Singing the Praises of Securities Regulation

Eddie Cantor was an actor, singer, and comedian who made his name in the Ziegfeld Follies and lost his money in the 1929 crash. Reading about him over the last couple of days, I was struck not by the similarities between today and 1929, but by the differences. One principal difference, actually: federal regulation of securities transactions. As you read the story below try to pick out all the places where our present securities laws would have led to a different result. Ready?

In 1929, Eddie Cantor’s neighbor Nathan Jonas advised him to buy a big chunk of a new investment trust called Goldman Sachs Trading Corporation (GSTC). Cantor invested most of his life savings in GSTC. It was selling for $350/share. By 1933 it had sunk to $1.75.

GSTC was the center of a web of funds that employed layers of borrowed money to turn small equity stakes into piles of cash. The example generally cited (because it appears to be the only transaction recorded) is the Shenandoah & Blue Ridge Corporation funds.

The transaction worked like this: GSTC organized an investment fund called Shenandoah Corporation and put $40 million (mostly borrowed) into it. Shenandoah raised $20 million more by selling debt to the public. Shenandoah invested its $60 million in a controlling stake in another GSTC investment fund: Blue Ridge Corporation. Blue Ridge sold about $130 million in securities to the public. It sold some equity, but mostly debt. Blue Ridge used its $190 million to buy utility stock.

For a minimal cash outlay (maybe as little as $10 million) GSTC ended up in control of a $190 million cash pool. Because the debt holders of each investment fund were promised a set rate of return, the majority of any increase in the value of Blue Ridge’s investment portfolio would go directly to GSTC. However, for the same reason, even a small decrease in the value of the Blue Ridge portfolio would lead to default: as Harold Bierman dryly observed “this was a risky investment.”

So, why did so many people invest? There was in 1929 a craze for investment funds. These funds were entirely opaque to investors. They were sold on name recognition. For instance, on the board of Blue Ridge were: future Secretary of State John Foster Dulles, future Sullivan & Cromwell managing partner Arthur Dean, economist, Muzak founder, and head of Goldman Sachs Waddill Catchings, and Walter Sachs.

After he got wiped out, Eddie Cantor spent a couple of years trying to make it so that people would burst out laughing whenever someone said “Goldman Sachs.” Then he tried a more serious, and ultimately, less effective approach – he sued. His was one of more than 20 shareholder derivative suits brought by the shareholders of GSTC. Eventually, these suits were consolidated and in 1933 they were settled for about $385,000. It doesn’t sound like much, especially since only $85,000 of it was cash. The rest was GSTC stock that the company (now called Pacific Eastern Corporation) gave itself.