There is a legitimate field for dealers in state
and municipal bonds, as for other merchants.
and municipal bonds, as for other merchants.
Louis Brandeis - 1914 - Other People's Money, and How Bankers Use It
But the investor's servility
is due partly, also, to his ignorance of the
facts. Is it not probable that, if each in-
vestor knew the extent to which the security he
buys from the banker is diluted by excessive
underwritings, commissions and profits, there
would be a strike of capital against these unjust
exactions?
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? 100 OTHER PEOPLE'S MONEY
THE STRIKE OF CAPITAL
A recent British experience supports this
view. In a brief period last spring nine differ-
ent issues, aggregating $135,840,000, were offered
by syndicates on the London market, and on the
average only about 10 per cent. of these loans
was taken by the public. Money was "tight,"
but the rates of interest offered were very liberal,
and no one doubted that the investors were
well supplied with funds. The London Daily
Mail presented an explanation:
"The long series of rebuffs to new loans at the
hands of investors reached a climax in the ill
success of the great Rothschild issue. It will
remain a topic of financial discussion for many
days, and many in the city are expressing the
opinion that it may have a revolutionary effect
upon the present system of loan issuing and
underwriting. The question being discussed is
that the public have become loth to subscribe
for stock which they believe the underwriters can
afford, by reason of the commission they receive,
to sell subsequently at a lower price than the
issue price, and that the Stock Exchange has
begun to realize the public's attitude. The public
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? WHAT PUBLICITY CAN DO 101
sees in the underwriter not so much one who in-
sures that the loan shall be subscribed in return
for its commission as a middleman, who, as it
were, has an opportunity of obtaining stock at
a lower price than the public in order that he
may pass it off at a profit subsequently. They
prefer not to subscribe, but to await an oppor-
tunity of dividing that profit. They feel that
if, when these issues were made, the stock were
offered them at a more attractive price, there
would be less need to pay the underwriters so
high commissions. It is another practical pro-
test, if indirect, against the existence of the
middleman, which protest is one of the features
of present-day finance. "
Compel bankers when issuing securities to
make public the commissions or profits they are
receiving. Let every circular letter, prospectus
or advertisement of a bond or stock show clearly
what the banker received for his middleman-
services, and what the bonds and stocks net
the issuing corporation. That is knowledge to
which both the existing security holder and the
prospective purchaser is fairly entitled. If the
bankers' compensation is reasonable, consider-
PUBLICITT AS A REMEDY
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? 108 OTHER PEOPLE'S MONEY
ing the skill and risk involved, there can be no
objection to making it known. If it is not
reasonable, the investor will "strike," as in-
vestors seem to have done recently in England.
Such disclosures of bankers' commissions or
profits is demanded also for another reason: It
will aid the investor in judging of the safety of
the investment. In the marketing of securities
there are two classes of risks: One is the risk
whether the banker (or the corporation) will find
ready purchasers for the bonds or stock at the
issue price; the other whether the investor will
get a good article. The maker of the security
and the banker are interested chiefly in getting it
sold at the issue price. The investor is interested
chiefly in buying a good article. The small
investor relies almost exclusively upon the banker
for his knowledge and judgment as to the quality
of the security; and it is this which makes his
relation to the banker one of confidence. But
at present, the investment banker occupies a
position inconsistent with that relation. The
bankers' compensation should, of course, vary
according to the risk he assumes. Where there
is a large risk that the bonds or stock will not be
promptly sold at the issue price, the underwriting
commission (that is the insurance premium)
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? WHAT PUBLICITY CAN DO 103
should be correspondingly large. But the banker
ought not to be paid more for getting investors
to assume a larger risk. In practice the banker
gets the higher commission for underwriting the
weaker security, on the ground that his own risk
is greater. And the weaker the security, the
greater is the banker's incentive to induce his
customers to relieve him. Now the law should
not undertake (except incidentally in connection
with railroads and public-service corporations) to
fix bankers' profits. And it should not seek to
prevent investors from making bad bargains.
But it is now recognized in the simplest mer-
chandising, that there should be full disclosures.
The archaic doctrine of caveat emptor is vanishing.
The law has begun to require publicity in aid of
fair dealing. The Federal Pure Food Law does
not guarantee quality or prices; but it helps the
buyer to judge of quality by requiring disclosure
of ingredients. Among the most important facts
to be learned for determining the real value of a
security is the amount of water it contains.
And any excessive amount paid to the banker
for marketing a security is water. Require a
full disclosure to the investor of the amount of
commissions and profits paid; and not only will
investors be put on their guard, but bankers'
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? 104 OTHER PEOPLE'S MONEY
compensation will tend to adjust itself auto-
matically to what is fair and reasonable. Ex-
cessive commissions--this form of unjustly ac-
quired wealth--will in large part cease.
REAL DISCLOSURE
But the disclosure must be real. And it must
be a disclosure to the investor. It will not suffice
to require merely the filing of a statement of facts
with the Commissioner of Corporations or with
a score of other officials, federal and state. That
would be almost as ineffective as if the Pure Food
Law required a manufacturer merely to deposit
with the Department a statement of ingredients,
instead of requiring the label to tell the story.
Nor would the filing of a full statement with the
Stock Exchange, if incorporated, as provided
by the Pujo Committee bill, be adequate.
To be effective, knowledge of the facts must be
actually brought home to the investor, and this
can best be done by requiring the facts to be
stated in good, large type in every notice, circu-
lar, letter and advertisement inviting the investor
to purchase. Compliance with this requirement
should also be obligatory, and not something
which the investor could waive. For the whole
public is interested in putting an end to the
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? WHAT PUBLICITY CAN DO 105
bankers' exactions. England undertook, years
ago, to protect its investors against the wiles of
promoters, by requiring a somewhat similar dis-
closure; but the British act failed, in large
measure of its purpose, partly because under it
the statement of facts Was filed only with a public
official, and partly because the investor could
waive the provision. And the British statute has
now been changed in the latter respect.
DISCLOSE SYNDICATE PARTICULARS
The required publicity should also include a
disclosure of all participants in an underwriting.
It is a common incident of underwriting that no
member of the syndicate shall sell at less than the
syndicate price for a definite period, unless the
syndicate is sooner dissolved. In other words,
the bankers make, by agreement, an artificial
price. Often the agreement is probably illegal
under the Sherman Anti-Trust Law. This price
maintenance is, however, not necessarily objec-
tionable. It may be entirely consistent with the
general welfare, if the facts are made known.
But disclosure should include a list of those par-
ticipating in the underwriting so that the public
may not be misled. The investor should know
whether his adviser is disinterested.
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? 106 OTHER PEOPLE'S MONEY
Not long ago a member of a leading banking
house was undertaking to justify a commission
taken by his firm for floating a now favorite pre-
ferred stock of a manufacturing concern. The
bankers took for their services $250,000 in cash,
besides one-third of the common stock, amount-
ing to about $2,000,000. "Of course," he said,
"that would have been too much if we could have
kept it all for ourselves; but we couldn't. We
had to divide up a large part. There were fifty-
seven participants. Why, we had even to give
$10,000 of stock to (naming the presi-
dent of a leading bank in the city where the busi-
ness was located). He might some day have
been asked what he thought of the stock. If he
had shrugged his shoulders and said he didn't
know, we might have lost many a customer for
the stock. We had to give him $10,000 of the
stock to teach him not to shrug his shoulders. "
Think of the effectiveness with practical Amer-
icans of a statement like this:
A. B. & Co.
Investment Bankers
We have today secured substantial control of
the successful machinery business heretofore
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? WHAT PUBLICITY CAN DO 107
conducted by at , Illinois, which
has been incorporated under the name of the
Excelsior Manufacturing Company with a capital
of $10,000,000, of which $5,000,000 is Preferred
and $5,000,000 Common.
As we have a large clientele of confiding
customers, we were able to secure from the
owners an agreement for marketing the Pre-
ferred stock--we to fix a price which shall net
the owners in cash $95 a share.
We offer this excellent stock to you at $100. 75
per share. Our own commission or profit will
be only a little over $5. 00 per share, or say,
$250,000 cash, besides $1,500,000 of the Common
stock, which we received as a bonus. This cash
and stock commission we are to divide in various
proportions with the following participants in the
underwriting syndicate:
C. D. & Co. , New York
E. F. & Co. , Boston
L. M. & Co. , Philadelphia
I. K. & Co. , New York.
O. P. & Co. , Chicago
Were such notices common, the investment
bankers would "be worthy of their hire," for
only reasonable compensation would ordinarily
be taken.
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? 108 OTHER PEOPLE'S MONEY
For marketing the preferred stock, as in the
case of Excelsior Manufacturing Co. referred to
above, investment bankers were doubtless
essential, and as middlemen they performed a
useful service. But they used their strong position
to make an excessive charge. There are, how-
ever, many cases where the banker's services
can be altogether dispensed with; and where
that is possible he should be eliminated, not
only for economy's sake, but to break up
financial concentration.
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? CHAPTER VI
WHERE THE BANKER IS SUPERFLUOUS
The abolition of interlocking directorates will
greatly curtail the bankers' power by putting an
end to many improper combinations. Publicity
concerning bankers' commissions, profits and
associates, will lend effective aid, particularly by
curbing undue exactions. Many of the specific
measures recommended by the Pujo Committee
(some of them dealing with technical details)
will go far toward correcting corporate and bank-
ing abuses; and thus tend to arrest financial
concentration. But the investment banker has,
within his legitimate province, acquired control
so extensive as to menace the public welfare,
even where his business is properly conducted.
If the New Freedom is to be attained, every
proper means of lessening that power must be
availed of. A simple and effective remedy,
which can be widely applied, even without new
legislation, lies near at hand:--Eliminate the
banker-middleman where he is superfluous.
Today practically all governments. states and
109
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? 110 OTHER PEOPLE'S MONEY
municipalities pay toll to the banker on all
bonds sold. Why should they? It is not be-
cause the banker is always needed. It is because
the banker controls the only avenue through
which the investor in bonds and stocks can or-
dinarily be reached. The banker has become the
universal tax gatherer. True, the pro rata
of taxes levied by him upon our state and city
governments is less than that levied by him upon
the corporations. But few states or cities escape
payment of some such tax to the banker on every
loan it makes. Even where the new issues of
bonds are sold at public auction, or to the highest
bidder on sealed proposals, the bankers' syndicates
usually secure large blocks of the bonds which
are sold to the people at a considerable profit.
The middleman, even though unnecessary, col-
lects his tribute.
There is a legitimate field for dealers in state
and municipal bonds, as for other merchants.
Investors already owning such bonds must have
a medium through which they can sell their
holdings. And those states or municipalities
which lack an established reputation among
investors, or which must seek more distant
markets, need the banker to distribute new issues.
But there are many states and cities which have
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? SUPERFLUOUS BANKERS 111
an established reputation and have a home
market at hand. These should sell their bonds
direct to investors without the intervention of a
middleman. And as like conditions prevail with
some corporations, their bonds and stocks should
also be sold direct to the investor. Both financial
efficiency and industrial liberty demand that the
bankers' toll be abolished, where that is possible.
The business of the investment banker must
not be confused with that of the bond and stock
broker. The two are often combined; but the
functions are essentially different. The broker
performs a very limited service. He has properly
nothing to do with the original issue of securities,
nor with^their introduction into the market. He
merely negotiates a purchase or sale as agent for
another under specific orders. He exercises no
discretion, except in the method of bringing
buyer and seller together, or of executing orders.
For his humble service he receives a moderate
compensation, a commission, usually one-eighth
of one per cent. (12 1/2 cents for each $100) on
the par value of the security sold. The invest-
ment banker also is a mere middleman. But he
is a principal, not an agent. He is also a merchant
BANKER AND BBOKEB
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? 112 OTHER PEOPLE'S MONEY
in bonds and stocks. The compensation received
for his part in the transaction is in many cases
more accurately described as profit than as com-
mission. So far as concerns new issues of
government, state and municipal bonds, espe-
cially, he acts as merchant, buying and selling
securities on his own behalf; buying commonly
at wholesale from the maker and selling at retail
to the investors; taking the merchant's risk and
the merchant's profits. On purchases of corpo-
rate securities the profits are often very large;
but even a large profit may be entirely proper;
for when the banker's services are needed and
are properly performed, they are of great value.
On purchases of government, state and munic-
ipal securities the profit is usually smaller; but
even a very small profit cannot be justified, if
unnecessary.
HOW THE BANKER CAN SERVE
The banker's services include three distinct
functions, and only three:
First: Specifically as expert. The investment
banker has the responsibility of the ordinary
retailer to sell only that merchandise which is
good of its kind. But his responsibility in this
respect is unusually heavy, because he deals in an
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? SUPERFLUOUS BANKERS 118
article on which a great majority of his customers
are unable, themselves, to pass intelligent judg-
ment without aid. The purchase by the investor
of most corporate securities is little better than a
gamble, where he fails to get the advice of some
one who has investigated the security thoroughly
as the banker should. For few investors have the
time, the facilities, or the ability to investigate
properly the value of corporate securities.
Second: Specifically as distributor. The banker
performs an all-important service in providing
an outlet for securities. His connections enable
him to reach possible buyers quickly. And good-
will--that is, possession of the confidence of regu-
lar customers--enables him to effect sales where
the maker of the security might utterly fail to
find a market.
Third: Specifically as jobber or retailer. The
investment banker, like other merchants, carries
his stock in trade until it can be marketed. In
this he performs a service which is often of great
value to the maker. Needed cash is obtained
immediately, because the whole issue of securities
can thus be disposed of by a single transaction.
And even where there is not immediate payment,
the knowledge that the money will be provided
when needed is often of paramount importance.
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? 114 OTHER PEOPLE'S MONEY
By carrying securities in stock, the banker per-
forms a service also to investors, who are thereby
enabled to buy securities at such times as they
desire.
Whenever makers of securities or investors
require all or any of these three services, the
investment banker is needed, and payment of
compensation to him is proper. Where there is
no such need, the banker is clearly superfluous.
And in respect to the original issue of many of our
state and municipal bonds, and of some corporate
securities, no such need exists.
It needs no banker experts in value to tell us
that bonds of Massachusetts or New York, of
Boston, Philadelphia or Baltimore and of scores
of lesser American cities, are safe investments.
The basic financial facts in regard to such bonds
are a part of the common knowledge of many
American investors; and, certainly, of most pos-
sible investors who reside in the particular state
or city whose bonds are in question. Where the
financial facts are not generally known, they are
so simple, that they can be easily summarized and
understood by any prospective investor without
interpretation by an expert. Bankers often
WHEEE THE BANKER SERVES NOT
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? SUPERFLUOUS BANKERS 11&
employ, before purchasing securities, their own.
accountants to verify the statements supplied by
the makers of the security, and use these account-
ants' certificates as an aid in selling. States and
municipalities, the makers of the securities,
might for the same purpose employ independent
public accountants of high reputation, who would
give their certificates for use in marketing the
securities. Investors could also be assured with-
out banker-aid that the basic legal conditions are
sound. Bankers, before purchasing an issue of
securities, customarily obtain from their own
counsel an opinion as to its legality, which inves-
tors are invited to examine. It would answer
the same purpose, if states and municipalities
should supplement the opinion of their legal
representatives by that of independent counsel
of recognized professional standing, who would
certify to the legality of the issue.
Neither should an investment banker be needed
to find investors willing to take up, in small lots,
a new issue of bonds of New York or Massa-
chusetts, of Boston, Philadelphia or Baltimore, or
a hundred other American cities. A state or
municipality seeking to market direct to the
investor its own bonds would naturally experi-
ence, at the outset, some difficulty in marketing a
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? 116 OTHER PEOPLE'S MONEY
large issue. And in a newer community, where
there is little accumulation of unemployed capital,
it might be impossible to find buyers for any large
issue. Investors are apt to be conservative;
and they have been trained to regard the inter-
vention of the banker as necessary. The bankers
would naturally discourage any attempt of states
and cities to dispense with their services. En-
trance upon a market, hitherto monopolized by
them, would usually have to be struggled for.
But banker-fed investors, as well as others could,
in time, be brought to realize the advantage of
avoiding the middleman and dealing directly with
responsible borrowers. Governments, like private
concerns, would have to do educational work; but
this publicity would be much less expensive and
much more productive than that undertaken by
the bankers. Many investors are already impa-
tient of banker exactions; and eager to deal
directly with governmental agencies in whom they
have more confidence. And a great demand Cv. old,
at once, be developed among smaller investor*
whom the bankers have been unable to interest,
and who now never buy state or municipal bonds.
The opening of this new field would furnish a mar-
ket, in some respects more desirable and certainty
wider than that now reached by the bankers.
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? SUPERFLUOUS BANKERS 117
Neither do states or cities ordinarily need the
services of the investment banker to carry their
bonds pending distribution to the investor.
Where there is immediate need for large funds,
states and cities--at least the older communities
--should be able to raise the money temporarily,
quite as well as the bankers do now, while await-
ing distribution of their bonds to the investor.
Bankers carry the bonds with other people's
money, not with their own. Why should not
cities get the temporary use of other people's
money as well? Bankers have the preferential
use of the deposits in the banks, often because
they control the banks. Free these institutions
from banker-control, and no applicant to borrow
the people's money will be received with greater
favor than our large cities. Boston, with its
$1,500,000,000 of assessed valuation and $78,033,-
128 net debt, is certainly as good a risk as even
Lee, Higginson & Co. or Kidder, Peabody & Co.
But ordinarily cities do not, or should not,
require large sums of money at any one time.
Such need of large sums does not arise except
from time to time where maturing loans are to be
met, or when some existing public utility plant
is to be taken over from private owners. Large
issues of bonds for any other purpose are usually
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? 118 OTHER PEOPLE'S MONEY
made in anticipation of future needs, rather than
to meet present necessities. Modern efficient
public financiering, through substituting serial
bonds for the long term issues (which in Massa-
chusetts has been made obligatory) will, in time,
remove the need of large sums at one time for
paying maturing debts, since each year's maturi-
ties will be paid from the year's taxes. Purchases
of existing public utility plants are of rare occur-
rence, and are apt to be preceded by long periods
of negotiation. When they occur they can, if
foresight be exercised, usually be financed without
full cash payment at one time.
Today, when a large issue of bonds is made, the
banker, while ostensibly paying his own money to
the city, actually pays to the city other people's
money which he has borrowed from the banks.
Then the banks get back, through the city's de-
posits, a large part of the money so received. And
when the money is returned to the bank, the
banker has the opportunity of borrowing it again
for other operations. The process results in
double loss to the city. The city loses by not
getting from the banks as much for its bonds as
investors would pay. And then it loses interest
on the money raised before it is needed. For the
bankers receive from the city bonds bearing rarely
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? SUPERFLUOUS BANKERS 119
less than 4 per cent. interest; while the proceeds
are deposited in the banks which rarely allow
more than 2 per cent. interest on the daily
balances.
CITIES THAT HELPED THEMSELVES
In the present year some cities have been led by
necessity to help themselves. The bond market
was poor. Business was uncertain, money tight
and the ordinary investor reluctant. Bankers
were loth to take new bond issues. Municipali-
ties were unwilling to pay the high rates de-
manded of them. And many cities were prohib-
ited by law or ordinance from paying more than
4 per cent. interest; while good municipal bonds
were then selling on a 4 1/2 to 5 per cent. basis.
But money had to be raised, and the attempt was
made to borrow it direct from the lenders instead
of from the banker-middleman. Among the
cities which raised money in this way were Phila-
delphia, Baltimore, St. Paul, and Utica, New
York.
Philadelphia, under Mayor Blankenburg's
inspiration, sold nearly $4,175,000 in about two
days on a 4 per cent. basis and another "over-the-
counter" sale has been made since. In Balti-
more, with the assistance of the Sun, $4,766,000
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? 120 OTHER PEOPLE'S MONEY
were sold "over the counter" on a 4 1/2 per cent.
basis. Utica's two "popular sales" of 41/2
per cent. bonds were largely "over-subscribed. "
And since then other cities large and small
have had their "over-the-counter" bond sales.
The experience of Utica, as stated by its Control-
ler, Fred G. Reusswig, must prove of general
interest:
"In June of the present year I advertised for
sale two issues, one of $100,000, and the other of
$19,000, bearing interest at 4 1/2 per cent. The
latter issue was purchased at par by a local bidder
and of the former we purchased $10,000 for our
sinking funds. That left $90,000 unsold, for
which there were no bidders, which was the first
time that I had been unable to sell our bonds.
About this time the 'popular sales' of Baltimore
and Philadelphia attracted my attention. The
laws in effect in those cities did not restrict the
officials as does our law and I could not copy their
methods. I realized that there was plenty of
money in this immediate vicinity and if I could
devise a plan conforming with our laws under
which I could make the sale attractive to small
investors it would undoubtedly prove successful.
I had found, in previous efforts to interest people
of small means, that they did not understand the
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? SUPERFLUOUS BANKERS 121
meaning of premium and would rather not buy
than bid above par. They also objected to mak-
ing a deposit with their bids. In arranging for
the 'popular sales' I announced in the papers
that, while I must award to the highest bidder, it
was my opinion that a par bid would be the highest
bid. I also announced that we would issue bonds
in denominations as low as $100 and that we
would not require a deposit except where the bid
was $5,000 or over.
is due partly, also, to his ignorance of the
facts. Is it not probable that, if each in-
vestor knew the extent to which the security he
buys from the banker is diluted by excessive
underwritings, commissions and profits, there
would be a strike of capital against these unjust
exactions?
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? 100 OTHER PEOPLE'S MONEY
THE STRIKE OF CAPITAL
A recent British experience supports this
view. In a brief period last spring nine differ-
ent issues, aggregating $135,840,000, were offered
by syndicates on the London market, and on the
average only about 10 per cent. of these loans
was taken by the public. Money was "tight,"
but the rates of interest offered were very liberal,
and no one doubted that the investors were
well supplied with funds. The London Daily
Mail presented an explanation:
"The long series of rebuffs to new loans at the
hands of investors reached a climax in the ill
success of the great Rothschild issue. It will
remain a topic of financial discussion for many
days, and many in the city are expressing the
opinion that it may have a revolutionary effect
upon the present system of loan issuing and
underwriting. The question being discussed is
that the public have become loth to subscribe
for stock which they believe the underwriters can
afford, by reason of the commission they receive,
to sell subsequently at a lower price than the
issue price, and that the Stock Exchange has
begun to realize the public's attitude. The public
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? WHAT PUBLICITY CAN DO 101
sees in the underwriter not so much one who in-
sures that the loan shall be subscribed in return
for its commission as a middleman, who, as it
were, has an opportunity of obtaining stock at
a lower price than the public in order that he
may pass it off at a profit subsequently. They
prefer not to subscribe, but to await an oppor-
tunity of dividing that profit. They feel that
if, when these issues were made, the stock were
offered them at a more attractive price, there
would be less need to pay the underwriters so
high commissions. It is another practical pro-
test, if indirect, against the existence of the
middleman, which protest is one of the features
of present-day finance. "
Compel bankers when issuing securities to
make public the commissions or profits they are
receiving. Let every circular letter, prospectus
or advertisement of a bond or stock show clearly
what the banker received for his middleman-
services, and what the bonds and stocks net
the issuing corporation. That is knowledge to
which both the existing security holder and the
prospective purchaser is fairly entitled. If the
bankers' compensation is reasonable, consider-
PUBLICITT AS A REMEDY
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? 108 OTHER PEOPLE'S MONEY
ing the skill and risk involved, there can be no
objection to making it known. If it is not
reasonable, the investor will "strike," as in-
vestors seem to have done recently in England.
Such disclosures of bankers' commissions or
profits is demanded also for another reason: It
will aid the investor in judging of the safety of
the investment. In the marketing of securities
there are two classes of risks: One is the risk
whether the banker (or the corporation) will find
ready purchasers for the bonds or stock at the
issue price; the other whether the investor will
get a good article. The maker of the security
and the banker are interested chiefly in getting it
sold at the issue price. The investor is interested
chiefly in buying a good article. The small
investor relies almost exclusively upon the banker
for his knowledge and judgment as to the quality
of the security; and it is this which makes his
relation to the banker one of confidence. But
at present, the investment banker occupies a
position inconsistent with that relation. The
bankers' compensation should, of course, vary
according to the risk he assumes. Where there
is a large risk that the bonds or stock will not be
promptly sold at the issue price, the underwriting
commission (that is the insurance premium)
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? WHAT PUBLICITY CAN DO 103
should be correspondingly large. But the banker
ought not to be paid more for getting investors
to assume a larger risk. In practice the banker
gets the higher commission for underwriting the
weaker security, on the ground that his own risk
is greater. And the weaker the security, the
greater is the banker's incentive to induce his
customers to relieve him. Now the law should
not undertake (except incidentally in connection
with railroads and public-service corporations) to
fix bankers' profits. And it should not seek to
prevent investors from making bad bargains.
But it is now recognized in the simplest mer-
chandising, that there should be full disclosures.
The archaic doctrine of caveat emptor is vanishing.
The law has begun to require publicity in aid of
fair dealing. The Federal Pure Food Law does
not guarantee quality or prices; but it helps the
buyer to judge of quality by requiring disclosure
of ingredients. Among the most important facts
to be learned for determining the real value of a
security is the amount of water it contains.
And any excessive amount paid to the banker
for marketing a security is water. Require a
full disclosure to the investor of the amount of
commissions and profits paid; and not only will
investors be put on their guard, but bankers'
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? 104 OTHER PEOPLE'S MONEY
compensation will tend to adjust itself auto-
matically to what is fair and reasonable. Ex-
cessive commissions--this form of unjustly ac-
quired wealth--will in large part cease.
REAL DISCLOSURE
But the disclosure must be real. And it must
be a disclosure to the investor. It will not suffice
to require merely the filing of a statement of facts
with the Commissioner of Corporations or with
a score of other officials, federal and state. That
would be almost as ineffective as if the Pure Food
Law required a manufacturer merely to deposit
with the Department a statement of ingredients,
instead of requiring the label to tell the story.
Nor would the filing of a full statement with the
Stock Exchange, if incorporated, as provided
by the Pujo Committee bill, be adequate.
To be effective, knowledge of the facts must be
actually brought home to the investor, and this
can best be done by requiring the facts to be
stated in good, large type in every notice, circu-
lar, letter and advertisement inviting the investor
to purchase. Compliance with this requirement
should also be obligatory, and not something
which the investor could waive. For the whole
public is interested in putting an end to the
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? WHAT PUBLICITY CAN DO 105
bankers' exactions. England undertook, years
ago, to protect its investors against the wiles of
promoters, by requiring a somewhat similar dis-
closure; but the British act failed, in large
measure of its purpose, partly because under it
the statement of facts Was filed only with a public
official, and partly because the investor could
waive the provision. And the British statute has
now been changed in the latter respect.
DISCLOSE SYNDICATE PARTICULARS
The required publicity should also include a
disclosure of all participants in an underwriting.
It is a common incident of underwriting that no
member of the syndicate shall sell at less than the
syndicate price for a definite period, unless the
syndicate is sooner dissolved. In other words,
the bankers make, by agreement, an artificial
price. Often the agreement is probably illegal
under the Sherman Anti-Trust Law. This price
maintenance is, however, not necessarily objec-
tionable. It may be entirely consistent with the
general welfare, if the facts are made known.
But disclosure should include a list of those par-
ticipating in the underwriting so that the public
may not be misled. The investor should know
whether his adviser is disinterested.
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? 106 OTHER PEOPLE'S MONEY
Not long ago a member of a leading banking
house was undertaking to justify a commission
taken by his firm for floating a now favorite pre-
ferred stock of a manufacturing concern. The
bankers took for their services $250,000 in cash,
besides one-third of the common stock, amount-
ing to about $2,000,000. "Of course," he said,
"that would have been too much if we could have
kept it all for ourselves; but we couldn't. We
had to divide up a large part. There were fifty-
seven participants. Why, we had even to give
$10,000 of stock to (naming the presi-
dent of a leading bank in the city where the busi-
ness was located). He might some day have
been asked what he thought of the stock. If he
had shrugged his shoulders and said he didn't
know, we might have lost many a customer for
the stock. We had to give him $10,000 of the
stock to teach him not to shrug his shoulders. "
Think of the effectiveness with practical Amer-
icans of a statement like this:
A. B. & Co.
Investment Bankers
We have today secured substantial control of
the successful machinery business heretofore
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? WHAT PUBLICITY CAN DO 107
conducted by at , Illinois, which
has been incorporated under the name of the
Excelsior Manufacturing Company with a capital
of $10,000,000, of which $5,000,000 is Preferred
and $5,000,000 Common.
As we have a large clientele of confiding
customers, we were able to secure from the
owners an agreement for marketing the Pre-
ferred stock--we to fix a price which shall net
the owners in cash $95 a share.
We offer this excellent stock to you at $100. 75
per share. Our own commission or profit will
be only a little over $5. 00 per share, or say,
$250,000 cash, besides $1,500,000 of the Common
stock, which we received as a bonus. This cash
and stock commission we are to divide in various
proportions with the following participants in the
underwriting syndicate:
C. D. & Co. , New York
E. F. & Co. , Boston
L. M. & Co. , Philadelphia
I. K. & Co. , New York.
O. P. & Co. , Chicago
Were such notices common, the investment
bankers would "be worthy of their hire," for
only reasonable compensation would ordinarily
be taken.
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? 108 OTHER PEOPLE'S MONEY
For marketing the preferred stock, as in the
case of Excelsior Manufacturing Co. referred to
above, investment bankers were doubtless
essential, and as middlemen they performed a
useful service. But they used their strong position
to make an excessive charge. There are, how-
ever, many cases where the banker's services
can be altogether dispensed with; and where
that is possible he should be eliminated, not
only for economy's sake, but to break up
financial concentration.
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? CHAPTER VI
WHERE THE BANKER IS SUPERFLUOUS
The abolition of interlocking directorates will
greatly curtail the bankers' power by putting an
end to many improper combinations. Publicity
concerning bankers' commissions, profits and
associates, will lend effective aid, particularly by
curbing undue exactions. Many of the specific
measures recommended by the Pujo Committee
(some of them dealing with technical details)
will go far toward correcting corporate and bank-
ing abuses; and thus tend to arrest financial
concentration. But the investment banker has,
within his legitimate province, acquired control
so extensive as to menace the public welfare,
even where his business is properly conducted.
If the New Freedom is to be attained, every
proper means of lessening that power must be
availed of. A simple and effective remedy,
which can be widely applied, even without new
legislation, lies near at hand:--Eliminate the
banker-middleman where he is superfluous.
Today practically all governments. states and
109
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? 110 OTHER PEOPLE'S MONEY
municipalities pay toll to the banker on all
bonds sold. Why should they? It is not be-
cause the banker is always needed. It is because
the banker controls the only avenue through
which the investor in bonds and stocks can or-
dinarily be reached. The banker has become the
universal tax gatherer. True, the pro rata
of taxes levied by him upon our state and city
governments is less than that levied by him upon
the corporations. But few states or cities escape
payment of some such tax to the banker on every
loan it makes. Even where the new issues of
bonds are sold at public auction, or to the highest
bidder on sealed proposals, the bankers' syndicates
usually secure large blocks of the bonds which
are sold to the people at a considerable profit.
The middleman, even though unnecessary, col-
lects his tribute.
There is a legitimate field for dealers in state
and municipal bonds, as for other merchants.
Investors already owning such bonds must have
a medium through which they can sell their
holdings. And those states or municipalities
which lack an established reputation among
investors, or which must seek more distant
markets, need the banker to distribute new issues.
But there are many states and cities which have
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? SUPERFLUOUS BANKERS 111
an established reputation and have a home
market at hand. These should sell their bonds
direct to investors without the intervention of a
middleman. And as like conditions prevail with
some corporations, their bonds and stocks should
also be sold direct to the investor. Both financial
efficiency and industrial liberty demand that the
bankers' toll be abolished, where that is possible.
The business of the investment banker must
not be confused with that of the bond and stock
broker. The two are often combined; but the
functions are essentially different. The broker
performs a very limited service. He has properly
nothing to do with the original issue of securities,
nor with^their introduction into the market. He
merely negotiates a purchase or sale as agent for
another under specific orders. He exercises no
discretion, except in the method of bringing
buyer and seller together, or of executing orders.
For his humble service he receives a moderate
compensation, a commission, usually one-eighth
of one per cent. (12 1/2 cents for each $100) on
the par value of the security sold. The invest-
ment banker also is a mere middleman. But he
is a principal, not an agent. He is also a merchant
BANKER AND BBOKEB
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? 112 OTHER PEOPLE'S MONEY
in bonds and stocks. The compensation received
for his part in the transaction is in many cases
more accurately described as profit than as com-
mission. So far as concerns new issues of
government, state and municipal bonds, espe-
cially, he acts as merchant, buying and selling
securities on his own behalf; buying commonly
at wholesale from the maker and selling at retail
to the investors; taking the merchant's risk and
the merchant's profits. On purchases of corpo-
rate securities the profits are often very large;
but even a large profit may be entirely proper;
for when the banker's services are needed and
are properly performed, they are of great value.
On purchases of government, state and munic-
ipal securities the profit is usually smaller; but
even a very small profit cannot be justified, if
unnecessary.
HOW THE BANKER CAN SERVE
The banker's services include three distinct
functions, and only three:
First: Specifically as expert. The investment
banker has the responsibility of the ordinary
retailer to sell only that merchandise which is
good of its kind. But his responsibility in this
respect is unusually heavy, because he deals in an
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? SUPERFLUOUS BANKERS 118
article on which a great majority of his customers
are unable, themselves, to pass intelligent judg-
ment without aid. The purchase by the investor
of most corporate securities is little better than a
gamble, where he fails to get the advice of some
one who has investigated the security thoroughly
as the banker should. For few investors have the
time, the facilities, or the ability to investigate
properly the value of corporate securities.
Second: Specifically as distributor. The banker
performs an all-important service in providing
an outlet for securities. His connections enable
him to reach possible buyers quickly. And good-
will--that is, possession of the confidence of regu-
lar customers--enables him to effect sales where
the maker of the security might utterly fail to
find a market.
Third: Specifically as jobber or retailer. The
investment banker, like other merchants, carries
his stock in trade until it can be marketed. In
this he performs a service which is often of great
value to the maker. Needed cash is obtained
immediately, because the whole issue of securities
can thus be disposed of by a single transaction.
And even where there is not immediate payment,
the knowledge that the money will be provided
when needed is often of paramount importance.
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? 114 OTHER PEOPLE'S MONEY
By carrying securities in stock, the banker per-
forms a service also to investors, who are thereby
enabled to buy securities at such times as they
desire.
Whenever makers of securities or investors
require all or any of these three services, the
investment banker is needed, and payment of
compensation to him is proper. Where there is
no such need, the banker is clearly superfluous.
And in respect to the original issue of many of our
state and municipal bonds, and of some corporate
securities, no such need exists.
It needs no banker experts in value to tell us
that bonds of Massachusetts or New York, of
Boston, Philadelphia or Baltimore and of scores
of lesser American cities, are safe investments.
The basic financial facts in regard to such bonds
are a part of the common knowledge of many
American investors; and, certainly, of most pos-
sible investors who reside in the particular state
or city whose bonds are in question. Where the
financial facts are not generally known, they are
so simple, that they can be easily summarized and
understood by any prospective investor without
interpretation by an expert. Bankers often
WHEEE THE BANKER SERVES NOT
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? SUPERFLUOUS BANKERS 11&
employ, before purchasing securities, their own.
accountants to verify the statements supplied by
the makers of the security, and use these account-
ants' certificates as an aid in selling. States and
municipalities, the makers of the securities,
might for the same purpose employ independent
public accountants of high reputation, who would
give their certificates for use in marketing the
securities. Investors could also be assured with-
out banker-aid that the basic legal conditions are
sound. Bankers, before purchasing an issue of
securities, customarily obtain from their own
counsel an opinion as to its legality, which inves-
tors are invited to examine. It would answer
the same purpose, if states and municipalities
should supplement the opinion of their legal
representatives by that of independent counsel
of recognized professional standing, who would
certify to the legality of the issue.
Neither should an investment banker be needed
to find investors willing to take up, in small lots,
a new issue of bonds of New York or Massa-
chusetts, of Boston, Philadelphia or Baltimore, or
a hundred other American cities. A state or
municipality seeking to market direct to the
investor its own bonds would naturally experi-
ence, at the outset, some difficulty in marketing a
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? 116 OTHER PEOPLE'S MONEY
large issue. And in a newer community, where
there is little accumulation of unemployed capital,
it might be impossible to find buyers for any large
issue. Investors are apt to be conservative;
and they have been trained to regard the inter-
vention of the banker as necessary. The bankers
would naturally discourage any attempt of states
and cities to dispense with their services. En-
trance upon a market, hitherto monopolized by
them, would usually have to be struggled for.
But banker-fed investors, as well as others could,
in time, be brought to realize the advantage of
avoiding the middleman and dealing directly with
responsible borrowers. Governments, like private
concerns, would have to do educational work; but
this publicity would be much less expensive and
much more productive than that undertaken by
the bankers. Many investors are already impa-
tient of banker exactions; and eager to deal
directly with governmental agencies in whom they
have more confidence. And a great demand Cv. old,
at once, be developed among smaller investor*
whom the bankers have been unable to interest,
and who now never buy state or municipal bonds.
The opening of this new field would furnish a mar-
ket, in some respects more desirable and certainty
wider than that now reached by the bankers.
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? SUPERFLUOUS BANKERS 117
Neither do states or cities ordinarily need the
services of the investment banker to carry their
bonds pending distribution to the investor.
Where there is immediate need for large funds,
states and cities--at least the older communities
--should be able to raise the money temporarily,
quite as well as the bankers do now, while await-
ing distribution of their bonds to the investor.
Bankers carry the bonds with other people's
money, not with their own. Why should not
cities get the temporary use of other people's
money as well? Bankers have the preferential
use of the deposits in the banks, often because
they control the banks. Free these institutions
from banker-control, and no applicant to borrow
the people's money will be received with greater
favor than our large cities. Boston, with its
$1,500,000,000 of assessed valuation and $78,033,-
128 net debt, is certainly as good a risk as even
Lee, Higginson & Co. or Kidder, Peabody & Co.
But ordinarily cities do not, or should not,
require large sums of money at any one time.
Such need of large sums does not arise except
from time to time where maturing loans are to be
met, or when some existing public utility plant
is to be taken over from private owners. Large
issues of bonds for any other purpose are usually
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? 118 OTHER PEOPLE'S MONEY
made in anticipation of future needs, rather than
to meet present necessities. Modern efficient
public financiering, through substituting serial
bonds for the long term issues (which in Massa-
chusetts has been made obligatory) will, in time,
remove the need of large sums at one time for
paying maturing debts, since each year's maturi-
ties will be paid from the year's taxes. Purchases
of existing public utility plants are of rare occur-
rence, and are apt to be preceded by long periods
of negotiation. When they occur they can, if
foresight be exercised, usually be financed without
full cash payment at one time.
Today, when a large issue of bonds is made, the
banker, while ostensibly paying his own money to
the city, actually pays to the city other people's
money which he has borrowed from the banks.
Then the banks get back, through the city's de-
posits, a large part of the money so received. And
when the money is returned to the bank, the
banker has the opportunity of borrowing it again
for other operations. The process results in
double loss to the city. The city loses by not
getting from the banks as much for its bonds as
investors would pay. And then it loses interest
on the money raised before it is needed. For the
bankers receive from the city bonds bearing rarely
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? SUPERFLUOUS BANKERS 119
less than 4 per cent. interest; while the proceeds
are deposited in the banks which rarely allow
more than 2 per cent. interest on the daily
balances.
CITIES THAT HELPED THEMSELVES
In the present year some cities have been led by
necessity to help themselves. The bond market
was poor. Business was uncertain, money tight
and the ordinary investor reluctant. Bankers
were loth to take new bond issues. Municipali-
ties were unwilling to pay the high rates de-
manded of them. And many cities were prohib-
ited by law or ordinance from paying more than
4 per cent. interest; while good municipal bonds
were then selling on a 4 1/2 to 5 per cent. basis.
But money had to be raised, and the attempt was
made to borrow it direct from the lenders instead
of from the banker-middleman. Among the
cities which raised money in this way were Phila-
delphia, Baltimore, St. Paul, and Utica, New
York.
Philadelphia, under Mayor Blankenburg's
inspiration, sold nearly $4,175,000 in about two
days on a 4 per cent. basis and another "over-the-
counter" sale has been made since. In Balti-
more, with the assistance of the Sun, $4,766,000
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? 120 OTHER PEOPLE'S MONEY
were sold "over the counter" on a 4 1/2 per cent.
basis. Utica's two "popular sales" of 41/2
per cent. bonds were largely "over-subscribed. "
And since then other cities large and small
have had their "over-the-counter" bond sales.
The experience of Utica, as stated by its Control-
ler, Fred G. Reusswig, must prove of general
interest:
"In June of the present year I advertised for
sale two issues, one of $100,000, and the other of
$19,000, bearing interest at 4 1/2 per cent. The
latter issue was purchased at par by a local bidder
and of the former we purchased $10,000 for our
sinking funds. That left $90,000 unsold, for
which there were no bidders, which was the first
time that I had been unable to sell our bonds.
About this time the 'popular sales' of Baltimore
and Philadelphia attracted my attention. The
laws in effect in those cities did not restrict the
officials as does our law and I could not copy their
methods. I realized that there was plenty of
money in this immediate vicinity and if I could
devise a plan conforming with our laws under
which I could make the sale attractive to small
investors it would undoubtedly prove successful.
I had found, in previous efforts to interest people
of small means, that they did not understand the
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? SUPERFLUOUS BANKERS 121
meaning of premium and would rather not buy
than bid above par. They also objected to mak-
ing a deposit with their bids. In arranging for
the 'popular sales' I announced in the papers
that, while I must award to the highest bidder, it
was my opinion that a par bid would be the highest
bid. I also announced that we would issue bonds
in denominations as low as $100 and that we
would not require a deposit except where the bid
was $5,000 or over.
