INTERLOCKS IN CORPORATE MANAGEMENT

CHAPTER I

SCOPE OF STAFF SURVEY

LEGISLATIVE PURPOSE

Restraints on trade developed through the device of common management officials in ostensibly competing business organizations have been prominent in the history of the Federal Government's efforts to assure business freedom in the flow of interstate commerce. The interlocking directorate device attended the development in the United States of the corporation as the organization best equipped to meet the vast capital requirements of modern industry. Legislation to curb the use of the device in abuse of the new economic power afforded by the corporation paralleled its development.

Since the turn of the century there have been a number of congressional and private studies into the frequency and extent in the corporate structure of interconnected managements. At the present time, however, there is a scarcity of information relative to the social and economic effects, as embodied in actual business transactions, of decisions made by linked corporate managements. There is virtually no reliable current information that will demonstrate either acceptable or undesirable effects that have resulted from the circumstance that common management personnel participated in, or influenced, particular business transactions.

The problems of interrelated corporate managements, for the most part, have been of concern only in the economic policies of the United States. Except in the field of banking, foreign governments, particularly in those countries where there has been little public interest in the maintenance of high competitive standards, have had little or no objection to interlocking corporate managements. In the United States, at common law, common corporate directors were not prohibited, and the device itself was not considered to embody the seeds of public wrong. Contracts between two companies were not void, but merely voidable even when a majority or more of the directors of each were identical. A contract between two corporations, where the common directors constituted less than a majority, could be upheld successfully on a showing that the corporation had been represented by independent directors, that the vote of the interested director was not necessary to carry the motion, and that his presence was not needed to constitute a quorum. Even where the common director participated actively in making a contract between the two corporations, it

1 See note: Interlocking Directorates, 29 Ind. L.J. 429, 430; Means, "Interlocking Directorates," 8 Encyclopedia of Social Sciences 148.

2 Corsicana National Bank v. Johnson, 251 U.S. 68 (1919).

3 Geddes v. Anaconda Mining Co., 254 U.S. 590, 599 (1920).

was not absolutely void, but only voidable on a showing of unreasonableness.*

Restraints on trade, monopolization, and monopolies that employed or were developed by means of common corporate management officials were subject to the reach of the broad provisions of the Sherman Act. In such cases, after the Government successfully had challenged the combination, relief to dissolve the interlock and to prohibit its recurrence normally was available."

Disclosures in congressional and private investigations during the first decade of the 1900's brought a popular reaction as to the adequacy of the Sherman Act as a mechanism to preserve a competitive economic structure. Proof under the Standard Oil case's rule of reason, and the necessity to show that the challenged restraint or monopolization in fact had been accomplished and was in operation, were considered to be serious obstacles to timely corrective action. The investigations of the oil, tobacco, steel and money trusts disclosed evils that stimulated popular support for legislation that would reach specific practices at an early stage and arrest conspiratorial growth in its incipiency and before consummation. In response to this widespread demand, the Clayton Act was enacted in 1914.

In the Clayton Act, interlocking by common directors was one of the anticompetitive devices outlawed. In its report on the Clayton Act, the Senate Judiciary Committee emphasized the function of the legislation as supplemental to the Sherman Act and specified its intent to reach common corporate management members:

*** Broadly stated, the bill, in its treatment of unlawful restraints and monopolies, seeks to prohibit and make unlawful certain trade practices which, as a rule, singly and in themselves, are not covered by the act of July 2, 1890, or other existing antitrust acts, and thus, by making these practices illegal, to arrest the creation of trusts, conspiracies, and monopolies in their incipiency and before consummation. Among other of these trade practices which are denounced and made unlawful may be mentioned discrimination in prices for the purpose of wrongfully injuring or destroying the business of competitors; exclusive and tying contracts; holding companies; and interlocking directorates. [Emphasis supplied.]

The landmark report of the "Pujo Committee," and a classic series of articles by Louis D. Brandeis (later Justice of the United States Supreme Court) in Harper's Weekly, each of which denounced the practices and social impact of the "Money Trust," generated the popular outcry against new devices that were used to interlock corporate managements. Not only did he consider the practice inherently evil from a moral, business, and political point of view; Mr. Brandeis recognized the interlocking directorate as a primary means to acquire

Twin-Lick Oil Company v. Marbury, 91 U.S. 587 (1875).

U.S. V. American Tobacco Co., 221 U.S. 106 (1911); Standard Oil Company of N.J. V. U.S., 221 U.S. 1 (1911).

Public Law 212, 63d Cong., 38 Stat. 730; 15 U.S.C. 12 et seq.

7 U.S. Senate Committee on the Judiciary, Unlawful Restraints and Monopolies, S. Rept. No. 698, 63d Cong., 2d sess., July 22, 1914, at p. 1.

8 U.S. House of Representatives Committee on Banking and Currency, Investigation of Concentration of Control of Money and Credit, H. Rept. No. 1593, 62d Cong., 3d sess., Feb. 28, 1913.

Louis D. Brandeis, Breaking the Money Trusts, Harper's Weekly, Nov. 22, 1913, to Jan. 17, 1914.

concentrated power over vast segments of the economy. The following quotation illustrates the intensity of his convictions on this subject:

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,10

To illustrate the mechanics of the "Money Trust," which he likened to an "endless chain" and a "vicious circle of control," Mr. Brandeis created the following example, admittedly in part supposititious:

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 Co., 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 & Telegraph Company, and in both Mr. Morgan (or a partner) is a director. The telegraph company has a special 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."

While Mr. Brandeis' series of articles in Harper's provided the dramatic catalyst needed to generate popular support for remedial legislation, the factual material that was the foundation for his articles was the product of a special subcommittee of the Committee on Bank ing and Currency of the House of Representatives. This special subcommittee, appointed to investigate the concentration of control of money and credit, under the chairmanship of A. P. Pujo, had made its report on February 28, 1913.

In its investigation, the Pujo committee collected voluminous documentary evidence and received extensive testimony from the country's leading financiers. The committee found that 180 men held 385 directorships in 41 banks and trust companies, which had total resources of

$3,832 million and total deposits of $2,834 million. The investigation showed that these 180 men held 50 directorships in 11 insurance companies with total assets of $2,646 million; 155 directorships in 31 railroad systems with a total capitalization of $12,193 million; 6 directorships in 2 express companies and 4 directorships in 1 steamship company, having a combined capitalization of $245 million. These same men were found to have 98 directorships in 28 producing and trading corporations with a total capitalization of $3,583 million and total gross annual earnings in excess of $1,145 million; and 48 directorships in 19 public utilities corporations with a total capitalization of $2,826 million. The "inner group," composed of these 180 financial leaders, held 746 directorships in 134 corporations with total resources or capitalization of $25,325 million.12

Its consideration of the deleterious business and political effects of the concentrated power exercised by the "inner group" caused the Pujo committee to conclude that the first step in a remedy would be to prohibit interlocking directorates in potentially competing financial institutions under Federal jurisdiction, subject to a qualification that a director of a national bank should be permitted to be an officer or a director of not more than one trust company doing business in the same locality. The committee's purpose was to prevent the establishment of unified sources of industrial financing by the preservation of competition in banking. The committee said in its report:

It is manifestly improper and repugnant to the theory and practice of competition that the same person or members of the same firm shall undertake to act in such inconsistent capacities. The exception in the case of a trust company is suggested, because of the different character of business that may be transacted by the latter. Nor is it just to the stockholders or depositors of either institution that an officer or director of a national bank should essay to serve two masters whose interests should be so divergent. When we find, as in a number of instances, the same man a director in a half dozen or more banks and trust companies all located in the same section of the same city, doing the same class of business and with a like set of associates similarly situated all belonging to the same group and representing the same class of interests, all further pretense of competition is useless. For all practical purposes of competition such banks and trust companies may as well be consolidated into a single entity."

In addition to the information collected by the Pujo committee, facts as to the effects of common corporate managements on particular business transactions had been secured in an investigation of the United States Steel Corp. that had been conducted by a special subcommittee of the House of Representatives organized to investigate violations of the Sherman Act, the Stanley committee.14 As a result of its investigation, the Stanley committee concluded that the device of interlocking corporate managements had resulted in inside dealings for personal gain, preferential treatment to favored suppliers, reduced prices to favored customers, and excessive fees paid to favored representatives for services supplied. These pernicious effects were attributed to the community of interests among the few individuals that con

12 Statement of Representative James F. Byrnes in House debate on H.R. 15657, 63d Cong., 2d sess.. May 23, 1914; 51 Congressional Record 9182.

13 Investigation of Concentration of Control of Money and Credit, H. Rept. No. 1593, 62d Cong., 3d sess., Feb. 28, 1913. p. 140.

14 Investigation of United States Steel Corp., H. Rept. No. 1127, 62d Cong., 2d sess.. Aug. 2, 1912.