Evidence of chicanery on the part of the insurance industry sparked a New York State investigation that prompted the passage of reform legislation.
Late in 1904, Thomas W. Lawson,
What attracted the press’s attention were the activities of the flamboyant James Hazen Hyde, who five years after graduating from college was earning $100,000 a year as vice president of the Equitable, which had been founded by his father. Hyde became majority shareholder of the Equitable upon his father’s death in 1899. It was a sizable, wealthy company, with 600,000 policyholders and assets of $400 million.
Hyde lived ostentatiously. He was famous for his many elaborate parties, all of which were paid for by the Equitable. One of these, held on January 31, 1905, caused a sensation. Hyde had a restaurant redecorated to resemble Versailles at the time of the reign of King Louis XIV, hired a French actress to recite lines from the plays of French dramatist Racine for the guests, and served a lavish and expensive meal. The entire cost, as estimated by reporters, came to $200,000.
The event had political repercussions. Alarmed at the impact of Hyde’s spendthrift ways on the insurance company’s image, company president James W. Alexander and thirty-five other officers and agents brought charges of malfeasance against him, engaging the services of Charles Evans Hughes, who would soon become one of the country’s leading attorneys but then was about to initiate an investigation of the state’s natural gas business. The directors demanded that the Equitable be converted to a mutual company, one therefore owned and controlled by policyholders. This would have resulted in Hyde’s departure.
In the war for control of the company that followed, E. H. Harriman and J. P. Morgan clashed, albeit indirectly. Both men hoped to use the Equitable’s cash reserves to finance some of their deals. The battle ended when Hyde sold his Equitable shares to Thomas Fortune Ryan,
During the course of the investigation, Hughes uncovered many episodes of mismanagement, fraud, falsified statements, and bribery of public officials. Among other things, he reported that since 1896 Mutual Life had maintained a “house of mirth” in Albany for the entertainment of state legislators. Over the next few months, insurance industry scandals, as they were called, dominated the news. Each week another lurid illustration of corporate chicanery turned up. Prominent politicians were found to be involved with Hyde. Senator Thomas Platt
James Hazen Hyde.
It was not long before investment bankers were drawn into the investigation. Hughes uncovered the fact that, in order to conceal bribes and losses, several investment banks, Kuhn Loeb being the most prominent, had made year-end loans to and sales for several insurance companies. These actions increased reported cash balances for the insurance companies and enabled the investment banks to report inflated figures for outstanding loans and holdings. When the fiscal year ended, the insurance companies would repay the loans and make payments for the sales, and the banks would receive fees for their services.
Jacob Schiff,
In November, the name of Vermilye and Company,
William A. Read, a former head of Vermilye, denied all implications of wrongdoing and demanded specifics and proof of the claims. These appeared to come the following month, when a Metropolitan vice president, Haley Fiske, testified that Vermilye had sold Metropolitan 3,333 shares of Lake Shore and Michigan Southern Railway, then quoted at $400 per share, for $350 per share, and that Vermilye did not receive a commission from the buyer on the transaction, but rather obtained one from the seller. This last matter would have been a violation of law and New York Stock Exchange rules, because Vermilye would have been serving both buyer and seller as agent, without the former knowing of the relationship with the latter. In other words, the Metropolitan would not have known that Vermilye had that incentive from the seller. Following these developments, nothing further was heard for a while about the commissions. Apparently Hughes lacked evidence to corroborate allegations of wrongdoing on that score. He turned instead to the matter of price movements in the Lake Shore stock and the spread between the bid and offer prices.
Read answered the assertions. In a letter to the editor of the New York Daily Tribune, he pointed out that Fiske had not complained about the price. Rather, the Metropolitan officer had informed the Armstrong Committee, “I do not want to do any injustice to Mr. Read. He is quite certain that his transaction was entirely justified by the rules of the Street and by right dealing.” Alluding to the half-forgotten matter of the commission, Read added, “Whether or not the commission was reasonable is comparatively immaterial, but it is vital to my reputation in the community that the refutation of the charge that I took a commission without the knowledge of my client be given equal publicity with the charge itself.” He might also have added that Lake Shore was a thinly traded issue and that large changes in price were fairly common when substantial blocks of stock changed hands.
With this, the matter was dropped. Clearly Hughes thought that he lacked sufficient evidence to continue. Still, doubts and suspicions remained. Even if Read were not guilty of having acted improperly in the matter of the Lake Shore stock, the issue of rebates given to Metropolitan by Vermilye required further investigation. Were there rebates, and, if so, who gave them? Hughes said that he had proof of Vermilye’s involvement and indicated that the evidence would be introduced at the proper time.
It was not until the following year that the public learned just who was culpable. It was not Read but rather Donald and George Mackay.
This was not the end of the matter. The Mackays sued Read, charging that he had improperly retained commissions earned in the Metropolitan transactions. A month later, Read issued a statement in which he attempted to clarify the situation. He charged the Mackays with attempting to appropriate for themselves commissions of slightly less than $50,000 that he had earned through dealings with Metropolitan during the last few months of Vermilye’s existence. He stated:
Acute differences then existed between the partners, and Messrs. Mackay, Fish, and Hollister were engaged in an effort to appropriate to themselves the name and goodwill of the firm of Vermilye & Co., excluding me from any interest therein. Under these circumstances I undertook and carried out on my individual account the three transactions which are the subject of this lawsuit. The acts of my partners prevented me from doing the business in any way but individually. As to all of these matters, I acted under the advice of counsel, and am content to abide by the decision of the court.
With this the matter ended. The Mackays did not initiate a lawsuit against Read, which may be taken as evidence that their claims were without foundation. Read came out of the situation with his honor and reputation intact, and the Mackays might have considered themselves fortunate for having received little more than a rap on the knuckles, perhaps because of Donald Mackay’s age and former eminence—he had served as president of the New York Stock Exchange.
The Armstrong Committee’s investigations affected the ways in which Wall Street and the insurance industry conducted business. The revelations prompted demands for reform and regulation that intensified after the committee’s report was made public on February 22, 1906.
The committee stunned the financial community by announcing its intention to “revolutionize” the way new securities issues were awarded to underwriters. Up until that time, all new issues were placed on a negotiated basis, which is to say that the company issuing a security would approach a banker or vice versa. The bank and the company would then work out the terms of the financing, including price, amount, and maturity and interest rates. The committee proposed that all future underwritings for companies over which it had authority be placed on a competitive basis, with any investment bank able to bid for the business, which would presumably go to the bank making the best offer. The concept was rejected, but it remained a source of contention. As it was, the old ways prevailed, with banks wooing customers on the basis of personal relationships, service, placement power, and reputation. However, New York and other states did prohibit insurance companies from participating in investment banking.
In addition, Hughes helped draft new legislation that prohibited insurance companies from making contributions to political campaigns and also required registration of lobbyists and curbed their activities. Congress followed his lead, passing the Corrupt Practices Act of 1907
The Armstrong Committee investigations also led to changes in the way insurance companies were run. The investigations revealed that some of the larger companies were run as autocracies, with trustees having little control over management. High corporate officers often received salary increases without the knowledge of trustees. In addition, the committee uncovered problems in the incentives offered to general sales agents. The agents earned commissions on all policies sold and often had large territories; this led them to sell as many policies as possible with little follow-up and little concern for the long-term welfare of the buyers. Following the committee’s report, general agents were made salaried workers, and policy salespeople were required to take training courses in how best to serve customers.
The Armstrong Committee did much to inform the public of how and why Wall Street bankers conducted their affairs. The shock of learning how much money was involved and the fees earned for various services helped accelerate the movement toward reform, which previously had been lagging. As for the Equitable itself, its joint ownership of National Bank of Commerce, New York’s second-largest financial institution, was challenged. Equitable and Mutual Life Insurance were obliged to sell their control shares, which were purchased by J. P. Morgan, First National Bank, and National City Bank. Ironically, by enabling this move, the Armstrong investigation, which was aimed at limiting financial concentration, further consolidated the power of the Morgan group.
Hughes went on to run for the New York State governorship in 1906, defeating Democrat William Randolph Hearst. One of his programs as governor involved the establishment of the Public Service Commission, which was granted investigative and regulatory powers, including the authority to review all new utilities issues. On the basis of his record, Hughes received the Republican nomination for president in 1916; he narrowly lost the election to Woodrow Wilson. He later served as U.S. secretary of state (1921-1925) and as chief justice of the United States (1930-1941).
Hyde left the country and wound up in Paris two days before the conclusion of the Armstrong Committee investigation. He denied any intentions of relinquishing his citizenship, saying, “I am too good an American for that. That report was circulated by enemies to injure me, but they have failed.” He remained in Paris for the next thirty-five years, devoting much of his time to Franco-American relations. He returned to the United States for visits after World War II, and he died in Saratoga, New York, in 1959.
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Beebe, Lucius. The Big Spenders. Garden City, N.Y.: Doubleday, 1966. Contains a colorful sketch of James Hazen Hyde and the backdrop for the Armstrong investigation. -
Carosso, Vincent. Investment Banking in America. Cambridge, Mass.: Harvard University Press, 1970. The classic history of American investment banking, with a section on the Armstrong investigation. -
James, Marquis. The Metropolitan Life. New York: Viking Press, 1947. Contains an account of the Armstrong investigation from the vantage point of the Metropolitan. -
Logan, Sheridan. George F. Baker and His Bank, 1840-1955. New York: Author, 1981. A view of the Armstrong investigation from the point of view of an ally of J. P. Morgan. -
Pusey, Merlo. Charles Evans Hughes. 2 vols. New York: Macmillan, 1951. Volume 1 has a chapter on the Armstrong investigation, explored from Hughes’s point of view. -
Roe, Mark J. Strong Managers, Weak Owners: The Political Roots of American Corporate Finance. Princeton, N.J.: Princeton University Press, 1994. Argues that politics has always played a key role in the ownership structure of large U.S. firms. Chapter 6, on insurers, includes discussion of the Armstrong Committee investigations. Bibliography and index.
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