Corporations and Business Regulation

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Corporations and Business Regulation

Free Incorporation. Like private law, the changing legal treatment of corporations reflected an assault on privilege and the impact of an erratic economy. Anglo-American law originally viewed the process of incorporation as a grant of authority issued by the government to private persons charged with performing specific tasks that benefited the public as well as the investors in the corporation. A good example is a corporation created to build a bridge, which would improve transportation for the community and make a regulated profit by charging tolls. The mechanism for policing corporations was the corporate charter, issued on a one-by-one basis in special legislation and subject to revocation if the corporation exceeded its carefully defined grant of authority. Beginning with the Revolution, Americans criticized this approach to incorporation as an abuse of government powers that gave undue privileges to the few people who obtained a special corporate charter. That attack intensified during the 1830s and 1840s, and beginning around midcentury, egalitarian principles led states to adopt new procedures for the creation of corporations. Entrepreneurs no longer needed to obtain a special charter but merely to comply with a standardized set of requirements. The Alabama constitution of 1867 typified the trend in providing that “corporations may be formed under general laws, but shall not be created by special act.” The decline of the special charter posed a new problem in law, however, for the charter had been the principal mechanism for regulating corporations. The charter did not altogether lose this function in any state until New Jersey enacted its general incorporation law in 1889, but alternative approaches to regulation began to emerge as the principle of free incorporation became established.

Decline of Mixed Enterprise. The relaxation of traditional supervision of corporations was paralleled by a shift in the financing of large-scale enterprise. State and municipal governments—which since the 1820s had invested actively in a variety of transportation schemes that promised to repeat the success of the Erie Canal—retreated from similar ventures as one unsuccessful business after another failed to produce anything but higher taxes. By 1874 sixteen state constitutions barred the state from owning corporate stock. As government investment dried up, corporations turned to private capital markets that expanded rapidly after British businessmen invested in American outlets following the European uprisings of 1848 and the discovery of gold in California (1849). And as government oversight disappeared along with government capital, the unregulated scramble for financing ushered in an era of unscrupulous and powerful businessmen and financiers known as Robber Barons. State laws reacted belatedly to specific tricks that had cheated investors, such as “watered stock”—free stock given to promoters which induced unwary investors to purchase stock in the belief that it was backed by real corporate assets. For example, the Illinois constitution of 1870 provided that “no railroad corporation shall issue any stock or bonds, except for money, labor or property actually received.” Informed observers recognized, however, that such piecemeal efforts could not substitute for new regulatory structures.

Shareholder Suits. If the corporation was no longer to be regarded as an extension of government authority, one new approach was to give the victims of corporate mismanagement new tools with which to protect themselves. This was the idea behind the type of lawsuit known today as the shareholder derivative suit. Through this device, one stockholder could bring suit on behalf of all stockholders against corporate officials whose abuses of power had cheated investors. The shareholder derivative suit was built upon the

idea that the corporation was a sort of trust fund, that is, a fund that one group of people managed for the benefit of others. In the case of a corporation, the beneficiaries of the fund were the investors and, if the corporation dissolved, the people to whom it owed money. The comparison of a corporation to a trust fund sought to restore the accountability that had eroded with the waning idea of the corporation as a state-conferred privilege. As the U.S. Supreme Court declared in 1875, “the idea that the capital of a corporation is a football to be thrown into the market for the purposes of speculation… is a modern and wicked invention.”

Police Power. The weakened tie between corporations and government caused courts to rethink not only the nature of the corporation but also the nature of government. Traditionally jurists reasoned that regulation of corporations was based on authority reserved by governments when they granted charters, and the terms of the charter defined the scope of the regulatory authority. In Commonwealth v. Alger (1851) Massachusetts justice Lemuel Shaw articulated a new view that the “police power” to regulate health, safety, and morals was an inherent attribute of government sovereignty. Shaw declared that “every holder of property, however absolute and unqualified may be his title, holds it under the implied liability that his use of it may be so regulated, that it shall not be injurious to the equal enjoyment of others having an equal right to the enjoyment of their property, nor injurious to the rights of the community.” In essence Shaw found that state legislatures could pass laws applying the traditional maxim sic utere tuo, ut alienum non laedas (“use your own so as not to injure another’s”), which courts had enforced when a property owner claimed to suffer from a neighbor’s use of property, such as the noises or odors emanating from a factory. Legislatures and courts would wrestle with the usefulness of this reasoning as a variety of groups sought protection from different types of corporate activities.

Labor Regulations. Most legislation to protect laborers focused on the length of the working day. Workers rallied for “Eight hours for work, eight hours for rest, and eight hours for what we will!” From a legal point of view, the most clear-cut situations involved the practices of governments as employers, which could reduce hours of employment without prompting complaints that regulatory legislation was interfering with private enterprise. The federal government passed the first of several eight-hour laws in 1868, and several state governments acted similarly. The regulation of work for private firms began with child labor. Every northeastern state had enacted some sort of child-labor legislation by 1851, but the precedent spread slowly to other parts of the workforce. Massachusetts limited women working in manufacturing to ten hours per day and sixty hours per week, but a parallel proposal for men failed to pass. Enforcement of labor legislation was generally weak. A New Jersey law of 1851 barred children under ten from factories, but the penalty for a violation was only a fine of $50.

Railroad Regulation. State railroad commissions were the most important regulatory agencies to emerge during the third quarter of the nineteenth century. The Massachusetts railroad commission created in 1869 brought to culmination a line of administrative development in New England that dated back to the first state railroad commission, established in Rhode Island in 1839. Provided with inspection powers to undertake “general supervision of all railroads,” the Massachusetts commission filed annual reports to the legislature and notified the companies of needed repairs, unfair rates, or infractions of law. Although it gained considerable influence, especially through the work of Commissioner Charles Francis Adams Jr., the agency had no powers to fix rates or order changes in railroad practices. The so-called Granger laws adopted in the Midwest during the 1870s adopted a more aggressive regulatory stance. In Illinois, Wisconsin, and Iowa farmers and small merchants combined to pass legislation that set maximum railroad rates and authorized the state railroad commission to prosecute railroads or warehouses found to be in violation of any state law.

PINKERTON’S NATIONAL DETECTIVE AGENCY

The son of a Scottish constable, Allan Pinkerton (1819–1884) founded the nation’s first detective agency, which is still in existence. Born in Glasgow and trained as a cooper, Pinkerton became involved in labor demonstrations and fled to the United States in 1842 in order to avoid arrest. He settled in Dundee, Illinois, where, as a freelance detective, he helped apprehend a band of local counterfeiters. While in Illinois Pinkerton also became an ardent abolitionist and smuggled fugitive slaves into Canada. After becoming the first detective on the Chicago police force in 1850, he established Pinkerton’s National Detective Agency, specializing in railroad security. Its emblem was an eye, and its motto was “We Never Sleep.” In 1861 Pinkerton uncovered a plot to assassinate Abraham Lincoln, and he personally guarded the president-elect as he traveled to Washington, D.C., for his inauguration. When the Civil War started in April, Lincoln appointed Pinkerton chief of the Secret Service Bureau. During the course of the conflict Pinkerton, under the alias “Maj. E. J. Allen’ organized espionage rings that operated behind enemy lines.

The Pinkerton Agency greatly expanded after the war, compiling the nation’s most complete files on criminal activity. By this time criminals feared Pinkerton so much that they referred to him as “The Eye” (from which the term “private eye” later arose). Starting in the 1870s the agency became increasingly identified with management in labor disputes. Pinkerton men infiltrated the Molly Maguires, a secret labor organization, in 1875–1877 and attempted to break the Homestead Strike of 1892. Some of the western outlaws they encountered included Frank and Jesse James and Butch Cassidy and the Sundance Kid.

Source: James D. Horan, The Pinkertons: The Detective Dynasty That Made History (New York: Crown, 1967).