of Government bonds. On January 22, 1932, Howard Bruce, without authority, returned Mr. Hendley's note, which was marked "Paid," surrendered the Government bonds, and accepted a new note of C. W. Hendley & Co., Inc., unsecured except by the pledge of the guaranty fund certificate.

Shortly afterward, the Hendley Co. made a composition with creditors. The bank lost $47,000 on this transaction; approximately $30,000 on other loans to this company, $3,900 on collateral loans and $17,000 on a mortgage loan to Hendley individually. The $50,000 loan was ratified by the discount committee and the board after the surrender of the bonds.

Mr. Bruce and Mr. Hendley have given conflicting versions of the circumstances leading to the surrender of the bonds. Even according to Mr. Bruce's version, his action was unwarranted (pp. 216–19).

Bartlett Hayward Co.

Unusual precautions were taken, even before the bank's failure, to assure the Bartlett Hayward Co. the benefit of a setoff (pp. 230-7). This company's discounted note for $750,000 was sent by the Baltimore Trust Co. to the Mellon National Bank in Pittsburgh for "safe keeping" to make sure that the Baltimore Trust Co. would not discount it or pledge it with the Reconstruction Finance Corporation, thereby jeopardizing the debtor's right of setoff in the event of the bank's failure.

The Bartlett Hayward Co., the Koppers Co., which controls it and the Mellon National Bank are all dominated by the Mellon interests. Thus, the note was placed substantially in the custody of the debtor. Indeed, before it was paid, it was actually delivered by the Mellon National Bank to the president of the Bartlett Hayward Co.

Its deposit balance of $421,343.85 was set off against its note on March 14, 1933, although less favored borrowers whose papers had been pledged to the Reconstruction Finance Corporation which held four-fifths of the notes rediscounted by the bank, were denied a setoff until the following year. The difficulty did not arise in respect to the notes rediscounted with the Federal Reserve bank.

Howard Bruce explains that this unusual treatment by his bank of the $750,000 note of a company with which he was connected, occurred against his will and that he consented only to avoid the threatened withdrawal of the deposit, which would have been disastrous to the bank and would have subjected him to greater criticism. He also points out that other companies in which he was substantially interested did not withdraw their deposits and did not take similar precautions to assure themselves favored treatment.

III. ANALYSIS OF THE BANK'S POLICIES AND CONDUCT OF THE DIRECTORS

The most striking fact disclosed by the investigation, persisting throughout the life of the consolidated institution, is that control of the bank's policies was allowed to gravitate into the hands of the executive officers and to remain there without suitable restriction or supervision, even in the face of repeated and unmistakable danger signals.

Mr. Norton's promotional activities did not serve as a warning. Although superseded as president, he was allowed as vice chairman of the board to involve the bank in further losses. The same unbounded faith was placed in Mr. Symington, a successful industrialist, but as yet untried as a banker.

Even after the disastrous revelations of the summer of 1931, when Howard Bruce was made chairman of the board and chief executive officer, the same unquestioning faith was exhibited; no independent action was taken by the directors to inform themselves, but they were content with whatever information the officers chose to present to them. The bank was, in fact, a one-man institution (pp. 535 ff.).

Failure of directors to make examinations

The directors did not observe the bylaws requiring them to cause examinations to be made of the books and affairs of the company with or without notice to any of the officers. This bylaw, made optional in 1929, was likewise ignored (pp. 293 ff.).

Investment losses

Analysis reveals that the Baltimore Trust Co.'s investment policy was wholly unsuited to its needs and constituted an invitation to the disaster that followed. Of the $18,529,616.31 of investments, $8,944,858.72, or 48 percent, was lost (p. 259).

Charts prepared especially for the report analyze the general types of investments in which the bank's assets were placed. Similar analyses for the year 1950 are made for banks in central reserve cities, other Reserve cities (in which Baltimore is classed) and in country banks. The charts show that the distribution of Baltimore Trust assets bears a greater similarity to that of country banks than to either of the other classes.

Indeed, analysis shows that if this bank's portfolio had been balanced as well as the average country banks the loss would have been less by millions of dollars, even assuming no greater care had been exercised in individual investments (p. 243).

This maldistribution of investments was made possible by the directors' failure' to exercise reasonable supervision and not requiring the investment committee to function over a period of years. Only once, on January 2, 1929, did the board have before it a complete list of investments. The officers had lists from time to time but even these did not show the actual market value of the bank's holdings (pp. 254 ff.).

The lax investment policy not only caused a large proportion of the bank's assets to become frozen-it also caused the directors, seeking to offset losses or prospective losses, to engage in speculative investments which led to further heavy losses.

The directors negligently authorized the investment of $5 million in common stocks in December 1929 when over $12 million (more than its entire capital and surplus) was frozen in bank promises and coal loans and investments alone (p. 260). Although the break in the stock market suggested to the board that a favorable opportunity to invest in common stocks was present, it seems not to have occurred to these gentlemen that because of this decline, it might be prudent to appraise their own portfolio. It is incredible that any of the directors engaged in private mercantile business would have neglected for years to take stock to ascertain losses and shrinkages.

Stocks amounting to $3,966,795 were purchased in 1930 by Mr. Symington pursuant to this authorization and no subsequent supervision of the investment account was exercised by the directors to observe the effect of this action. In the summer of 1931 the directors permitted almost $6 million more of the bank's funds to be frozen in the Baltimore Co. and Baltimore-Gillet Co. so that in 1932 and 1933 the stocks purchased in 1930 had to be sacrificed in a low market at a loss of $1,768,102.31 (p. 260 ff.).

Losses in loans

The bulk of the loan losses of over $10 million was sustained upon a comparatively few accounts. The preliminary report treated of the large policy loans, many of which were unsecured. No system of espionage was needed to discover that while the appearance of regularity was maintained many of the largest loans had been consummated by the senior officers and merely initialed by the junior officers under the direction of their superiors, and without real consideration by the discount committee. At board meetings no scrutiny was given even to the largest loans reported, but they were all ratified with machinelike regularity (p. 269 ff.).

Collateral loans

The handling of collateral accounts was most chaotic. After building a colossal organization, the directors neglected to take suitable steps to avoid the dangers of uncoordinated authority and decentralized responsibility. Each of the 19 vice presidents was authorized to lend money on collateral, and he passed on securities without supervision. The discount committee did not ascertain whether the collateral was adequate in amount or marketable in sufficient quantities to permit liquidation without loss. The committee did not require the listed collateral to be reported to it, and the officers' valuation of the unlisted collateral was accepted without question (pp. 272, 563).

Nor did the discount committee supervise the subsequent handling of collateral to assure liquidation before it had depreciated. Not until January 1933, too late to avert the loss, did that committee adopt the practice of inspecting the collateral cards (pp. 279, 563).

The board never investigated the activities of the discount committee to which it had delegated the vital function of passing on loans. The directors could have learned that their discount committee was not properly performing its duty in respect to large loans through 3 sources:

1. The periodic invesigations required by their own bylaws.

:

2. The criticisms contained in the examiners' reports.

3. The experience of large losses which began quite early.

These should have warned the directors that the discount committee had either ceased to exercise independent judgment upon some of the largest matters or that it was incompetent in its work. None of these possible sources of information was tapped and the directors were not awakened to their duty (pp. 561, 562).

Mergers with other banks

Incredible as it seems, the bank merged with other banks without adequate appraisal of their assets (p. 282 ff.). The same lack of realism which permitted directors to go on for years without appraising their own assets blinded them to the possibility of loss in the acquisition, lock, stock, and barrel of assets of other institutions.

Chargeoffs, reserves, and dividends

Although chargeoffs were grossly inadequate, they nevertheless attained large proportions, but the directors were not moved to inquire into the causes. Analyses would have led to an understanding of the general course of the bank's business, the type of its investments and the character of some of its large loans, and would not unlikely have resulted in radical changes in personnel sufficiently early to avert many of the losses (pp. 288 ff.).

The directors, however, received without question the exuberant reports of the president; accepted without analysis the aggregate figures submitted to them; continued to declare dividends at the established rate and serenely assumed that what remained after dividends would suffice to provide against all losses.

When the depression came in 1930 the directors adhered to the policy of "dividends first and reserves afterward," and the chargeoffs, instead of increasing sharply decreased in the face of diminishing profits and increasing losses. Even after the raising of the guaranty fund and the setting up of the $9,400,000 reserve, when losses arose which were not anticipated in calculating the reserve, no further provision was made as common prudence would have suggested (pp. 291 ff.).

IV. PERIOD OF LIQUIDATION

Baltimore national bank option

The plan of reorganization gave the Baltimore Trust Co. an option to purchase the stock of the Baltimore National Bank at $21.29 per share. When the option expired without being exercised by the trust company's directors, the Baltimore National Bank's assets had a value of at least $25 per share, without considering the intangible value of its deposit line, or the trust or safe deposit business taken over from the Baltimore Trust Co.

No attempt was made to find a customer for the option. Both severe criticism and vigorous defense have followed this action, and the conflicting viewpoints are treated in detail in the report. Later, by private sale, the Mercantile Trust Co. acquired a one-third interest in the Baltimore National Bank at $20 per share (p. 305 ff.).

Operations from February 24, 1933, to March 31, 1936

In appraising the work of the liquidating corporation due credit should be given for the industry, devotion, and intelligence bestowed by its officers upon a variety of problems inherited from the bank.

Moreover, under the aggressive management of its president, Henry B. Thomas, Jr., it actively and diligently sought out and even created opportunities to reconstruct crippled businesses of which the bank had become the owner. The 1934 report of the Comptroller of the Currency discloses that the average cost of liquidating closed national institutions has been $6.50 per $100 collected. Figures as to State banks are not available, but are said to be higher. Collections of the Baltimore Trust Corp. cost $2.06 on each $100. While costs are likely to increase, the favorable contrast to date is noteworthy.

All settlements involving over $5,000 are reviewed in the report and, with few exceptions, appear to have been advantageous. Unlike the Baltimore Trust Co., the liquidating corporation reviews its assets regularly and its records are well maintained (pp. 320-452).

V. AND VI. LAW, CONCLUSIONS AND RECOMMENDATIONS

Numerous conflicting legal standards of liability of corporate directors have been formulated by the courts, and these have been reviewed extensively in the report. Despite some divergence of opinion, it is well settled that bank directors must be more than figureheads; they must supervise the work of the officers and must be diligent in ascertaining and in keeping informed as to the condition of its affairs.

They may rely upon the information and advice given them by executive officers whose probity and competency are not under just suspicion, but cannot surrender to them the responsibilities resting on directors. They must direct and not be led. They must heed warnings from responsible sources, and must see that statutes established for the protection of depositors are observed. Mere errors of judgment while acting with integrity, skill, and prudence, do not subject them to liability; but ignorance, lack of skill, and honesty of motive are not sufficient defenses to negligence (pp. 454–521).

Directors Personally Liable

Directors are personally liable for their own negligent acts and also losses resulting from negligent conduct of the officers made possible by their negligent failure to supervise. The material assembled in this and the preliminary report indicates that the directors of the Baltimore Trust Co. have been guilty of both types of negligence, and appropriate suits are recommended.

Criminal prosecutions are not recommended because the actual knowledge prerequisite to a successful prosecution, as laid down in the recent Coblentz cases, was not present. Opportunity to know the true condition of the bank, accompanied by gross recklessness and inattention, while furnishing ground for civil actions for negligence, is not under the decisions sufficient foundation for criminal proceedings (pp. 522 ff.).

The failure of the directors to supervise is sufficiently indicated in section III. Abdictation of control, failure to maintain adequate reserves and to make proper chargeoffs, declarations of dividends without a proper study of earnings and losses, complete disregard of examiners' reports, failure to place any restraint upon the reckless investment policy of the president, acquisition of other banks without examination of their assets, failure to maintain supervision over collateral accounts or the work of the discount committee and complete indifference to gross improprieties in the trust department are the more important derelictions of duty disclosed in that section of the report (pp. 533 ff.). Other acts criticized

Other acts involving gross neglect of duty were the sanctioning of large underwriting commitments in remote enterprises, such as coal companies in which over $3 million was lost, and the blind ratification of similar undertakings begun by the president without authority, including the $320,000 investment in sand banks on the Mississippi and Ohio Rivers, $750,000 in the Baltimore Mail Steamship, and $1 million in International Mercantile Marine.

Toleration of the indirect purchase of the bank's own stock led to the Baltimore-Gillet fiasco in which the bank lent $5,750,000 of its funds in "repurchase agreements" on securities of almost no marketability and of doubtful value. The Baltimore-Gillet Co. was permitted to waste its substance in attempting to salvage subsidiary enterprises, and the sum so advanced by the bank is a total loss.

The loss of $1 million on the bank stock sold to its employes is likewise chargeable to the directors because they permitted its accumulation by the Baltimore company at inflated prices when it was heavily indebted to the bank. The loan of $350,000 to Gillet & Co. was a further consequence of the original illegal stock purchases. Other loans negligently made are detailed in the report (pp. 546-576).

Other recommendations

The direct losses to depositors and stockholders, to say nothing of the slowing down of business activity in the community have been so widespread that an attempt should be made to formulate the lessons taught by this experience. Suits against directors and officers are, as a practical matter, not a complete or satisfactory remedy. It is important to consider what prophylactic measures may reasonably be adopted.

The writer of this report lays no claim to special knowledge of the subject, and the suggestions which follow are submitted as a modest contribution to the problem of preventing like catastrophes in the future. No attempt is made to deal with the more abstruse problems of finance, but merely to present a few fairly obvious protective measures.

Limiting ratio of deposits to capital

Large capital investment is a safeguard only if it forms a relatively large percentage of total resources. Under the present law the State authorities have no power to fix the ratio of deposits to capital. This should be remedied. Segregation of banking functions

A State bank may still engage in commercial and investment banking, although the practice has not ben pursued since 1933. The State law should contain the same prohibition as the Federal law. Indeed, many thoughtful persons believe that, to avoid abuses, a complete separation of the trust, savings, investment and commercial banking functions should be required, since they are governed by entirely different principles.

Limitations on investments

Limitations should be put on the amount and type of bank investments. Like national banks, State institutions should be prohibited from buying stocks. Banks should not be permitted to invest in bonds customarily rated lower than Baa, except in special and supervised circumstances. Moody disapproves of securities rated below "A" as bank investments. Investments in bank premises and the retention of other real estate should be further restricted as well as the power to lend money on mortgages. Second mortgages should be prohibited. Statements of condition

Many deliberate window dressings of the Baltimore Trust Co. would have been prevented if bank statements were required to be more informative. Concealment by broad generalization prevented depositors from discovering, before it was too late, that their money was being diverted from normal banking to operate coal mines, sand banks, shipping lines, and other industrial enterprises and to gamble in common stocks. The ruinous purchases of the bank's own stock through the Baltimore company were also made possible because the public was kept in the dark.

Depositors now can learn of the bank's condition only from common rumor, and even good banks may innocently suffer. Howard Bruce makes a valuable suggestion, that statements show the average figure for the preceding 30 days.

Every bank statement should publish the investment portfolio and give both the market and cost price of each item. Reserve accounts should not be lumped, but should state clearly their purpose. If the reserve is against fluctuation in assets, this should be stated; but if it is merely a segregation of dead accounts or fairly certain losses or for other accrued items, it should not be allowed to masquerade as something else. The bank commissioner should have authority to require the publication of additional information.

Amendment to criminal law

Proof of actual knowledge of the falsity of representations should not be required to convict officers or directors who have falsely represented their bank's condition. The public is as effectually defrauded by false statements recklessly made as by those made with actual knowledge of their falsity.

Strengthening the banking department

The State banking department should be strengthened by giving the commissioner power, with the approval of the banking board, to adopt additional rules and regulations having the force of law. The commissioner should also have authority to remove any officer or director who has violated any law or regulation, or for neglect or incompetency. The establishment of branches and the inauguration of major policies should require the approval of the commissioner.

He is now powerless to prevent unsound practices except when they threaten capital impairment. Unless broad power is given to prevent and correct improper tendencies, which today merely affect liquidity, but tomorrow may impair solvency, regulation cannot become genuinely vital and protection will remain largely illusory.