<html> <head><style type ="text/css">body { font-family: "Bloomberg Prop Unicode I", Verdana, sans-serif; font-size:125%; letter-spacing: -0.3pt; color: #FF9F0F; background-color: #000000; text-align: left; } p {line-height: 1.25em; max-width:900px; width:expression(document.body.clientWidth > 900? "900px": "auto" );} h1, h2, h3 { text-align: left; font-weight: normal; color: #FFFFFF; } h1 { font-size: 130%; } h2 { font-size: 115%; } h3 { font-size: 100%; } #bb-style { font-size: 90%; max-width:900px; width:expression(document.body.clientWidth > 900? "900px": "auto" ); } b, strong { font-weight: bold; } i, em { color: #FEC54A; } pre { font-family: "Andale Mono", "Monaco", "Lucida Console"; letter-spacing: -0.3pt; line-height: 1.25em; } table { border: 0; font-size: 90%; width: 100%; margin-left: auto; margin-right: auto; } td, tr { text-align: left; } td.numeric { text-align: right; } a:link { color:#53B2F5; text-decoration: none; } a:visited {color:#53B2F5} a:active {color:#53B2F5} a:hover {color:#53B2F5} </style> </head> <body> <p>By T.J. Stiles</p> <p>On June 27, 1848, Daniel Drew found himself in court over insider trading. Not because it was illegal; there was no law against it at the time. Rather, his partners had sued him because he hadn't divided the profits fairly.</p> <p>Drew launched the caper in 1844, in Wall Street's paleolithic era. At the time, brokers would gather at the stock exchange in New York City on weekday mornings and listen as securities were called one at a time. They made bids and offers, concluded their sales, and prices were scribbled on a big chalkboard. Then they had lunch. Then they went through the entire list once more.</p> <p>A broker's printed price sheet for May 8, 1844, lists only 41 securities; just 15 were stocks, the rest forms of debt, mostly state and federal bonds. Yet already brokers were making short sales, issuing margin calls, enduring bubbles and panics, and trading in primitive derivatives.</p> <p>No one understood this market better than Drew. Born in 1797, he started his working life by driving cattle from New York’s upstate counties to Manhattan. He began to trade animals as well, learning market psychology, the movers of prices, the uses of debt.</p> <p>In 1830, he took over the Upper Bull's Head Tavern, on Third Avenue and 24th Street, where drovers stayed on their journeys in and out of the city. This platform made Drew a central figure in the cattle market -- speculating, lending money, brokering sales, providing information about movements in prices to newspapers.</p> <p>It was an easy step from livestock to corporate stock, and he launched a banking and brokerage firm on Wall Street, with Nelson Robinson and Robert Kelley, called Drew, Robinson &amp; Co.</p> <p>Drew didn't look like much. "A cross between a cartman and a small trader," thought his contemporary Matthew Hale Smith. Slouching, stoop-shouldered and completely illiterate, he was nonetheless immensely clever. Wall Street memoirist William Fowler wrote, "We have said his intellect was subtle. The word subtle does not altogether express it. It should be vulpine."</p> <p>Drew was a businessman as well as a financier. Together with Isaac Newton (a prominent ship builder, not the scientist), he operated a steamboat line between Manhattan and Albany on the Hudson River. He fought a successful fare war against Cornelius Vanderbilt in 1831, winning Vanderbilt's respect -- respect and suspicion, which were pretty much the same with him. "I am not afraid of my enemies," Vanderbilt later declared, "but my God, you must watch out when you get among your friends."</p> <p>Acting on a principle later famously expressed in "The Godfather," Vanderbilt coordinated his affairs with his friend Drew. They invested in one another's enterprises to create a disincentive for mutual treachery and competition. And Vanderbilt placed a trusted subordinate, his son-in-law Daniel B. Allen, in Drew's Wall Street firm to keep him under surveillance.</p> <p>The 1844 plot grew out of Drew's attempt to synthesize his Wall Street business with his steamboat operations. By bringing in his financial partners, he would have the resources to buy control of the Mohawk &amp; Hudson River Railroad, New York state's first railway, which provided a shortcut between the Erie Canal and the Hudson River. He would then divert the railroad's freight traffic to his steamboats, improving the line's profits. The financial firm would get a fee, and benefit from insider trading once the partners controlled the railway.</p> <p>As the court documents put it, "Such stock was to be from time to time sold as might by them be deemed advantageous." Drew, of course, would make money from both ends of the scheme.</p> <p>It worked. Starting on Sept. 16, 1844, Drew, Robinson &amp; Co. began buying the stock. In 1845, Newton became the railroad's president. In 1846, all the stock was sold for a nice profit. The problem was, Drew didn't give Robinson, Allen and Kelley their proper spoils -- so they asked a judge to enforce the terms of their conspiracy.</p> <p>The resolution of the case is as telling as the plot itself. That's because it was secret. Like most such lawsuits, it was settled out of court and out of public view. The culture of Wall Street wasn't the same as that of the rest of America, and men of finance knew it.</p> <p>In 1842, for example, an executive of the Stonington Railroad cautioned William D. Lewis of the Girard Bank, an important stockholder in the railway, about a proposal by some of the company's directors. "They take a very mercantile view of the subject, which is fully adequate to an existence in a more mercantile atmosphere," he wrote, "but in our political climate ... corporations must subsist upon a very spare diet &amp; practice very fascinating manners, or the Sovereign People will crawl them all over, &amp; if they do not terminate their existence, will at least render it of no value."</p> <p>Loosely translated, he meant, "What’s clever in business might seem like fraud to the public, and could lead to a government crackdown."</p> <p>Yet the "mercantile view" continued to diverge from the prevailing political view, because there was money in it. And it wasn't just shifty old cattle drovers like Drew who hatched conspiracies.</p> <p>Lewis was a distinguished gentleman, manager of a prestigious bank, yet he often corresponded about "an operation in our stock." On May 9, 1844, a Stonington director briefed him on plans to manipulate the railroad's share prices: "The idea is to give a decided value to the stock by making an arrangement with the Long Island Co. and selling out ... at its improved value."</p> <p>That is, they'd announce a major deal with the Long Island Rail Road, then dump the stock when it soared on the news.</p> <p>Wall Street, of course, did channel capital to productive enterprises, and played an important role in America's economic rise. But insider trading proliferated early on, and neither investors nor the public liked it.</p> <p>When Vanderbilt died in 1877, the directors of his railroads jointly published a tribute. "It is to his lasting honor that his uniform policy was to protect, develop, and improve the interests with which he was connected, instead of seeking a selfish and dishonorable profit through their detriment," it read. "In a period of crafty devices for sinister ends, he taught the way of success through legitimate means."</p> <p>To be fair, Vanderbilt had also manipulated stocks, sometimes pushing them down to hurt his rivals. But this tribute shows that business figures recognized the harm of insider trading -- and believed they lived in "a period of crafty devices for sinister ends."</p> <p>Historians will argue over whether that's a fair characterization, but it illustrates how Wall Street had its own culture from the beginning. When it diverged too far from that of the rest of the country, astute financiers expected trouble.</p> <p>(T.J. Stiles won the Pulitzer Prize and the National Book Award for "<a href="http://www.amazon.com/First-Tycoon-Epic-Cornelius-Vanderbilt/dp/0375415424">The First Tycoon: The Epic Life of Cornelius Vanderbilt</a>." He is at work on a biography of George Armstrong Custer. The opinions expressed are his own.)</p> <p>To contact the author of this post: T.J. Stiles at tjstiles@tjstiles.net.</p> <p>To contact the editor responsible for this post: Timothy Lavin at tlavin1@bloomberg.net.</p> <p><br class="spacer_"></p> </body> </html>