Why Enron Always Happens

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Wall Street’s securities market dates back to shortly after the Revolution, and the New York Stock and Exchange Board, as the New York Stock Exchange was called until 1863, was formally organized in 1817. But much trading took place in often ephemeral rival exchanges that cropped up from time to time and on the Street itself, and there was no Wall Street institution at this time powerful enough to regulate stock trading effectively. Neither the state nor the federal government regarded the regulation of markets as part of its duties, and because the New York State judiciary was profoundly corrupt, even the ordinary rules of law were at best sporadically enforced. No one was in charge, and what rules there were could be ignored with impunity. But as lone as the mar- ket was very small, peer pressure kept matters under control.

The Civil War changed everything. The national debt ballooned, and an avalanche of new federal securities was soon being traded on Wall Street, which became the second-largest securities market on earth, after London. With millions suddenly at stake, for a few years on Wall Street it was capitalism red in tooth and claw.

The Erie Railroad, which competed directly with Vanderbilt’s New York Central, was largely run for the benefit of its management, which speculated freely in its stock rather than act for the benefit of its stockholders. Vanderbilt resolved to force the feckless Erie to be run in a businesslike manner and thus rationalize the competition among the railroads serving New York City, and he decided to do so by simply buying control of it, by acquiring a majority of the 251,050 shares of common stock outstanding. Being the richest man in the country, with unimpeachable credit, he should have found it easy. He didn’t.

To make sure that the Erie board couldn’t interfere with Vanderbilt’s plans, his lawyer asked Justice George G. Barnard of the New York Supreme Court to issue an injunction suspending Daniel Drew from the board and forbidding the company from converting any bonds into stock or issuing any new stock. Drew responded by having a Justice Gilbert, sitting in Brooklyn, issue injunctions voiding Barnard’s and, all important, ordering the company to continue converting bonds into stock as usual. The Erie directors were now in a nearly no-lose situation. As one writer of the day explained, “Since they were forbidden by Barnard to convert bonds into stock, and forbidden by Gilbert to refuse to do so, who but the most captious could blame them for doing as they pleased?”

NEW CONCEPTS IN ACCOUNTING HAVE ALWAYS PROVIDED WAYS TO SKATE NEAR THE EDGE.

While the Vanderbilt brokers bought all the Erie stock that was offered, Jim Fisk delivered another newly minted 50,000 shares for sale. “If this printing press don’t break down,” he commented, “I’ll be damned if I don’t give the old hog all he wants of Erie.” Vanderbilt kept right on buying, and by the end of the day he held almost 200,000 shares. Was it a majority of the stock? No one knew, except possibly Drew, Fisk, and Gould, for no one knew how much stock was outstanding.

The Erie directors had taken the precaution of converting their ill-gotten gains into greenbacks, and they fled to New Jersey, safely beyond Judge Barnard’s arrest warrants. At that moment it was a standoff. Fisk, Gould, and Drew had the Erie Railway and seven million dollars of the Commodore’s money, but Vanderbilt had New York. The battle for ultimate control moved to Albany and the New York state legislature.

In the 1860s that body was, perhaps, the most corrupt legislature in history. Jay Gould, according to the New York Herald , went to Albany with a trunkload of $1,000 bills. Arrested and held on the colossal bail of $500,000, he simply posted it in cash and went back to work on the legislators. Meanwhile, Vanderbilt, though as honest a man as his times allowed him to be and far more respected by everyone than the rascals running the Erie, realized there was growing opposition to his controlling the Erie as well as his other railroads. That would give him a near-monopoly on trunk-line rail transportation in New York State, and any victory he purchased in Albany might turn out to be very short-lived. He decided to get in touch with Drew and settle matters.

VANDERBILT DEMANDED THAT THE NEWEY PRINTED stock be taken off his hands at a price near what he had paid for it. To get their agreement. lay Gould and Jim Fisk were made president and controller of the Erie Railway. The main losers were the genuine stockholders of the Erie, whose equity in the company the new shares had diluted by about 35 percent.

While the nation’s newspapers had a field day with the Erie Wars—the story got far more play than the contemporaneous impeachment of President Andrew Johnson —Wall Street bankers, brokers, and lawyers were appalled. The New York Stock Exchange and the Open Board of Brokers quickly forced reform in the rules. The exchanges, which merged the following year to become the country’s overwhelmingly dominant exchange, required that companies henceforth maintain open registries of their securities and announce any new issues of stock 30 days in advance. The merged exchange also required that member firms trade listed securities only on the floor of the exchange, where all the members could keep an eye on things.