Other People's Money


THE ordinary business of a competitive industrial world is done, us the saying goes, at arm’s length. This is a phrase which applies to that multiplicity of daily transactions in which business men deal with one another, each acting upon principles of more or less enlightened selfishness in trying to get a profit out of a bargain, each acting for his own personal interest and expecting the other party to the transaction to do likewise.

This is, of course, old-fashioned, plain, commercial business, the kind that old-time merchants knew and practised in the great days of Tyre and Sidon, as keenly and perhaps as intelligently as their descendants practise it to-day. Arm’s length business, genuine commercial competition, is much the same as it was hundreds of years ago. Caveat emptor is not perhaps as broad a principle. The buyer does not have to look out quite so much as he did, because the law looks out for him more than formerly. Guaranties survive acceptances as they did not a hundred years ago, but in its main features the game is the same.

The merchants who made their fortunes years ago made them, for the most part, through this old-fashioned rivalry because it then was the only way. A great change has come over the character of modern business, however. The difference in wealth-acquiring methods between the old-time commercial magnates, the great merchants of our fathers’ and grandfathers’ time, and the men who, in wealth and influence, hold their position now, to a very marked extent is not merely a difference in the meaning or instrumentalities of commerce, — the corporation against the old partnership or individual enterprise, — but represents a fundamental change in the relative position of the transacting parties to business dealings and the elimination of arm’s length in those dealings.

To view this change adequately, we must first consider briefly a branch of law which was of relatively small scope or importance in our grandfathers’ time and which is of enormous importance and scope in the business life of our day. That is the law which deals with those relations in which arm’s length does not exist and as to which the rules of each for himself do not apply.

The relationships of guardian and ward, trustee and beneficiary, the executors and the estate of the dead man, principal and agent, — all involving, as they do, the reposing of trust and confidence of one in another, — are relationships which the law puts outside the rules of the market place. Fiduciary relations like these and ordinary commercial relations are separated by distinct legal barriers.

The highest ethical expression of the law is the so-called ‘Fiduciary Principle,’ which applies to these relationships, a principle which has been worked out and applied in countless decisions of courts of equity. The rules laid down by the courts in judgments involving these trust relations are based upon a judicial realization that a position of trust exposes its occupant to special temptations which can best be overcome if the law forbids certain acts through which temptations otherwise might arise.

The trustee, for example, cannot buy from himself as an individual, cannot sell trust property to himself, cannot speculate with trust funds and retain anything but the losses and the shadow of prison. The reasoning upon which this fiduciary principle is based was expressed with quaint beauty many years ago by a great jurist, Judge Story: —

It may be correctly said with reference to Christian morals that no man can faithfully serve two masters whose interests are in conflict. If, then, the seller were permitted, as the agent of another, to become the purchaser, his duty to his principal and his own interest would stand in direct opposition to each other, and thus a temptation perhaps in many cases too strong for resistance by men of flexible morals or hackneyed in the common devices of worldly business would be held out which would betray them into gross misconduct and even into crime. It is to interpose a preventive check against such temptations and seductions that a positive prohibition has been found to be the soundest policy encouraged by the purest principles of Christianity.

An extended consideration of that great branch of law involving the fiduciary principle is, of course, unnecessary here. The point for my present purpose is this: In our grandfathers’ and even in our fathers’ time, the trust relationship from which this principle arose was not an ordinary but an extraordinary incident of business life.

A man of large affairs once or again in his lifetime might be a trustee under a will for some dead relative or friend, or he might be a guardian, perhaps, for some child. He might have agents in whom he himself placed some degree of confidence and who owed the duty of fidelity to him. He might have a partner, and some of the reciprocal duties of the trust relation would exist throughout the association.

Ordinarily, however, the business life of the old-time man of affairs was, as has been said, an ann’s length contest. It was through his equipment for that contest, his enterprise, foresight, good judgment, and diligence, that he could expect to attain success.


The old rule, as stated by Judge Story, has not changed with years in its application to the older forms of trust relationship. Judge Cardozo, in a recent opinion, expressed the same lofty principle as applied to co-adventurers in a case involving the duties of a managing co-adventurer in a noncorporate real estate transaction: —

Many forms of conduct, permissible in a workaday world, for those acting at arm’s length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to these, there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the disintegrating erosion of particular exceptions. Only thus has the level of conduct for fiduciaries been kept on a level higher than that trodden by the crowd.

The corporation, of course, introduces a new method of doing business. Stockholders form a sort of intangible partnership whose active leaders are the president and officers of the company, chosen by the directors. Into the sphere of arm’s length commercialism the rise of the corporation has thrust a vast increase of new fiduciary relationships.

At first they were recognized as fiduciary relationships by few judges. The gross methods of railroad looting practised in the decade following the Civil War aroused no part of the indignation which they would have aroused to-day. In some courts, the relation of the directors and officers of corporations to stockholders was not considered, in the early days, as fiduciary in the old sense. But a majority of enlightened courts, almost from the first, declared that there was no difference in principle between the dealings by which the directors or corporate officers made profits at the company’s expense and the dealings by which trustees or guardians or executors might attempt to do the same thing. The old fiduciary principle applied to and forbade all such transactions.

The corporation cases which came before the courts were in the early days, and for natural reasons, mostly railroad cases, involving construction contracts, land purchases, bond issues, and the like, in which the directors found themselves personally interested. More than forty years ago the New York Court of Appeals, in a case of this class, laid down the old rule of fiduciary obligation in language of the utmost plainness. It declared, referring to a director shown to have been interested personally in a transaction with his company: —

He stood in the attitude of selling as owner and purchasing as trustee. The law permits no one to act in such inconsistent relations. It does not stop to inquire whether the contract or transaction was fair or unfair. It stops the inquiry when the relation is disclosed and sets aside the transaction or refuses to enforce it at the instance of the party whom the fiduciary undertook to represent, without undertaking to deal with the question of abstract justice in the particular case. It prevents frauds by making them, so far as may be, impossible. Knowing that real motives often elude the most searching inquiry, it leaves neither to judge nor jury the right to determine, upon a consideration of its advantages or disadvantages, whether a contract made under such circumstances stand or fall.

When it was urged in this case that the director was only one of ten directors, and that the others had voted for the contract, the court brushed aside the argument as immaterial.

So severe and uncompromising a rule could not meet the demands of the growing field of interrelations between corporations having, for example, common directors. Writing as referee, after his retirement from the bench, the decision in a great case involving interlocking directors, arising out of the relations of the New York Central with the Harlem Railroad Company, Judge Andrews, a former Chief Justice of the New York Court of Appeals, said: —

The great expansion in recent times of business corporations, the intimate relations which often exist between them, the participation in many cases of the same persons in the management of corporations, between which occasions may arise for mutual business arrangements, and the necessity of establishing a working rule which, while still protecting the interest of each corporation and its stockholders, shall not render such arrangement impracticable, have led to a modification of a stricter rule which in some earlier cases has been declared by which all contracts between corporations having common directors are voidable at the election of either.

Just what this modification should be which the courts would approve was not made clear in the decision of the court which followed Judge Andrews’s decision as referee. It nevertheless was a question which required a practical answer, which the courts failed to give.

When a practical question requires an answer, however, the answer always comes. It may not be a desirable answer. It may be an answer which overlooks essential features of a situation, and represents solely the interest of one of the parties interested. The practical answer which large corporations now make to this question is to be found in a clause frequently contained in their charters: —

Any director or officer of this corporation may contract with this corporation on behalf of himself, or on behalf of any other corporation in which he may be interested, and the fact of such interest shall not affect the validity of any contract so made.

The provisions of the charter of a corporation in which he buys stock are, of course, binding upon the stockholder. The old fiduciary principle found impracticable in the operation of holding companies with many subsidiaries, with minority stock in the hands of the public, has been thus modified in the current machinery of corporate affairs. This solution of the difficulty is somewhat extreme.

Perhaps it was right to dissemble your love, But — why did you kick me downstairs?

To find a satisfactory intermediate ground on this matter is far from simple.


This common clause in corporate charters, to which I have referred, should not be misunderstood. It is not a license to steal. It does not mean that directors can do anything they please with the property of their corporation. It simply marks a recognition of the existence of a great and still-growing field in which serving two masters seems quite the practical thing to do — the servant to decide what is fair to each.

The old law, to be sure, said this could not be done at all, as it created temptations which might prove, as Judge Story so quaintly suggests, ‘perhaps in many cases too strong for resistance by men of flexible morals or hackneyed in the common devices of worldly business.’

Whether this ‘hackneyed’ class has become entirely extinct may reasonably be doubted. Nevertheless, the corporate structure, annually growing more complicated with its increasing field of interrelations, holding-company devices, affiliations, subsidiaries, investment trust representations, nonvoting stock, and the like, has made this old rule less practical unless these new relationships are to cease entirely by some radical change in the corporate structure itself. Such a change is not likely. If, however, the demands of the corporate structure to-day create a new field of temptation, it is perhaps an unavoidable one unless this whole tendency of its growth receives some such radical revision. Perhaps the courts were too much alarmed about the fiduciary principle and the dangerous possibilities of permitting men to serve two masters. Perhaps, on the other hand, we are not sufficiently alarmed about it.

At any rate, it would seem fairly obvious that if this field of temptation for the servant serving many masters is to exist it needs safeguards about it. Just how a servant serves two or more masters should be of interest to all these masters. It is a subject on which they should have plenty of information as to the acts of their servants. Most of us need to have our morals reënforced at times by the healthy reflection that ultimately we shall have to account for what wo do with other people’s money and property. Particularly is this true in situations where we are not wholly disinterested and where we may have our own personal interests to advance. Ordinary trustees are bound to account in surrogate’s and probate courts for all their acts with reference to trust property.

What about the machinery, then, for accountability in this new field of handling other people’s property in the corporate world? The clause I have quoted, now commonly used in the charters of corporations, says in substance that the fact of the existence of divided loyalty shall not necessarily invalidate the legality of a contract made by directors having other personal or corporate interests. It means that a further element of proof is required to make such a contract void. That element is fraud or gross unfairness to one of the corporate masters badly served.

What facilities has the corporation developed for making available the facts on which the answer to this question depends, to the stockholders who are, in theory, the masters of these servants, or perhaps, more accurately, the wards of these trustees, the officers and directors of these corporations?

If the fiduciary principle itself is to be modified or shorn of effectiveness by this common clause in corporate charters to which I have referred, another principle also legally well settled in the old law also has been changed on this matter of accountability.

Here again we have a collision between the old law of the courts and the corporation on the theory and practice of accountability of directors. The old rule of the common law, years ago, declared that stockholders had a right to know, which right to know included the right to examine corporate books and records.

Stockholders are entitled to inspect the books of the company for proper purposes, at proper times, and they are entitled to such inspection though their only object is to ascertain whether their affairs have been properly conducted by the directors or managers.

Such right is necessary to their protection. To say that they have the right but it can be enforced only when they have ascertained in some way, without the books, that their affairs have been mismanaged or that their interests are in danger, is practically to void the right in the majority of cases.

The foregoing is quoted from an ancient equity case in New Jersey. The rule which it declares establishes obviously another inconvenient and impractical proposition from the standpoint of the promoters of modern corporations.

The principle of having books of account and records subject to investigation by stockholders who might have become such simply for the purpose of investigating these books for other purposes, leaving to the varying views of judges the determination of whether and on what conditions this right of inspection should be exercised, has proved objectionable.

We should not forget that corporation statutes in the United States have mainly been created for the benefit of company promoters and organizers, to furnish them facilities for organization which shall make incorporation in one state more desirable than in another. They have not been devised primarily for the protection of the individual stockholder.

To-day we are told there are 20,000,000 individual stockholders owning common stock of American corporations; but the common-law right of the stockholder to inspect the company’s books, records, and papers is, under the corporate law of most of the great chartering states and under current corporate charters, almost as extinct as the great auk.

The common or garden substitute for the right to inspect books and records is the common clause of corporate charters, reënforced by state statutes, providing that it is for the directors ‘to determine whether and to what extent, and at what times and places and under what conditions and regulations, the accounts and books of the corporation or any of them shall be open to the inspection of the stockholders, and no stockholder shall have any right to inspect any account or book or document of the corporation except as conferred by statute or authorized by the Board of Directors or by a resolution of the stockholders.’

The right ‘conferred by statute,’ as referred to in the foregoing quotation, is largely limited to simply obtaining a list of the stockholders of the company suffering perchance from a common grievance, if there be a grievance, which grievance can be ascertained only by books which may be withheld from their inspection by directors in control of the corporation itself. No citation of authority is necessary to show how practically valueless is this right. Yet, what the old New Jersey case, from which I have quoted, said is still true: —

To say that they have the right but it can be enforced only when they have ascertained in some way, without the books, that their affairs have been mismanaged or that their interests are in danger, is practically to void the right in the majority of cases.

Once more we have an impractical court rule and an equally objectionable statutory and corporate substitute. No middle ground between these two has yet been evolved, and the corporate rule of no information to minority stockholders is in the ascendancy.


The voting rights of stockholders need little discussion. Lacking information, intelligent voting is impossible. Lacking power, voting is useless for the average small stockholder. The main effect of the proxy is not to assert rights but to waive them.

There are exceptional conditions to which the foregoing does not apply, but these exceptional conditions are too rare to require consideration here. The voting rights of the stockholder are normally of substantially no value except to those exercising control or representing stock in such large quantities as to require at least respectful consideration from those in control.

The average stockholder is quite conscious that his voting rights are of negligible importance. Even if this were not true, there is another marked tendency in corporate organization, that of centralizing voting rights in small groups. The Stock Exchange authorities took vigorous action to prevent one aspect of this growth in connection with the ‘A’ and ‘B’ stock of Dodge Brothers, by which the bankers practically reserved to themselves control of the business operations of an enormous corporation, a control which the Stock Exchange authorities felt to be undesirable, as it involved responsibility which bankers, as such, are incapable of exercising wisely.

In other fields, however, this process of eliminating voting rights of the stockholder has gone on unchecked. Little has yet been done to regulate so-called ‘investment trusts’ which during the past few years have proved so attractive to so many investors. On April 1 of this year, there were reported two hundred and seventy of these so-called investment trusts handling over four and one-half billion dollars of other people’s money and controlled in large part by bankers who, by a modest investment of their own money, have obtained voting control over this vast amount of investment money — a control which has been too frequently exercised by the bankers in selling to the investment trusts which they operate securities which they themselves have issued. The tendency to consolidate control in organizations of this kind over the vast amount of sound securities available for investment goes on apace.

To-day we are told that, out of nine billion dollars’ worth of railroad stocks now outstanding, all but two billion dollars’ worth are held by corporate stockholders, insurance companies, investment trusts, and the like, rather than by individuals. How much this tendency has been accelerated by the feeling of helplessness of the average stockholder as to his own incapacity to watch over his own money, it is, of course, impossible to say.

The danger point in modern capitalism in America is the breaking down of the practical effectiveness of the fiduciary principle through the failure to evolve adequate methods of applying it in the supremely important field of corporate finance, and in a period characterized by an enormous increase in the general and highly lucrative business of handling other people’s money. The breaking down of that principle appears largely in the practical inability of the average man to find out just what is being done with his money, through the increasing complexity of the corporate structure and through the chilling repulses with which his desire for knowledge has been met by state statutes, constructed particularly to facilitate the promoters’ desire for secrecy and power.

Investment is becoming more and more an act of faith. Human nature has not made extraordinary advances, so far as anyone knows, in its capacity to resist temptation. Yet, no thinking person can doubt that the field for temptation in the higher reaches of the corporate world has been enlarged to enormous proportions.

What we are slowly coming to in American finance is the system of old China. The Chinese merchant knew he could not go to court for redress from his debtor. China has no lawyers. Having no other protection against dishonesty, the Chinese merchant developed a system of not trusting anybody he did not know was honest. No business man whose word was not good, who did not pay his debts and meet his obligations, could continue in Chinese business, which required a continued and unvarying reputation for probity.

We are to-day, in America, approaching a new age of faith, in which the individual, in an era of corporations, super-corporations, giant banks, and investment trusts, is driven to rely mainly on his faith in the character of those with whom he deals, to whom he entrusts his savings, and who control the destinies of the corporations in which he invests. Whether this represents a step forward or a step backward remains to be seen.

The changes which the large corporate organizations have brought about in the general conditions under which modern business is conducted have been on the whole exceedingly useful in improving the quality of our business morals.

Some of these improvements, particularly in relation to honesty of dealing between the great corporation and the public, were pointed out by Owen D. Young in an interesting address some years ago. Honest goods, honestly represented and honestly sold, are the rule rather than the exception in the world of big business. Those grafting and dishonest methods which might be possible in small concerns are not practical on a wide scale in a great corporate organization, because the profits in crooked accounts and dishonest goods would speedily disappear in the grafting and dishonesty generated within the organization itself. It would be practically impossible to create an organization with thousands of employees who would be dishonest to the buying public and honest to the company by which they were employed. Too many crooks spoil the broth.

Successful schemes for large-scale dishonesty obviously must be confined to small groups for their operation. The sugar frauds, for example, in the exposure of which Secretary Stimson did such excellent work years ago, were of this character.

One of the great contributions of the large business corporation to the quality of our business morals is that it keeps the rank and file in big business on a high standard of honesty as well as of efficiency. The field of business in which the edges of honesty begin to blur is a smaller and more select one, and nearer the top. The whole corporate organization is articulated to keep dishonesty in the rank and file at a minimum. Personnel departments, auditors, expert accountants, inspectors, investigators, form but a small part of this prophylactic system of preserving the gums of big business.

The temptations incidental to the intangible and far-away stockholder, who puts his proxy in the wastebasket and who never attends an annual meeting, are temptations which have no existence with the rank and file of the corporations’ employees. So far as the average employee is concerned, his employer is not intangible but real, a person higher in rank than himself who in turn is responsible to one superior to himself. The corporate executives are chosen not only for their efficiency but for the quality and character of their industrial leadership. The corporate structure builds up like a mountain. It has a broad base, basking in the sunshine. It rises gradually higher and higher to a peak lost in the clouds, where, except when occasionally a Teapot Dome is illumined by some flash of investigating lightning, the struggle of primitive contending forces is visible only to God.

Some of us still read Macaulay. Those of us who have given up this good habit at least can remember the early thrill of his two great essays in which he gives to us, with such amazing thoroughness, pictures of the great nabobs, Hastings and Clive, and of the memorable trials of these empire builders in the House of Commons. Every schoolboy used to know these trials, particularly that of Hastings, and he memorized as his graduating oration, perhaps, Burke’s marvelous opening address for the prosecution. Clive’s case is not so familiar, except for one sentence, which contains one of the most human defenses ever interposed by a great offender at the bar of public opinion.

Macaulay gives it to us in its proper setting. Clive had been describing, he said, in vivid language the situation in which his victory had placed him. A great Prince dependent upon his favor; an opulent city afraid of being given up to plunder; wealthy bankers bidding against each other for his smile; coffers filled with gold and thrown open to him alone. ‘By God, Mr. Chairman,’ he exclaimed, ‘at this moment I stand amazed at my own moderation.’ Neither innocence nor effrontery could have devised a more interesting theory of self-defense. If it were true, and the English people apparently considered it to be the case, that the servants of the John Company were exposed to temptation greater than human nature could bear, punishment of one of them, even Clive, could be only an inadequate solution, and the great East India Company passed from private hands.

Clive’s defense is something more than an exclamation of a harassed, self-pitying nabob of a century and a half ago. There is a fundamental difficulty in any system of law under which conditions like those which confronted him could exist and from which like temptations could arise. It is with some of the Clive conditions in a more prosaic corporate world, far removed from Indian Princes and the jewels of the East, that this paper deals; with a concentration of opportunity and a consequent undue strain on honesty which far exceed those which confronted Clive. That with which we have to deal is the immense growth, in a relatively short period of time, in the business of handling other people’s money.

It is not merely other people’s money. It is for the most part unwatched, or inadequately watched, other people’s money. It is the concentration of control over the most profitable aspects of American business in the hands of a group continuously growing smaller, in which opportunities and temptations constantly grow larger.


As I have said, the corporation laws in the past almost uniformly have been made to encourage promoters and financiers to use one state rather than another for incorporation purposes.

This means, of course, a very considerable revenue to a state whose laws are favorable to such interests. We are now in a new phase of capitalism. We have had, since the war, an enormous increase in the direct participation of small investors in common stock, largely of American corporations. Nothing like it ever has happened in the world. If it be true that we have, in America, some 20,000,000 persons who have invested their savings in American industrial corporations, this fact should make advisable a reconsideration of the safety features of the corporate structure. This programme of participation is in many ways thrilling. A vast number of great corporations have arranged for employee ownership of stock in their companies, to ensure additional enthusiasm of the employee in his own work by increasing his personal interest in its operation, of which he and his savings form a part. Consumer ownership and public ownership programmes have still further enlarged this field of small stockholder investment in the corporate field. It is highly important from the standpoint of the nation itself that this participation should prove satisfactory, that the corporate structure should be such as to make these investments quite safe.

At the same time that this programme has steadily proceeded, we also have had an enormous increase in concentration of financial control of American industries by the concentration in relatively small hands of the control of credit. When the Pujo investigation of banks was made years ago, we refused to be alarmed sufficiently at the concentration of credit then obtained by the interlocking of directors of financial groups. Nothing was done to stop this concentration, which has become more extreme during the past few years by the merger of banks into enormous banking systems — a concentration which in other fields, and with banking assistance, has resulted in great mergers in the industrial and public utility fields.

It would be highly undesirable if the good features of modern capitalism, the participation of millions of our people in the fruitful held of corporate investment, should prove disappointing to them. American capitalism is on trial to-day in a new way and must meet the tests of new conditions. It is highly advisable that we should see those conditions, and that those of us who believe that on the whole, with all its defects, the system is far superior to any other elsewhere existing should take the steps necessary to safeguard it and improve it where dangers exist.

It is easy to indulge in muckraking. It would be, of course, a very simple matter to point out cases to illustrate the extent to which opportunities for monetary success without service have increased through defects in the corporate structure. I have refrained from giving these illustrations for several reasons. In the first place, muckraking does not interest me. Moreover, the great statesmanship in America is to be found to-day in its business and industrial life rather than in the world of our politics. We have never had a larger group of industrial statesmen in the wider reaches of our business affairs, a greater number of men of high character, sound judgment, and wide vision, exercising power in an enormous range of usefulness, whose standards of honor are such as to entitle them to the confidence which they receive. The great change in the attitude of our people toward big business, our willingness to permit large unit groups, to allow the growth of great corporations, is due mainly to the public confidence in the effective leadership of men of this class — a confidence which it would be a serious misfortune to disturb or destroy by any confusion created in the public mind between this group and those who exercise, in the same field, without substantial service, the opportunities to which I have referred.

An additional reason for avoiding anything resembling the muckraking point of view on the subject is that I am also conscious that the exercise of many of the opportunities which the rich field of handling other people’s money offers to a small class of favored individuals in corporations involves neither crime, fraud, nor anything with which the law can deal in any event.

Take an illustration: Here are a couple of large corporations. There is a merger in sight, and a stock-marketing movement to follow. What is more natural than the use by insiders of advance information? Why not? Is there anything illegal about it? The existence of the opportunity makes the temptation, and there is no law conceivable by which the use of these opportunities can be prevented. They are to-day more or less inherent in the system itself. The question of whether or not such opportunities shall be exercised becomes a matter of personal ideas of good taste on the part of those to whom the opportunities come.

So, we have an intangible field of honor applicable at the top of the corporate structure as a substitute for the law which appears at the bottom.

Knowledge, as the copy book used to say, is power. No system of law can be devised which shall make this maxim ineffective.

How can we modernize the corporate structure so that these opportunities shall have some more direct bearing upon the service and the rewards for work?

How can we revitalize the fiduciary principle so that in the vast field of corporate organization and operation rules can be adopted consistent with the democratization of corporate industry? The best answer to Communism is not extirpating Reds or denouncing Bolshevism, but cleaning house.