Other People's Money, and How the Bankers Use It

by Louis Dembitz Brandeis

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.