Frankfurter v. Pupils

Felix Frankfurter, Vienna-born Jew whose name shines brightest in the most famed law school of the U. S., had written a law. The President had signed it. And last week every firm of corporation lawyers in the land, including nearly all the cleverest pupils of Harvard's Professor Frankfurter, sidetracked most of their other business to find a way to finance U. S. industry without disrupting the existing financial system. They could not; their professor had outsmarted them ("with diabolical brilliance''); and some-were vexed.

Some were even alarmed. As far as they could see at first glance--and they had been trained to see through any law--the so-called Securities Act had made it practically impossible for any corporation to raise any new capital.

President Roosevelt started out to get a law which would effectively tell the buyer of a bond or a stock what he was buying, and thereby put an end to a system which permitted fraud & folly. After several ridiculous attempts had been made to write the Securities Act it was turned over to Professor Frankfurter, who did not become the New Deal's Attorney General as some had expected, but is nevertheless part of the Brain Trust. Felix Frankfurter, disgusted with much of the "American System," had reason to rejoice last week in the almost unanimous opinion that his bill would change, quite beyond recognition, the whole machinery of finance.

The Securities Act can be considered in two main parts: 1) Issuing new stocks and bonds; 2) buying & selling stocks and bonds already issued.

New Capital. Will any corporation be able to raise any more money? Before any bonds or stocks can be issued, a company's directors must sign and "register" with the Federal Trade Commission a complete account of the company's affairs. If any "material'' fact is misstated or if any "material" fact is omitted, each director is liable for the loss incurred by a buyer of the security. Few lawyers were prepared to advise businessmen last Week that they could afford to take any such chance.

In last Sunday's New York Times, Braintruster Adolf Augustus Berle Jr., onetime infant prodigy, now railroad adviser to the R. F. C., came out with an explanation of Braintruster Frankfurter's bill. He said directors need not be scared if they "relied"' honestly upon the statements of accountants, engineers and other experts. But the bill provides that each director must personally know that the accountants and experts were capable of making an accurate report, etc. Furthermore, since they are equally liable for all losses, it remained to be seen whether accountants and experts would dare to take the chance of going into bankruptcy and jail for any mistake they might make. And, in any case, Felix Frankfurter's ex-pupils who are now corporation lawyers doubted whether "experts" could supply all the information which directors would have to sign.

Forecast. After a week of fretting, many lawyers believed the results might be as follows:

1) Big private bankers would continue to issue securities for the biggest and best known corporations whose directors would be reasonably safe in signing information supplied by the most famed accountants and experts who could, if brought to court, show they had tried their best to put their honest opinion about a great company into figures.*

2) But (since, under the new law, 20 days must elapse between a banker's agreement to take a company's securities and the resale to the public) no banker would make a "firm" deal with a company. The banker would become merely a distributive agent for the corporation's securities-- i. e. the banker would not contract to supply a corporation with cash.

3) Small cat & dog bankers would continue to float cat & dog securities--since they would have little capital and less reputation to lose.

4) Capital would be extremely difficult to raise for the multitude of middle-sized honest companies. Thus most middle-sized bankers would quit the underwriting business.

5) The big underwriting bankers would cease to have salesmen (some firms fired their salesmen last week). Other bankers would turn themselves into organizations of salesmen, avoiding the responsibility of dealing in their own securities and with little capital to lose if anything should go wrong.

6) The prospectuses of new issues would be so voluminous that no investor could possibly read them--so that, while securities would be created with greater care, the investor would actually know less than ever what he was buying. ("Summaries" will be very risky.)

Buying & Selling. The country might conceivably get on without new securities but what worried the bankers even more last week was the section applying to sale of securities already issued, for flotations of new issues have dwindled to practically nothing in the last three years. Stocks & bonds now outstanding do not have to be registered with the Federal Trade Commission, but a seller is liable for damages if his representations, either oral or written, are misleading because of an omission of any material fact.

Bankers and brokers therefore practically ceased making any representations about stocks and bonds. Salesmen twiddled their thumbs. They could take orders to buy & sell (and thus the stock exchanges continued at full blast), but they hesitated to recommend a stock or urge the purchase of a bond if it involved use of the mails or interstate commerce. Of course they advised old clients whom they could trust, for it was the racketeer, the sue-&-settle people, who would save every scrap of a firm's written matter waiting for a chance to trip it up. that Wall Street feared most. Many firms ceased or radically altered their "market letters."

Significance. There must always be a risk in buying or in selling a security. In the past, too much of the risk has been passed on to the buyer. The purpose of the Securities Act is obviously to place the largest part of the risk with the seller.

While lawyers wrestle with the immediate problem of what their banking and brokerage clients can or dare do, the Brain Trust has no doubt that, out of the Act, a new and better system will be evolved to supply the financial needs in Industry. With such purposes, neither Professor Frankfurter's ex-pupils nor any good banker quarreled.

Pending court decisions (which must interpret nearly every clause in the bill) Braintruster Berle, in his New York Times article, gave comfort to businessmen by announcing that the New Deal would put no honest man in jail. (Honest men need worry only about their ability to prove themselves honest.) Finally, there is behind the Securities Act a strong reminder that a corporation is not a thing which anybody has a "right" to create but that it should be created by the state "only when there is some reasonable likelihood in statecraft . . . that it will be a useful organism." Ultimately, nation-wide corporations should be created (and controlled) by the Federal Government. The present bill gives the Federal (only really effective government) its first real control.

Frankfurter. It was good Republican Henry Lewis Stimson, Secretary of War under President Taft, who first took Felix Frankfurter to Washington. As a U. S. attorney Lawyer Stimson had been vastly impressed with his ruddy, nervous little assistant who still had an accent when he came to him shortly after graduation from the Harvard Law School in 1906. Felix Frankfurter stayed long enough in Washington to gain the respect of President Wilson (who called him from Harvard in 1918 to head the War Labor Policies Board) and, more important, the lasting friendship of Assistant Secretary of the Navy Franklin Delano Roosevelt.

When the "brain trust" was being formed during last year's campaign President Roosevelt naturally included the man who had divided Harvard into two camps --Frankfurter and anti-Frankfurters. Anglo-Saxon-minded defenders of common law and the case system of teaching it deplored his long lectures on administrative and constitutional law. The Frankfurters pointed with pride to the way he sent his pupils home to wrangle for weeks over one of his neat, sharp questions. Put in an abrupt, jerky voice, they were usually questions of broad social significance. Public-minded, unselfish, a disciple of Liberals Oliver Wendell Holmes and Louis Dembitz Brandeis, Felix Frankfurter has turned down a seat on the Massachusetts Supreme Court and partnerships in firms worth $200,000 a year. Now 50, a man with a perpetually crisp, alert expression, and a charming wife, he will take a leave of absence next year.

*As everyone knows, accounting is not an exact science. In every big balance sheet there is room for honest difference of opinion.

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