exceptions, elected to continue their banking functions and restricted their operations in the field of securities to governmental and other issues specifically exempted from the operation of the new law. Thousands of employees of these institutions were forced to make new connections, and many joined the staffs of some of the 17 defendant investment banking houses.

It is the theory of the complaint that the pre-existing and flourishing combination and conspiracy met this situation by a further agreement among the conspirators to the effect that certain of the defendant firms should succeed to or “inherit” the conspiratorial “rights” theretofore parcelled out to the commercial banks and their affiliates by the operation of “the triple concept” above described, and that the combination or conspiracy should accordingly, and it is alleged did, continue to operate as before. This is the predecessor-successor phase of the case in a nutshell. The complaint originally read as though certain firms became and were the real successors of others in a legal sense whereas what was intended to be pleaded, as disclosed by an amendment of the complaint made in the course of pre-trial conferences, is that the “successors” were such only in the sense that the alleged conspirators so agreed as part of the operation of their integrated, overall combination and conspiracy.

In 1941 the Securities and Exchange Commission promulgated a rule requiring securities of companies, affected by the provisions of the Public Utility Holding Company Act of 1935, 15 U.S. C.A. § 79, et seq., to be sold by compulsory public sealed bidding, and similar action, relative to debt securities of railroads, was adopted by the Interstate

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Commerce Commission in 1944. In this connection and in very comprehensive terms the complaint charges that these 17 defendants as part of the same integrated, over-all combination and conspiracy agreed to discredit the use of competitive bidding, private placements and agency sales as methods of disposing of security issues. The competitive bidding phase of the charge is divided roughly into three parts: (1) Opposition to campaigns which resulted in the adoption of the rules above referred to. (2) Refusal to submit sealed competitive bids and the adoption of a great variety of “devices” for the purpose of sabotaging the new rules and hence defeating the purposes of the two governmental agencies which had made public sealed bidding compulsory with respect to a not inconsiderable area of security issues. Such “devices” were alleged to have included: the organization of -overly-large syndicates, the grant of participations equal to those of the manager, the reduction of management fees and the merger of accounts. (3) After -certain insurance companies had bid in a large issue of securities of the American Telephone & Telegraph Company in the fall of 1941, it is charged that a certain agreement was made on December 5, 1941 and “approved” on May 5, 1942, by virtue of which the insurance companies were to be eliminated as direct ’bidders for security issues.

According to the complaint the means adopted by the conspirators to accomplish their ends were many and various. 'They seem to include, under the heading -of “customs and practices,” said to have been agreed upon to effectuate the design of the conspirators, many of the alleged abuses which over the years have •been charged against investment banking houses in general, but which have not as yet been affected by specific legislation.

This in brief is the framework and the essence of the charge against these 17 defendant investment banking firms. Much of the detail is omitted for the moment in the interest of clarity. Many of the charges against defendants were from time to time abandoned and removed from the case and no further reference will be made to them.

Thus “the substantial terms” of the “continuing agreement and concert of action” originally alleged against the group of 17 in paragraph 44 of the complaint included: (1) an agreement to cement their relationships with issuers by securing clearances from such issuers before making their investment banking facilities available to competing business enterprises and by refusing to act as advisers or underwriters for small business concerns; (2) an agreement to utilize their domination and control to encourage and promote consolidations, mergers, expansions, refinancings and debt refundings to increase their investment banking business; and (3) an agreement to concentrate the business of purchasing and distributing security issues in a single market. These were all withdrawn by counsel for the government.

The following “customs and practices,” alleged in paragraph 45 to have been “formulated and adopted” by agreement of the group of 17 were originally included but later dropped: (1) the formation of “standby accounts” for all security issues of a particular issuer to prevent the assembling of competing groups and thus discourage issuers from disposing of issues at competitive bidding; (2) in the event of insolvency or reorganization of issuers with whom a “traditional banker” relationship existed with a member of the group, to cause a partner, officer or other nominee to be appointed to influence protective committees for the benefit of such “traditional bankers”; and (3) subsequent to the divorcements required by the Investment Companies Act of 1940, 15 U. S.C.A. § 80a-l et seq., continuing to influence managing investment companies or trusts in which capital had been “strategically invested” so that voting powers would be exercised “in the interests of defendant banking firms.”

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Such other issues as were removed from the case by consent need not be specified, except as they may be hereinafter referred to.

The complaint bears every evidence of careful and prolonged preparation, its articulation is close and compact, every word is carefully chosen and fitted exactly in its proper place. Thus it is the 17 defendant banking houses, arrayed against the balance of the investment banking industry, and alleged to be acting in combination to monopolize “the cream of the business,” and divide it up among themselves, by excluding those investment banking houses which are not part of the conspiracy. If the charge is true the restraints are ingeniously devised to create a controlled rather than a free market at every level. The operation of “the triple concept” prevents competition as between defendants themselves; the domination and control over issuers and the “fixing” of the price to be paid issuers for their security issues deprives issuers of a free market in which to raise the money they need; non-defendant firms are deprived of an opportunity to compete for the business; the trading operations of dealers and brokers are restricted during the period of the continuance of syndicates formed for the distribution of new security issues; and investors are deprived of an opportunity to purchase securities in a free market.

And all this is said to have gone on for almost forty years, in the midst of a plethora of congressional investigations, through two wars of great magnitude, and under the very noses of the Securities and Exchange Commission and the Interstate Commerce Commission, without leaving any direct documentary or testimonial proof of the formation or continuance of the combination and conspiracy. The government case depends entirely upon circumstantial evidence.

Certain Alleged Unifying Elements Abandoned or Disproved

During the prolonged and extensive pre-trial conferences, there was much discussion of the method to be pursued by the government in attempting to prove that these 17 defendant investment banking houses had formed a combination and were acting jointly as a group. As pointed out in my memorandum of April 9, 1951, filed with Pretrial Order No. 3, United States v. Morgan, D.C., 11 F.R.D. 445, 454-455 , the unifying elements of the alleged conspiracy were obscure, as no industry-wide uniformity was charged, there was no powerful group such as the “Big Three” operating against independents in the American Tobacco Co.

1

case, no letter or series of agreements presenting a definite plan to which others might consciously adhere as in the Interstate Circuit

2

and Masonite Corp.

3

cases and there appeared to be many non-defendant investment banking firms which were larger, had more capital and did more business than some of the defendants herein. Certain aspects of the present case, however, which have since been abandoned or disproved seemed to have relevance to this important phase of the case.

The first of these was the fact that it was claimed that defendants and their “predecessors” had invented the syndicate system to further their plan or scheme. This charge, which was evidently the basis for the allegation that the conspiracy was formed “in or about 1915,” has been conclusively disproved and has been virtually abandoned.

The second such possible unifying element was the Investment Bankers Association, originally joined and for many months of the trial continued as a defendant and alleged co-conspirator. Each of the defendant firms was and

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had for many years been a member of this Association, particularly during the period when the Association, through its officers and committees took a strong position against the adoption of rules and regulations requiring compulsory publie sealed bidding for certain types of new security issues. On motion of the government, however, the Investment Bankers Association was, with my approval, eliminated as a defendant and the charge that it was a co-conspirator was withdrawn. The name of its president Emmett F. Connely, was, however, continued in the list of alleged co-conspirators, evidently because he had made a speech on October 7, 1941 criticizing the purchase of the American Telephone & Telegraph bonds by a group of certain large insurance companies at public sealed bidding and one or two men connected with some of the defendant firms had in one form or another expressed their approval of the speech.

Perhaps the most impressive indication of joint action by the defendants lies in the detailed and explicit allegation of the complaint relative to reciprocity. Not only is it charged that each defendant banking firm keeps a reciprocity record to show the business it has given to each of the other defendant banking firms and the business received from them; but also that over a period of time the profits from such participations are substantially equivalent, with due allowance for differentials in prestige and underwriting strength. If substantiated, these allegations would indicate some systematic and continuous arrangement between the defendants to pay one another off in return for the alleged agreement to defer to one another as “traditional bankers.”

Here again, however, there was not merely a failure of proof but an affirmative demonstration that the allegations are without foundation in fact.

No evidence of any kind, whether by way of alleged reciprocity records, deposition proof or documents, was produced on this phase of the case against Dillon Read, Drexel, Glore Forgan, Morgan Stanley, Smith Barney, Union Securities and White Weld; nor were any alleged reciprocity records introduced against Harriman Ripley and Kuhn Loeb. Such records as were received in evidence were of the most disparate character. They covered different periods of time, included non-defendant firms as well as defendant firms, and were so fragmentary and different in character one from the other as to make it clear that they had not been prepared as the result of any joint action whatever. No calculations of reciprocal obligations, such as would have been required by the operation of the conspiracy as alleged, could possibly have been made from these miscellaneous and incomplete loose leaf books and cards.

A careful scrutiny of the documents received in evidence on this part of the case, taken in connection with the so-called reciprocity records and such testimony as was taken by deposition, indicate that a few individual defendant firms, motivated by various considerations of a purely business character, and acting separately and not in combination, did no more than is often found done by business men generally. In the course of a business relationship it is a natural and normal thing for those in the same industry occasionally to seek business on the basis of business given. Were there some uniformity or some common pattern the case would be different. As it is, there is a pattern of no pattern; and I find that, considering all the evidence in the record, including the stipulated statistical data, the reciprocity charge has been disproved.

The Applicable Law Relative to Conspiracy

The Sherman Act is not an open door through which any court or judge may pass at will in order to shape or mould the affairs of business men according to his own individual notions of sound economic policy. Nor was it ever intended by the Congress that judges should determine such policy questions as: the desirability of compulsory

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sealed bidding for new security issues; the propriety of officers or partners of investment banking firms accepting directorships on the boards of issuers; the good or bad effects of the solicitation of proxies by investment bankers; and whether investment bankers should be permitted to advise issuers concerning their financial affairs, the formulation of long range plans for expansion and refunding, the setting up of specific security issues and kindred subjects and also perform services and assume risks in connection with the registration and distribution of such security issues. The regulation of such matters is a legislative function and the series of statutes which have become law since the great depression of 1929 and the following years bear ample testimony to the fact that the Congress is mindful of its power to regulate such matters, by reason of their connection with interstate commerce.

What the Sherman Act does is to declare illegal “every contract, combination * * * or conspiracy” in restraint of trade or commerce and to make guilty of a misdemeanor “every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce” among the states or with foreign nations. The task of the judge is to determine whether the conduct challenged in the litigation contravenes the prohibitions of the statute. This is no mandate to the judiciary to decide anti-trust cases according to individual ideas of expediency, which may change according to the personal philosophy or even the political affiliation of the judge. It is the combination or joint action of the many which is the essence of the offense. Unless there is some agreement, combination or conspiracy the Sherman Act is not applicable.

But it is supposed by some that the requirement of combination is a mere empty phrase to which one must indeed do lipservice, but which may easily be got around by finding agreement, combination or conspiracy when in truth and in fact no agreement, combination or conspiracy exists, provided the result obtained seems desirable and in the public interest. This is not the law but only another aspect of the false but seductive doctrine that the end justifies the means which, so far as I know, has never taken lodgment in American jurisprudence; and I hope it never will.

True it is that conspiracies whether by business men or others engaged in unlawful schemes are often hard to detect. No direct proof of agreement between the wrongdoers is necessary; circumstantial evidence of the illegal combination is here as elsewhere often most convincing and satisfactory. But, when all is said and done, it is the true and ultimate fact which must prevail. Either there is some agreement, combination or conspiracy or there is not. The answer must not be found in some crystal ball or vaguely sensed by some process of intuition, based upon a chance phrase used here or there, but in the evidence adduced in the record of the case which must be carefully sifted, weighed and considered in its every aspect. This is an arduous but necessary task.

Especially is this true in a case such as the present one where the great bulk of the documentary evidence is initially received against a particular defendant and only subject to connection against the others in the event that the combination or conspiracy is proved. According to well established precedents such documents may be used circumstantially against all; but this works both ways as the probative force of such proof, when considered circumstantially may not tend to support the factual conclusion that the combination or conspiracy existed but rather the contrary. In any event it is well settled that statements contained in such documents, received subject to such connection, may not be used to establish the truth of their contents, except as against the particular defendant against whom such documents are received generally. And it is well that this is so for much that

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is contained in casual memoranda and even in messages, reports, teletypes and diary entries is mere rumor and gossip, which frequently turns out to be unreliable hearsay. Once the conspiracy is established, however, all such statements become those of agents of the group, to be considered against all the defendants as part of the proofs in the case generally.

PART I

The Investment Banking Business

It would be difficult to exaggerate the importance of investment banking to the national economy. The vast industrial growth of the past fifty years has covered the United States with a network of manufacturing, processing, sales and distributing plants, the smooth functioning of which is vital to our welfare as a nation. They vary from huge corporate structures such as the great steel and automobile companies, railroads and airlines, producers of commodities and merchandise of all kinds, oil companies and public utilities, down to comparatively small manufacturing plants and stores. The variety and usefulness of these myriad enterprises defy description. They are the result of American ingenuity and the will to work unceasingly and to improve our standard of living. But adequate financing for their needs is the life blood without which many if not most of these parts of the great machine of busines would cease to function in a healthy, normal fashion.

The initial inquiry in any anti-trust case must be into the character and background of the industry involved. In a case such as this, which covers so long a period of time and a multiplicity of issues and which is largely documentary in character, it is not too much to say that it is impossible to pass upon questions of credibility of witnesses and to understand and interpret the thousands of miscellaneous exhibits, including memoranda, letters, diary entries, teletype inter-office messages and so on without some fairly adequate understanding of the way in which the business is and has been conducted. Thus we turn to the evolution and growth of the investment banking business and the way it functions in the modem American scheme of financial affairs.

By way of prefatory comment and to facilitate orientation, it may be helpful first to describe some of the major factors. The central thought, as in every anti-trust ease, must be the character and scope of competitive effort or the lack of competitive effort.

The principal factors which one must constantly bear in mind are: (1) the evolution of the syndicate system from its inception prior to the turn of the century, and its function in the issuance and distribution of securities; (2) the impact on the investment banking business of economic forces and a series of acts of Congress including the Banking Act of 1933, the Securities Act of 1933, the Securities Exchange Act of 1934 and the Public Utility Holding Company Act of 1935, and the various amendments to these statutes, supplemented by rulings and regulations of the Securities and Exchange Commission and the Interstate Commerce Commission; and (3) the complete and comprehensive static and statistical data which show the details of every relevant security issue in the period from January 1, 1935, to December 31, 1949.

While the complaint alleges that the syndicate system was invented at or about the time of the Anglo-French Loan in 1915 by the defendants and their “predecessors,” it has been conclusively established, as already stated, that the syndicate system as a means of issuing and distributing security issues was in use at least as early as the 1890’s; and in this early period price maintenance was to some extent used, as it was appreciated even in those days that the problem of placing upon the market a large bulk of new securities required careful management and planning lest the very quantity involved should depress the price and make distribution within a reasonable time difficult if not impossible.

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The present method for issuing and distributing new security issues thus has its roots in the latter part of the nineteenth century. It is the product of a gradual evolution to meet specific economic problems created by demands for capital, which arose as the result of the increasing industrialization of the country and the growth of a widely dispersed investor class. It was born in large part because of, and gradually adapted itself to, conditions and needs which are peculiar to the business of raising capital.

I. Prior to the First World War

Prior to the year 1900, the large majority of industrial and business units which existed in this country were small in size and their capital needs were small; use of the corporate form was not widespread. There was no substantial and widely scattered class of persons with surplus savings who sought promising investment opportunities. A large part of the capital needed came from abroad. Securities sales operations were conducted principally by selling agents who sold on a commission basis, and more often than not it was the issuer who bore the risk of how successfully and how quickly the required funds would be obtained.

The evolution of the investment banking industry in the United States is illustrated by the early phases of the development of two of the defendant investment banking firms, Goldman, Sachs & Co. and Lehman Brothers.

Goldman, Sachs & Co. traces its origin back to the year 1869, when Marcus Goldman started a small business buying and selling commercial paper. In the year 1882, he was joined in that business by Samuel Sachs, and at that time the firm, which had been known as Marcus Goldman, became M. Goldman & Sachs. In the year 1885, when additional partners joined the firm, the firm became Goldman, Sachs & Co., and has continued as such from then on to today. At that time, it was very difficult for small manufacturers and merchants to get capital with which to operate, so Goldman, Sachs & Co. developed the business of buying their short-term promissory notes, thus furnishing them with needed capital, and selling these notes to banks or other investors. This commercial paper business prospered and continued to expand in the 1880’s and 1890’s, and, by the time of the year 1906, when the opportunity first arose for Goldman, Sachs & Co. to underwrite some financing for United Cigar Manufacturers, now known as the General Cigar Company, the firm had established many contacts all over the country with merchants and manufacturers. During this period, also, partners of Goldman, Sachs & Co. took frequent trips to Europe, because at that time it was difficult to raise capital for American enterprises in the financial markets of this country, and they entered into arrangements with European bankers, whereby they would lend money in this country for their account.

Likewise, the firm of Lehman Brothers traces its ancestry back to about 1850. Since then, a series of partnerships, formed from time to time upon the withdrawal or death of partners or the addition of new ones, has conducted business under the name of Lehman Brothers. The firm had prospered greatly as “cotton bankers,” and, years before the turn of the century, it had established its headquarters in New York City.

In the late 1890’s and the early 1900’s, the prime securities were railroad bonds and real estate mortgages. The public utilities business had not as yet achieved great importance, and, consequently, public utility securities were generally looked upon with disfavor. Railroad and public utility financing was handled by a small number of firms. The railroad financing was done to a considerable extent by Kuhn, Loeb & Co., J. P. Morgan & Co., Vermilye & Co. and August Belmont; and a large percentage of the capital was furnished by French and German underwriters. The public utility financing was done to a large extent by Harris, Forbes & Co., which had become a specialist in the securities of companies providing power and light. Harris,

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Forbes & Co. was becoming known as an underwriter which understood and knew how to solve the problems of those companies, and had the knack of raising capital for the growing industry. There was an open field in certain light industrial and retail store financing which had been neglected or overlooked.

After the beginning of this century, as family corporations grew larger and needed more capital for expansion, or when the head of a family died and money was needed to pay inheritance taxes, it became increasingly apparent that commercial paper, which was short-term money, was insufficient to meet the capital requirements of those small enterprises. At about this time, Goldman, Sachs & Co., desirous of entering the business of underwriting securities, conceived the idea of inducing privately owned business enterprises to incorporate and to launch public offerings of securities. In the early 1900’s it was considered undignified to peddle retail store securities, but Goldman, Sachs & Co. believed that, with the growth in size of family corporations and other privately owned business enterprises, there would be a market on a national basis for their security issues. The problems involved in offering securities to the public, where no securities were previously outstanding in the hands of the public, were new and difficult of solution, and different from the problems involved in the underwriting of bonds of a well known railroad. The sale of retail or department store securities required a different market.

When the opportunity arose in the year 1906 for Goldman, Sachs & Co. to underwrite the financing of United Cigar Manufacturers, it was unable to undertake the entire commitment alone, and could not get the additional funds which it needed to underwrite from commercial banks or other underwriters, as they would not at that time underwrite this type of securities. Henry Goldman prevailed upon his friend Philip Lehman of Lehman Brothers to divert some of his capital from the commodity business and to take a share in the underwriting. The result was that the two firms, Goldman, Sachs & Co. and Lehman Brothers, became partners in the underwriting of the financing of United Cigar Manufacturers. When the opportunity arose in that same year for Goldman, Sachs & Co. to underwrite the financing of Sears, Roebuck & Co., it was perfectly natural for it again to turn to Lehman Brothers for assistance, and the two firms became partners in that enterprise. Thus it was through this oral arrangement between two friends, Henry Goldman and Philip Lehman, through this informal partnership, that Goldman, Sachs & Co. was able to obtain the capital which it needed to underwrite these two security issues in the year 1906. Without such capital, it would have been unable to enter the business of underwriting securities. The events which occurred in the year 1906 set the pattern for subsequent financings which Goldman, Sachs & Co. underwrote prior to the First World War. In the period from the year 1906 to the year 1917, although Goldman, Sachs & Co. occasionally underwrote financings with other partners, notably Kleinwort Sons & Co., merchant bankers of London, its principal partner was Lehman Brothers.

These two firms, as partners or joint adventurers, continued to act together thereafter underwriting securities of clothing manufacturers, cigar manufacturers, department stores and merchants, and the kind of businesses that most investment bankers, who were interested only in the securities of heavy industrials, railroads and to some extent public utilities, would not touch. The two firms began to cultivate acquaintances and build up relationships with securities dealers in other parts of the country who could market in their respective cities or towns the type of securities in which the two firms were particularly interested ; and, as their reputations grew, they began to underwrite securities in the industrial field. They added to their staffs persons who were experts on merchandising and retail store methods, and they developed the business of selling

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their services to family and other privately owned enterprises.

While the evidence is not explicit on the point it would seem reasonable to assume that, prior to World War I, the firms interested in the securities of railroads, public utilities and heavy industries were establishing similar contacts, building up similar staffs of experts in their particular fields and otherwise doing whatever they could to enhance their reputations in their own specialities.

In the period from the year 1906 to the year 1917, Goldman, Sachs & Co. and Lehman Brothers together underwrote the financings of many enterprises which had a small and humble beginning, but which later grew to very great size, among them being United Cigar Manufacturers, Sears, Roebuck & Co., B. F. Goodrich Company, May Department Stores Company and F. W. Woolworth Company. Many of the business concerns whose securities were underwritten by Goldman, Sachs & Co. and Lehman Brothers during this period were houses with which Goldman, Sachs & Co. had previously had commercial paper transactions. As Goldman, Sachs & Co. and Lehman Brothers were better known at the time than many of the business enterprises whose securities they underwrote, investors bought the securities to some extent in reliance on their reputation.

There thus grew up between these two firms an informal, oral arrangement whereby they, as partners or joint adventurers, purchased security issues directly from issuers, and divided equally the profit which was realized from their sale.

There was then no network of securities dealers throughout the country, such as there is at the present time. In or about the year 1905 or 1906, there were only about five investment banking houses which had a national distribution system for securities: Lee Higginson & Co.; N. W. Harris & Co.; N. W. Halsey & Co.; Kidder, Peabody & Co.; and William Salomon & Co. Investment banking houses such as J. P. Morgan & Co., Kuhn, Loeb & Co., and William A. Read & Co. were underwriters of securities primarily in the New York market. Up to about the year 1912 or 1915, there were approximately only two hundred and fifty securities dealers in the entire United States, most of whom were concentrated in the eastern and middle eastern parts of the country. It was not until the time of the launching of the Liberty Loan in the year 1917 that we find a large number of independent dealers engaged in the business of distributing securities throughout the country.

As there was no network of securities dealers on a nation wide scale, the underwriters sold as many securities as they could directly to individual investors, and the sale of security issues generally was not completed rapidly. For example, it took Goldman, Sachs & Co. and Lehman Brothers three months to sell the Sears, Roebuck & Co. security issue which they underwrote in the year 1906, and, in many other instances, it took the underwriters much longer to complete the distribution of security issues. The personnel of the distributing organizations was small, and their operations were concentrated in the eastern and northeastern parts of the country. The purchase and banking groups were characteristically organized to last for a period of one year, and the manager had broad powers to extend the period. This power to extend was frequently exercised by the manager; there are records of such groups continuing from two to five years or longer. Investment banking firms kept lists of investors, and, whenever they underwrote a security issue, they would go directly to the investors and try to sell them that particular security.

This method of distribution was adequate for the sale of a limited number of security issues to a limited investing public; it was wholly inadequate for a later time when new security issues were to follow each other in rapid succession, since the slowness of distribution of a greatly increased volume of securities required excessively large capital re

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sources on the part of the originating banker and the purchase and banking groups for the purpose of carrying the securities. Accordingly, it is interesting to observe that, as an incident of the long periods of distribution, the investment banker’s “spread,” that is, the difference between the price paid to the issuer for the security and the price received for it from the investing public, was larger during this period than in later years.

Prior to World War I, the United States was a debtor and not a creditor nation. Investment banking firms in this country turned to Europe to find wealthy individuals and other investment bankers who would be willing to share the risk and underwrite the security issues of business enterprises in the United States. European investment banking firms also sold to investors in Europe the securities of American business enterprises. Among some of the European investment banking firms to which Goldman, Sachs & Co. and Lehman Brothers turned to during this period were Kleinwort Sons & Company, Helbert, Wagg & Russell and S. Japhet & Company, all of London, Labouchere Oyens & Company, of Amsterdam, and others in Berlin and Zurich. Goldman, Sachs & Co. had established business relationships with all of these investment banking firms prior to the year 1906, when it was anxious to enter the international banking business in order to be able to furnish its American clients with letters of credit and foreign exchange. All of these contacts became very useful when Goldman, Sachs & Co. entered the investment banking business.

With this background, it is easy to see that many of the issuers, especially those whose securities were not well known to the public, leaned heavily upon the sponsorship of the investment banking firms under whose auspices the securities were sold. Issuers invited partners or officers of investment banking firms to serve on their boards of directors, in order to interest investors in their securities. Some of the prospectuses, which in those early days were little more than notices, stated that a partner or officer of a particular investment banking firm would go on the board of directors of the issuer whose securities were being offered to the public for sale. Investment bankers sometimes asked to be put on the boards of directors of issuers in order to know how they were managed and to protect the interests of the investors to whom they had sold the issuer’s securities. Since the investment bankers sponsored the securities and lent their names to their sale, they felt a certain obligation to the investors to whom they sold the securities to see to it that the issuers did. not adopt any policies or engage in any practices which would impair the value of those securities. This was especially important in connection with foreign investors.

Another development which was to have repercussions later on arose out of the difficulty of obtaining underwriters to share the risk. Thus it was that, prior to World War I, it was not unusual to find officers, directors and shareholders of issuers made participants on original terms in the underwriting of security issues; and investment bankers approached wealthy friends and other moneyed individuals, who were willing to take the risks involved, and asked them to participate. Commercial banks also took participations in substantial amounts.

In the period under discussion, it was common for an investment banker to purchase an entire issue directly from the issuer at a stated price, and that banker alone would sign the purchase contract with the issuer. Generally, the investment banker’s agreement to purchase represented a firm obligation. This investment banker would then immediately organize a larger group, composed of a limited number of investment banking firms, which was sometimes called a “purchase syndicate,” whereby he would, in effect, sub-underwrite his risk by selling the securities which he had purchased alone from the issuer to this larger group, at an increase or “step-up” in

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price. The investment banker who purchased the entire issue directly from the issuer was known as the “originating banker” or “house of issue.” The originating banker became a member and the manager of the “purchase syndicate.” Goldman, Sachs & Co. is said to be one of the first investment banking firms to develop this method of underwriting securities ; and, although this method may have been developed to underwrite the securities of the smaller, less well-known industrial enterprises and of the family concerns which were for the first time launching securities for sale to the public, other investment bankers used the same method to underwrite the securities of large industrial enterprises, railroads and utilities. As business enterprises in this country grew in size, and as the amounts of capital required by these enterprises became larger, sometimes a second group, more numerous than the “purchase syndicate,” would be formed in order to spread still wider the risk involved in the purchase and sale of the securities. The “purchase syndicate” would then sell the securities which it had purchased at an increase in price from the originating banker to this second larger group, which was sometimes called a “banking syndicate,” at another increase or “step-up” in price. The originating banker and the other investment banking firms, which were members of the “purchase syndicate,” usually became members of the “banking syndicate” and the originating banker became its manager. The transfer of the securities to the “purchase syndicate” and then to the “banking syndicate” was practically simultaneous with the original purchase of the securities from the issuer by the originating banker.

Even at a time before there was any delegation of powers to any particular one of the original purchasers, according to the testimony of Harold L. Stuart of Halsey, Stuart & Co., “there was an agreement between the houses to buy them and to sell them and to maintain a price” which was even then called a “public offering price.”

Stuart also described the first syndicate in which his firm participated, which was a $10,000,000 issue of First Mortgage Bonds of the Commonwealth Edison Company in December, 1908. There were two managers who were paid a fixed fee, an equivalent of the present day management fee, and the two managers had broad powers. Sales through the manager pro rata for the accounts of the members of the syndicate and also sales of non-withdrawn bonds on behalf of the syndicate members through dealers and directly to institutions and other buyers were contemplated. Further details appear in the syndicate agreements of certain issues of bonds of the Pacific Gas & Electric Company and United Light & Railways Company in 1912 and 1913.

From all the above it is evident that the various steps which were taken, including use of the purchase and banking groups above described, were all part of the development of a single effective method of security underwriting and distribution, with such features as maintenance of a fixed price during distribution, stabilization and direction by a manager of the entire coordinated operation of originating, underwriting and distributing the entire issue.

This evolution of the syndicate system was in no sense a plan or scheme invented by anyone. Its form and development were due entirely to the economic conditions in the midst of which investment bankers functioned. No single underwriter could have borne alone the underwriting risk involved in the purchase and sale of a large security issue. No single underwriter could have effected a successful public distribution of the issue. The various investment bankers combined and formed groups, and pooled their underwriting resources in order to compete for business. These groups of investment bankers were not combinations formed for the purpose of lessening competition. On the contrary, there could have been no competition without them. Unless investment bankers combined and formed such groups there

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would have been no underwriting and no distribution of new security issues. Perhaps the English system,

1

which seems superior in the view of some, has many advantages. But the investment banking business in America grew and developed and prospered according to an indigenous American pattern.

The most significant fact about the period prior to World War I is that in it will be found the beginnings, the seeds as it were, from which in the course of time and by a gradual and traceable evolution there grew the elaborate and effective modern methods by which investment bankers, skilled in the application of their special techniques, perform the integrated services by which they earn their livelihood.

Thus in these early times we find investment bankers employing trained experts who spend much of their time developing plans and designing the set-ups of issues of securities which will be especially suitable for the needs of a particular issuer, at a particular time and under particular circumstances. We find groups forming for the purposes of competition, sometimes small groups developing into larger ones. And we find the already well developed shaping up of the syndicate system, with features of price maintenance and stabilization and broad powers delegated to the managers in connection with distribution and otherwise, not as a means of merely merchandizing securities, as one would buy and sell hams and potatoes, as suggested by government counsel, but rather as a means of integrating the steps of purchase and distribution necessary to the attainment of the ultimate goal of channeling the savings of investors into the coffers of the issuer as a single unified, integrated transaction. No longer does the issuer bear the risk alone and distribute its securities by agents selling on a commission basis. The pattern of performing a series of interrelated services by the investment banker, including the formulation of the plan and method to be pursued in raising the money, the undertaking of the risk and the distribution of the security issue as a whole, has already emerged.

II. Between World War I and the Securities Act of 1933

The aftermath of the war was a period of over-production and mal-distribution accompanied by a sharp decline in the prices of commodities. A nation at peace could not absorb all the products of an economy, which, but a short time before, had been geared for the effective waging of war. Many business enterprises were faced with the problem of reorganizing in order to get their operations back on a profitable basis. By the year 1923, however, the nation’s economy had recovered from the “commodity or inventory panic,” and business enterprises began to enjoy more prosperous conditions.

In the following decade there was an unprecedented expansion of industrial and business enterprises, an increase in the number and geographical distribution of investors; and the use of the corporate form was adopted more and more widely. As domestic business units increased in size and number, the demands for investment capital reached a magnitude never before experienced. The United States had become a creditor nation; and, for the first time, foreign governments, foreign municipalities and foreign corporations turned to this country to raise capital from private American investors. Those investment banking firms which were dependent upon European capital for their underwriting strength went into eclipse and other banking investment firms came to the fore.

J. P. Morgan & Co. was the leading firm. But all the great publicly owned banks were in the investment banking business, first for their own account and later indirectly through either subsidiary or affiliated corporations formed for the

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purpose. Dillon Read, Lee Higginson, the old Kidder Peabody and Blair appear to have been perhaps the best known names in all-around business. Kuhn Loeb together with J. P. Morgan & Co. were leaders in railroads, in which field older firms such as Speyer, J. & W. Seligman, and Ladenburg Thalmann were also important. Bonbright, Harris Forbes, Halsey Stuart and Coffin & Burr were leaders in public utilities. Lehman and Goldman Sachs were leaders in merchandising and other fields. The largest distributing firms were those particularly connected with the banks, such as National City, Guaranty and Chase. But a number of other banks were active, such as First National, Bankers Trust, the principal banks in Boston, Chicago, Cleveland and Pittsburgh, and others. Among other firms then in existence but appearing less frequently were E. B. Smith, C. D. Barney, White Weld, Blyth Witter, Stone & Webster, Field Glore, Hallgarten and Brown Brothers.

Security issues followed one another in rapid succession and, whereas before World War I an issue of one million dollars was considered large, in the middle 20’s issues of twenty and twenty-five million dollars were by no means unusual.

The impact of these economic forces upon the investment banking industry was precisely what one would have expected. The number of underwriters in the syndicates increased, in order both to spread the risk and to effect a widespread and rapid distribution of the securities to the public. Even so the problems of distribution became so complicated that it became customary to form an additional group called a “selling syndicate” or “selling group.” The new “selling syndicate” was much larger and more widely dispersed than the purchase and banking groups had been.

There were three types of these selling syndicates throughout this period. While they represented successive steps in the development of investment banking, and while there were shifts in the type that was most extensively used, all three were used throughout the 1920’s.

The first type was known as the “unlimited liability selling syndicate.” In this group, each member agreed to take a pro rata share in the purchase of the security issue by the selling syndicate from the previous group, at a stated price, and to take up his share of any unsold securities, which remained in the syndicate at the time of its expiration. The syndicate agreement stated the terms upon which the offering to the public was to be made. Each member was given the right to offer securities to the public, and he received a stated commission on all confirmed sales. However, regardless of the amount of securities which he sold, he still retained his liability to take up his proportionate share of unsold securities. The undivided syndicate combined selling with the assumption of risk; therefore, both houses with distributing ability and houses with financial capacity, but without distributing ability, were included in the syndicate. Usually, a banking group was not organized where this type of selling syndicate was to be used. The purchase group sold the security issue directly to the selling syndicate.

The dealers who did the actual selling of the securities objected to the “unlimited liability selling syndicate,” as they were compelled to take up in their proportionate shares the securities, which the other dealers, who were members of the selling syndicate, were unable to sell. Consequently, the second type of selling syndicate, which was known as the “limited liability selling syndicate,” subsequently was developed. This syndicate operated in much the same manner as the undivided syndicate, except that the obligation of each member was limited to the amount of his commitment, and, when he distributed that amount, he was relieved of further liability. Each member retained his proportionate liability for the costs of carrying the securities, shared in the profits or losses of the trading account, and was liable for

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such other expenses as occurred after the purchase from the purchase or banking group. A banking group was usually organized where the “limited liability selling syndicate” was to be used.

The “limited liability selling syndicate” gradually evolved into the third type of selling syndicate, which was simply known as the “selling group.” The “selling group” differed from the “limited liability selling syndicate” in that its members relieved themselves of all liability for carrying costs, the trading account and other expenses. Each member of the “selling group” was concerned only with expenses connected with the actual retail distribution of securities. The financial liability of the member was restricted to selling or taking up the amount of securities for which he subscribed. Usually, a large banking group was organized where the “selling group” was to be used. The banking group took over the liability for carrying costs, the trading account and other expenses.

The size and makeup of the selling syndicates varied with the circumstances of the particular security issue. Among the important factors, which were considered in the selection of dealers, were the size of the security issue, the type and quality of the security, the size and nature of the class of investors to whom the distribution was to be made, and the ability of a dealer to distribute securities of a particular type. All of these factors were considered in the selection of underwriters and dealers for the formation of the underwriting syndicates and selling groups.

In all of these types of selling syndicates, the members acted as principals, and not as agents of the manager, in distributing securities to the public. The syndicate agreement specified the price at which the securities were to be sold, and it was a violation of the agreement for a member to sell at any other price. The manager traded in the open market during the period of distribution in order to maintain the public offering price. Through such stabilizing operations, the manager sought to prevent any securities, which had been sold by dealers, from coming back into the market in such a manner as to depress the public offering price. It was felt that with respect to the securities which appeared in the market, the members of the selling syndicate had not performed their function of “placing” with investors, for which they were paid a selling commission; and, consequently, “repurchase penalties” were provided for, whereby the manager had the right to cancel the selling commission on the sale of those securities which he purchased in the market at or below the public offering price. Under most agreements, the manager had the option of either cancelling the selling commission on the sale of the securities, or of requiring the member who sold the securities to take them up at their cost to the trading account. Records of the serial numbers of securities were kept, and the securities which appeared in the market were thus traced to the dealers who sold them. Stabilizing operations and the repurchase penalty were used in all of the three types of selling syndicates which prevailed throughout this period. However, where a “selling group” was used, it became more and more common practice to restrict the re-purchase penalty to the cancellation of commissions.

The operations of the “selling syndicate” like those of the pre-war withdrawing subscribers, dealers and selling agents, were directed by the manager whose general supervisory function over the whole machinery of purchase and distribution was continued. Even in the earlier period provisions for maintenance of the public offering price by persons to whom title had passed had been included in some agreements.

As testified by Harold L. Stuart “you simply had to have such a clause in order to make this business function in putting the securities on the market,” because “there were many ways that shrewd people could beat the game and spoil the putting of any security issue on the market unless you did this.”

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A significant development and one quite in keeping with the economic conditions above referred to, is that the periods for distribution became much. shorter than they had been in the period prior to the war. Usually the life of the syndicate was designated as from thirty to sixty days, with a provision for earlier termination or for extension not exceeding a like period by the manager. As a matter of fact, however, the periods of distribution were generally much shorter.

The “market out” clause was evidently developed somewhere in the neighborhood of 1914 or 1915, and its use was fairly general at an early date.

As the amounts of capital required by business enterprises became larger, and the number and size of securities issues greatly increased, the problems with which investment bankers were confronted, in connection with the underwriting of security issues, multiplied. Extensive investigations had to be conducted into the affairs of a business enterprise, and studies made of its financial structure and capital needs, at considerable expense to the investment banker, before that banker would undertake the risk and underwrite the securities of that enterprise. In this connection, investment banking firms were compelled to bring into their organizations individuals who' had new types of specialized knowledge and experience; so that they gradually built up teams of specialists, who were experts in the different fields in which their respective investment banking firms underwrote securities.

Throughout this period prior to 1933, officers and directors of issuers continued to be made participants on original terms in the underwriting of the security issues of those issuers and other moneyed individuals also continued to participate. This was the much criticized “gravy train” about which much was heard in the early stages of the trial. The practice seems to have gradually disappeared in the course of time, due perhaps to the fact that the investment bankers in adequate numbers became available as underwriters and the liability provisions of the Securities Act of 1933 made such opportunities for profit less attractive. In any event, government counsel now agree that this issue is out of the case.

While there were some instances in the earlier period of a purchase by the members of a banking syndicate in severalty, the more usual legal form in which the transfer was made from the issuer to the participating underwriters in the decade now under consideration was a joint or joint and several purchase.

More important than any of the other developments between World War I and the passage of the Securities Act of 1933 was the effect of the unprecedented era of expansion upon the participation of the great banking institutions and their affiliates. As the need for vast amounts of new capital for expansion, plant construction and the establishment of thousands of new enterprises made increasing demands for new money, the banks and their affiliates became increasingly interested in managing and participating in the various underwritings. While the evidence in this case relative to the pre-Securities Act period is far from complete, there is ample documentary evidence to show that many of the banks became directly interested through their bond departments and many others formed affiliates, as above stated. J. P. Morgan & Co., the First National Bank and the Bankers Trust Company and many others in New York City, as well as large banking institutions in Chicago, Cleveland and other cities did a large investment banking business. The National City Company, the Guaranty Company and Chase Securities Corporation, affiliates of the National City Bank, the Guaranty Trust Company of New York and the Chase National Bank were in the investment banking business in a big way. The National City Company as of December 31, 1929, had a capital of $110,000,000. On the same date the capital of the Chase Securities Corporation was over $101,000,000. The economic power of these huge aggregations of

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-capital vis-a-vis the relatively small capital of issuers was a factor of no mean significance in the period just before the great depression. There was an additional leverage in the multiplicity of banking functions which could be placed at the disposal of issuers. Added to this was the vast influence and prestige which must have made itself felt in a variety of ways. Issuers were dependent upon these great banking institutions in a way which finds no parallel in the relations between issuers and investment bankers in the period subsequent to the passage of the Banking and Securities Acts.

Before it became necessary by law to choose between commercial banking on the one hand and investment banking on the other, many of these great banking institutions were private banking houses under no statutory duty to make the disclosures required of national banks and others and this, coupled with the lack of legal requirements for disclosure of relevant facts connected with security issues, helped to make the period under discussion what has been described in the trial as an era of “dignity and mystery.”

In such an atmosphere it seems altogether probable that, wholly in the absence of any conspiratorial combination, issuers felt a strong inclination to continue to bring out issue after issue with the same bankers. Indeed, it is probably not too much to say that many issuers took pride and satisfaction from the very circumstance of their connection with these giants of American finance. Such sponsorship of an offering of securities to the public was of real value.

In any event, these great banking institutions and their affiliates were doing a huge investment banking business, and they were using the money of their depositors as well as their own resources-to underwrite one security issue after another.

Some of the evidence which goes back to this earlier period leads to the suspicion that with reference to one or two particular issuers there may have developed some arrangement or combination of participants, continuing throughout a number of successive issues, which might, taken in isolation and separately, have constituted violations of the Sherman Act. At this late date, after practically all of those personally concerned have died and the files and other documentary evidence are no longer available, no adjudication of the legality of such isolated transactions is possible, nor is such adjudication requested by the government. Some references have been made in the evidence to contracts with a few issuers by which an investment banker was given “preferential rights”; and Harold L. Stuart testified that he tried to get such contracts whenever he could. They seem to have been ineffectual, however, and have long since gone out of use, due at least to some extent to the disapproving attitude of the SEC. In any event, I cannot find that they were sought or used to any extent by the defendants in this case.

III. Further Developments 1933-1949

Following the Armstrong Insurance investigation

1

in 1905 and Governor Hughes’ Committee Report in

1909

2

there had been other investigations which covered activities of investment bankers. The Pujo investigation

3

was conducted in 1912 and 1913, the Utility Corporation inquiry by the Federal Trade Commission

4

started in 1928; and

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these were followed by a long series of hearings, under the auspices of various committees of the Congress, which resulted in the Banking Act of 1933

5

(known also as the Glass-Steagall Act), the Securities Act of 1933

6

and the Securities Exchange Act of 1934.

7

From December 10, 1931 through February 1932 the Senate Committee on Finance pursuant to the Johnson Resolution

8

undertook to investigate the flotation of foreign bonds and other securities in the United States. Perhaps the most important of these investigations was the Gray-Pecora investigation of the Senate Committee on Banking and Currency

9

which began on April 11, 1932 and continued through May 4, 1934.

In this chronological survey of the history and development of the investment banking business it will suffice to say that these statutes, together with the Public Utility Holding Company Act of 1935

10

and the Maloney Act,

11

effective June 25, 1938, which added Section 15A to the Securities Exchange Act of 1934, and authorized the organization of the National Association of Securities Dealers, Inc. (NASD), under the supervision of the SEC, which followed, effected changes of the most radical and pervasive character; and these changes were made with a complete and comprehensive understanding by the Congress of current methods of operation in common use in the securities issue business, such information having been made available in the course of the investigations to which reference has just been made.

Institutions which had previously engaged both in commercial and deposit banking on the one hand and investment banking on the other were required to elect prior to June 16, 1934, which of the two functions they would pursue to the exclusion of the other. This resulted in the complete elimination of the commercial banks and trust companies from the investment banking business; and the various bank affiliates were dissolved and liquidated.

The elaborate procedures which now became necessary in connection with the sale of new issues of securities were at first implemented by the Federal Trade Commission and then, upon the creation of the Securities and Exchange Commission, transferred to it. The regulation of the securities business which followed with such salutary and beneficial results has been one of the significant developments of our time. The era of “dignity and mystery" was over.

When we come to discuss the syndicate system and its operation, it will be appropriate to treat in some detail the various applicable provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934, with their respective amendments, and also the numerous regulations, interpretations and releases of the SEC relative thereto. For the sake of continuity and clarity, however, this brief recital of the development of the investment banking business will be continued in order to furnish general background.

Security issue financing was relatively inactive as the result of the great depression, up until about the end of 1934. Thereafter, except for an occasional falling off in the depression of 1937 and in

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the early years of World War II, the needs of industry kept the demand for new capital at a high level. The reduction of interest rates as the result of government manipulation brought about refundings on a large scale and further refundings continued in volume as interest rates continued to fall.

The size of issues increased. An issue of $5,000,000 was considered small. In this period there were 155 issues of $50,-000,000 and larger; 559 issues of $20,-000,000 and larger and over 1,000 issues of $10,000,000 and larger.

Due largely to the impact of the income and inheritance tax laws, the importance of the individual as an investor diminished and there was an extraordinary and continued growth in the size and investment needs of large institutional investors such as life and casualty companies, savings banks, investment trusts, pension funds, universities, hospitals and fraternal orders.

Perhaps the most significant change of all was caused by the withdrawal from the field of investment banking of the capital funds of the commercial banks and their affiliates, which had previously been among the foremost managers and underwriters of security issues. As already stated, investment banking firms could participate in and manage under-writings only with their own money. As of the end of 1949 only 7 of the defendant firms had a capital of 5 million dollars and larger, 8 a capital of between 2 and 5 millions and 2 a capital of between 1 and 2 millions. Nor could any of them use all of their capital or borrowing power for underwritings, as each was engaged in other activities which tied up a part of their capital funds and they were all subject to certain regulations of the SEC and the various exchanges which promulgated rules and regulations affecting the amount of capital available for underwriting.

The Revenue Act of 1932, which became effective on June 22, 1932, for the first time imposed a tax on the transfer of bonds, Sec. 724, 47 Stat. 274 , 26 U.S.C.A. Int.Rev. Acts, p. 634. A transfer tax on stocks had previously been enacted in 1914; but in 1932 this tax was greatly increased in amount, Sec. 723, 47 Stat. 272 , 26 U.S.C.A.Int.Rev. Acts, p. 630. Section 11 of the Securities Act of 1933 imposed on each underwriter a civil liability, for any omission or misstatement of a material fact in the registration statement, equal to the entire amount of the issue. By later amendment in 1934, Title II, Sec. 206 (d) of the Securities Exchange Act of 1934, this liability was changed to “the total price at which the securities underwritten by him and distributed to the public were offered to the public.” 15 U.S.C.A. § 77k(e). The liability thus defined plus the transfer taxes made it necessary for the underwriters to abandon the purchase of security issues jointly or jointly and severally, and resulted in the purchase by the various underwriters in severalty, which has been the prevailing method ever since. Otherwise an underwriter might still be liable under Section 11 of the Securities Act of 1933, as amended, for the entire amount of the issue. Significantly, since the 1933 Act, the underwriters still frequently take title jointly or jointly and severally when the security is a municipal or other issue not subject to the Securities Act of 1933.

The old banking and purchase syndicates with the “step-up” of earlier days which had been gradually going out of vogue, now completely disappeared. The form in which underwriting transactions commonly took place from the passage of the Banking and Securities legislation up to the present time is that of a purchase or “underwriting agreement” between the issuer and the underwriters represented by the manager, and an “agreement among underwriters.”

The substance of the entire transaction is substantially what it was before. The manager, like the originating banker or manager in the previous periods, handles the negotiations with the issuer-and supervises the whole process of underwrit

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ing and distribution. The management fee of today is not a new development either in form or in purpose after the Securities Act of 1933, but is the direct equivalent of the management fee paid by the members of the syndicate to the manager for his services in pre-1933 financings, where the syndicate either purchased directly from the issuer or from a prior “original purchaser.”

Dealer and group sales are still made, under the authority of the manager who directs the entire process of distribution. But the change in the character of the investing public and especially the development of institutional investors on such a large scale and the impact of regulation by the SEC and of the Securities Act of 1933, the Securities Exchange Act of 1934 and the organization and functioning of the NASD, brought about a gradual decrease in the use of selling group agreements, especially in issues of the higher grades of debt financing and preferred stock. It is worthy of note that in performing his function of making sales for the accounts of the underwriters both to dealers and to institutions the manager sells “out of the pot.” In other words, he does not allocate particular bonds to particular underwriters but simply sells “bonds” and does not allocate numbers to any participant until the time comes for delivery of securities to the purchasers.

In accordance with the trend of the previous period spreads are gradually becoming smaller and smaller; and the maximum life of the syndicates is now 15, 20 or 30 days, although in some cases the maximum period may be longer, and it is not unusual to find clauses authorizing the manager to extend the period with or without the consent of a certain proportion of the underwriters. Price restrictions may, however, be removed earlier than the actual termination date of the syndicate, and as a practical matter they are generally terminated within a few days after the offering.

Stabilization provisions have become commonplace pursuant to statutory provisions and administrative regulations and interpretations relating to their use. While the authority to stabilize is generally given, it is only in relatively few cases that the authority has been exercised.

The use of “penalty clauses” has varied and the same is true of the use of price maintenance clauses. This subject will be discussed in greater detail when we come to the portion of this opinion devoted to syndicates. But it is well to bear in mind throughout that the entire pattern of the statutory scheme above referred to, as implemented by the various rules and regulations of the SEC and the rules of Fair Practice of the National Association of Securities Dealers, Inc., approved by the SEC pursuant to legislative authority, contemplates the sale of each security issue at the public offering price proposed in the prospectus and set forth in the registration statement as finally made effective by the SEC. Having proposed and tendered a security issue to the public at the public offering price, it is not strange that those who propose to sell the entire issue at this public offering price should be required to make a bona fide attempt to do so.

1

Otherwise, the elaborate statutory provisions relative to “the public offering price” would be meaningless. Nor, under these circumstances, should one wonder that some investment banking houses continued to use price maintenance clauses while others did not.

In the previous period a few issues were brought out by public sealed bidding and there were some private placements. In the present period public sealed bidding transactions very greatly increased due to the adoption by the SEC in 1941 of Rule U-50, in connection with all security transactions of companies affected by the Public Utility Holding Company Act of 1935 and to the ruling in 1944 of the Interstate Commerce

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Commission, requiring all debt issues railroads to be sold at public sealed bidding. of

Due in part to the registration provisions of the Securities Act of 1933, but also in large measure to the increase in the number of institutional investors and their particular requirements, private placements grew by leaps and bounds.

In 1937 the $48,000,000 Convertible 3%s of the Bethlehem Steel Corporation which came out on September 8, 1937 and the $44,244,000 issue of 5% Convertible Preferred Stock of the Pure Oil Company on September 3, 1937 were conspicuously unsuccessful and many of the underwriters suffered serious embarrassment. Repercussions were felt throughout the entire investment banking industry; and thereafter the number of underwriters in practically every syndicate was largely increased in order to spread the risk more widely.

The period 1933-1949 is the critical period in this case, as it includes the years immediately prior to the filing of the complaint in October, 1947.

Fortunately, there is in the record accurate and complete stipulated data with respect to every relevant security issue in the United States from July 26, 1933 to December 31, 1949. The Issuer Summaries, in two volumes, give the name of the issuer, the date of the offering, the description of the issue, the type of transaction, the number of underwriters and whether defendants or non-defendants, the name of the manager or co-managers, contemplated gross spread and certain other information relative to secondaries. The Issue Data Sheets for all underwritten issues of $1,-000,000 or more, in the fifteen year period 1935-1949, give all the information and particulars concerning the names and positions of the participants, a breakdown of the contemplated gross spread and so on. Public Sealed Bidding Sheets, which are to be read together with the Issue Data Sheets, set forth the names of the managers of the winning and losing accounts, whether defendants or non-defendants, and the names of the defendant firms who were participants therein. This permits statistical analysis of the entire period. With respect to the period prior to July 26, 1933, Pre-Securities Act Issuer Summary Sheets, containing further stipulated data, whenever available, are in evidence and give the necessary background applicable to all issuers whose various security issues touch controverted issues of fact in the case.

1

New if any of the documents in evidence can be properly understood except with reference to the detailed information thus stipulated. Here is an indisputable record of what the defendant firms did as distinguished from mere scraps and fragments of miscellaneous documents containing surmise, conjecture and the thoughts of some who were scarcely in a position to define or implement firm policies. To make matters worse, casual memoranda are subjected by government counsel to critical analysis, such as might be applied to deeds or wills or other documents prepared by lawyers, using technical, closely integrated words of art. Had this complete and accurate static data been available to the government before the suit was brought I gravely doubt that the action would have been filed.

In this last and final period the Securities and Banking Acts, the numerous and detailed rules and regulations of the SEC, the multiplicity of forms, prospectuses and registration statements which were required to be prepared and filed, and the organization and operation of the NASD, all had a profound effect upon the investment banking business. But none of these developments altered the basic function of the syndicate operation as

a

unitary, integrated means of underwriting and distributing a security issue, under the direction of a manager.

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This remained fundamentally the same as it was in the beginning. Such changes as had taken place from first to last were the normal and natural reactions of business men with common problems, to the course of economic events and the legislation which has been described.

IV. How the Investment Banker Functions

It was extremely difficult, in the midst of the conflicting statements of counsel and the welter of miscellaneous documents which followed one another into the record without witnesses to describe the attendant circumstances, to get any adequate grasp of just what investment bankers did. Finally, when Harold L. Stuart of Halsey Stuart & Co. was called as a government witness and remained on the witness stand for many months the light began to dawn. I watched him closely for many weeks, asked questions which were designed to test his forthrightness and credibility and checked his testimony with the utmost care against many of the documents already in evidence and much of the testimony taken by deposition, which had already been read into the record. I became convinced that this man, who probably knows as much if not more about the investment banking business than any other living person, was a man of complete integrity upon whose testimony I could rely with confidence.

Thereafter, and with the consent and approval of counsel for all parties, I went with counsel for both sides to the office of Halsey Stuart & Co. and watched one of the large issues “go through the hopper.” I examined the bundles of securities, the tickets and slips from which the various book entries were to be made, watched the deliveries and snooped into every nook and cranny of what was going on. This was all done with the understanding that anything that occurred would be placed upon the record if anyone so desired; and, with a similar understanding, the greater part of two weeks was spent in my chambers with Stuart and various assistants and members of his staff going over every aspect and practically every document connected with two typical security issues from beginning to end. One was a negotiated underwritten issue and the other an issue brought out at public sealed bidding. Neither of these issues had any relation whatever to this case and nothing of a controversial character was included. But the result was that for the first time I felt possessed of the necessary background, and could thereafter, with a modicum of assurance, interpret and assess the probative value of the documents which constituted the greater part of plaintiff’s proof. As Stuart continued to testify as a witness for many weeks thereafter, the facts relative to the actual operation of the investment banking business were fully developed in the record.

The types of issues, methods of raising money and the general apparatus of finance which I am about to relate are the ABC’s of investment banking, known to every investment banker but not to others.

The problem before an issuer is in no real sense that of selling a commodity or a manufactured article. In essence what the issuer wants is money and the problem is how and on what terms he can get it. Basically, it is simply a question of hiring the money.

Thus a knowledgeable issuer, and most of them are definitely such, will scan the possibilities, which are more numerous than one might at first suppose.

The available types of transactions include many which may be consummated by the issuer without using any of the services of an investment banker. In other words, the raising of a particular sum may be engineered and consummated by the executive or financial officers of an issuer according to a plan originated and designed by them; and this may be done after prolonged collaboration with one or more investment bankers, whose hopes of being paid for the rendition of some sort of investment banking services never reach fruition.

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Thus the necessary funds may be raised by:

1. A direct public offering by the issuer without an investment banker.

2. A direct offering to existing security-holders without an investment banker.

3. A direct private placement without an investment banker.

4. A public sealed bidding transaction without the assistance of an investment banker.

5. Term bank loans, commercial mortgage loans, leasebacks and equipment loans by commercial banks, life insurance companies and other institutions.

Where the services of an investment banker are used, the typical transactions are even more varied. The principal ones are:

1. A negotiated underwritten public offering.

2. An underwritten public offering awarded on the basis of publicly invited sealed bids, an investment banker having been retained on a fee basis to shape up the issue.

3. A negotiated underwritten offering to existing security-holders. Here the investment banker enters into a commitment to “stand by” until the subscription or exchange period has expired, at which time the investment banker must take up the securities not subscribed or exchanged.

4. An underwritten offering to existing security-holders awarded on the basis of publicly invited sealed bids, an investment banker having been retained on a fee basis to render the necessary assistance.

5. A non-underwritten offering to existing security-holders, with an investment banker acting as agent of the seller on a negotiated basis.

6. A private placement with an investment banker acting as agent of the seller on a negotiated basis.

There are many and sundry variations of the types of transactions just described, depending on the designing of the plan, the amount of risk-taking involved and the problems of distribution; and these variations are reflected in the amount of compensation to be paid to the investment banker, which is always subject to negotiation. And it is worthy of note that, where the services of an investment banker are availed of in the preparation of an issue for publicly invited sealed bids, then pursuant to SEC, ICC and FPC rulings, the investment banker who has rendered financial advisory services for a fee cannot bid on the issue.

Moreover, the static data reveal numerous instances where combinations of these types of transactions are used. The avenues of approach to the ultimate goal of hiring the money on the most advantageous terms, and in ways peculiarly suited to the requirements of the particular issuer at a given time and in a certain state of the general securities market, are legion. And issuers, far from acting in isolation, are continually consulting and seeking advice from other qualified financial advisers such as their commercial bankers and others.

Sometimes an issuer knows pretty well in advance which type of transaction it wishes to use. More often this is not determined until every angle has been explored. In either event, the methods to be followed present a complex series of possibilities, many of which involve intricate calculations of the effective cost of the money and a host of otlfer features affecting the capital structure of the issuer, plans for future financing, problems of operation of the business and so on.

Generally the money is needed for a special purpose at a particular time, which may or may not be determined at the will of the issuer. Examples are: for expansion, the building of a new plant, the purchase of existing facilities, the scrapping of one set of elaborate and costly machines and their replacement by others more efficient and up-to-date, or for refunding. Often it is deemed important by the ■ management that there

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be a wide distribution of the securities or that they be placed with investors in a particular geographical locality or among those who utilize the services of the issuer or purchase its products. When good will is involved or favorable treatment of existing security-holders is desired, the issuer may have sound reasons for not wishing to obtain the highest possible price for the issue.

If a given type of transaction is tentatively selected, the issuer has before it an almost infinite number of possible features, each of which may have a significant bearing on the attainment of the general result. The method to be pursued may be through an issue of bonds or preferred or common stock or some combination of these. If a debt issue is contemplated there are problems of security and collateral, debentures or convertible debentures, serial issues, sinking fund provisions, tax refund, protective and other covenants, coupon rates and a host of other miscellanea which may affect the rating (by Poor’s or Moody’s, Fitch or Standard Statistics), or the flexibility necessary for the operation of the business and the general saleability of the issue in terms of market receptivity. These details must each be given careful consideration in relation to the existing capital structure and plans for the future. If equity securities seem preferable on a preliminary survey, the available alternatives are equally numerous and the problems at times more vexing. What will do for one company is not suitable for another, even in the same industry. At times prior consolidations and reorganizations and an intricate pattern of prior financing make the over-all picture complicated and unusually difficult. But in the end, sometimes after many months of patient effort, just the right combination of alternatives is hit upon.

The actual design of the issue involves preparation of the prospectus and registration statement, with supporting documents and reports, compliance with the numerous rules and regulations of the SEC or ICC or FPC and the various Blue Sky Laws passed by the several States. In view of the staggering potential liabilities under the Securities Act of 1933 this is no child’s play, as is known only too well by the management of issuers.

This hasty and far from complete recital of available alternatives will suffice to indicate the milieu in which the investment banker demonstrates his skill, ingenuity and resourcefulness, to the extent and to the extent only that an issuer wishes to avail itself of his services. It is always the hope of the investment banker that the issuer will use the full range of the services of the investment banker, including the design and setting up of the issue, the organization of the group to underwrite the risk and the planning of the distribution. If he cannot wholly succeed, the investment banker will try to get as much of the business as he can. Thus he may wind up as the manager or co-manager, or as a participant in the group of underwriters with or without an additional selling position; or he may earn a fee as agent for a private placement or other transaction without any risk-bearing feature. Or someone else may get the business away from him.

Thus we find that in the beginning there is no “it.” The security issue which eventuates is a nebulous thing, still in futuro. Consequently the competition for business by investment bankers must start with an effort to establish or continue a relationship with the issuer. That is why we hear so much in this case about ingenious ways to prevail upon the issuers in particular instances to select this or that investment banking house to work on the general problem of shaping up the issue and handling the financing. This is the initial step; and it is generally taken many months prior to the time when it is expected that the money will be needed. It is clear beyond any reasonable doubt that this procedure is due primarily to the wishes of the issuers; and one of the reasons why issuers like this form of competition is that they are

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under no legal obligation whatever to the investment banker until some document such as an underwriting agreement or agency contract with the investment banker has actually been signed.

Sometimes an investment banking house will go it alone at this initial stage. At times two or three houses or even more will work together in seeking the business, with various understandings relative to the managership or co-managership and the amount of their underwriting participations. These are called nucleus groups. Occasionally one comes across documents pertaining to such nucleus groups which seem to contemplate the continuance of the group for future business, only to find that in a few weeks or less the whole picture has changed and some realignment of forces has taken place.

The tentative selection of an investment banker to shape up the issue and handle the financing has now been made; and there ensues a more or less prolonged period during which the skilled technicians of the investment banker are working with the executive and financial advisers of the issuer, studying the business from every angle, becoming familiar with the industry in which it functions, its future prospects, the character and efficiency of its operating policies and similar matters. Much of this information will eventually find its way in one form or another into the prospectus and registration statement. Sometimes engineers will be employed to make a survey of the business. The investment banker will submit a plan of the financing, often in writing; and this plan and perhaps others will be the subject of discussions. Gradually the definitive plan will be agreed upon, or perhaps the entire matter will be dropped in favor of a private placement, without the services of an investment banker. Often, and after many months of effort on the part of the investment banker, the issuer will decide to postpone the raising of the money for a year or two.

In the interval between the time when the investment banker is put on the job and the time when the definitive product •begins to take form, a variety of other problems of great importance require consideration. The most vital of these, in terms of money and otherwise, is the timing of the issue. It is here, with his feel and judgment of the market, that the top-notch investment banker renders what is perhaps his most important service. The probable state of the general security market at any given future time is a most difficult thing to forecast. .Only those with ripe trading experience and the finest kind of general background in financial affairs and practical economics can effectively render service of this character.

At last the issue has been cast in more or less final form, the prospectus and registration statement have been drafted and decisions relative to matters bearing a direct relation to the effective cost of the money, such as the coupon or dividend rate, sinking fund, conversion and redemption provisions and serial dates, if any, are shaped up subject to further consideration at the last moment. The work of organizing the syndicate, determining the participation positions of those selected as underwriters and the making up of a list of dealers for the selling group or, if no selling group is to be used, the formulation of plans for distribution by some other means, have been gradually proceeding, practically always in consultation with the issuer, who has the final say as to who the participating underwriters are to be. The general plans for distribution of the issue require the most careful and expert consideration, as the credit of the issuer may be seriously affected should the issue not be successful. Occasionally an elaborate campaign of education of dealers and investors is conducted.

Thus, if the negotiated underwritten public offering route is to be followed, we come at last to what may be the parting of the ways between the issuer and the investment banker — negotiation relative to the public offering price, the spread and the price to be paid to the issuer for the securities. These three

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are inextricably interrelated. The starting point is and must be the determination of the price at which the issue is to be offered to the public. This must in the very nature of things be the price at which the issuer and the investment banker jointly think the security can be put on the market with reasonable assurance of success; and at times the issuer, as already indicated in this brief recital of the way the investment banker functions, will for good and sufficient reasons not desire the public offering price to be placed at the highest figure attainable.

Once agreement has been tentatively reached on the public offering price, the negotiation shifts to the amount of the contemplated gross spread. This figure must include the gross compensation of all those who participate in the distribution of the issue: the manager, the underwriting participants and the dealers who are to receive concessions and re-allowances. Naturally, the amount of the spread will be governed largely by the nature of the problems of distribution and the amount of work involved. The statistical charts and static data indicate that the amount of the contemplated gross spreads is smallest with the highest class of bonds and largest with common stock issues, where the actual work of selling is at its maximum. While no two security issues are precisely alike and they vary as the leaves on the trees, it is apparent that the executive and financial officers of issuers may sit down on the other side of the bargaining table confidently, and without apprehension of being imposed upon, as data relating to public offering prices, spreads, and net proceeds to issuers from new security issues registered under the Securities Act of 1933 are all public information which are publicized among other means by the wide distribution of the prospectuses for each issue.

And so in the end the “pricing” of the issue is arrived at as a single, unitary determination of the public offering price, spread and price to the issuer.

With public sealed bidding issues the whole procedure is radically different. The issue is designed and shaped up by the management of the issuer, with or without the services of an investment banker. As the problems of distribution are not the same, due particularly to the high quality of the securities generally involved, their sale in bulk to institutional investors, and the fact that, as no one knows in advance who the successful bidder will be, there is no time available for preparing the market or setting up any elaborate distribution machinery, the formation of the underwriting group follows a different pattern; and the issuer is not concerned with the public offering price but only with receiving the highest amount bid for the issue. However, when the participating underwriters in a public sealed bidding account confer at their “price meetings” before agreeing upon the amount of the bid to be submitted on their behalf by the manager, they first make up their minds on the subject of the price at which they think the entire issue can be sold to the public.

After the bids are opened, and without reference to the issuer, the underwriters in the winning account promptly decide among themselves the public offering price, the method of sale and the amount of any concessions or allowances. The difference between the bid price and the public offering price thus arrived at is the spread or anticipated gross compensation of the participants and the manager.

This very brief outline has been telescoped into bare essentials by way of general background. As a matter of fact no two security issues present quite the same problems; some are relatively simple and follow somewhat standardized lines, especially in many public sealed bidding transactions. The methods and practices of the various defendant investment banking firms vary greatly. The competitive pattern of the different firms will be found to depend largely on the background, the personnel and matters of policy peculiar to each firm. But

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one thing stands out. ■ This record has not revealed a single issuer which can fairly be said to be the “captive” of any or all or any combination of these seventeen defendant firms. The reason why private placements of new debt issues, with or without the services of an investment banker, increased from 14% of the total of all such issues in 1936 to 73% of the total of all such issues in 1948, is because the issuers were free to choose and did choose to use this type of transaction to raise the funds they needed, rather than to go by the negotiated underwritten route or any of the others which were available. And it is equally clear that, although there has never been any rule, regulation or statutory or other law preventing issuers from resorting of their own free choice to public sealed bidding as a means of raising capital, issuers have done so only in rare and exceptional eases, unless compelled to resort to public sealed bidding by the mandate of the SEC or the ICC or some state regulatory body having jurisdiction.

PART II

The Seventeen Defendant Investment Banking Firms

The last but far from the least important feature of the background of the case concerns the origin, organization, personnel and general competitive pattern of each of the defendant investment banking houses. Without a clear understanding of the significant differences between them, and the circumstances under which they were formed and developed their respective policies and ways of doing business, it is futile to attempt any rational appraisal of the documents which form the bulk of the government’s case. Here again one must bear in mind that the facts about to be described are all matters of common knowledge throughout the investment banking industry. Letters, reports and memoranda are interpreted and understood by investment bankers in the light of these facts. The descriptions of the various firms will follow the order in which their names appear in the complaint.

1. Morgan Stanley & Co.

On July 1, 1871, Francis A. Drexel, Anthony J. Drexel and J. Pierpont Morgan, with others, formed a co-partnership for the transaction of a general foreign and domestic banking business under the firm names of Drexel Morgan & Co. in New York and Drexel & Co. in Philadelphia. Following the death of Anthony J. Drexel in the year 1893, the co-partnership of Drexel & Co. (Philadelphia) and Drexel Morgan & Co. (New York) expired on December 31,1894, and the partners thereof, on the same day, formed a co-partnership for the transaction of a general foreign and domestic banking business under the firm names of J. P. Morgan & Co. in New York and Drexel & Co. in Philadelphia. The partners of Drexel Morgan & Co. and of J. P. Morgan & Co. were at all times partners of Drexel & Co., but, from about the year 1910, certain persons possessed the authority of partners in Drexel & Co., who were not partners of J. P. Morgan & Co. This Drexel & Co. is not the same investment banking firm as the Drexel & Co. which is a defendant in this case.

J. P. Morgan & Co. was, at the time that the Banking Act of 1933 was enacted on June 16, 1933, a private banking firm, engaging in what was known as a private banking business. This included investment banking, deposit banking, and other kinds of commercial banking and letter of credit business, both foreign and domestic. The important investment banking business of J. P. Morgan & Co. was conducted on a wholesale basis, as J. P. Morgan & Co. had no distributive facilities for securities. It had only one office in New York City, and no branches or offices elsewhere, excepting the office which was maintained in Philadelphia by Drexel & Co., which was regarded as the “Philadelphia end of J. P. Morgan & Co.” J. P. Morgan & Co. was not a departmentalized firm,

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but mingled its commercial and investment banking activities. Among the partners who have been shown in the record to have engaged in investment banking work were George Whitney, Thomas W. Lamont, Arthur M. Anderson, William Ewing and Harold Stanley.

On or about June 16, 1934, J. P. Morgan & Co. elected to cease engaging in the investment banking business, and chose to remain a bank of deposit, in compliance with the provisions of the Banking Act of 1933, which required the separation of commercial and investment banking to be effected by June 16, 1934. J. P. Morgan & Co., in effect, discontinued its investment banking activities on or about June 16, 1933, the date upon which the Banking Act of 1933 was enacted, with the exception of one or two security issues. The investment banking business of J. P. Morgan & Co., therefore, simply ceased to be. By the time that Morgan Stanley & Co. Incorporated, commenced business, the investment banking business of J. P. Morgan & Co. had been discontinued, as a practical matter for approximately two and one-half years, and, absolutely, for approximately one and one-half years.

Morgan Stanley & Co. Incorporated, was organized pursuant to a decision made by some of the partners of J. P. Morgan & Co. to resign from that firm and to form another investment banking organization. The first discussions within J. P. Morgan & Co. concerning a new investment banking organization were had in June and July, 1935, as the securities market was opening up, and the final decision to organize Morgan Stanley & Co. Incorporated, was made around the middle or 20th of August, 1935. Various alternatives were examined and abandoned before the ultimate form of organization was decided upon. There was some thought of using the Drexel name, but difficulty arose with the heirs of the Drexel Estate. Another plan considered was the formation of a company to be known as Ewing & Co., which would have small capital, and would not underwrite but only give financial advice, but this plan was abandoned as unsound.

Morgan Stanley & Co. Incorporated, was organized on September 6, 1935, under the laws of the State of New York, and commenced business on September 16, 1935. Certain of the partners and employees of J. P. Morgan & Co., and certain of those persons who possessed the authority of partners in Drexel & Co., most of whom were active in the investment banking business of those firms, withdrew from those firms and formed the new organization. Of the then seventeen partners of J. P. Morgan & Co., Harold Stanley, Henry S. Morgan and William Ewing resigned; and, at. about the same time, there also resigned from J. P. Morgan & Co. certain employees, namely, John M. Young, who was-head of the Bond Department, Allen. Northey Jones, who was head of the-Statistical Department, and Archer M. Vandervoort. These men, together with. Perry E. Hall and Edward H. York, Jr., who at that time possessed the authority of partners in Drexel & Co., organized the new Morgan Stanley & Co. Incorporated. On February 13, 1936, Alfred Shriver became an officer and a director of Morgan' Stanley & Co. Incorporated, and, on October 19, 1936, Sumner B. Emerson became an officer and a director. The previous association of both of these-men had been principally with the Guaranty Trust Company of New York or its securities affiliate, the Guaranty Company.

On September 16, 1935, when Morgan. Stanley & Co. Incorporated, commenced business, Harold Stanley was president, William Ewing was executive vice-president, Henry S. Morgan was treasurer and secretary, and each of these three men was a director. Prior to December 31, 1927, when Harold Stanley became a partner in J. P. Morgan & Co., he had! been an employee and subsequently vice-president of the Guaranty Trust Company of New York from 1915 to 1927, and. president of the Guaranty Company from. 1921 to 1927; and prior to the time that William Ewing became a partner in J..

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P. Morgan & Co., he had been an employee of N. W. Harris & Co. and subsequently of the Harris Trust & Savings Bank from 1906 to 1916, and an employee of J. P. Morgan & Co. from 1916 to 1927.

On or about September 16, 1935, all of the common (voting) stock of Morgan Stanley & Co. Incorporated, was owned entirely by stockholders who were both officers and directors, with the exception of Allen Northey Jones, who was an officer but not a director. Allen Northey Jones, however, became a director on February 13, 1936. Alfred Shriver and Sumner B. Emerson became common stockholders of Morgan Stanley & Co. Incorporated, shortly after their employment as officers and directors. On September 18, 1935, Morgan Stanley & Co. Incorporated, issued $7,000,000 (70,000 shares) of preferred (non-voting) stock, of which $400,000 (4,000 shares) was purchased by two officers of Morgan Stanley & Co. Incorporated, namely, Henry S. Morgan and William Ewing, and of which the remaining $6,600,000 (66,-000 shares) was purchased by nine partners of J. P. Morgan & Co. In 1936, Harold Stanley acquired $100,000 (1,-000 shares) of preferred (non-voting) stock, pursuant to an option dated September 18, 1935.

On or about November 28, 1941, Morgan Stanley & Co. Incorporated, adopted a plan of liquidation. On December 5, 1941, all of the outstanding preferred (non-voting) stock was redeemed and cancelled pursuant to the plan of liquidation which was completed on December 23, 1941. Morgan Stanley & Co., the partnership, was formed on December 16, 1941, and it is this partnership, apart from certain withdrawals and additions, which is a defendant in this case. The corporation was dissolved and the partnership formed by the former common stockholders in order, among other reasons, to qualify Morgan Stanley & Co. for membership on the New York Stock Exchange, and to enable William Ewing to retire from active participation while becoming a limited partner.

When Morgan Stanley commenced business on September 16, 1935, it set up an entirely new office at No. 2 Wall Street, and organized an entirely independent staff. Morgan Stanley never conducted business in the premises of J. P. Morgan & Co., but moved into its own office the day it opened for business. Morgan Stanley and J. P. Morgan & Co. remained thereafter as distinct, independent and autonomous firms. Morgan Stanley & Co. Incorporated, did, however, conduct closings of its underwritings, that is, the payment for and the delivery of securities, on the premises of J. P. Morgan & Co. very often until the year 1941, and, thereafter, the current partnership “generally” conducted its closings in the same place. Morgan Stanley paid a fee to J. P. Morgan & Co. in connection with each closing. No legal succession or privity of title existed as between Morgan Stanley and J. P. Morgan & Co. There was no devolution of any kind from one to the other. Morgan Stanley was run by its common stockholders as an independent, separate business, without consultation with J. P. Morgan & Co., although casual talks may have occurred.

Morgan Stanley was a conspicuously small organization when it first opened for business, and it has remained, to this day, a small organization. It had only one office when it first opened for business, and still has only one; it had only seven common stockholders when it first opened for business, and it does not have many more partners today. When the new organization commenced business, it immediately proceeded to try to obtain business from whatever source it could, and, in this connection, it made every kind of new business effort that its executives could think of. It broadcast announcements of its formation; compiled studies of outstanding securities that might be refunded at a saving; its personnel took turns calling on various people throughout the country; and they called on banks and asked them,

*658

if they knew of any business that might be done, to remember that Morgan Stanley was in business.

Morgan Stanley was a new organization for the underwriting and wholesaling of investment securities, and it confined its activities entirely to underwriting and wholesaling. Morgan Stanley started out exclusively as a wholesale organization, underwriting and selling to dealers, and from the beginning made no effort to build up an organization for the handling of distribution. It was not until some time in May, 1941, that it began to retail securities. Morgan Stanley has done primarily a high-grade bond business, but it has also managed issues of common and preferred stock. Unlike some of the other defendant firms, Morgan Stanley did no business in equipment trust certificates, and there is no evidence that it did any business in municipals. It has sought the managership of security issues, rather than participations in underwriting syndicates, and, consequently, has been in a position where other investment banking firms have sought from it participations in underwriting syndicates which it has formed and managed. Morgan Stanley was opposed to competitive bidding and did not participate in competitive bidding before it was made compulsory by Rule U-50, which became effective on May 7, 1941, as to the securities of public utility companies which were subject to the Public Utility Holding Company Act of 1935.

2. Kuhn Loeb & Co.

The partnership of Kuhn Loeb was founded in New York City in 1867, and has continued as such ever since. There is no problem of successorship, as the firm elected to eliminate its private banking functions on or prior to the date fixed by the Glass-Steagall Act. Until the late ’20’s it was a strictly family affair, and the partners included over the years many names of distinction in the banking business, including Jacob H. Sehiff, Felix M. Warburg, Otto H. Kahn, and Mortimer L. Sehiff. The first partner to be taken in, who was not related by marriage or otherwise to one or another of the others, was Jerome J. Hanauer in 1911.

The firm decided at an early date not to become interested in public utilities, but it had a large and select clientele among the railroads. With a small or-, ganization, Kuhn Loeb concentrated its efforts in the fields of railroad and industrial financing.

During the early and middle ’20’s there were only four partners. Lewis L. Strauss, the son-in-law of Hanauer, George W. Bovenizer and Sir William Wiseman became partners in 1929; John M. Sehiff, Gilbert W. Kahn and Frederick M. Warburg, all of the younger generation, entered the firm in 1931; and Benjamin J. Buttenwieser, an employee, joined in 1932. Elisha Walker, a banker of wide experience, and Hugh Knowlton became partners in 1933. In 1941, after a long interval, two more employees were taken in, Percy M. Stewart and Robert F. Brown. In 1942 Hugh Knowlton left the firm but again became a partner in 1946. In 1949 the firm had only twelve partners, including J. Emerson Thors and Robert E. Walker, who became such in that year.

This firm, with a limited number of employees and a single office in New York City, differs radically from many of the other defendant firms, which are highly organized and departmentalized, have large distributing facilities, and hundreds of employees. While some of these other firms had large buying departments, most of this work was done in' Kuhn Loeb by the partners.

The old Kuhn Loeb “prestige” business with the railroads was seriously affected by the ICC order requiring public sealed bidding for railroad securities which became effective on July 1,1944. Thereafter, the firm’s policies as to the -number and character of the issues it would sponsor as manager radically changed.

3. Smith Barney & Co.

The firm of Chas. D. Barney & Co., a partnership, was organized in Philadel-.

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phia in 1873 to do a general investment banking business. The investment banking firm of Edward B. Smith & Co. was also founded in Philadelphia, in 1892. From their organization to December 31, 1937, these two firms were in no way connected or affiliated with each other.

At the time that the Banking Act of 1933 was enacted on June 16, 1933, the Guaranty Company of New York was a very large organization, with a total personnel of approximately 500 persons, including 17 senior officers and 21 junior officers. The decision of the Guaranty Trust Company of New York to dissolve its securities affiliate, the Guaranty Company, presented an acute personal problem to these officers and employees, since this action would necessarily eliminate most of their jobs. On June 6, 1934, William C. Potter, chairman of the Board of Directors of the Guaranty Trust Company of New York, wrote a letter to the stockholders of the Guaranty Trust Company of New York concerning this proposed dissolution. This letter explained how the problem of the future employment of those officers and employees was partly solved:

“* * * Arrangements have been made by Mr. Joseph R. Swan, President of the Guaranty Company of New York, and some of the principal executives (all of whom are retiring from the Guaranty Company of New York on or before June 16, 1934) to become members of the firm of Edward B. Smith & Co., a banking house that has for many years conducted a general securities business. It is expected that a majority of the staff of the Guaranty Company will become associated with the new firm. Certain others of the Guaranty Company organization will remain and liquidate its affairs. Others will be taken into the organization of the Trust Company, and the remainder we shall endeavor to assist in finding employment elsewhere.”

On June 16, 1934, 4 of the 17 individuals, who had been senior officers of the Guaranty Company on June 16, 1933, joined Edward B. Smith & Co. as general partners. These were Joseph R. Swan, president, and Burnett Walker, Irving D. Fish, and J. Ritchie Kimball, vice-presidents. Similarly, on June 16, 1934, 13 of the 21 individuals, who had been junior officers of the Guaranty Company, were employed by Edward B. Smith & Co. Among these 13 individuals were Holden K. Farrar, James N. Land and Karl Weisheit, all 3 of whom eventually became partners in Smith Barney.

In 1934, 3 other individuals, who had been senior officers of the Guaranty Company, joined other investment banking firms as partners or officers: John D. Harrison joined Lazard Freres; Frederick L. Moore joined Kidder Peabody; and John F. Patterson joined Blyth. In 1936, Alfred Shriver, who had been a senior officer of the Guaranty Company prior to June 16, 1934, and president of the Guaranty Company in liquidation thereafter, joined Morgan Stanley, as a vice-president and director. In late 1933, John A. Wright, Jr., a junior officer of the Guaranty Company, joined the investment banking firm of Drysdale & Company. The remaining 9 of the 17 senior officers and the remaining 7 of the 21 junior officers of the Guaranty Company remained with the Guaranty Company in liquidation, joined the staff of the Guaranty Trust Company of New York, or went with other commercial banks, brokerage houses, industrial or business corporations.

Looking at the reorganized firm of Edward B. Smith & Co. on and after June 16, 1934, we find that it included 15 general partners, 3 special or limited partners (2 of whom were also general partners), and 522 employees. Of these, 4 general partners and 237 employees had formerly been with the Guaranty Company, either as senior or junior officers or employees; 11 general partners, all 3 special or limited partners, and 285 employees, had been with the old firm of Edward B. Smith & Co. The 237 employees of Edward B. Smith & Co., who

*660

had formerly been with the Guaranty Company, constituted slightly more than 'one-half of the total personnel of the Guaranty Company as of June 16, 1933. The capital of Edward B. Smith & Co., as of June 16, 1934, totalled $5,000,000, of which $3,500,000 was general capital, and $1,500,000 was limited capital. All of its capital was contributed by the general and special partners of the firm.

Edward B. Smith & Co. did not succeed, either

de jure

or

de facto,

to the investment banking business of the Guaranty Company, the securities affiliate of the Guaranty Trust Company of New York, by reason of the fact that individuals, who had been with the Guaranty Company as senior or junior officers or employees prior to June 16, 1934, joined Edward B. Smith & Co. on that date as general partners or employees, or for any other reason.

The firm of Edward B. Smith & Co. as so constituted, remained without substantial change until December 31, 1937, when it was dissolved in connection with the formation of Smith Barney & Co.

In 1937, as a result of two highly unsuccessful security issues, namely, an offering to shareholders of $44,244,300 of 5% cumulative convertible preferred stock of the Pure Oil Company on September 3, 1937, and an offering to shareholders of $48,000,000 of

Sy2%

convertible debentures of the Bethlehem Steel Corporation on September 8, 1937, Edward B. Smith & Co. not only suffered heavy losses, but found itself in the difficult position of having its available capital, which was required to be free if the firm was to continue in the underwriting business, substantially frozen in the then unsaleable securities of these two companies. Accordingly, as of the close of business on December 31, 1937, the firm of Edward B. Smith & Co. in effect merged with the theretofore wholly separate firm of Chas. D. Barney & Co., which had the necessary capital, to form the new firm of Smith Barney & Co.

Smith Barney & Co. was organized to begin operations as of January 1, 1938, as successor to the business of Edward B. Smith & Co. and Chas. D. Barney & Co., as a limited partnership under the laws of the State of New York, by a group of 27 general partners and 4 special partners (one of whom was also a general partner), all of whom had been general or special partners of either the firm of Edward B. Smith & Co. or of the firm of Chas. D. Barney & Co. Of the 27 general partners of Smith Barney as of January 1, 1938, 13 had been partners of Chas. D. Barney & Co. and 14 had been partners of Edward B. Smith & Co. Among those general partners of Smith Barney as of January 1, 1938, who had previously been partners of Edward B. Smith & Co., were Joseph R. Swan, Burnett Walker, Irving D. Fish, J. Ritchie Kimball, James N. Land and Karl Weisheit, all of whom had been affiliated with the Guaranty Company either as senior or junior officers.

Since at least June 16, 1934, Edward B. Smith — Smith Barney has had a large organization with extensive distribution facilities. It has principal branch offices in charge of one or more partners in Philadelphia and Chicago, and the firm has or has had offices in other important cities, including Boston and Cleveland. In addition to the usual Buying and Syndicate Departments, the firm has NeW Business, Trading, Sales and Municipal Departments. Smith Barney is engaged in a general investment banking business, and distributes all types of securities at both wholesale and retail.

The size of the organization and the widespread location of its offices, indicate the great importance to the firm of obtaining a relatively large volume of securities for distribution. With a large distributing force, a large number of participations-in issues managed by other houses is essential to the economic and proper functioning of its organization. Accordingly, Edward B. Smith — Smith Barney has always been very much interested in participations as well as managements, and the evidence shows many instances in which its principal effort was directed toward this objective. Jo

*661

seph R. Swan testified on deposition that his “principal concern” personally was to try to obtain the managership of financing, or so to establish himself with the issuer that, if he could not obtain the managership of the business, he would get as large a participation as possible.

The stipulated static data confirm this. Thus, the participation tables show that in the period 1935-1949, Edward B. Smith — Smith Barney participated in almost five times as many negotiated underwritten issues managed by others as it did in those which it managed or co-managed itself. Edward B. Smith— Smith Barney managed or co-managed some 130 negotiated underwritten issues during this period. It participated, however, in 607 such issues managed by others. Similarly, in total dollar volume of participations in all negotiated issues $1,000,000 and larger (including those managed by itself), Edward B. Smith— Chas D. Barney — Smith Barney ranked third among all defendant and non-defendant firms for the period 1935-1949.

The stipulated public sealed bidding sheets show that Smith Barney was a member of an account headed by the alleged co-conspirator, Lee Higginson, which bid unsuccessfully for a $6,860,000 bond issue of Chicago Union Station, which was offered on June 10, 1941.

Prior to this time Chas. D. Barney & Co. had bid unsuccessfully on several issues offered at public sealed bidding, twice as a member of accounts headed by others (Connecticut River Power Co., February 18, 1936; Pennsylvania Railroad Co., January 10, 1936), and once as manager of an account (Turners Falls Power & Electric Co., November, 1936).

During the period 1941-1949, Smith Barney, bidding as either the head or a member of a bidding account, bid for a total of 275 new and secondary issues $1,000,000 and larger of domestic and foreign business corporations (excluding domestic railroad equipment trust certificates). It bid for 86 issues as the head of a bidding account, winning 16 issues.

4. Lehman Brothers

Since about 1850, a series of partnerships, formed from time to time upon the withdrawal or death of partners, has conducted business under the name of Lehman Brothers. The early phases of its development have already been discussed in Part I of this opinion

1

and will not be recounted here. At the date of the commencement of this action, the firm of Lehman Brothers consisted of 16 partners.

Lehman Brothers’ principal place of business is in New York City. It also has offices in Chicago, Los Angeles and Houston, and it holds memberships on the New York Stock Exchange, American Stock Exchange,

2

Chicago Board of Trade and Midwest Stock Exchange.

3

Lehman Brothers ranks high among the leaders of the investment banking industry in the amount of capital employed. In 1944, its capital was about $10,000,-000.

Throughout the record there are frequent references to a number of persons who are or have been partners of Lehman Brothers. Members of the family have always been its leading partners, as today in the person of Robert Lehman, who has been a partner since July 1, 1921, and is now the only partner bearing the Lehman name. Philip Lehman, who was a partner from about September 1, 1885, until his death on March 21, 1947, was a son of one of the three founders of the firm and its moving spirit in the first decades of the century. Robert Lehman is his son and successor. Other members of the Lehman family who were partners of the firm at one time or another are Arthur Lehman, Harold M. Lehman and Allan S. Lehman, all three of whom are now deceased, and Herbert H. Lehman, formerly Governor of the State of New York and presently a United States Senator. There were gathered around this family core as partners other men of

*662

outstanding ability, who have contributed immensely to the firm’s development. Among these other partners were: John M. Hancock, who became a partner on August 1, 1924, and was the first person outside of the Lehman family to be admitted to partnership; Monroe C. Gut-man, widely experienced in domestic and international banking, became a partner on January 1, 1927, and has since played an important part in the buying of new issues; he is the only partner of the firm whose deposition was taken by the government in pre-trial proceedings in this action, and was too ill to be cross-examined ; Paul M. Mazur, a well known marketing and department store expert, became a partner on July 1, 1927; he had previously done constructive work for various department stores, and is now primarily responsible for the operation of the firm’s Industrial Department. Each of these three individuals are partners of the present firm.

Lehman Brothers acts in all capacities for issuers in the handling of negotiated transactions. It has headed and it has participated in underwritten public offerings, and it has acted as agent for the issuer in non-underwritten public offerings, and private placements, and assisted issuers in obtaining term bank loans. It engages in arbitrage transactions and does a commission business on commodities and securities exchanges. It distributes all types of securities, both at wholesale and retail, and it has bought, sold and placed securities for its own account. It distributes also a large volume of municipal securities.

The firm effects the distribution of corporate securities through its Syndicate and Sales Departments. It has a separate Municipal Department which handles all matters with respect to municipal and revenue securities. Another department of significance in this case is its Industrial Department, which includes its New Business Department, and was developed as part of an agressive movement to increase its investment banking business during the series of disputes with Goldman Sachs, hereafter referred to.

Lehman Brothers offers issuers a wide variety of services which go far beyond simply assisting in the raising of capital. The firm attaches great importance, quite apart from investment banking matters, to its role as a counselor to industry. The multiform activities of the Industrial Department typify the scope of the services which Lehman Brothers offers to business enterprises. The Industrial Department, while embracing the characteristics of the “buying department,” common to most investment banking firms, includes, in addition, a complex of services which most nearly resembles management or efficiency engineering.

As has been previously pointed out in Part I of this opinion,

1

commencing with the underwriting of the United Cigar Manufacturers preferred and common stocks in June, 1906, Lehman Brothers conducted its business of heading security issues in an informal partnership with Goldman Sachs. This informal partnership between Lehman Brothers and Goldman Sachs lasted for nearly 20 years and was never reduced to writing. The two firms worked together on the basis of mutual trust. Later the-two firms entered into a period of bitter-controversy, which is to some extent described in a subsequent part of this. opinion,

2

and, for about two years they split apart, and then came together again.

Long before the ICC required the debt-securities of railroads to be sold at public sealed bidding, Lehman Brothers, as-head of a bidding account, bid for and; won the Cincinnati Union Terminal $12,-000,000 bond issue of February 14, 1939. On February 18, 1936, many years prior to promulgation by the SEC of Rule U-50, Lehman Brothers, as head of a bidding account, bid for and won the Connecticut River Power $20,300,000 bond issue, which had been put up for bidding under a local administrative rule. Much earlier, in April, 1926, with Halsey-

*663

Stuart and Hallgarten, Lehman Brothers bid for and won a $30,000,000 bond issue of Uruguay, and in April, 1928, with Kountze Bros, and Wood Low & Co., won an issue of $2,145,000 equipment trust certificates of Chicago & North Western Railway.

During the period 1941-1949, Lehman Brothers, bidding as either the head or a member of a bidding account, bid for a total of 385 new and secondary issues $1,000,000 and larger of domestic and foreign business corporations (excluding domestic railroad equipment trust certificates). The firm thus bid on 61% of the total of 632 such issues which were sold at public sealed bidding during this period. It bid for 186 issues as the head of a bidding account, winning 35 issues.

5. Glore Forgan & Co.

On March 1, 1920, Charles F. Glore and others formed in Chicago the partnership of Glore, Ward & Co.

On December 29, 1920, Marshall Field, Glore, Ward & Co., a corporation was organized under the laws of Illinois. It continued the business previously conducted by the partnership Glore, Ward & Co. Marshall Field III, who was 26 years of age and who had not been a member of the former partnership, became president of this corporation. He had participated in a student training course in the Chicago office of Lee Higginson & Co. from October 23, 1919 to February 1, 1920. The partners of the former partnership became vice-presidents. On December 31, 1927, the name of this corporation was changed to Field, Glore & Co. On September 26, 1929, Field, Glore

&

Co., Incorporated, was organized under the laws of Delaware, and it continued the business previously conducted by the Illinois corporation, Field Glore & Co.

On March 16, 1931, the partnership of Field, Glore & Co. was formed, and it continued the business previously conducted by the Delaware corporation, Field, Glore & Co., Incorporated. From that day to the present the business has been conducted by a succession of partnerships formed from time to time upon the withdrawal or addition of partners, under the same firm name, which, however, was changed from Field, Glore & Co. to Glore, Forgan & Co. on January 2, 1937. On July 6, 1935 Marshall Field III retired from the then firm.

At the time of the commencement of this action the defendant firm of Glore, Forgan

&

Co. consisted of eight partners : Charles F. Glore, who died during the trial; John F. Fennelly, Rudolph E. Vogel and James W. Pope, were located in the Chicago office; and J. Russell Forgan, Halstead G. Freeman, Edward F. Hayes and Wright Duryea, in the New York office. The following became partners on August 1, 1950: Hyde Gillette, Charles S. Vrtis, Edwin Cummings Parker, James P. Jamieson and Alfred C. West, in the Chicago office; Charles J. Hodge, Thomas D. Mann and Paris S. Russell, Jr., in the New York office.

This Chicago firm has done a general investment banking and brokerage business; has good distributing facilities, and is interested in managerships and as many participations in desirable issues as it can secure. Its public sealed bidding record is good. There is no suecessorship problem involved.

6. Kidder Peabody

&

Co.

The original firm of Kidder Peabody & Co., for many years one of the leading houses, and described throughout the trial as “old” Kidder Peabody, was founded in 1865, to engage in the commercial and investment banking business. In its heyday it did a large and profitable business and was identified with a long series of security issues of the American Telephone & Telegraph Company, acting as New England manager for all negotiated underwritten issues of the Telephone Company and its subsidiaries after about 1899.

During the fall of 1930 the “old” firm ran into financial difficulties, caused by falling prices of securities it owned, the withdrawal of large deposits by the Italian Government, and to time deposits

*664

which were due or renewable, including a payment to the Bank of International Settlements, said to have amounted to $4,000,000.

Harold Stanley testified:

“J. P. Morgan & Co. had sold the stock of Bank of International Settlements, which looked as if it wouldn’t be able to get its money back and have to take a loss unless something were done. If Kidder, Peabody had failed, an old firm— and it had been a very prominent firm in some ways — it would have shaken confidence and upset everything.”

Accordingly, in an effort to save “old” Kidder Peabody, a $10,000,000 Revolving Fund was raised, of which $2,500,000 each came from J. P. Morgan & Co. and Chase National Bank, $1,250,000 from First National Bank of Boston, $1,000,-000 each from Bankers Trust Company and Guaranty Trust Company of New York, $750,000 from Shawmut Bank of Boston, $500,000 from First National Bank of New York and $250,000 each from Merchants National Bank and Second National Bank, both of Boston. The partners of the “old” firm raised an additional $5,000,000.

It soon developed that the condition of the “old” firm was worse than had been supposed. It was thought that the name and some vestige of the repute of the “old” firm might still be salvaged and the advances already made recovered. There is no point in tracing every step of the negotiations. Edwin S. Webster, one of the heads of Stone

&

Webster, and a man of substance, thought his son, Edwin S. Webster, Jr., who had met with an accident and was then confined to a hospital, might be interested. Young Webster and Albert Gordon had been classmates in the Harvard Business School, both seemed men of promise and they, together with Chandler Hovey, a brother-in-law of Mr. Webster, Sr., who had a brokerage business in Boston, began business as the three partners of the new Kidder Peabody

&

Co., which is the firm named as a defendant herein, on March 17, 1931. None of the members of the “old” firm remained as partners, three, with the remnants of the “old” firm’s staff, remained for a time as employees. Later on in that year, G. Herman Kinnicutt, then in his 60s, became a fourth partner. He had formerly been senior partner of Kissel Kinnicutt

&

Co., which had gone into liquidation.

The subsequent history of the Revolving Credit and the arrangements made for the repayment of the $5,000,000 loaned as above stated, is developed in great detail but may be passed over. In 1935 the new firm threatened to exercise an option it had to give up the name, and dissolve the firm; and this led to a settlement agreement which was eventually carried out.

By the Bill of Sale as of March 6,1931, certain securities and assets, including the firm name and good will, leases, stock exchange seats, furniture, fixtures, documents and books, were transferred to the-new firm. An agreement of the same date between the old and the new partners, and corporations representing those who had made the advances above referred to, contained a large number of terms, including Article III, Section 2, which provides: “The new firm does not assume directly or indirectly any liabilities of the present firm whether known or unknown, direct or contingent, except the liabilities specifically set forth herein to be assumed by the new firm.” These do not appear to have been substantial.

In 1934, when the Glass-Steagall Act took effect, Kidder Peabody took over the lease for office space of the Phildelphia National Company, the securities affiliate of the Philadelphia National Bank; and virtually the entire organization; of employees, together with the president, Or-us J. Matthews, left the Philadelphia National Company and came with Kidder Peabody. Matthews became a partner some time in 1935.

When Chase Harris Forbes Corporation went out of business, 10 or 15 salesmen from its organization were added to the Kidder Peabody sales staff; other men came over from the Guaranty Com

*665

pany and the National City Company. During 1934 Frederick L. Moore, from the Guaranty, became a partner, and Walter V. Moffitt, also from the Guaranty, became a partner in 1935.

Under the leadership of Gordon the affairs of Kidder Peabody prospered; progress was slow at first, but there was steady growth in every phase of its business. The partners and employees went after everything, for managerships if they could be secured, if not for participations and even selling positions. No issue was too small, no participation too insignificant. Offices were opened, first in Chicago, then in Hartford and Albany, in addition to the principal offices in New York, Boston and Philadelphia. By the time this action was commenced, Kidder Peabody maintained a larger selling organization and a larger trading department than at any time in its history, with representatives and correspondents in many leading cities of the United States where it did not have offices, and had moved up from practically no business at all, in 1931 in the depths of the great depression, to a major position in the entire investment banking industry.

The statistical tables are so comprehensive and complete that they accurately reflect the progress and also the competitive pattern of each of the defendant banking firms. Kidder Peabody will serve as an illustration. In the first triennial period, 1935-1937, Kidder Peabody ranked 18th in dollar amount of new negotiated underwritten managements of issues $1,000,000 and larger, and it ranked 25th in number of issues. In the last triennial period, 1947-1949, it ranked 3rd in number of issues and 11th in dollar amount. Its progress in the smaller issues is shown by the tables relating to issues between $100,000 and $1,000,000, and indicates that the whole •competitive pattern of the firm was undergoing change, development and growth during the entire period 1935-1949. With reference to these smaller issues, Kidder Peabody had no rank whatever in number of issues, and it stood 200th in dollar amount, in the first triennial. In the last triennial it ranked first both in number of issues and dollar amount. Its progress in public sealed bidding accounts and private placements was substantial.

7. Goldman Sachs & Co.

In 1882, Marcus Goldman and Samuel Sachs formed a partnership to continue a commercial paper business which had been begun by Marcus Goldman in 1869. With the withdrawal of partners or the addition of new partners from time to time, the business has been conducted by a succession of partnerships from 1882 to date, except for the period from January 21,1922, to December 31, 1926, when the business was conducted as a joint stock association. Beginning in 1885, each of the partnerships and the joint stock association did business under the name of Goldman Sachs & Co. As in the case of Lehman Brothers, the early phases of its development have already been discussed in Part I of this opinion

1

and will not be narrated here. Similarly, its relationship with Lehman Brothers is described to some extent above in the statement of the origin, organization and personnel of Lehman Brothers

2

and also in a subsequent part of this opinion.

3

Goldman Sachs’ principal place of business is in New York City; and, in addition, the firm has various branch offices and representatives in other cities. Goldman Sachs not only has a New Business Department, but, as Walter E. Sachs testified on deposition, “Goldman, Sachs & Company is a new business department.” In approximately 1935, Goldman Sachs established a Retail Sales Department. Its capital in 1944 was about $6,500,000.

At the date of the commencement of this action, the firm of Goldman Sachs consisted of 13 partners. Among the personnel of Goldman Sachs whose names

*666

appear in the record, and who are or have been partners in the firm, are the following : Marcus Goldman, who founded the business in 1869, and who is the grandfather of Walter E. Sachs; Samuel Sachs who joined Marcus Goldman as a partner in 1882, when the business became known as M. Goldman & Sachs, is the father of Walter E. Sachs and an uncle of Howard J. Sachs; Walter E. Sachs, who was first employed by Goldman Sachs in 1905, and who became a partner in 1910, is the only member of the present firm whose deposition was taken by the government; Howard J. Sachs, who became a partner in 1915 and is a member of the present firm, is a cousin of Walter E. Sachs; Henry S. Bowers, also a member of the present firm at the time of the commencement of this action, became a partner in 1915, and was the first partner of the firm who was not related to either the Goldman family or the Sachs family; and Sidney J. Weinberg, who entered the employ of Goldman Sachs in 1907, became a partner in 1927, and is a member of the present firm.

The business now conducted by Goldman Sachs consists in part of: (1) dealing in commercial paper — the buying of short term promissory notes from merchants and manufacturers and the selling of such notes to banks or institutional investors — the business which the firm’s founder started in 1869; (2) a brokerage business, the firm having been a member of the New York Stock Exchange since the late 1890’s, except for the period when it was a joint stock association; and (3) investment banking.

It is not a part of the regular business of the firm to invest its own capital in permanent long term investments in the companies whose securities it underwrites. Since the time that Goldman ■ Sachs first entered the investment banking business in 190fi, it has concentrated its underwriting efforts on the security issues of companies engaged in retailing or merchandising or in the manufacturing of consumers’ goods. It has never been prominent as an underwriter in the railroad or public utility fields; but it distributes all types of securities both at wholesale and at retail.

The passage of the Glass-Steagall Act, which became effective on June 16, 1934, had no material effect on Goldman Sachs. In the early days of its business, Goldman Sachs did not accept deposits at all. For some years prior to the Glass-Steagall Act, the firm did have some depositors, but this activity was never a very important feature of the firm’s business, and after the passage of the Act, the firm discontinued it. The Act did not affect Goldman Sachs’ commercial paper business, which continued.

In October, 1929, when the devastating crash in the stock market occurred, Goldman Sachs found itself as an underwriter in the midst of a number of under-writings, and, as Walter E. Sachs testified on deposition, it lost millions of dollars in having to take up securities at the underwritten price at a time when the market price of those securities was greatly depressed. Not only did Goldman Sachs suffer large monetary losses at the time, but because of the losses incurred by investors in securities of the Goldman Sachs Trading Corporation, which Goldman Sachs had sponsored, its reputation as an investment banker was dealt a blow from which it took years to recover. After heading with Hayden Stone the financing for Warner Brothers Pictures on August 25, 1930, Goldman Sachs was not to head another underwriting for almost five years.

In the period 1906-1917, Goldman Sachs had few, if any, underwriting participations in financings headed by others. In the period 1918-1933, it had some modest participations in such financings. There was a further change in the post-Securities Act period. After approximately 1935, when, as has been previously stated, Goldman Sachs established a Betail Sales Department, it began to take substantial participations in issues managed by others. The stipulated data indicate the extent of this change. In the period 1935-1949, Goldman Sachs participated in 570 underwriting syndi

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cates for negotiated issues managed by other investment banking firms, in addition to having participations in 87 such syndicates which it managed or co-managed itself. Another change in this period 1935-1949, and one which resulted from the registration requirements of the Securities Act, was the increased use of private placements by issuers as an alternative method of raising money. The growing importance of this method of financing, in direct competition with other methods, was reflected in the large number of private placements handled by Goldman Sachs in this period, as compared with the previous periods. In the 29 years after 1906, the year it entered the investment banking business, to 1935, Goldman Sachs had handled only 2 private placements. It handled 69 private placements in the 15-year period 1935-1949. Throughout the period 1935-1949, Goldman Sachs continued to solicit the business of heading financings for relatively small concerns which had not previously offered securities to the public, and, during this period, Goldman Sachs headed financings for 28 such issuers.

When Rule U-50 became effective on May 7, 1941, Goldman Sachs, which had had very little experience in the management of public utility issues, did not reorganize its staff or alter the organization of its Buying Department or of any of its other departments in order to enable it to head public sealed bidding accounts for such issues to any large extent. Despite this, however, during the period 1941-1949, Goldman Sachs headed bidding accounts which bid for a total of 24 new and secondary issues $1,000,-000 and larger of domestic and foreign business corporations (excluding domestic railroad equipment trust certificates), winning 6 issues. But the firm’s record of participating in bidding accounts headed by others tells a different story. In the period 1941-1949, it was a member of bidding accounts which bid for 334, or 53%, of the total of 632 such issues which were sold at public sealed bidding during that period.

8. White Weld & Co.

Established in 1895 under the name of Moffat & White, this partnership changed its name in 1910 to White Weld & Co. and the firm has been in continuous operation under that name ever since. It is not claimed to be “successor” to any institution which was forced to give up investment banking by the terms of the Glass-Steagall Act.

The activities of the firm differ from those of any of the other defendants, and consist of three broad categories, “position” business, commission or brokerage business, and that of managing and distributing security issues. About one-half of the firm capital is devoted to the purchasing of securities of corporations which White Weld is interested in building “from the ground up” and then holding such securities for the long pull and not for resale. One-quarter of the firm capital is employed in its commission business, and only the remaining one-quarter is available for investment banking of the kind with which we are here concerned. As the entire capital of White Weld as of July 6, 1949, was in the neighborhood of $6,500,000, about $1,650,000 was available at that time for underwritings. As of the close of 1945 these figures were much smaller.

White Weld has made a specialty of private placements, as is indicated by the statistics, which show White Weld as agent for the seller in 53 private placements in the period 1935-1947. While opposed to compulsory public sealed bidding on principle, as not being in the best interests of issuers, White Weld’s record of public sealed bidding accounts during the same period exceeded its position in negotiated underwritten transactions by a considerable margin. The bulk of its business in the distribution of securities consisted of its participations, as underwriter, in negotiated and public sealed bidding issues managed by others. Thus, despite the relatively small amount of capital allocated to its underwriting activities, White Weld nevertheless ranked high in participations in both public sealed bidding and negotiated is

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sues. Comparing the records of all investment bankers for the

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