Expansion of Kidder, Peabody's retail sales organization was initiated by the Boston partners, and by the end of the decade all of the branches had added new personnel to their brokerage operations. In 1927 the Wall Street office started its own in-house sales school, which soon "graduated" about a dozen salespeople who bought and sold mostly AT&T shares and those of Kidder, Peabody's own investment trusts. The firm did not seek or carry margin accounts. In terms of its total profits, brokerage trailed considerably behind the firm's banking and underwriting business.
Increased attention to sales was not Kidder, Peabody's most important concession to the "New Era's" financial optimism. The firm's most obvious departure from its old ways came with the decision to organize affiliated corporations of its own. There was nothing new in the practice of banks setting up separate entities to perform functions that the parent firm did not want to provide or could not legally do. Commercial banks had employed securities affiliates to extend their securities operations in the years immediately before World War I, and they greatly expanded these activities in the 1920s. Kidder, Peabody employed the same technique, though for different reasons, when it established the Kidder, Peabody Acceptance Corporation in April 1922.
Originally intended to provide commercial credits in dollars to manufacturers and merchants for the purchase of raw materials in both domestic and foreign markets, as well as to assist the financing of imports and exports generally, the Acceptance Corporation became the vehicle through which Kidder, Peabody subsequently launched its own investment trusts. This occasioned no surprise, for the Acceptance Corporation itself was not an entirely new entity. Its origins went back to the turn-of-the-century.
The Acceptance Corporation evolved out of the New England Cotton Yam Company (NECY), a merger of nine Massachusetts textile companies organized by Kidder, Peabody in July 1899. The consolidation never proved profitable, although it aroused widespread comment at the time and was labeled a trust and monopoly by critics of big business. In 1903 NECY, a New Jersey corporation, was recapitalized and reorganized under a Massachusetts charter. When the new corporation proved no more profitable than the original consolidation, it was liquidated. By the end of 1917 NECY had sold all its physical properties. The funds received were invested mostly in securities of the spun-off companies. These changes transformed NECY into a holding company in which Kidder, Peabody was the dominant influence. The firm, together with the Barings, held large blocks of NECY securities; Kidder, Peabody partners and officers were represented on the board.
In view of its new status and functions NECY altered its charter in 1918 and changed its name to New England Investment Company (NEIC). Then in 1921, in anticipation of adding to its functions and scale of operations, NEIC was reincorporated with increased authorized stock plus a new assortment of securities, some to be marketed for new money. The name also was altered slightly, the word company being replaced with corporation. Within a few months and before these latest changes were effected, NEIC's name was changed again, this time to The Kidder, Peabody Acceptance Corporation.
Capitalized at slightly more than $10 million, the securities of the Acceptance Corporation were designed to serve several purposes. Two classes of preferred stock were issued: Class A was used in exchange for the common shares of the predecessor company (NEIC), and Class B was sold to raise new capital. Both were nonvoting. Only the common stock had this right, all of which was held for the purpose of control by Kidder, Peabody and Baring Brothers.
Kidder, Peabody served the Acceptance Corporation in several ways. All its directors as well as the president and treasurer were partners in the firm. Kidder, Peabody distributed and dealt in the corporation's preferred stock, negotiated exchanges of issues, and served as transfer agent. In several instances the firm arranged exchanges of Acceptance Corporation shares for stocks in other companies Kidder, Peabody was financing.
For all practical purposes the Acceptance Corporation was a branch of the firm with the additional advantages of incorporation. Kidder, Peabody gained considerably by the relationship. By specializing in the letter of credit and acceptance business, the corporation extended and diversified Kidder, Peabody's activities in these areas. In addition it became a means through which the firm could enlarge its underwritings, for the corporation proved to be both a source of funds as well as a market for securities.
Originally the corporation functioned primarily as an acceptance bank. Prior to World War I Kidder, Peabody had financed American overseas trade with foreign currencies, chiefly sterling. Use of dollar acceptances at the time was slight. After the war demand for the latter increased so markedly that in 1919 the Federal Reserve Act was amended to facilitate the formation of corporations to engage in international banking. The Edge Act, as this amendment came to be known, encouraged the use of dollar acceptances still further. At the time the Acceptance Corporation was organized the volume of dollar acceptances outstanding stood at about $600 million; by the end of 1929 it had reached a peak of more than $1.7 billion.
The Acceptance Corporation shared in the booming business. The volume of its outstanding acceptances, which increased from some $4 million in 1922 to nearly $40 million in 1929, made it one of the most important companies in the business. It stood second in the country among specialized acceptance houses and about twelfth among all banks issuing these instruments. Needless to say, the corporation's acceptances enjoyed prime status among brokers and dealers.
But the Acceptance Corporation was more than a source of profits; it also aided and benefited the firm as an underwriter of an investor in its promotions. This was particularly true in 1928 and 1929 when the corporation's participation in Kidder, Peabody's underwritings increased significantly. The corporation's augmented operations in the new issues business altered both its liquidity and character. In the early 1920s most of its investments were in federal government bonds; by the end of the decade these had been replaced with securities of companies promoted by Kidder, Peabody. And while the corporation continued to function as an acceptance bank, it also took on many characteristics of an investment trust.
At the time Kidder, Peabody widened the functions of the Acceptance Corporation, the firm strayed still further from its conservative principles by sponsoring its own investment trusts. Fewer than 200 of these companies had been organized in the United States by the end of 1926. Then a rising stock market and growing public demand for equities led to the formation of more. In 1927, the year Kidder, Peabody organized its first investment trust (Kidder Participations, Inc., No. 1), 140 such companies were set up and the movement had just begun to pick up momentum. By 1929 the number of investment trusts in operation stood at 770, more than four times as many as had been organized in the nation's entire history. Kidder, Peabody contributed to that total with two of its own-Kidder Participations, Inc., No. 2 organized in 1928, and Kidder Participations, Inc., No. 3 set up in 1929. All three were management trusts, their portfolios controlled by the companies' officers and directors, nearly all of whom were partners in the firm.
Various reasons prompted Kidder, Peabody to launch these corporations. The announced purpose was to satisfy the demands of its clients and friends "to devise some means whereby they could acquire a stock interest in our business." Stockholders in the trusts found the prospect of sharing in the firm's underwriting profits highly attractive. Kidder, Peabody explained the organization of Participations No. 2 by saying that No. 1 was so successful and "the demand for its shares so insistent that it seemed wise to repeat the undertaking." Similar words were employed at the time No. 3 was established.
Investment houses, of course, appreciated the profits to be made from organizing these corporations. Flotation of investment trust securities was a profitable business. But an equally important motive was the additional working capital such companies made available to the firms that sponsored them. This reason, probably more than any other, accounted for Kidder, Peabody's decision to launch its own investment trusts. Also important was the fact that these affiliates provided the banking house that organized them with a market for the securities it sponsored. William Holway Hill, who was made a Kidder, Peabody partner in November 1926 and served as a director of all three of the firm's investment trusts, subsequently testified that almost all of the Participations' holdings were in "securities of companies [with] which Kidder, Peabody & Co. had banking relations."
This was the declared objective of the Participations. Their function, as stated in a circular dated January 1929, consisted of "underwritings, participations, purchasing of blocks of securities and trading." While these activities would be conducted "with due regard to the reasonable safety of the Preferred stocks," the corporations' funds would be invested "with a view to the probable increase from year to year in security values." Investment in growth stocks, in other words, was the clearly stated purpose of the Participations.
The directors were given a free hand to choose securities as they deemed best. "The only limitation upon the absolute discretion of the Board of Directors in the choice of investments," Kidder, Peabody declared, was that not more than 10 percent of No. 1's "outstanding capital shall be invested in the securities of one corporation." This restriction was raised to 20 percent in the case of Participations No. 2 and No. 3.
There were few significant differences between the investment policies of the Participations and the Acceptance Corporation. All held both stocks and bonds, but not in the same proportions. The Participations invested more in stocks than bonds; the reverse was true of the Acceptance Corporation. All four participated equally in Kidder, Peabody's offerings, both as underwriters and investors.
Kidder, Peabody charged no fee for its services in organizing the Participations. The firm paid itself in the companies' common stock, taking one-fourth of the total in the case of No. 1 and No. 2, and one-half in the case of No. 3.
Management of the three trusts was vested in Kidder, Pea-body. Any conflict of interest was obviated by a statement to that effect in the agreements setting up the trusts. Each gave the directors and officers, all of whom were associated with the banking house, authority "to buy or sell to or otherwise deal with any firm, corporation or organization in which any one or more of the officers or directors of this corporation may be a member or in which he or they may be financially interested."
All three Participations had similar capital structures. Each issued $5 million of preferred stock, and No. 1 and No. 2 issued 2.5 million shares of no par common. For No. 3 the amount of common was 100,000 shares. The preferred stock of all three trusts had complicated participating provisions and was convertible into common.
Kidder, Peabody sold the stock privately in blocks of one preferred and three-quarter share of common for Participations No. 1 and No. 2, and one of each in the case of No. 3. The blocks were offered at $102, $103.50 and $103.50, respectively, for the three trusts. The common stock not thus distributed was Kidder, Peabody's bonus. Sales went well, so that by December 1929, there were 1,300 preferred shareholders and 1,200 owners of common in No. 1; about 1,500 preferred and common holders in No. 2; and by December 1930 approximately 1,700 preferred and common holders in No. 3.
Two additional investment trusts were launched in 1927 and 1929, both with Kidder, Peabody's cooperation and assistance. They bore the name of the investment firm that co-sponsored them, Mitchum, Tulley & Co., a San Francisco house and long-time correspondent and underwriting partner of Kidder, Pea-body. The two trusts (Mitchum Tulley Participations No. 1 and No. 2) were organized and functioned like the Kidder Participations. Two Kidder, Peabody officials were on the directorates of the Mitchum Tulley trusts, with their other officers all recruited from the San Francisco banking house. Size was the only significant difference between the Kidder, Peabody and the Mitchum, Tulley companies, the latter being considerably smaller. Total capital stock of Mitchum, Tulley No. 1 had a nominal value of about $1 million. In all other respects, such as the various complicated provisions of the preferred stock and unit sales of preferred with common shares, they were similar to the three Kidder Participations.
Still another of Kidder, Peabody's ventures into new financial areas was its organization of The Peabody Trust Company of Boston, incorporated under the laws of Massachusetts in August 1927. The stated reason for this addition to the Kidder, Peabody group of companies was to provide the firm's clients with "complete financial services," an objective widely acclaimed and pursued by financiers in the 1920s. The trust company was organized to function as a bank, but its chief purpose was to manage estates and trusts. To do this successfully, as Kidder, Peabody stressed in a circular announcing the formation of the company, required "integrity, ability, experience, and sound judgment." The trust company possessed all these qualities by virtue of the fact that its directors and officers were "either partners of Kidder, Peabody & Company or men... long associated with that firm."
Within a few months of its organization, the trust company increased its original capital from $200,000 to $500,000. Compared to the capitalization of other similar Boston institutions at the time, The Peabody Trust Company was a relatively small organization. But the fact that it was so closely tied to Kidder, Peabody gave it a prestige and status far beyond its actual resources. The Commercial & Financial Chronicle, commenting on its establishment, said that it was "the first important charter granted in Boston in a great many years." An even more important indication of its respected position among Boston financial institutions was the extent of its success in attracting clients. By the end of 1929 capital, surplus, and demand deposits exceeded $5.7 million, while trust accounts amounted to $10.4 million.
Kidder, Peabody and its various affiliates held most of the trust company's stock. Apart from these institutions, shareholders in The Kidder Peabody Trust Company, as it was renamed in 1929, numbered fewer than fifty.
