Week after week throughout the early 1930s a seemingly endless procession of bankers appeared in Washington, D.C., to testify before various congressional committees and federal agencies to explain their conduct and actions during the halcyon days preceding the stock market crash. The Federal Trade Commission, which had begun its probe into the practices of utility corporations more than a year before the panic, uncovered numerous abuses, many of them, involving prominent financiers. Its findings were pushed off the front pages of the daily press by the more startling disclosures that came out of the Senate Finance Committee's inquiry into the sale of foreign bonds, and the alleged connections between the bankers who distributed these issues and America's entry into World War I. A few days after the start of these hearings, the Senate Banking and Currency Committee launched its probe of short sales on the New York Stock Exchange.
Not satisfied with such a limited mandate, the Senate expanded the committee's authority and assigned the task of conducting the investigation to a special subcommittee. The probe started late in April 1932 and lasted until May 1934. Its findings revealed gross abuses on the part of stock market operators who had enticed innocent investors to buy securities that were being manipulated for the benefit of a few insiders. Other, more lurid, aspects of high finance in the 1920s disclosed by the subcommittee included the profiteering that accompanied the launching of several investment trusts, the deceptions perpetrated by Ivar Kreuger, the once highly respected Swedish financier, and the many questionable practices employed by some of Wall Street's most eminent figures. All this proved to be only a prologue to the still more shocking revelations that came out after January 1933, when the New York City attorney Ferdinand Pecora was appointed the subcommittee's counsel. Through him the public learned of the misdeeds of other prominent bankers and the heavy losses they inflicted on investors. No other investigation accomplished more to shatter Wall Street's reputation than this one. Its findings, together with those of several other House and Senate committee probes, played a decisive role in bringing about a new era in American finance, in which the investment banker would become more closely regulated than most other business executives.
Kidder, Peabody's partners escaped Pecora's wrathful questioning, and the firm also was spared a searching examination of its record by other congressional investigators. During the 1920s Kidder, Peabody had not employed any of the selling practices that, though legal and acceptable during the days of the great bull market, came under attack and censure during the grim days of the depression. The firm had not engaged in the kind of speculative operations that so disfigured the records of other houses, nor had it abused the confidence of investors or violated its fiduciary responsibilities. And while the Kidder Participations had not performed as successfully as their sponsors had hoped, the firm had not misused its investment trusts. William Holway Hill, a partner in the old firm, testified that while the Participations were intended for "the benefit of all concerned," they had not "worked out" that way, and the recent disclosure of abuses had led him to conclude that the kind of close relations that had existed between Kidder, Peabody and its investment trusts should be avoided in the future. Such ties, he said, provided "too much possibility of misuse of power." The new partners not only concurred fully with this view, but moved immediately to disassociate the reorganized firm entirely from these earlier ventures.
By the time Pecora concluded his probe, Congress already had established the basic framework for federal regulation of the securities industry. The first of several statutes designed to reform Wall Street practices was the Securities Act of May 1933. With certain exceptions, among them federal, state, and local government bonds, the law required the registration of all new issues in excess of $100,000 that were to be sold in interstate commerce or through the mails. To prevent the kinds of deception that had been perpetrated in the 1920s the law also required that a detailed prospectus, disclosing all pertinent information relating to the securities, accompany the offering. Originally the Federal Trade Commission was authorized to enforce the law, but in 1934 this task was assigned to the newly created Securities and Exchange Commission.
Three weeks after President Franklin D. Roosevelt signed the Securities Act, Congress passed the Glass-Steagall Banking Act. One of its provisions required the complete separation of commercial and investment banking. Its effect upon the financial community was far more drastic than the Securities Act. The latter, despite the pained outcry from Wall Street, required investment houses to revise their underwriting and distribution practices, while the 1933 Banking Act brought about fundamental structural changes in the securities business. The law's divorcement provision outlawed the security affiliates of commercial banks, and forced private banking partnerships, like Kidder, Peabody, to choose between deposit and investment banking. More than two-thirds of the nation's private banks opted for investment banking. Since Kidder, Peabody already had decided to deemphasize its deposit business, the law, which went into effect in June 1934, only served to expedite the firm's transition from a private to an investment banking house.
Compliance with the Banking Act brought widespread changes in the makeup of the investment banking community. Old, established firms had to revise their operations, dropping some services and adding others. The law also was responsible for the organization of new firms to replace the defunct security affiliates. These and other changes resulted in a major reshuffling of personnel, as former officers of security affiliates and partners in private banks that chose to stay in the deposit business moved to various security houses, both old and newly organized firms.
Kidder, Peabody was not immune to the consequences of the Banking Act. The reorganization of the securities business that occurred in the year following the passage of that law provided Kidder, Peabody the opportunity to recruit some of the experienced personnel necessary to strengthen the firm's investment banking capability. Early in 1933, when the Chase Harris Forbes Corporation was dissolved, Kidder, Peabody added to its staff a group of salesmen from that organization. And the next year Fred Moore, who had himself just joined Kidder, Peabody, initiated the move that led to the firm's takeover of the offices and most of the staff of the Philadelphia National Company, the security affiliate of the Philadelphia National Bank, then the second largest commercial bank in Pennsylvania. The affiliate's president, Orus J. Matthews, was made manager of Kidder, Peabody's New Philadelphia branch, and two of his vice presidents (Erwin A. Stuebner and Alfred Rauch) became his assistant managers. The addition of new sales personnel and the acquisition of a Philadelphia office, at a time when retrenchment was the order of the day on Wall Street, fitted perfectly the new Kidder, Peabody partners' long-term plans for the firm: to strengthen and widen its ability to distribute securities.
On June 6, 1934, ten days before the Banking Act's divorcement provision went into effect, Congress approved the Securities Exchange Act, the last of the early New Deal's major securities statutes. This lengthy and detailed measure extended the full disclosure principle of the Securities Act to issues listed on national exchanges, prohibited various practices considered inimical to the public interest, and regulated others subject to abuse. The law created an independent five-member Securities and Exchange Commission (SEC) to police the securities markets.
Many of the law's provisions did not affect investment bankers directly, and several of the reforms it incorporated were strongly endorsed by prominent Wall Streeters. G. Hermann Kinnicutt of Kidder, Peabody, for example, had been among the financiers who appeared before the Senate Banking and Currency Committee to urge that enforcement of the securities laws be entrusted to an independent agency, rather than kept with the Federal Trade Commission, as the House version of the SEC bill originally had recommended.
During the half-dozen years following the passage of the SEC law, Congress enacted several other statutes limiting and regulating still further the activities of investment bankers. In August 1935 the Public Utility Holding Company Act authorized the SEC to review new security issues of electric and gas utility holding companies and their subsidiaries providing interstate service. The law also required that the SEC approve the types of securities these companies issued and their price and method of offering, as well as supervise the relations between these corporations and the investment houses that financed them. Three years later, the Chandler Act limited the activities of investment bankers in reorganizing publicly held corporations.
Still other restrictions followed in rapid succession. The Trust Indenture Act of 1939, the Investment Company Act, and the Investment Advisers Act, the last two of which were approved in 1940, extended still further the SEC's regulatory authority over investment houses. By the time the last of these laws went into effect few, if any, of the investment bankers' traditional functions and services fell outside the SEC's purview.
Meanwhile, the industry itself also had moved toward greater and more effective self-regulation. In June 1938 Congress added the Maloney Amendment to the SEC law, creating the National Association of Securities Dealers, Inc. This organization, designed to regulate the over-the-counter brokers and dealers under SEC supervision, grew out of the industry's 1933 Blue Eagle code under the National Industrial Recovery Act.
While the federal government was busy enacting legislation to prevent a recurrence of the abuses that had so disfigured American finance in the 1920s, investment bankers were undergoing a difficult period of readjustment. The protracted depression and continued suspicion of Wall Street, even more than federal regulation, made the 1930s an especially difficult decade for investment bankers. Recovery was slow and irregular. The volume of new corporate issues stayed at depression levels throughout most of the decade, rising from $380 million in 1933 to $4.4 billion in 1936, only to drop back to $2.1 billion in 1939 (see Table 5.1). The latter figure was not exceeded again until 1940, when new corporate offerings that year amounted to slightly more than $2.6 billion. Brokerage commissions also fell precipitously as the volume of shares traded on the New York Stock Exchange tumbled from 1.1 billion shares in 1929 to 425.
