What was this investment that turned so awry for Downton Abbey’s Lord Grantham in the opening episode of Season Three?
The Grand Trunk Railway (GTR) was a Canadian company that began under a Canadian charter in 1852. It was the pioneer railway for the country. Financed wholly by British capital, its Board of Directors had always met in London to take any corporate action, and all shareholders were residents of the British Isles. The shares of stock were placed upon the London Stock Exchange and had been dealt in as speculative stock. When Lord Grantham got the bad news, so did many other investors, but the crisis was localized to British shareholders.
On November 10, 1919 the Government entered into an agreement with the GTR for the acquisition of the entire capital stock of the Grand Trunk with the exemption of the small amount of guaranteed stock. The act of the acquisition was passed in May of 1920 (which is likely when Lord Grantham received the news).
To determine the stock value, a board of three arbiters was selected: one to be appointed by the Government, one by GTR, and the third was to be Sir Walter Cassels, the President of the Exchequer Court of Canada. The value would be determined by majority rule.
Imagine my surprise when I read that Grand Trunk selected William H. Taft as their arbiter. William H. Taft? The former American President? Looking at what was essentially a British issue with only British stockholders to answer to? But it’s true – he did in fact spend time in arbitration on a variety of issues after leaving office, and was known for international arbitration.
The board sat for 71 days, reviewed over 8,000 documents and 500 exhibits before making their determination:
…we, the undersigned arbitrators, a majority of the Board, after mature deliberation and after careful consideration of the evidence adduced, do order, award, adjudge, and determine that there is no value, to the holders thereof, in the “First”, “Second” or “Third Preference Stock”, or in the “Ordinary or Common Stock” of the Grand Trunk. As witness our hands this seventh day of September, A.D., 1921. [emphasis mine]
The New York Times headline the following day read “Grand Trunk Stock Declared Worthless. Arbitration Board, With Taft Dissenting, Says Canada Should Pay Nothing to Stockholders.”
Lord Grantham’s fortune was gone and never coming back.
Reasons for failure
Why did the board decide that the stock was worthless? There were multiple reasons, all coming back to the point that the GTR was a huge mess:
The railway had a rocky financial history almost from the start. It ran into problems in 1860 but was saved by new capital secured thanks to concessions made by bondholders. It had to ask for government loans in 1909 and in 1913.
One project in particular was doomed from the start: The Grand Trunk Pacific line. It was an absurdly expensive project due to building a railroad through the most difficult terrain of Canada and also building parts of the railway too close to other rail lines. It was clear even to GTR that the finished railway would not be profitable and they refused to run it, hoisting it on to the government’s shoulders. By the time of the arbitration, it was already in liquidation. “This company is hopelessly bankrupt with no prospect now or for years to come of earning even its operating expenses, much less its fixed charges. …It would be difficult to imagine a more misconceived project than that to which the Grand Trunk committed its credit in this unfortunate enterprise,” read one part of the Grand Trunk Arbitration reasoning. Ouch.
Furthermore the arbitration found that the management decisions bordered on criminal negligence. In Downton, Lord Grantham’s lawyer trails off when discussing management: “Charles Hays was the presiding genius and since he died the management is not –“, politely deciding not to voice his true opinion on the new management.
Hays died in the sinking of the Titanic in 1912. From that year forward, the railway wasn’t run as it should. Maintenance of systems and equipment were abandoned. And the accounting was dubious. “The first point raised by Counsel is that the accounts of the Grand Trunk Railway System have been so manipulated – I use a milder term than that used by [prosecution] – as to render the accounts as presented by the books unreliable and unsatisfactory. ” writes Sir Walter Cassels in his reasoning.
I would use a stronger term than Sir Walter based on the following exchange alone:
McLaren is Chief Auditor to the Grand Trunk Railway. In 1919, according to his sworn statement there was a deficit of $6,483,000. Instead of showing this deficit, he shows a surplus of $5,556.
I [Sir Walter] asked him this question: —
“Q: And that being a deficit, instead of showing a deficit of $6,483,000, you show a surplus of $5,556 and that is the same all the way through?”
His answer is: —
I would call that cooking the books.
Another section of the Grand Trunk Arbitration reasoning read like an email exchange from the offices of Goldman Sachs. The only difference is that cablegrams were exchanged rather than emails. The series of selected cablegrams between the chairman (Chamberlain) and president (Smithers) of GTR found in the arbitration reasoning included the following:
January 28, 1917 Chamberlain to Smithers:
Mr. Biggar [General Counsel] thinks that unless Government waives its rights or gives consent, it would be improper if not illegal to pay dividends on the guaranteed stock or any preference stock without first making provision for payment of overdue interest on Government loans… We were criticised by the Government for having paid last year on First Preference [Stock] and if we were now to pay on First, Second and Third [Stock] it would be impossible for us to get consent of Parliament for the increase we are asking.
Hmm how to avoid paying the overdue interest while still paying shareholders?
On February 20, 1917: Smithers to Chamberlain: “…do you see any objection charging revenue with $1,000,000 for maintenance of way showing the amount in the balance sheet as permanent way renewal funds. Have you any other suggestion to make?”
Ah yes. Cooking the books again. Good call.
February 28, 1917: Chamberlain to Smithers:
Think we could probably get away with dividends on First Preference, but am very much affraid [sic] if you declare dividend on Second, Government will call on us to Pay Grand Trunk Pacific interest.
They ended up paying the dividends and not the interest. And they probably wished they had used the telephone so these embarrassing exchanges didn’t end up in public records.
William Taft Dissents
So. The arbiters deemed that there was no value in the GTR stock. But, our friend William Taft dissented. He came up with a value for the stock of “not less than forty-eight million dollars.”
His reasoning was weak. He spent a fair amount of time rambling on about the history of the Grand Trunk Railway System – helpful for me, but not so helpful for his argument – and speculated on how business is bound to improve.
But even the dissenter acknowledged that management consistently understated earnings and expenses from 1912 to 1920. Taft outlined how they manipulated accounts in 1917 to make the Canadian Government think they would go bankrupt unless the government took over the Grand Trunk Pacific line. They did it again in 1919 to make the financial conditions seem better than they were. But Taft argued that poor management is not a reason to punish the shareholders, especially as the shareholders did not know what management was doing. He may have had a point, but the accounting “methods” of the GTR were so bungled that the other two arbitrators clearly agreed that it would be impossible to determine an amount for the stock value.
This arbitration ended the long saga of the Grand Trunk Railway. Stockholders tried to appeal the decision, but in the summer of 1922, the appeal was dismissed.
“Grand Trunk Arbitration: The Award and Reasons for Award.” Delivered at Ottawa, September 7, 1921. The Honourable Sir Walter Cassels, Chairman, Right Honourbale Sir Thomas White, K.C.M.G, and The Honourable William Howard Taft contributing.
“Grand Trunk Decision.” Times [London, England] 10 Sept. 1921: The Times Digital Archive. Web. 12 Jan. 2013.
“Grand Trunk Stock Declared Worthless. Arbitration Board, With Taft Dissenting, Says Canada Should Pay Nothing to Stockholders.” New York Times, 7 Sept. 1921: New York Times Archive. Web. 11 Jan. 2013.
“The Grand Trunk.” Times [London, England] 8 Sept. 1921: The Times Digital Archive. Web. 12 Jan. 2013.
“The Grand Trunk Appeal.” Times [London, England] 29 July 1922: The Times Digital Archive. Web. 12 Jan. 2013.