The story behind financial scams like FTX: The Charitable Corporation Scandal of 1732
In modern capitalism, it seems like the tales of corporations and managers engaging in fraud and defrauding their investors happen like the changing of the seasons.
In fact, these scandals can be traced back to the very beginnings of publicly traded companies, when the first stockbrokers bought and sold company shares and government securities in the coffee houses of London’s Exchange Alley in the 17th century.
As an 18th century financial historian, I am struck by the similarities between what is known as the “Charitable Corporation Scandal” and the recent collapse of FTX.
A noble cause
The Charitable Corporation was founded in London in 1707 with the noble mission of “helping the industrious poor by helping them with small sums at statutory interest”.
Essentially, it sought to provide low-interest loans to poor artisans and protect them from predatory pawnbrokers who charged interest rates of up to 30%. The company provided loans at an interest rate of 5% against a pledge of property as security.
The Charitable Corporation was modeled after Monti di Pietà, a charitable lending institution established in Catholic countries during the Renaissance to combat usury or high interest rates.
Unlike the Monti di Pietà, however, the British version – despite its name – was non-profit. Instead, it was a business model. The company was funded by offering investors shares that would in turn make money while doing good. Under its original mission, it was like an 18th-century version of today’s socially responsible investing, or “sustainable mutual fund.”
raid on the fund
In 1725, the Charitable Corporation diverted from its original mission when a new board of directors took over.
These men turned the company into their own piggy bank and took money out of it to buy stock and prop up their other companies. At the same time, the company’s employees began to cheat: security checks were discontinued, books were kept irregularly and deposit amounts were not recorded.
Investigators would eventually find that £400,000 or more in capital was missing – roughly $108 million in today’s dollars.
In the fall of 1731, rumors began to circulate about the solvency of the Charitable Corporation. The warehouseman at the time, John Thomson, who was responsible for all loans and liens but was also in league with the five fraudulent directors, hid the company’s books and fled the country.
At the quarterly shareholders’ meeting, they found that the money, deposit and accounts had disappeared. It was then that the owners of the Charitable Corporation shares appealed to the British Parliament for a remedy. One-third of the applicants were women, a proportion equal to the percentage of women who owned shares in the Charitable Corporation.
Many women were attracted to society because of their public mandate to provide small loans to working people. It is also possible that they were deliberately aimed at fraud.
The parliamentary inquiry led to various indictments against managers and employees of the Charitable Corporation. Many of them had to appear before Parliament and were arrested if they didn’t. The managers and employees believed most responsible for the 1732 fraud, such as William Burroughs, had their assets confiscated and inventoried to recoup losses suffered by shareholders.
Bankruptcy proceedings were instituted against banker and broker George Robinson and warehouseman Thomson. Both Sir Robert Sutton and Sir Archibald Grant were expelled as members of the House of Commons, with Grant prevented from leaving the country and Sutton eventually being impeached in multiple courts.
In the end, shareholders got a partial government bailout – Parliament approved a lottery that returned just 40% of what the company’s creditors had lost.
The Risks of Concentrated Power
There are several key features that stand out in the collapse of both the Charitable Corporation and FTX. Both companies offered something new or ventured into a new sector. In the first case, it was microcredit. In the case of FTX, it was cryptocurrency.
In the meantime, the management of both companies has been centralized in the hands of just a few people. The Charitable Corporation ran into trouble when it reduced its directors from 12 to five and consolidated most of its lending business in the hands of one employee – Thomson. FTX’s example is even more extreme, where founder Sam Bankman-Fried is in charge.
In both cases, the main scam was to use a company’s assets to prop up another company run by the same people. For example, in 1732 the company’s directors bought shares in the York Buildings Company, in which many of them also had interests. They hoped to juice stock prices. When that didn’t happen, they realized they couldn’t cover what they had taken out of the Charitable Corporation’s funds.
Fast forward almost 300 years and a similar story seems to have played out. Bankman-Fried allegedly took funds from his client accounts at FTX to cover his cryptocurrency trading firm, Alameda Research.
The news of both scams also came as a surprise and without warning. Part of this is because managers were highly respected and well-connected in both politics and finance. Few public figures distrusted them, and this proved a useful excuse for fraud.
I would also argue that in both cases the company’s connection to philanthropy gave it another layer of coverage. The very name of the Charitable Corporation announced its altruism. And even after the scandal subsided, commentators pointed out that the original microcredit business was useful. FTX founder Bankman-Fried is an advocate of effective altruism and has argued that making lots of money was useful to him and his businesses so he could give it away for what he believed to be effective causes.
After the collapse of the Charitable Corporation in 1732, Parliament made no statutes that would prevent such a fraud from happening again.
A tradition of loose oversight and regulation is the hallmark of Anglo-American capitalism. If the reaction to the 2008 financial crash is any indication of what is to come after FTX collapses, it’s possible that some bad actors like Bankman-Fried will be punished. But every regulation is rolled back at the first opportunity – or not introduced at all.
Amy Froide, Professor of History, University of Maryland, Baltimore County
This article was republished by The Conversation under a Creative Commons license. Read the original article.
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