INTERLOCKING DIRECTORATES
The practice of interlocking directorates is the root of many evils.
It offends laws human and divine. Applied to rival corporations,
it tends to the suppression of competition and to violation of the
Sherman law. Applied to corporations which deal with each other, it
tends to disloyalty and to violation of the fundamental law that no
man can serve two masters. In either event it tends to inefficiency;
for it removes incentive and destroys soundness of judgment. It is
undemocratic, for it rejects the platform: “A fair field and no
favors,”--substituting the pull of privilege for the push of manhood.
It is the most potent instrument of the Money Trust. Break the control
so exercised by the investment bankers over railroads, public-service
and industrial corporations, over banks, life insurance and trust
companies, and a long step will have been taken toward attainment of
the New Freedom.
The term “Interlocking directorates” is here used in a broad sense
as including all intertwined conflicting interests, whatever the
form, and by whatever device effected. The objection extends alike
to contracts of a corporation whether with one of its directors
individually, or with a firm of which he is a member, or with another
corporation in which he is interested as an officer or director
or stockholder. The objection extends likewise to men holding the
inconsistent position of director in two potentially competing
corporations, even if those corporations do not actually deal with each
other.
THE ENDLESS CHAIN
A single example will illustrate the vicious circle of control--the
endless chain--through which our financial oligarchy now operates:
J. P. Morgan (or a partner), a director of the New York, New Haven &
Hartford Railroad, causes that company to sell to J. P. Morgan & Co.
an issue of bonds. J. P. Morgan & Co. borrow the money with which to
pay for the bonds from the Guaranty Trust Company, of which Mr. Morgan
(or a partner) is a director. J. P. Morgan & Co. sell the bonds to the
Penn Mutual Life Insurance Company, of which Mr. Morgan (or a partner)
is a director. The New Haven spends the proceeds of the bonds in
purchasing steel rails from the United States Steel Corporation, of
which Mr. Morgan (or a partner) is a director. The United States Steel
Corporation spends the proceeds of the rails in purchasing electrical
supplies from the General Electric Company, of which Mr. Morgan (or
a partner) is a director. The General Electric sells supplies to the
Western Union Telegraph Company, a subsidiary of the American Telephone
and Telegraph Company; and in both Mr. Morgan (or a partner) is a
director. The Telegraph Company has an exclusive wire contract with the
Reading, of which Mr. Morgan (or a partner) is a director. The Reading
buys its passenger cars from the Pullman Company, of which Mr. Morgan
(or a partner) is a director. The Pullman Company buys (for local use)
locomotives from the Baldwin Locomotive Company, of which Mr. Morgan
(or a partner) is a director. The Reading, the General Electric, the
Steel Corporation and the New Haven, like the Pullman, buy locomotives
from the Baldwin Company. The Steel Corporation, the Telephone Company,
the New Haven, the Reading, the Pullman and the Baldwin Companies,
like the Western Union, buy electrical supplies from the General
Electric. The Baldwin, the Pullman, the Reading, the Telephone, the
Telegraph and the General Electric companies, like the New Haven, buy
steel products from the Steel Corporation. Each and every one of the
companies last named markets its securities through J. P. Morgan & Co.;
each deposits its funds with J. P. Morgan & Co.; and with these funds
of each, the firm enters upon further operations.
This specific illustration is in part supposititious; but it represents
truthfully the operation of interlocking directorates. Only it must be
multiplied many times and with many permutations to represent fully the
extent to which the interests of a few men are intertwined. Instead of
taking the New Haven as the railroad starting point in our example, the
New York Central, the Santa Fé, the Southern, the Lehigh Valley, the
Chicago and Great Western, the Erie or the Père Marquette might have
been selected; instead of the Guaranty Trust Company as the banking
reservoir, any one of a dozen other important banks or trust companies;
instead of the Penn Mutual as purchaser of the bonds, other insurance
companies; instead of the General Electric, its qualified competitor,
the Westinghouse Electric and Manufacturing Company. The chain is
indeed endless; for each controlled corporation is entwined with many
others.
As the _nexus_ of “Big Business” the Steel Corporation stands, of
course, preëminent. The Stanley Committee showed that the few men who
control the Steel Corporation, itself an owner of important railroads,
are directors also in twenty-nine other railroad systems, with 126,000
miles of line (more than half the railroad mileage of the United
States), and in important steamship companies. Through all these
alliances and the huge traffic it controls, the Steel Corporation’s
influence pervades railroad and steamship companies--not as carriers
only--but as the largest customers for steel. And its influence with
users of steel extends much further. These same few men are also
directors in twelve steel-using street railway systems, including some
of the largest in the world. They are directors in forty machinery
and similar steel-using manufacturing companies; in many gas, oil and
water companies, extensive users of iron products; and in the great
wire-using telephone and telegraph companies. The aggregate assets of
these different corporations--through which these few men exert their
influence over the business of the United States--exceeds sixteen
billion dollars.
Obviously, interlocking directorates, and all that term implies, must
be effectually prohibited before the freedom of American business can
be regained. The prohibition will not be an innovation. It will merely
give full legal sanction to the fundamental law of morals and of human
nature: that “No man can serve two masters.” The surprising fact is
that a principle of equity so firmly rooted should have been departed
from at all in dealing with corporations. For no rule of law has,
in other connections, been more rigorously applied, than that which
prohibits a trustee from occupying inconsistent positions, from dealing
with himself, or from using his fiduciary position for personal profit.
And a director of a corporation is as obviously a trustee as persons
holding similar positions in an unincorporated association, or in a
private trust estate, who are called specifically by that name. The
Courts have recognized this fully.
Thus, the Court of Appeals of New York declared in an important case:
“While not technically trustees, for the title of the corporate
property was in the corporation itself, they were charged with the
duties and subject to the liabilities of trustees. Clothed with
the power of controlling the property and managing the affairs of
the corporation without let or hindrance, as to third persons, they
were its agents; but as to the corporation itself equity holds
them liable as trustees. While courts of law generally treat the
directors as agents, courts of equity treat them as trustees, and
hold them to a strict account for any breach of the trust relation.
For all practical purposes they are trustees, when called upon in
equity to account for their official conduct.”
NULLIFYING THE LAW
But this wholesome rule of business, so clearly laid down, was
practically nullified by courts in creating two unfortunate
limitations, as concessions doubtless to the supposed needs of
commerce.
_First:_ Courts held valid contracts between a corporation
and a director, or between two corporations with a common director,
where it was shown that in making the contract, the corporation
was represented by independent directors and that the vote of the
interested director was unnecessary to carry the motion and his
presence was not needed to constitute a quorum.
_Second:_ Courts held that even where a common director participated
actively in the making of a contract between two corporations, the
contract was not absolutely void, but voidable only at the election of
the corporation.
The first limitation ignored the rule of law that a beneficiary is
entitled to disinterested advice from _all_ his trustees, and not
merely from some; and that a trustee may violate his trust by inaction
as well as by action. It ignored, also, the laws of human nature, in
assuming that the influence of a director is confined to the act of
voting. Every one knows that the most effective work is done before any
vote is taken, subtly, and without provable participation. Every one
should know that the denial of minority representation on boards of
directors has resulted in the domination of most corporations by one
or two men; and in practically banishing all criticism of the dominant
power. And even where the board is not so dominated, there is too often
that “harmonious coöperation” among directors which secures for each,
in his own line, a due share of the corporation’s favors.
The second limitation--by which contracts, in the making of which the
interested director participates actively, are held _merely voidable_
instead of absolutely void--ignores the teachings of experience.
To hold such contracts merely voidable has resulted practically in
declaring them valid. It is the directors who control corporate action;
and there is little reason to expect that any contract, entered into by
a board with a fellow director, however unfair, would be subsequently
avoided. Appeals from Philip drunk to Philip sober are not of frequent
occurrence, nor very fruitful. But here we lack even an appealing
party. Directors and the dominant stockholders would, of course, not
appeal; and the minority stockholders have rarely the knowledge of
facts which is essential to an effective appeal, whether it be made to
the directors, to the whole body of stockholders, or to the courts.
Besides, the financial burden and the risks incident to any attempt of
individual stockholders to interfere with an existing management is
ordinarily prohibitive. Proceedings to avoid contracts with directors
are, therefore, seldom brought, except after a radical change in the
membership of the board. And radical changes in a board’s membership
are rare. Indeed the Pujo Committee reports:
“None of the witnesses (the leading American bankers testified)
was able to name an instance in the history of the country in
which the stockholders had succeeded in overthrowing an existing
management in any large corporation. Nor does it appear that
stockholders have ever even succeeded in so far as to secure
the investigation of an existing management of a corporation to
ascertain whether it has been well or honestly managed.”
Mr. Max Pam proposed in the April, 1913, Harvard Law Review, that the
government come to the aid of minority stockholders. He urged that
the president of every corporation be required to report annually to
the stockholders, and to state and federal officials every contract
made by the company in which any director is interested; that the
Attorney-General of the United States or the State investigate
the same and take proper proceedings to set all such contracts
aside and recover any damages suffered; or without disaffirming
the contracts to recover from the interested directors the profits
derived therefrom. And to this end also, that State and National Bank
Examiners, State Superintendents of Insurance, and the Interstate
Commerce Commission be directed to examine the records of every bank,
trust company, insurance company, railroad company and every other
corporation engaged in interstate commerce. Mr. Pam’s views concerning
interlocking directorates are entitled to careful study. As counsel
prominently identified with the organization of trusts, he had for
years full opportunity of weighing the advantages and disadvantages
of “Big Business.” His conviction that the practice of interlocking
directorates is a menace to the public and demands drastic legislation,
is significant. And much can be said in support of the specific measure
which he proposes. But to be effective, the remedy must be fundamental
and comprehensive.
THE ESSENTIALS OF PROTECTION
Protection to minority stockholders demands that corporations be
prohibited absolutely from making contracts in which a director has a
private interest, and that all such contracts be declared not voidable
merely, but absolutely void.
In the case of railroads and public-service corporations (in
contradistinction to private industrial companies), such prohibition
is demanded, also, in the interests of the general public. For
interlocking interests breed inefficiency and disloyalty; and the
public pays, in higher rates or in poor service, a large part of the
penalty for graft and inefficiency. Indeed, whether rates are adequate
or excessive cannot be determined until it is known whether the gross
earnings of the corporation are properly expended. For when a company’s
important contracts are made through directors who are interested on
both sides, the common presumption that money spent has been properly
spent does not prevail. And this is particularly true in railroading,
where the company so often lacks effective competition in its own field.
But the compelling reason for prohibiting interlocking directorates
is neither the protection of stockholders, nor the protection of
the public from the incidents of inefficiency and graft. Conclusive
evidence (if obtainable) that the practice of interlocking directorates
benefited all stockholders and was the most efficient form of
organization, would not remove the objections. For even more important
than efficiency are industrial and political liberty; and these are
imperiled by the Money Trust. _Interlocking directorates must be
prohibited, because it is impossible to break the Money Trust without
putting an end to the practice in the larger corporations._
BANKS AS PUBLIC-SERVICE CORPORATIONS
The practice of interlocking directorates is peculiarly objectionable
when applied to banks, because of the nature and functions of those
institutions. Bank deposits are an important part of our currency
system. They are almost as essential a factor in commerce as our
railways. Receiving deposits and making loans therefrom should be
treated by the law not as a private business, but as one of the public
services. And recognizing it to be such, the law already regulates
it in many ways. The function of a bank is to receive and to loan
money. It has no more right than a common carrier to use its powers
specifically to build up or to destroy other businesses. The granting
or withholding of a loan should be determined, so far as concerns the
borrower, solely by the interest rate and the risk involved; and not
by favoritism or other considerations foreign to the banking function.
Men may safely be allowed to grant or to deny loans of their _own_
money to whomsoever they see fit, whatsoever their motive may be. But
bank resources are, in the main, not owned by the stockholders nor by
the directors. Nearly three-fourths of the aggregate resources of the
thirty-four banking institutions in which the Morgan associates hold
a predominant influence are represented by deposits. The dependence of
commerce and industry upon bank deposits, as the common reservoir of
quick capital is so complete, that deposit banking should be recognized
as one of the businesses “affected with a public interest.” And the
general rule which forbids public-service corporations from making
unjust discriminations or giving undue preference should be applied to
the operations of such banks.
Senator Owen, Chairman of the Committee on Banking and Currency, said
recently:
“My own judgment is that a bank is a public-utility institution and
cannot be treated as a private affair, for the simple reason that
the public is invited, under the safeguards of the government, to
deposit its money with the bank, and the public has a right to have
its interests safeguarded through organized authorities. The logic
of this is beyond escape. All banks in the United States, public
and private, should be treated as public-utility institutions,
where they receive public deposits.”
The directors and officers of banking institutions must, of course, be
entrusted with wide discretion in the granting or denying of loans.
But that discretion should be exercised, not only honestly as it
affects stockholders, but also impartially as it affects the public.
Mere honesty to the stockholders demands that the interests to be
considered by the directors be the interests of all the stockholders;
not the profit of the part of them who happen to be its directors.
But the general welfare demands of the director, as trustee for the
public, performance of a stricter duty. The fact that the granting of
loans involves a delicate exercise of discretion makes it difficult
to determine whether the rule of equality of treatment, which every
public-service corporation owes, has been performed. But that
difficulty merely emphasizes the importance of making absolute the
rule that banks of deposit shall not make any loan nor engage in any
transaction in which a director has a private interest. And we should
bear this in mind: If privately-owned banks fail in the public duty to
afford borrowers equality of opportunity, there will arise a demand for
government-owned banks, which will become irresistible.
The statement of Mr. Justice Holmes of the Supreme Court of the United
States, in the Oklahoma Bank case, is significant:
“We cannot say that the public interests to which we have adverted,
and others, are not sufficient to warrant the State in taking the
whole business of banking under its control. On the contrary we are of
opinion that it may go on from regulation to prohibition except upon
such conditions as it may prescribe.”
OFFICIAL PRECEDENTS
Nor would the requirement that banks shall make no loan in which a
director has a private interest impose undue hardships or restrictions
upon bank directors. It might make a bank director dispose of some of
his investments and refrain from making others; but it often happens
that the holding of one office precludes a man from holding another, or
compels him to dispose of certain financial interests.
A judge is disqualified from sitting in any case in which he has even
the smallest financial interest; and most judges, in order to be free
to act in any matters arising in their court, proceed, upon taking
office, to dispose of all investments which could conceivably bias
their judgment in any matter that might come before them. An Interstate
Commerce Commissioner is prohibited from owning any bonds or stocks in
any corporation subject to the jurisdiction of the Commission. It is
a serious criminal offence for any executive officer of the federal
government to transact government business with any corporation in the
pecuniary profits of which he is directly or indirectly interested.
And the directors of our great banking institutions, as the ultimate
judges of bank credit, exercise today a function no less important
to the country’s welfare than that of the judges of our courts, the
interstate commerce commissioners, and departmental heads.
SCOPE OF THE PROHIBITION
In the proposals for legislation on this subject, four important
questions are presented:
1. Shall the principle of prohibiting interlocking directorates
in potentially competing corporations be applied to state banking
institutions, as well as the national banks?
2. Shall it be applied to all kinds of corporations or only to banking
institutions?
3. Shall the principle of prohibiting corporations from entering into
transactions in which the management has a private interest be applied
to both directors and officers or be confined in its application to
officers only?
4. Shall the principle be applied so as to prohibit transactions with
another corporation in which one of its directors is interested merely
as a stockholder?