The two previous SEC Chairmen, Joseph P. Kennedy and James L. Landis, had constructed the initial design of the administrative agency with an acute understanding of the pitfalls in making and administering regulatory policy.(1) During Kennedy’s tenure, the SEC had consolidated the New Deal legislative victory of the securities act. During Landis’s Chairmanship, the administrative machinery was established which the SEC would use to implement the mandate of the 1934 and 1935 Acts. Yet, despite the agency’s growth from 1934 to 1939, the SEC remained a work in progress. Douglas’s tenure as SEC Chairman would be to use the machinery his predecessors had created to make permanent its institutional authority over the nation’s stock markets.
The SEC continued its business as the national economy began a downturn in early 1937, but it faced an uncertain future. By October 19, 1937, when the bottom once again fell out of the stock market, the national economy was in full-blown recession. Millions of Americans lost their jobs and thousands of businesses went bankrupt. Opponents of the New Deal, especially the Wall Street old-guard led by Richard Whitney, blamed the SEC for the recession, arguing that its policies restricted the free flow of capital into the markets undermining the economy. Douglas became the voice of regulation on the Commission, giving numerous speeches denying that SEC regulation of the markets had hurt the economy. Despite heavy opposition to continued SEC involvement in regulating the national economy, Douglas continued to advise President Roosevelt on action the government should take to reform the economy.
Douglas’s SEC moment came when the rest of the New Deal was in fast retreat. Stock prices had fallen by 30% in the two months preceding his election as Chairman. More than six million Americans lost their jobs. Charles Gay, the president of the NYSE, commented on Douglas’s appointment, stating it "gratifying" and commended Douglas for "his experience and intimate knowledge of the problems that confront the securities markets," but blamed the SEC for amateurish regulation and interference with the process and flow of capital.(2)
Stung by the recession, President Roosevelt suggested a relaxation of margin requirements and the nomination of John W. Hanes, a member of the NYSE, to the SEC. Douglas acceded to Roosevelt’s suggestion to appoint a business insider, but got his friend Jerome Frank nominated to the Commission as a counterweight to Hanes.(3) When study of the stock exchanges which had been ordered during Joseph Kennedy’s tenure as Chairman was finally published in 1937, Douglas used the opportunity to push for major reforms. The receipt of the Kennedy Stock Exchange investigation report prompted Douglas to prepare for a battle to reform the country’s stock exchanges by regulating the activities of the exchanges in the interest of the investing public.
Despite the economic downturn, an October 1937 Gallup Poll reported that 62% of all investors and 69% of all voters thought that "Government regulation of the stock exchanges has helped investors."(4) Aware of the value of public support for the role of the SEC in the national economy, Douglas gave numerous public speeches advocating the position of the SEC. He criticized the NYSE for its clubby atmosphere and lack of control over insider trading. Putting his SEC experience as a staff member, Commissioner and now as Chairman, into action, Douglas advocated that the Exchange regulate itself, but insisted that it must do so by segregating broker/dealer functions and by establishing strong new reforms for its members.
Yet, it soon became clear that the NYSE had its own internal conflicts. Inside the exchange, reform-minded members battled the old guard about working with the SEC to seek reorganization that would transform the NYSE from a private club into a modern, efficient organization. Douglas saw this division as an opportunity to push for reforms and called for a meeting between NYSE officials and the SEC. When Douglas, Gay and their negotiating teams met on November 19th for a final settlement attempt, the positions had so hardened that Douglas, responding to the NYSE’s proposed settlement, called off negotiations.
Richard Whitney was a Wall Street icon. Long influential among the national business community, he had been one of the New Deal’s sharpest critics. Whitney, who epitomized the private club-like character of the stock exchange, chafed at Douglas’s calls for intervention. He led the internal opposition on the NYSE Board of Directors to the SEC Chairman’s demands for reform. Even as NYSE reformers like President Gay sought an agreement with Douglas, Whitney, who retained enormous power among the old guard of the NYSE, resisted.
Despite Whitney’s resistance, the SEC reached a tentative agreement with the NYSE over regulation, segregation of broker and of dealer activities, the handling of client accounts, and democratization of the NYSE Board of Directors. In addition, NYSE President Charles Gay would step down and be replaced by William Martin, of whom Douglas approved. But negotiations broke down over a proposal to create an outside paid president to run the Exchange. Douglas threatened to take outright government control of the Exchange, which was strongly resisted by Whitney. In February 1938, as the battle of Wall Street raged and the positions hardened, in a heated meeting between Stock Exchange Counsel William H. Jackson and Douglas, Jackson said, "Well, I suppose you’ll go ahead with your own program?"
Douglas replied, "You’re damned right I will."
"When you take over the Exchange," Jackson intoned, "I hope you’ll remember that we’ve been in business 150 years. There may be some things you will like to ask us."
"There is one thing I’d like to ask," Douglas replied.
"What is it?"
"Where do you keep the paper and pencils?"(5)
The battle on Wall Street continued from late October 1937 until February 1938. Douglas's bravado alone, however, would not be enough to force the reforms. Ironically, it would be Richard Whitney himself who would provide the political impetus that allowed Douglas to push his program ahead, and eventually win the full cooperation of the Exchange.
For years, Richard Whitney had been illegally using securities from his wife’s trust as collateral for loans from friends. Facing losing ventures, Whitney’s thirty-one different Wall Street loans totaling $8,284,000 came due in late 1937. Whitney sought help from other Wall Street insiders, including his brother George Whitney and George’s partner Charles Lamont, to bail him out. The men agreed to make the loan to Richard Whitney without advising their other partners.
In every respect, the Whitney affair seemed to prove the need for reform of this "private club" that Douglas had been railing against. Douglas was unaware of Whitney’s troubles when he spoke to the New York Bond Club on January 7, 1938. His Bond Club address raised the stakes when he publicly notified Wall Street of the SEC’s plan to regulate the stock market with or without an agreement. Just two weeks later, the SEC issued a regulation requiring any short sell of a stock be made at a price higher than its most recent sale price. The unilateral imposition of the regulation on the stock market was the first in SEC history. Soon thereafter, facing the unilateral SEC moves, regional stock exchanges around the country began to reorganize themselves along the lines the SEC had recommended.
Despite Whitney’s troubles, he remained steadfastly and vocally opposed to any NYSE reforms. But on February 22, 1938, Whitney’s financial fraud was discovered by NYSE insiders. By March 7, the Governing Committee voted to press charges against Whitney. They notified Douglas, who immediately sensed that he had the political capital to force his reforms on Wall Street. The sight of Whitney, the Wall Street scion, pleading guilty in a New York courthouse to committing the kinds of insider acts Douglas and the SEC had been seeking to regulate dramatically strengthened Douglas’s position. By April 1938, 74% of Americans surveyed in a Gallup Poll believed that the Whitney affair proved the need for more SEC regulation of Wall Street.(6)
The Whitney bankruptcy and fraud was a national scandal, and Douglas immediately announced that the SEC would hold hearings. He requested that New York Prosecutor Thomas Dewey defer the final sentencing of Whitney until the SEC could call him before their investigation. On March 10, Whitney was indicted. The New York Stock Exchange expelled him on March 22, and shortly thereafter, agreed to adopt the reorganization measures including public representatives on the governing board, and a paid president and technical staff for the Exchange which had been proposed by the SEC. Douglas and new NYSE President William Martin held a series of round table discussions to work out the details, after which Douglas commented that his proposals were "all coming along like a horse race… You never know which will come in first."(7) But by then, the SEC had all the horses in the race. The battle on Wall Street had been won.
(1) Thomas K. McCraw, Prophets of Regulation (Cambridge: Belknap Press, 1984), Chapter 5.
(2) "Douglas Is Named Chairman of SEC," New York Times, September 22, 1937, p.41.
(4) "Stock Owners Call Commission Helpful," The Washington Post, October 17, 1937, B1.
(5) Bruce Allen Murphy, Wild Bill: The Legend and Life of William O. Douglas ( New York: Random House, 2003), 140-154, 144.
(6) "The Gallup Poll: Whitney Affair Found to Be Influencing Public View of Wall Street Regulation," The Washington Post, April 13, 1938, X2.
(7) "SEC ‘Crack-Downs’ Over, Douglas Says," The New York Times, June 4, 1938, p. 1.
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