Under the Affordable Care Act, you must have health insurance, or pay a fine. But what if you were arrested or jailed if you did not comply with the healthcare reform law? The website for the Affordable Care Act is now up and running again so Americans can enroll for health insurance. Obama has had problems making the Affordable Care Act a reality during the past few weeks. Millions of Americans have found out that their health care has been cancelled, despite promises to the contrary, because their plans didn’t meet the standards of the Affordable Care Act, and millions more have seen large jumps in their annual premiums. Other Americans could not sign up due to past website performance of an approximate 10% downtime so now the government is hoping the website will work and reverse their fortunes.

The problem is that given the increase in health care costs that will occur, many people will not be able to afford health care insurance and will face the prospect of paying fines for non-compliance. The whole process reminds me of what happened during the Roosevelt Administration and its ill-fated attempt to impose price controls on the economy during the 1930s.  

FINES FOR COMPETITION

After Roosevelt became President in 1933, he introduced the New Deal to bring the country out of the Great Depression. Manufacturing production was collapsing, trade was falling, people didn’t know where their next meal was coming from and unemployment lines were growing. As the chart below shows, unemployment had risen from around 1% in 1929 to 25% by 1933.

With any new legislation comes a new set of government rules, and the NRA created the inevitable regulatory nightmare. Raymond Clapper reported that between 4,000 and 5,000 business practices were prohibited by some 3,000 NRA orders that ran to over 10 million pages. Businesses that supported Roosevelt’s plan showed their support by putting up an NRA poster, which showed a blue eagle and the words “We Do Our Part” in their windows. If you watch an old movie, such as Gold Diggers of 1933, you can even see an NRA eagle that Busby Berkeley had his dancers form in the musical as a sign of Hollywood’s support for the NRA.  

BLACK MARKETS

As with any set of government regulations, you have to have enforcement. Black markets resulted from the NRA’s regulations and in some garment districts, enforcement police were used to make sure the rules were followed. Just as the Volstead Act was passed to enforce Prohibition, each state passed laws that administered the thousands of regulations created by the NRA. The New Jersey State Recovery Act was passed by that state’s legislature to make sure businessmen complied, regardless of whether they knew all the details or not. The biggest supporters of the price controls were big businesses which, as always, were better able to apply the regulations than small firms, and which could use the price controls to increase their profits and keep smaller, more efficient firms from competing against them. In the cleaners and dyers business in New Jersey, the industry set a “fair competition” price of 40 cents for pressing a suit. Before the Crash, tailors could charge 50 cents; now they were forced to charge 40 cents. Jacob Meged was a tailor of Polish descent who had a tailor shop at 138 Griffiths Street in Jersey City. He had a wife and four children and he needed money to feed his family. Other tailors were charging 40 cents, but he wanted to get more business, so he put a sign in his shop window advertising that he would press suits for 35 cents. After all, this was America where you were accustomed to being free to charge what you want. Beating the competition and being entrepreneurial was the American way, and he would be happy to press suits for 35 cents. Unfortunately, Jacob didn’t get more business and instead, he was arrested. J. Raymon Tiffany, Special Assistant Attorney General in charge of enforcing NRA codes in New Jersey took responsibility for prosecuting the tailor. When Jacob Meged was read the charges, he told Judge Kinkead that he was only vaguely aware of the existence of a code, but he pled guilty to the charge that he had violated the New Jersey State Recovery Act. Mr. Tiffany asked the court to impose a sentence stiff enough to warn other code violators that the law had teeth in it.  

UNSUITABLE JAIL SENTENCE

On Friday, April 20, 1934, Judge Robert V. Kinkead sentenced Jacob Meged to 30 days in the county jail, and he was ordered to pay a $100 fine. At 40 cents a suit, Meged would have to press 250 suits to cover his fine. That would be $100 he couldn’t use to feed his family, and in addition to this, he would lose a month’s earnings. As The New York Times put it, “He believed that the codes were designed to help the ‘little fellow’ and could not believe that by charging 35 cents instead of 40 cents to press a suit would put him behind bars. In court yesterday he stood as if in a trance when sentence was pronounced. He hoped that it was a joke.” It was no joke. Jacob Meged spent the weekend in jail, where he played checkers with fellow inmates. His case quickly became a cause célèbre, and although there is no record of it, over the weekend, political pressure was likely brought to bear upon Judge Kinkead to reverse the sentence. On Monday, Jacob Meged was called back before Judge Kinkead who remitted the fine and suspended sentence. Meged’s attorney explained that Meged had been ignorant of the meaning of the NRA, and now that the purpose of the NRA had been explained to him, he was anxious to comply. Judge Kinkead -who had no problem feeding his family, spoke to Meged like a father berating a little child. “I am glad you have come into court in a spirit of repentance…. The idea was to teach you a lesson. It never was the intention of this court that you pay the fine or be sent to prison. But there must be some way of impressing people who break the law that you did and it is necessary to demonstrate to people that the NRA State Act will be rigidly enforced.” The jocular judge even promised to be one of Meged’s customers if he raised his price to 40 cents for pressing a suit, though it is not known if Judge Kinkead ever followed up on his promise. Jacob Meged had an easy choice – shut up, do as you are told, comply, and you will be able to feed your family. Don’t comply and you could lose everything. So Jacob Meged did what he had to do. He went back to his shop. He took down the poster advertising his willingness to press a suit for 35 cents and replaced it with an NRA poster with the blue eagle on it. The photo of Jacob Meged at his shop, obviously staged, was published in newspapers with the caption: “The NRA is OK.” Jacob Meged also wired General Hugh Johnson, the head of the NRA, and let him know that he was “heartily in favor of it.” Meged was free from jail, but not free in spirit. He had to choose between his conscience and his family, and he chose his family. Although Jacob Meged’s incarceration was the most egregious result of the NRA, there were many other examples of the agency keeping people from competing freely in the market. As a result, in early 1935, the NRA announced that it would stop setting prices. The main supporters of the price controls had been the businessmen who ran the industries. According to Time Magazine, of the 2,000 businessmen that worked with the NRA, 90% opposed the chairman of the NRA’s decision to stop setting prices. Why compete with more agile, smaller firms when you can use the government to set up a cartel to protect you?  

FREED BUT NOT FREE

On May 27, 1935, in the court case of Schecter Poultry Corp. v. United States, the Supreme Court, in a unanimous decision, held that the mandatory codes section of the NRA was unconstitutional because it attempted to regulate commerce that was not interstate in character. They found that the codes represented an unacceptable delegation of power from the legislature to the executive. The Court held that the codes violated the United States Constitution’s separation of powers as an impermissible delegation of legislative power to the executive branch. The Court also held that the NIRA provisions were in excess of congressional power under the commerce clause. After the Supreme Court invalidated the NRA, Jacob Meged was free to speak his mind and indeed he did. When asked what he thought of the court’s ruling, he retorted . . . “[the] NRA never was any good and is no good now.” Nevertheless, the entire ordeal clearly took its toll on Jacob Meged. He became ill in 1938, went into the hospital on February 21, 1939 where he died at the young age of 54, only five years after initial arrest. Reviewing this misadventure of Joseph Meged, it makes you wonder about the unintended consequences of government interference in the marketplace. Who and when will be the next Joseph Meged? The government has proven it is able to enforce its writ regardless of the consequences, but I certainly hope that this time, the government will.

In 1933, a precedent was set for paying whisky as a dividend on common stock. As I have discussed in an earlier blog, entitled The Famous Whiskey Dividend, companies can invent creative ways to pay out dividends. In fact, when the going gets tough, the tough go drinking. After Prohibition was repealed in 1933, National Distillers Products Corporation distributed a dividend of one case of whiskey for each five shares that were owned. This pulled out the stops with paying dividends. Twenty years later, Park & Tilford provided a more sobering saga.  

PUMP AND DUMP

Originally founded in 1840, Park & Tilford had a long history of being a family-owned operation run by the Schulte’s. For decades, the company produced a broad line of whiskey and related products until it formally incorporated in 1923 in order to list on the NYSE. In 1943, in the middle of World War II, whiskey was scarce. Most companies that produced whiskey had their factories diverted to manufacturing more important goods – in the opinion of some folks – making whisky a hot product to the public. Since Park & Tilford owned a drug store in New York and went public during prohibition; the company diversified into cosmetics, perfumes and other drug sundries. Though Prohibition had been repealed in 1933, the diversion of resources to the production of war materiel had some people worried that Prohibition was being reintroduced de facto if not de jure. On December 15, 1943, D.A. Schulte, the President of Park & Tilford announced that the company was contemplating a distribution of whiskey to its shareholders. The announcement by Schulte had its effect. Based on these rumors, the stock advanced roughly 40 points over the next five months, as new shareholders tried to get access to scarce whisky to sell on the black market. This advance was an aggressive move in any market. The Schulte family owned over 90% of Park & Tilford stock, and they took advantage of the promise of the whiskey dividend to sell their stock to the public During the five months that followed the announcement, the family unloaded 93,000 shares through their broker, Ira Haupt & Co. The 93,000 shares the family sold may not seem like a large amount of stock until you realize that there were only 243,683 shares outstanding when the whiskey announcement was made. Ira Haupt & Co unloaded 40% of the outstanding shares as the stock hit new highs between December 1943 and May of 1944, as can be seen by the graph below. Park & Tilford stock had been at 57.625 on December 15, 1943 and advanced to 98.25 on May 26, 1944. It was classic pump and dump. Pump up the stock price then dump the shares on unwitting investors.

WHISKY DIVIDENDS

On May 26, the company formally announced the details of the whisky dividend. During World War II, the government imposed price controls on consumer goods, including liquor. The Government did not see the whiskey dividend as an exception to their regulations. The Office of Price Administration stepped in and limited the negotiability of the purchase rights and the maximum profit on the resale of the liquor. The stock price plummeted on the news. Since some shareholders were more interested in making cash than in drinking whiskey, they saw their profits from the whiskey dividend melt away, further causing a collapse in the stock price. If the government had not intervened with their ruling, the result might have been otherwise, but the government did intervene. The price of Park & Tilford fell 10 points on May 31st; and declined over 60 points during the month of June to close at 32 on June 28. The stock’s behavior relative to the S&P 500 is shown in the graph below.

LIQUID STOCKS

Until the announcement, Park & Tilford stock had been relatively illiquid. In the month of November 1943, only 7,000 shares of Park & Tilford had traded on the NYSE, but after the announcement was made, 24,500 shares, or about 10% of the float, traded in the next two days, and 115,000 shares, or half the float, traded during the rest of the month. The announcement of the whiskey dividend had made their stock very liquid. Unloading such a large number of shares caused Park & Tilford and the brokerage firm of Ira Haupt & Co. to run afoul of the SEC. During the period in which the 93,000 shares were dumped on the public, ten representatives of Ira Haupt & Co. solicited twenty-one customers to buy shares in the company, and the company’s chief statistician prepared a written analysis of the stock for a customer. The sale of stock by the Schulte family was, essentially, a secondary offering since the company had used a brokerage firm to distribute the stock. In a secondary offering, potential buyers know that insiders in the firm are unloading stock and the float is increasing. This tends to drive down the price of the stock. Park & Tilford used the rumors they had circulated about the Great Whiskey Dividend to push the price up so the family could unload their shares at a higher price; however, potential buyers were completely unaware they were buying shares from insiders.  

A TOAST TO PUMP AND DUMP

Though Park & Tilford argued that the shares they sold were not a secondary offering, the SEC saw otherwise and ruled against Park & Tilford and Ira Haupt & Co. since “[t]he only reasonable conclusion that could have been reached by respondent was that it was intended that a large block would be sold.” This rule was formalized by the SEC in Rule 154 which was adopted in 1954. If Park & Tilford’s principal shareholders had only sold a few hundred shares, there would have been no violation of SEC rules, but since the company had unloaded a large block of shares, they were effectively making a secondary offering. Ira Haupt & Co. should have insisted on a registration statement for the securities being distributed from Park & Tilford, and should have provided potential customers with a prospectus, but they did not. As a result, Ira Haupt & Co.’s membership in the NASD was suspended for twenty days. What have we learned here? Besides the fact that investors need to have all of the facts before investing, they also need to have a brokerage firm that is transparent with all relevant information, just the opposite of the behavior of Ira Haupt & Co. Had investors known they were being solicited to buy shares from insiders, and that the government was going to limit the profitability of the Whisky Dividend, the stock would never have risen in price as it did in order to be dumped by the Schultes. This is a classic case of not only buy on rumor and sell on news and don’t count your chickens before they are hatched, but most importantly, there is a sucker born every minute.

  Fifty years ago, John F. Kennedy was assassinated on Friday, November 22, 1963 in Dallas, Texas. The assassination not only shocked the nation, but shook the stock market as well. However, very few people have heard about The Great Salad Oil Swindle which nearly crippled the New York Stock Exchange that weekend. Officials at the NYSE took advantage of the closure of the exchange to keep the crisis caused by the swindle from spreading further. Here is what happened at the NYSE while the nation focused on the President’s funeral.

Salad Oil, Cornered and Quartered

The Great Salad Oil Swindle was carried out by Anthony “Tino” De Angelis, who traded vegetable oil (soybean oil) futures which was an important ingredient in salad oil. De Angelis had previously been involved in a swindle involving the National School Lunch Act while he President of the Adolph Gobel Co. When it was discovered that he had overcharged the government and delivered over 2 million pounds of uninspected meat, he and the company ended up bankrupt. Con-men don’t stop being cons, they just try to learn from their mistakes and make more money the next time around. Buying soybean oil futures would drive up the price of his vegetable oil holdings, which would increase both the value of his inventories and allow him to profit from his futures contracts. De Angelis could use these profits not only to line his own pockets, but to pay his staff, make contributions to the community, and in one case, pay the hospital bill of a government official. American Express had recently created a new division that specialized in field warehousing, which made loans to businesses using inventories as collateral. American Express wrote De Angelis warehouse receipts for millions of pounds of vegetable oil, which he took to a broker and discounted the receipts for cash. This proved to be an easy way to get money, so De Angelis began falsifying warehouse receipts for vegetable oil he didn’t have. American Express sent out inspectors to make sure that De Angelis had the vegetable oil that acted as collateral, but what they didn’t know is that many of the tanks were filled mostly with water with a minimum of oil floating on the top to fool the inspectors, or that some of the tanks were connected with pipes to other tanks so the oil could be transferred between tanks when the inspectors went from one tank to the other. If American Express had done their homework, they would have realized that De Angelis’s reported vegetable oil “holdings” were greater than the inventories of the entire United States as reported by the Department of Agriculture. Unsatisfied with the American Express loans, De Angelis was able to get additional loans from Bunge Ltd., Staley, Proctor and Gamble, and The Bank of America. By the time the swindle collapsed, De Angelis had gotten loans from a total of 51 companies.  

No Salad Today

When De Angelis got a large order from Spain, he started speculating in the futures market to increase his profits, but when the order was reversed, he decided to prop up the market rather than cut his losses. De Angelis pulled out all the stops. He forged warehouse certificates, stole warehouse certificates, kited checks and warehouse certificates, opened a new brokerage account at Ira Haupt & Co., and even attempted to bribe employees of other companies. You can’t hold up the market forever. Eventually, the whole house of cards collapsed. Inspectors were eventually tipped off about De Angelis’s fraud. Allied Crude was supposed to have $150 million in vegetable oil as collateral, but only had $6 million. When the inspectors found water in the tanks, and not oil, the gig was up. The futures market crashed. Soybean oil closed at $9.875 on Friday, November 15, at $9 on Monday and $7.75 on Tuesday, November 19, wiping out the entire value of the De Angelis loans. As you might guess, De Angelis’s company had been losing money all along, and the loans were used to cover these mounting losses. De Angelis’s goal was to sell out at the top and cover all of his losses, but of course, his plan didn’t work out that way. The crash of the soybean oil market in November 1963 is shown below. On Friday, November 22, the NYSE organized a bail out of Williston & Beane, and the firm was allowed to reopen at noon on Friday. Ira Haupt & Co. was a bigger problem. It collectively owned $450 million in securities and owed various banks over $37 million that it could not pay. At 1:41 pm, as soon as word that JFK had been shot flashed on the floor of the New York Stock Exchange (NYSE), began to sell off. The Dow Jones Industrials, which was recorded at hourly intervals in 1963, had been at 735.87 at 1 pm on November 22, ultimately declined to 730.18 by 2 pm. Over the next seven minutes, the market traded 2.2 million shares and lost an additional nineteen points, erasing around $11 billion in capitalization, before NYSE officials halted trading at 2:07 pm to stop the panic selling. The market rested, and the next day, JFK’s body lay in repose at the White House. On Sunday JFK’s was taken to the rotunda of the Capitol for public viewing. Over 250,000 people viewed the casket as a line stretched for 40 blocks, or 10 miles. Some people waited over 10 hours in the freezing cold to pay their last respects. On Monday, the casket was transferred to the National Cathedral where his funeral mass was broadcast to a stunned nation. Kennedy was buried in Arlington Cemetery, where the eternal flame was lit over his grave. The stock market remained closed on Monday and reopened on Tuesday, November 26, when the market traded over 9 million shares, closing the day at 743.52, moving up 4.5% from the previous day’s close. The table below provides the hourly performance of the DJIA on November 22 and 26, 1963

In the past, anyone could invest in fledgling companies before they listed on the NYSE. Today, this opportunity is rarely available to the average investor. This is illustrated by the outperformance of other companies, such as Xerox, Dr. Pepper and Kentucky Fried Chicken. By the time these companies moved onto the NYSE, a good portion of the advance in their stock price had already occurred. If you ignore the performance of the stock when it traded over-the-counter, you miss a substantial portion of the stock’s historic move, and without this information, you will never fully understand the returns that were available to investors in the past.  

Disney Trades on the OTC in 1946

Walt Disney Productions incorporated in 1938. The company issued its 6% Cumulative Convertible Preferred to the public in 1940; its common began trading OTC in 1946; and the company listed on the NYSE on November 12, 1957. If you study the changes Walt Disney made to his eponymous company before it listed on the NYSE, you can see how he primed the company to increase in price and make sure the listing on the NYSE was successful. Walt Disney, his brother Raymond and their wives owned over 25% of the stock. These shares were later put into the Disney Family Voting Trust which held 46.8% of the common stock in 1959. Having such a large ownership of the shares, Walt Disney had every incentive to drive the price up. The Preferred stock was issued at $25, but the company suffered large losses in 1941, caused by the disappointing returns from Pinocchio and Fantasia which were not as successful as Snow White had been. The company failed to meet its preferred dividend in July 1941. The company fell in arrears on the dividend, but since the preferred was cumulative, there was always the chance the company would make up the lost dividends, and they did. Disney restarted the regular dividend in July 1947, and caught up on the $7.50 in arrears in 1948 and in 1949. You can see the impact of this on the preferred stock, which had fallen in price to $3.50 by April 1942, rising to $32.50 by the beginning of 1946 to reflect the expectation of the missed dividends being paid. This is also when the company’s common began trading OTC. The preferred stock, whose chart is provided below, was redeemed on January 1, 1951 at $25 with all dividends paid.

Transforming Tomorrowland before Neverland

In the twelve years between 1946, when Disney common started trading OTC, and when it listed on the NYSE on November 12, 1957, Walt Disney introduced numerous innovations that transformed the company and increased its profits. Disney made animated films that had been delayed by the war, such as Alice in Wonderland, Peter Pan and Cinderella. The company began making live action movies with Treasure Island in 1950 and 20,000 Leagues under the Sea in Cinemascope in 1954. For TV, Disney introduced the Disneyland TV show (later Walt Disney’s Wonderful World of Color) in 1954, and the Mickey Mouse Club began production in 1955. Of course, Walt’s greatest innovation was Disneyland, which opened on July 17, 1955 for which Walt Disney hosted a live TV preview with Ronald Reagan and others. Note that all of these events occurred before Walt Disney Productions, as it was known then, listed on the NYSE. In the year before the stock first traded on the NYSE, the company did a 2-for-1 stock split and paid its first dividend on the common stock. One difference between Disney in the 1950s and Facebook or Twitter in the 2010s is that anyone could have bought the stock OTC before it listed on the NYSE. The stock wasn’t restricted to employees and venture capitalists. Anyone who went to Disneyland in 1955, watched the Mickey Mouse Club or the Disneyland TV show, or saw the movies Disney was releasing could have taken advantage of the company’s growth. The chart below shows how Disney stock performed between 1946 until 1975. The stock traded at 3 in 1949, moved up to 52 by July 1956 before splitting 2-for-1. The stock closed at $13.75 on November 12, 1957 when it debuted on the NYSE, and moved up to $59.50 by April 1959. The stock traded sideways until 1966 when it began another significant move as one of the “Nifty Fifty” stocks of the 1960s, hitting 244 by the beginning of 1973. One important difference between Disney and Facebook or Twitter was in the accessibility of the stock. Disney’s 6% Preferred was available OTC from 1940 to 1950 during which an investor could have made a 10-fold profit. The common stock made a 10-fold move between 1949 and its debut on the NYSE in 1957, then another 10-fold move by 1973 while it was a member of the Nifty Fifty in the 1960s. Since 1973, Disney stock has moved up another 30-fold. On a total return basis, even ignoring the 10-fold move in the Disney 6% Preferred, $1 invested in Walt Disney Productions common in 1948 would be worth over $48,000 today, assuming all dividends had been reinvested. Even $1 invested in Disney on November 12, 1957 would be worth $5,000 today. Disney certainly has been one of the top performing stocks on the NYSE since it debuted there in 1957; however, once you take into consideration the profits an investor could have made if they had bought Disney Preferred OTC in 1941, and had switched to the Common Stock when the Preferred was called, the returns increase 100-fold. Based upon Disney’s returns OTC and on the NYSE, Disney probably has the “happiest” shareholders on Earth.