Richard Whitney and the 1938 Fall of Wall Street's Best Connection

Five minutes after the opening bell on Tuesday 8 March 1938, the gong on the floor of the New York Stock Exchange sounded again and trading stopped. Charles R. Gay, the Exchange's president, climbed to the rostrum and read two announcements to a floor of about a thousand men who had no idea what was coming.

The first was procedural. Richard Whitney & Company had notified the Exchange that it could not meet its obligations, and the firm was suspended for insolvency. The second was not procedural at all. On 1 March, Gay said, the Exchange had come into possession of evidence of "conduct apparently contrary to just and equitable principles of trade" on the part of the firm's senior partner. Charges had gone to a special meeting of the Governing Committee the previous afternoon. A hearing was set for 17 March.

Richard Whitney had stood on that floor eight and a half years earlier and been credited, in print and on radio and in the memory of everyone listening to Gay, with stopping a panic single-handed. He had then served five consecutive terms as president of the institution now suspending him. He was the brother of a senior partner of J.P. Morgan & Co., and he was, at that moment, insolvent by several million dollars and a thief.

Groton, Harvard, and a Seat on the Floor

Richard Whitney was born in 1888 into the part of Massachusetts society that did not have to introduce itself. He went to Groton, then to Harvard, where he rowed and was taken into the Porcellian Club. He arrived in New York with the two assets that mattered most in the securities business of the period: a name people recognised, and a brother inside the house of Morgan.

George Whitney, six years older, became a partner at J.P. Morgan & Co. and eventually its president. Richard bought a seat on the Exchange in 1912 and set up his own bond house, Richard Whitney & Company, specialising in the unglamorous end of the market. His firm handled Morgan's brokerage on the floor, which meant that when 23 Wall Street wanted something bought or sold in the open market, Richard Whitney's clerks did it. No advertisement could have been worth more.

By 1928 he was a vice-president of the Exchange and a fixture of its governing class. He hunted, kept a country place in New Jersey, and treated the institution at the corner of Broad and Wall as a private club that happened to set the price of American industry. That view had a long pedigree, running back to the twenty-four brokers who signed the Buttonwood Agreement in 1792 and agreed to trade with one another on preferential terms.

The Bid That Made Him

On Thursday 24 October 1929, with the ticker running late and the visitors' gallery in tears, a group of bankers met at 23 Wall Street: Thomas W. Lamont of Morgan, Charles E. Mitchell of National City, Albert Wiggin of Chase, William Potter of Guaranty Trust, Seward Prosser of Bankers Trust. They agreed to commit roughly $20 million to supporting the market. Lamont came out to the reporters waiting in the lobby and produced the most durable understatement in American financial history: "There has been a little distress selling on the Stock Exchange."

At about half past one, Whitney walked across the floor to Post Number 2, where United States Steel traded, and asked for the price. Steel had been quoted below 200. "I bid 205 for 10,000 Steel," he said, above the last sale, and then moved from post to post placing similar orders in a dozen other leading issues. He had spent something close to the bankers' entire commitment in a few minutes.

It worked, for a day. Volume reached 12.9 million shares, a record, and the Dow Jones Industrial Average closed at 299.47, down only about six points from the previous close after having been far lower at midday. John Kenneth Galbraith, writing a quarter-century later, treated the walk to Post 2 as theatre of a very high order and the rally it produced as an illusion that lasted through the weekend and no longer (Galbraith, 1955). By the following Tuesday the index was at 230.07, and the selling that became Black Tuesday had made the bankers' pool irrelevant.

What survived was the picture. Whitney had been the visible man on the floor at the worst hour, and the Exchange elected him its president the following year.

Five Terms Against Washington

From 1930 to 1935 Whitney ran the New York Stock Exchange and made himself the most conspicuous opponent of federal securities regulation in the country. He testified in Washington, toured the country giving speeches carried on national radio, and argued in every forum available that the Exchange's own rules were sufficient and that government supervision would wreck a mechanism it did not understand.

Congress was not persuaded. The Securities Act of 1933 had already imposed registration and certified accounts on new issues, a requirement that owed much of its political force to the collapse of Ivar Kreuger's match empire the year before. Ferdinand Pecora's investigators were meanwhile taking apart the securities affiliates of the great commercial banks, work that produced the separation of deposit banking from underwriting under Glass-Steagall.

Appearing before the Senate Committee on Banking and Currency on 22 February 1934 to fight the bill that would create the Securities and Exchange Commission, Whitney warned the senators that they were about to destroy delicate machinery they could not repair. "You gentlemen are making a great mistake," he told them, and offered the sentence that his biographers have quoted ever since: "The Exchange is a perfect institution." Federal regulation, he predicted, would turn Wall Street into an empty lot.

The Securities Exchange Act passed in June 1934. Joel Seligman's history of the period treats Whitney's campaign as the decisive miscalculation of the old Exchange leadership: by making the case against regulation a matter of personal prestige, he ensured that his own failure would become the case for it (Seligman, 1982).

Jersey Lightning

The private man was not the public one. Richard Whitney & Company was a modest bond house with thin capital, and its partner had a weakness for ventures that a more careful person would have left alone — Florida land, Mississippi peat humus, mineral colloids.

In 1933, with Prohibition ending, he organised Distilled Liquors Corporation with a partner named F. Kingsley Rodewald, bought a forty-year-old Hildick cider and vinegar plant in New Jersey, and set out to sell applejack under the name Jersey Lightning. The public took the shares eagerly; they reached $45.40. The public would not, as it turned out, drink much applejack, which is harsh when young and which Americans emerging from thirteen dry years did not particularly want. Whitney imported 106,000 gallons of Canadian rye whiskey to give the company something else to sell. That did not move either.

By 1936 the stock was near $11, and Whitney was buying it. He and his associates ended up holding the great majority of the 148,750 shares outstanding, which created a problem with a particular shape. Those shares were not merely an investment gone wrong; they were collateral. Banks lent against them at something close to the quoted price, and the quoted price was whatever Whitney was willing to pay to keep it there. Supporting the market in Distilled Liquors was the same act as supporting his own borrowing base, and each new purchase required new borrowing, which required more support.

Through the winter of 1937–38 he tried to hold the stock at 9 and failed.

Borrowing Against Nothing

The arithmetic of the last months is preserved in the Exchange's own accounting of his affairs. In roughly four months up to the first week of March 1938, Whitney negotiated 111 separate loans totalling $27,361,500. More than $25 million of that was commercial bank borrowing, rolled continuously, each new loan repaying one that had come due.

Whitney's position was destroyed in the space between the last two points on that chart. The market peaked on 10 March 1937 at 194.40, then lost close to half its value in thirteen months as the recession of 1937–38 took hold. A man carrying an illiquid controlling block on borrowed money had no way through that, and by the winter he had stopped borrowing against assets he owned.

The Funds

What he turned to were funds held in trust, and he had access to three of them.

The New York Stock Exchange Gratuity Fund paid $20,000 to the family of a member who died, financed by assessments on the membership. Whitney had been one of its trustees since 1935. From it he took $657,000 in bonds and $221,508 in cash. He was also treasurer of the New York Yacht Club, and diverted $109,384 from its permanent fund to secure personal loans. The third was the estate of his late father-in-law, George R. Sheldon, of which he was a trustee, and from which roughly $105,000 in stocks and bonds went the same way.

He did not treat any of this as theft. In the account John Brooks assembled from the hearing records, Whitney's consistent position, held to the end, was that he had borrowed against securities he expected to replace, and that a man of his standing replacing them was a certainty rather than a hope (Brooks, 1969). Malcolm MacKay, working through the family papers decades later, reached the same conclusion about his state of mind and a bleaker one about what his connections had made possible. The belief was sincere, and it was sincere because nobody in his world had ever told him no (MacKay, 2013).

The Code of Silence

Somebody did know. In the autumn of 1937, George Whitney learned that his brother had pledged bonds belonging to the Gratuity Fund. He consulted Thomas Lamont, and between them they advanced Richard the money to put the securities back, and reported it to no one — not to the Exchange, not to the trustees, not to the SEC.

That decision, more than the thefts themselves, is what the Securities and Exchange Commission's 1938 report on the case treated as the scandal. The report described a code of silence within the Exchange's governing class, noted that irregularities in Whitney's affairs had been visible as early as 1935, and observed that an institution which policed itself had declined to police its own former president. William O. Douglas, who became SEC chairman in September 1937, had been preparing an argument about self-regulation for months. Whitney handed it to him finished.

The Exchange's comptroller established proof of the embezzlement on 1 March 1938. Charges went to the Governing Committee on 7 March, and Gay read them from the rostrum on the 8th.

Grand Central

Thomas E. Dewey, then district attorney of New York County, moved immediately. Whitney was charged on 10 March, indicted on the 11th for grand larceny in connection with the Sheldon trust securities, and arrested again on the 12th over the Yacht Club fund. He pleaded guilty and drew five to ten years.

On 12 April 1938, about six thousand people gathered at Grand Central Terminal to watch a Groton and Harvard man in handcuffs, flanked by armed guards, board the train to Ossining. Photographers were waiting at both ends of the journey. He served forty months of the sentence and was paroled from Sing Sing on 11 August 1941.

The Institution He Called Perfect

A committee had already been appointed to consider reorganising the Exchange. Carle Conway, chairman of Continental Can, headed it; its secretary was a thirty-one-year-old member named William McChesney Martin Jr., who wrote the report issued in January 1938. It recommended a paid president with a professional staff under him, and outside representation on the governing board — precisely the reforms the old guard had spent years resisting as an insult to a members' institution.

Six weeks later Gay read Whitney's suspension from the rostrum, and the resistance evaporated. Douglas had made it plain that the alternative to reorganisation was the SEC running the Exchange itself. On 1 July 1938 Martin became the first salaried president in the history of the New York Stock Exchange, and went on, thirteen years later, to run the Federal Reserve for nineteen.

Whitney's case did not create American securities regulation; the Securities Act and the Exchange Act were already law, and the SEC was already sitting. What it did was settle the question of whether the Exchange could be trusted to enforce those laws against its own. George Whitney's silence in the autumn of 1937 answered it: no. That answer is why the modern exchange has salaried officers who do not trade, outside governors drawn from beyond the membership, and an examination function reporting to somebody other than the people being examined. Seven decades later the discovery that a respected insider had been running a fraud that his peers half-suspected and did not report would produce the same argument about self-policing after Bernard Madoff's arrest.

From the gates of Sing Sing in August 1941, Whitney travelled to Barnstable, Massachusetts, where a job managing a dairy farm was waiting. It belonged to Caspar G. Bacon, a former lieutenant governor of the state, and it paid $200 a month and board. His parole barred him from the securities business. He later ran a textile fibre company in Florida, repaid what his brother had covered, and died at Far Hills, New Jersey, on 5 December 1974, at eighty-six.

He had told the Senate in February 1934 that the Exchange was a perfect institution. Four years and four months later it acquired the paid president, the outside governors, and the inspectors he had insisted it would never need, and the man who had bid 205 for ten thousand Steel was milking cows on Cape Cod for two hundred dollars a month.