Wall Street's First Cleanup Man
By Mike Brewster
The pending $1.4 billion settlement between 10 Wall Street investment banks on one side and the office of New York State Attorney General Eliot Spitzer and the Securities & Exchange Commission on the other appears on its face to be a huge victory for the crusading Spitzer, who stole a march on federal authorities by going after research-analyst conflicts of interest more than a year ago. Not only have the banks agreed to pay up but the settlement will most likely require them to fund independent stock research. In reality, though, the Wall Street firms should consider themselves lucky. In the annals of banking scandals, Spitzer's efforts rank a distant second to those of an Italian immigrant named Ferdinand Pecora.
Seventy years ago this spring, Pecora, a one-time New York City prosecutor with political ambitions, began 18 months of Senate hearings that forever changed the regulatory landscape for public companies -- and ended the careers of several of the nation's preeminent bankers.
NO SMOKING GUN.
In January, 1933, the Senate Banking & Currency Committee was about to wrap up a lackluster 10-month investigation into shady trading practices on the New York Stock Exchange that had preceded the stock market crash of October 29, 1929. The chairman of the committee, Senator Peter Norbeck (R-SD), had hoped to show that during the late 1920s the investment-banking arms of companies such as National City Bank -- an ancestor of today's Citigroup -- had used their companies' good names to push overvalued securities to bank depositors.
Norbeck had been moved by the thousands of South Dakotans who had ended up impoverished after their Anaconda Copper Co. and Cities Service Co. stock had lost their value in the wake of the crash. In 1929 alone, National City Co. had sold more than 1.3 million shares of doomed Anaconda Copper common to the public. But the bank presidents proved to be formidable opponents, and the committee's hearings produced little of note. Norbeck was resigned to the idea that his committee had failed to find the smoking gun that the incoming Roosevelt Administration needed to propose bold new legislation.
Norbeck's luck would soon change, though. Just two months before the committee's Mar. 4 report was due -- the day Franklin Roosevelt was to be inaugurated -- W. A. Gray, counsel to the Banking & Currency Committee, resigned. Norbeck had to scramble to find a replacement, and at least two candidates turned him down, partly because the position paid only $250 a month. Pecora was the third name on the senator's list.
LET ME AT 'EM.
Pecora had spent most of his boyhood with his siblings and parents in a grim basement apartment in the Chelsea section of New York City. He had begun a legal career at age 15, working in a lawyer's office to help his disabled shoemaker father support the family. He eventually became chief assistant district attorney in New York, a post he held from 1921 until 1929, the year his candidacy for district attorney was torpedoed by his own Democratic Party elders.
His failure to earn the New York DA nomination left Pecora disappointed, but more determined than ever to make a name for himself. He was in private law practice in New York when the call came from Norbeck in January, 1933. During his interview in the senator's office, Pecora, then 55, told Norbeck that if hired, he would do more than write the committee's report. He would expand the investigation and drag before Norbeck's committee the nation's biggest bankers and financiers, including J.P. Morgan, Samuel Insull, founder of the Insull utility empire, and Charles Mitchell of National City Bank. Norbeck hired Pecora on the spot.
Mitchell was a particularly juicy target. National City Bank's investment arm, National City Co., had become the biggest investment house in the country. National City had rapidly expanded its buying and selling of securities during the 1920s, right up to the crash on Black Tuesday. Mitchell arrived for his first day of testimony on February 21, 1933, surrounded by an array of National City Bank underlings. But Pecora had the advantage: Unknown to Mitchell, the chief counsel had spent several days the previous week at the offices of Sherman Sterling, National City's Wall Street attorneys, personally poring over the minutes of the bank's board meetings. The law firm had given Pecora access to the minutes out fear of his power to subpoena much more. By Mike Brewster
"BY THE WAY..."
Pecora's pointed questioning and Mitchell's shell-shocked answers paint a vivid picture of a vastly conflicted National City Bank. Its top officers, each of whom were paid $25,0000 a year, had been getting more than 20 times their salary, based on the volume of securities the investment arm sold. Mitchell himself raked in more than $1 million a year, or 40 times his salary. To keep growing, the investment arm had been pushing securities that its own brokers regarded as vastly overvalued.
Mitchell's personal fate was sealed by this casual question from Pecora: "By the way, that sale of bank stock that you referred to in the latter part of 1929 was made to a member of your family, wasn't it?" Mitchell had sold thousands of shares of National City Bank stock in 1929 at a loss, for tax purposes. Problem was, as he admitted under oath, he had sold them to his wife. Mitchell resigned days later and was arrested on two counts of tax evasion. Though eventually acquitted of the criminal charges by a New York federal court jury, Mitchell a civil court ordered him to pay more than $1.3 million in taxes, penalties, and interest.
President Roosevelt delighted in Pecora's success in the National City Bank case, made it clear that he could continue his investigation well beyond the Mar. 4 deadline. Pecora proceeded to unravel the Samuel Insull pyramid of companies and questioned investment banking luminaries such as J.P. Morgan, Kuhn Loeb senior partner Otto Kahn, and Clarence Dillon, head of Dillon Read. Pecora's investigation sent Insull's empire hurtling toward its 1935 bankruptcy and resulted in the 1934 conviction of Joseph W. Harriman, founder and president of the Harriman National Bank & Trust, for falsifying bank records.
ON THE ROPES.
The revelations of conflicts and corruption at the nation's largest banks led to the regulatory framework that governed financial institutions for the next seven decades. Pecora's findings prompted passage of the Glass-Steagall Act in 1933, which made it illegal for commercial banks to own investment affiliates, as well as of the Securities Act of 1933 and the Securities Exchange Act of 1934, which created the Securities & Exchange Commission.
Spitzer's investigations into Wall Street wrongdoing followed by three years Congress' 1999 decision to repeal Glass-Steagall on the theory that the walls that legislation erected between banking, securities, and insurance were damaging the competitiveness of U.S. financial-services companies. Among the powerful bankers Spitzer has on the ropes is Sandy Weill, the Citigroup chairman whose empire had its beginnings in Mitchell's National City Bank.
Of course, Spitzer, who is rumored to have aspirations to higher office, should note that successfully punishing corporate wrongdoers is no guarantee of political success. The rest of Pecora's career, while distinguished, never matched the magic of 1933 and 1934. In July, 1934, after his hearings wrapped up, he was considered for the chairmanship of the newly formed SEC but lost out to Joseph P. Kennedy.
Pecora served as one of Kennedy's commissioners for just a few months before being named to a seat on the New York State Supreme Court in 1935. In 1950, he lost the 1950 New York City mayoral election, a three-way contest in which he finished second to Vincent R. Impellitteri.
He died in 1971 at the age of 89, no doubt never dreaming that just 30 years later some of Wall Street's biggest firms would again be misleading investors -- and that another New York lawyer would bring them to heel.
Mike Brewster is author of the upcoming Unaccountable: How the Accounting Profession Forfeited A Public Trust (April, 2003), and co-author of King of Capital: Sandy Weill and the Making of Citigroup (June, 2002)