Andrews. Gatekeepers in Nineteenth Century Corporate

7/31/2019 Andrews. Gatekeepers in Nineteenth Century Corporate

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of unproductive inquiries in the 1840s and 1850s discouraged further efforts as many felt any remedy wasnot further legislation but further education of the public. 7 The Royal British Bank scandal in 1857 hadrevealed the problems of banks with unlimited liability when one third of the wealthier shareholders movedabroad to escape their debts.8 Recent research has shown that, rather than reflecting an acceptance ofgreed and deceit, it set off another moral panic over the effects of joint stock companies and the share

market on British life. Any remedies were only partly in more law and regulation. Parliament appealed to theolder values of the evangelical economy and models of the firm. By stripping rights from shareholders todisclosure and other reliance on directors an attempt was made to encourage them to act more like partnersin monitoring the business of an enterprise and the directors managing it.9 This reflects the appeal in recentyears to the extralegal effects of sources, practices and people sometimes described as soft, smart orreflexive regulation. It also goes beyond it to what Tomasic and Akinbami have recently described as anessential element within companies operating in financial markets, trust, a combination of socialresponsibility, ethics and fiduciary duties.10 Some of these are to be found in the role played by professionsin their management and governance.

Three professions were significant in the floating and collapse of Overend and the attribution ofresponsibility: lawyers, accountants and financial journalists, the ancestors of today's financial analysts.Overend's incorporation as a company, its listing and collapse occurred in a formative period for financialcapitalism and the emergence and development of these professions. The majority of the trading on the

London Stock Exchange was changing from British and foreign government debt to shares in British andforeign companies.11 These professions, and distinctive specializations within them, were moulded by thesechanges and, in turn, led to other changes in the development of financial markets. 12 Barristers werere-establishing themselves as professionals associated with the social and political elite and independent intheir self-regulation. Both solicitors and accountants were emerging as organised professional groups andattempting to win for themselves the professional autonomy that barristers had regained. Finally, in a fieldwhere information was valuable, was the press. So much money was made out of the lack of transparencythat market participants and their professional associates subverted disclosure requirements and fosteredconflicts of interests. The power of financial journalists to reveal information and to name and shame madethem powerful, but conflicts of interests, the manipulation of information by market insiders and inaccuratereporting made financial journalists and the media dangerously unreliable gatekeepers.

A summary of the recent literature on gatekeeping which emerges from the revelation of corporate failures inthe late 1990s, early 2000s and the present GFC (GFC) follows. This leads into an account of the conversionof Overend from a partnership to a listed joint stock company and its collapse and resulting litigation. Theroles of the legal and accounting professions as gatekeepers in these events are considered. The conclusiondraws together those issues which are seen in the gatekeeping literature or which remain unexplored in it.

2 The literature on the professions as corporate gatekeepers

I concede fully the danger that in allowing modern policy debates to frame historical research, we risk inflicting today'sagenda on historical sources that were differently oriented. On the other hand, we respect history when we consult itcarefully for the historical roots of modern problems.13

In explaining recent corporate failures there are four common explanations significant to gatekeepers:gatekeeper failure; misaligned incentives; herd mentality; and, a failure of ethics. Failure of ethics and greedare claimed to affect many, including the gatekeepers. Misaligned incentives are usually associated with

corporate managers and their inflation of earnings to push up the price of their options; herd mentality isassociated with individual and institutional investors' over concentration on quarterly results. Gatekeepersalso suffer from these as they also have misaligned incentives and are subject to herd instincts. Theaccounting scandals of the early 2000s led to new regulatory law and policy requiring lawyers andaccountants to be more attentive to their public and ethical duties seen, for example, in the US SarbanesOxley legislation. The GFC has seen a return to these issues in gatekeeping.14 In one of the most recentcontributions to the discussion, Langevoortt seeks to answer the question of why financial institutions hadretained so much of the risk of sub-prime loan instruments and considers the need to revisit Sarbanes Oxleyin respect of the law and accounting professions and financial service firms. He believes that the problemmay be in the structure of business organisations which promote loyalty and in the psychological effects of

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excessive risk taking.15 The underlying issue appears to be how to create confidence that participants infinancial markets are trustworthy.16

The writers, many influenced by neo-classical economics and its pursuit of maximising shareholder value,see the law as too blunt an instrument to regulate financial markets and listed companies. They believe, like

British laissez faire politicians in the 1800s, that the dynamics of the market are too complex to be graspedby policy and lawmakers. Intervention to correct the market, they claim, inevitably leads to furtherinterventions so that the competition should run freely with a few permanent legal rules. 17 State interference,according to them, will lead to misallocation of resources, economic inefficiencies and the overall loss ofwealth.18 They accept that legal regulation should be used only where there is significant 'market failure'.19

Who are the gatekeepers? While there has always been an interest in third party liability the term appears tohave been first used in the corporate regulation debate by Kraakman to refer to all private third parties whomay become liable but also to those 'who could disrupt misconduct by withholding support' and who could bepenalised for failing to do so. He distinguishes their duties from whistleblowing, resignation or other powersto punish wrongdoers. He sees it as the lightest of duties, an obligation to withhold assistance.20 Itsupplements direct enforcement which may fail for many reasons in deterring excessively risky transactions,including the cost of detection and prosecution and the limited assets of the company to pay any penalty orinnocent parties including creditors and employees. Such penalties are only justified if they can lower the

direct costs of enforcement and lower the incidence of the misconduct. 21 Kraakman argues that duties haveto be prescribed in advance as we only know if gatekeepers have failed after the event and so need topunish them rather than deter them.22 He distinguishes two kinds: those who are like bouncers who excludewrongdoers and those who are chaperones with an ongoing relationship with the enforcement target.Securities law and company law have many examples of chaperones.23 He includes Stock Exchanges asbouncers, although they do not appear to fit within his definition of gatekeeper.24

One of the striking things about the gatekeeper literature is how it ignores what Larsen terms the'professional project' of advancing the status and interests of the members of professional groups.25 In thecase of English solicitors, for example, this involved a limitation on the expansion of numbers in thenineteenth century which created an unmet need for work. The professional associations saw this asincreasing their members' status. The unmet demand created alternative professions including accountantswho did the bookkeeping attorneys had once done, although the new solicitors often controlled the allocationof work to them.26 This status reinforced the legitimacy of solicitors' work. Yet they also needed to have areputation for being useful to their clients to gain business. The gatekeeping writers ignore much of theliterature about the professions and their development. This reveals that there was no golden age in whichthere were clear demarcations between being a member of the legal or accounting professions and being inbusiness. They are also able to sustain conflicting conceptions of their respective professions. 27

Coffee's is the most considered account of corporate and securities gatekeepers and he does recognisesomething of the significance of the professional development of lawyers and accountants in the nineteenthand twentieth centuries. He concludes:

Law and accounting are very different professions. But the history of each of the last century suggests that professionsbehave similarly. In common, they protect their autonomy; they resist broad duties to the public; and they invest verylittle in self-policing.28

Coffee considers the role of accountants, lawyers and security analysts in general and in the particularcontexts of the failures of Enron and WorldCom.29 He recognises that the use of gatekeepers is analternative to a regulatory approach which is based on formal law.30 His basic analysis is still founded onpeople as rational economic actors. He concludes that there are four general reasons why gatekeepers mayfail: it is rational for them to acquiesce in the misconduct; imperfectly competitive markets lead to collusion; adecline in their reputational capital; and, a reduced exposure to litigation. He argues, for example, that thefailure by auditors as gatekeepers has been produced by the conflicts of interests in their consulting activitiesand in the decline of the threat of litigation.31

The first ground includes the others in the sense that collusion may be rational where parties are rewarded,

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reputational capital may not be affected, or, that there is little chance of having to pay damages. Kraakman'swork reflects this in looking at broader legal controls over good governance in corporations and in theregulation of their securities.32 Can legal rules induce gatekeepers to prevent misconduct at an acceptableprice?33 Where penalties are not set correctly gatekeepers may over or under monitor 34 and where the costsare too large gatekeepers may refuse to perform their roles, or to perform them in respect of the most risky

parties who are most in need of being exposed or deterred.35

Most attention has been paid to the role of reputational capital and possible liability. Kraakman finds thatwhat is at stake for the professionals is their reputation. Lawyers and accountants he claims, in particular,make attractive gatekeepers because of their investment in licences and standing. 36 One weak spot is legaland accounting firms with a few clients as the continuation of patronage may be a bribe to encourageprofessionals to turn a blind eye.37 Coffee focuses on examples in the context of collusive behaviour. Theseinclude auditors with conflicts of interests from their consulting work and their increasing identification withthe senior management of the company as their clients.38 Partnoy emphasises this aspect, preferring theterm 'reputational intermediary' to gatekeeper.39 He complicates Kraakman's original analysis by pointing outthat it has not been informed by all the rational choices, as some intermediaries may rationally decide thatthey will maximise their profits by depleting their reputational capital.40 He also has pointed out thatresponses are not always rational, so that when investment bank security analysts recommend the securitiesof the bank's investment banking unit, and are rewarded for it, the bank's reputations appear to have been

unharmed: 'these banks have maintained their reputations notwithstanding the extraordinary attempts of theiremployees to deplete them.'41 He explains this by the high costs to others of entering investment bankingand the difficulty of knowing who to punish because of mergers in the industry.42 Similarly he argues thataccounting firms have benefited from the costs and licences created by the regulation of the securitiesindustry.43 This could lead to problems of collusion.

In respect of possible liability, Coffee's fourth reason, Coffee concludes that the gatekeepers must continueto be entrusted with discretions but exposed to a real threat of litigation to ensure that they exercise theseproperly using appropriate standards of reasonableness. The problem he sees for policy makers is to expandthe discretion and not remove it from the law. So, for example, securities lawyers should be made to bear fullresponsibility for the adequacy of disclosure in the documents they approve. 44 His suggestions for reform,however, include changes to formal law including procedural law, disclosure and principal and agency. Healso recognises that there is much greater scope for peer review. 45 As indicated in the quotation above herecognises that there are long standing problems in the accounting and legal professions. 46

A few writers have worked outside the rational choice analysis of economics and have looked at gatekeepersfrom sociological and psychological perspectives. Langevoort has done so to explain how institutionalcultures develop perspectives on risk.As he writes:

Once gatekeepers find markers of hard work, intensity, optimism, and enthusiasm by people inside the organisationwho seem dedicated and sincere, they relax their guard. ... what I want to show ... is how hard work, intensity,optimism, and enthusiasm can sometimes be the source of the trouble. 47

Some have discussed the public duties or civic trusteeship role of gatekeepers to legitimise their actions andthe professions as a whole.48 Some tend to assume a golden age of high professional standards in arguingthat law and accounting have failed from the change within them from service to profit maximisation. Forexample, McWilliams claims that in the late twentieth century law and accounting sought to maximise profits

and to protect it through devices, such as limited liability for accounting firms, which led to a cultural drift asthey sought to retain clients and diluted the importance of reputation. 49 He tends to blame the managementof the companies which were the clients of these professional firms for the pressure which they placed ontheir professional advisers. The result was that the gatekeepers took on the values of their clients withmanagers in firms equally focused on maximising profits. Coffee also observes how law firms came toorganise themselves more like accounting firms.50

McWilliams notes that the solution proposed in the early 2000s for the legal profession and more so for theaccounting profession was external regulation, which further compromised their autonomy.51 Likenineteenth century lawyers he opposes this in the case of the legal profession as limits on lawyers' behaviour

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derived from their public ethos culture would be preferable. 52 He does not recognise the ambivalence oflawyers' commitment to the public interest, which is balanced by their own professional and businessinterests as revealed in studies of the profession. Or the extent to which rivalry continues between lawyers,accountants and auditors for clients.53 He appears to endorse the struggle by lawyers, if not accountants, inresisting the state in dominating their profession and requiring them to exercise stronger gatekeeping

powers.54

3 A brief history of Overend, Gurney & Co and its flotation and failure as Overend,Gurney & Co Ltd

Ten years ago that house stood next to the Bank of England in the City of London; it was better known abroad than anysimilar firm known, perhaps, better than any purely English firm. The partners had great estates, which had mostlybeen made in the business. They still derived an immense income from it. Yet in six years they lost all their own wealth,sold the business to the company, and then lost a large part of the company's capital. And these losses were made in amanner so reckless and so foolish, that one would think a child who had lent money in the City of London would havelent it better.55

Overend, Gurney was founded in the late 1700s as bill brokers and money dealers. By 1865 'it had obtainedthe highest commercial repute, and was universally considered ... to be one of the most flourishing and

money-making concerns in the greatest commercial city in the world'. 56 It was on the verge of becoming alimited liability company, a process in which a number of lawyers and accountants participated and aboutwhich financial journalists wrote. Its last decade as a partnership and limited company saw significantchanges in company law permitting this. British governments had long resisted the idea of limited liability ingeneral and the limited liability of banks in particular. Bagehot later observed that the:

Success of joint stock banking is very contrary to the general expectation of its origin. ... [A] great number of thinkingpersons feared that the joint stock banks would fast ruin themselves, and then cause a collapse and panic in thecountry.The whole of English commercial literature between 1830 and 1840 is filled with that idea. Nor did it cease in1840.57

These beliefs coincided with the interests of the Bank of England which was incorporated with limited liabilityunder Royal Charter. The restrictions on both incorporation and limited liability originally protected it and itsmonopolies.58 The granting of limited liability by simple registration had been resisted by leading corporate

lawyers as immoral. Cox, a leading company law practitioner and author of a major company law text, wrotein 1857:

The Law of Partnership hitherto has been ... that who acts through an agent should be responsible for his agent's acts,and that he who shares the profits of an enterprise ought also be subject to its losses; that there is a moral obligation,which it is the duty of the laws of a civilised nation to enforce, to pay debts, perform contracts and make reparation forwrongs. Limited Liability is founded on the opposite principle ... . 59

By that time limited liability had become available by registration except for banks. The insolvency of theRoyal British Bank in 1856 saw initial sympathy for its depositors expand to include its shareholders as bothfaced ruin. The difficulties of compensating depositors and getting wealthier shareholders to pay the bank'sdebts led to the extension of limited liability to joint stock banking companies. This resulted from laissez faireprinciples and the desire to avoid another moral panic. The policy, as indicated above, was intended to makeshareholders more like partners in more closely overseeing the activities of such banks. 60

When Overend became a joint stock company with limited liability 7 years later in 1865 the previouslyunthinkable, a banking company with limited liability, had become acceptable as the Banker's Magazinepointed out:

The transformation of Overend, Gurney and Co's far-famed discount establishment into a joint-stock company, marksanother era in the history of limited liability. The progress of the lately naturalized principle towards universal adoptionhas indeed been little short of marvelous. ... [I]t was introduced to the commercial world as a doubtful experiment. Itsfailure was prophesied by enemies, numerous and confident, and its most earnest advocates did not anticipate for itmore than a qualified success. ... A formidable band of financial magnates arrayed themselves against it, and, with fewexceptions, the representatives of the moneyed interest looked upon it with unconcealed dislike and apprehension; and

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yet, so completely has the experiment succeeded, that all these vaticinations have already passed out of memory. ...Our readers will remember how coolly it was looked upon by the banking world, and how many thought that publicconfidence could only be secured by establishments whose every shareholder stood in peril of the ruin which overtookthe unfortunate adventurers in Royal British, the Northumberland and Durham District, the Western Bank of Scotland,and sundry other defunct banking corporations. When the directors of the Bank of Manchester resolved to reconstitutetheir company on the new principle, there were many who shook their heads, and prophesied the coming of some greatdisaster to the bold men who ventured on a course so unusual ... . And now we have the latest, and probably thegreatest triumph which limited liability has yet achieved, in the announcement that the Messrs Gurney have followedthe example of forming their extensive establishment into a similar undertaking.61

The Banker's Magazinewent on to argue that limited liability was desirable for shareholders as it gave them'ease of mind by the division of responsibility especially in times of financial hardship' and it gave 'depositorsand discounters the unpaid capital of a number of shareholders to fall back on'. It referred to the possibility ofsmall investors now being able to profit from the growth of banks:

And to the political economist it is a source of gratification to see the mass of small capitalists admitted to participationin the profits which result from great commercial undertakings. ... By joint-stock associations with limited liability,everyone who has a few pounds to invest can become a partner in some great trading concern. That after making greatallowances for errors, failures, and frauds, the system works well for the shareholders, every one knows; and theconversion of Gurney and Overend's business into a corporation on the new principle, is only an additional illustrationof its soundness, and of the confidence with which it may be regarded by every class of investors. 62

The failure of Overend as a partnership

In retrospect it is clear that the incorporation of Overend was a response to its failure as a partnership. In the1850s there had been a boom in the British economy partly driven by the gold from the Australian colonies.In the late 1850s there were major changes to the partnership. A number of partners retired. Samuel Gurneya long standing member of the firm died. New partners were recruited. The firm entered into new areas ofbusiness apart from bill broking and money dealing. It began to lend on the security of the property ofsteamship and railway companies, on shares in these companies and on the security of goods held bymerchants for trading. It lent 4 million of which only 1 million was recoverable by 1865 but the business ofbill brokers and money dealers remained profitable.63

Stefanos Xenos, a Greek journalist and novelist and the proprietor of the Greek and Oriental SteamCompany, which had borrowed from Overend, left an account of his dealings with the partnership which hadruined him and brought it to the brink of bankruptcy. He described the partners he dealt with in the firm in theearly 1860s and attributes the failure of the partnership and of the subsequent limited liability company to theflawed character of David Ward Chapman, a view also held by the leading historian of the London discountmarket in the 1800s.64 Two of the partners, Samuel Gurney and John Henry Gurney, scarcely ever appearedin the office and Xenos never met them.65 Bankers are a form of gatekeeper and protector of investors.Xenos' account shows a lack of professionalism by some of the partners in the firm. It also illustrates acontinuing characteristic of the financial capitalism which occurred in this period, professionals andintermediaries themselves became market participants. The bank which had once financed listed joint stockcompanies, amongst other clients, became a listed joint stock company. It passed through the gate of whichit itself was a keeper.

Xenos's descriptions of the partners bring out the pious professionalism and the pursuit of greed which

coincided in the London financial markets. He describes Henry Edmund Gurney as:

a proud-spirited man, somewhat pompous ... but ... he had, many a time and oft, saved whole branches of commercefrom a crash, by assisting those at their head. He was a member of the Society of Friends, and a man incapable ofuttering an untruth, or playing a double game.66

Henry Edmund Gurney's approach to banking was professional and risk adverse:

To the success of Henry Edmunds Gurney's design three conditions were indispensable - a special knowledge ofmaritime property; a moderate rate of interest, say, never in any case to exceed 10 per cent, so that the shipowner may

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be able gradually to release his vessels; and an inviolable rule never to advance more than a certain amount on acertain valuation. Besides, the trade in which the mortgaged vessels were engaged should be closely inquired into, andthe capabilities and honesty of their owners ascertained.67

Unable to deal with all the business Gurney relied upon his other partners, David Ward Chapman and Arthur

George Chapman. Xenos wrote of David that his 'life was a round of pleasure. With the exception of the fewhours daily devoted to business, his whole time was taken up in giving or accepting entertainments.''68 Theprofessionalism of his younger brother, Arthur, was even less: 'he signed so many cheques ... his partners,to relieve him from this heavy work, presented him with an annuity'. 69 The other junior partner, RobertBirkbeck, according to Xenos displayed the professionalism expected of a banker:

He loved his work, and took an active part in all of the concerns of the firm. Endowed with great self-possession, hestood unmoved admidst commercial storms, and more than once, by his foresight and determination, saved the goodship of Lombard Street from being wrecked amidst the labyrinth of shoals and banks admidst which the two otherpartners and their precious favourites had entangled her.70

David Chapman further delegated the work of the firm. With limited knowledge of the condition of ships, theirowners and the trade in which they were involved inquiries were handed over to Edward Watkin Edwards.Edwards was a barrister and an Official Assignee of the Court of Bankruptcy. He was to use, for Overend'sbenefit, the information which he obtained in his official position.71 Xenos recounts how he was sent toEdwards in respect of his request for a loan of 80,000 for 6 months. Edwards approved it only afterrenegotiating the original terms Xenos had requested. He required a premium of 40,000 and 10% interestfor 6 months.72 The loan was approved without Edwards coming to Xenos' office or inspecting the ships.Xenos received the money before security was given and there was no request to see the insurancecontracts for the ships.73 Edwards also insisted that as a reward Xenos pay him an annual salary of 500 peryear. Xenos also gave him a yacht as a friendly gift. 74 In addition to his salary as an Official AssigneeEdwards received a salary of 5,000 a year from Overend although he was unable to recall exactly what hedid for the firm outside his office hours as Official Assignee. He lent this money to David Chapman under asecret arrangement. In 1864 his employment was ended when Birbeck pointed out the losses he had causedthe firm. Edwards insisted on being paid 20,000 and given a testimonial that his employment had ceased asthe firm was no longer engaged in business which required his assistance.75 By 1865 the firm was owed4 million of which about 1 million was recovered. Its bill discounting business remained profitable.76 But

with the outstanding bad debts it would have difficulty in continuing to trade.

An anonymous pamphleteer claimed that these conflicts of interests were common in the City as he referredto Edward's examination on the affairs of Overend after its bankruptcy:

It is sufficient to observe and admire the spectacle afforded by Mr Edwards. He is engaged in transactions with the firm,with a single partner of the firm, with customers of the firm, and with his own customers; and all of these transactions itis, of course, his duty to keep perfectly disentangled, and to prevent their exerting any influence on each other. And allof this is undertaken by a gentleman who has 'a very bad memory as to dates' and finds it hard to recall amounts whichare reckoned in hundreds of thousands. We can form, of course, no idea of the influence which Mr Edward'sinaccuracy may have exercised on the fortunes of Overend and Gurney; but he has given us an extraordinaryrevelation of the underground agency at work in the City, and the extent to which one quiet man may make use of greatnames for his own purposes, and without compromising himself. Had not this criminal investigation been set on foot,Mr Edwards might, we dare say, have continued with equal credit and success, to transact a dozen or so opposingbusinesses, and to do justice to any number of conflicting interests, including his own. 77

There is in this evidence of bankers behaving badly. Edwards, a lawyer and civil servant, in his role of anOfficial Assignee of the Court of Bankruptcy, and also an employee of Overend was compromised in anygatekeeping role by acquiescence in misconduct and collusion with little concern, it appears for hisreputation, or liability.

The failure of Overend as a limited liability joint stock company

The partners of Overend by 1865 faced bankruptcy. They decided to continue the business but in the form ofa joint stock company listed on the London Stock Exchange in the expectation that, with time, the value of

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the assets could be recovered. The good assets were to be transferred to the new company but not thedoubtful assets. The partners were to guarantee any deficiency in the transferred assets. They proposed toraise 5 million by the sale of shares, but not call for more than 1,250,000 to be paid up as this would besufficient to continue to carry on the business. The partners valued the goodwill of the firm which was to betransferred at 500,000. They proposed to accept half of this amount in the shares of the company and half

in cash but to subject it to a security in favour of the new company. This was all disclosed to the fourdirectors who joined the former partners as directors of the new company. 78

The partners' solicitor referred these arrangement to a conveyancer who recommended that there be twodeeds, one for the transfer of the goods and assets and the other to cover the doubtful assets which were tobe retained and wound up by the partners of the old firm. 79 On 12 June 1865 the deed of transfer was settledbut was not executed as the company needed to be in existence for this to be done. The prospectus wasissued on 13 June. It referred to only one deed, the deed of covenant in respect of the transfer of thebusiness.80 That deed stated that the whole of the existing assets were to be transferred to the company aswell as the liabilities, with the exception that that the company was to be at liberty to reject any of thebusiness, and that the partners in the old firm guaranteed the payment of all that appeared as assets on theface of the books of the company.81

On 27 July the second deed was settled relating to the excepted accounts and signed at the same time as

the first deed on 8 August several days after the company had commenced.82 The second deed was moreparticular than the first deed. It recounted the loss of 4 million as well as the failure of the partners to takeany profits, which amounted to 1 million and which reduced the amount of bad debts to 3 million. It statedthat half the price of the good will was to be set off against the bad debts and that the company was to havea lien over the shares, partly paid to 15, issued to the former partners. It stated that the company could callon the partners, who had large personal estates, if they defaulted on their guarantees. It limited the time theexcepted accounts were to be held in suspense so that the deficiencies had to be made up by a particulartime. This deed was not made available to potential shareholders to see nor provided to the stock exchangewhen an application was made for a quotation or listing.83

The unusual sequence of the timing of the two deeds and the issue of the prospectus was explained at thecriminal trial, referred to below. The solicitor for the promoters, the partners who were to be directors,received the draft of the first draft deed. He took it to the promoters who submitted it to another conveyancerfor an opinion. It was almost impossible to get the two conveyancers together to discuss their differingopinions as one was away from London campaigning in a general election.Finally, the day before theprospectus was to issue the first deed was settled. The second deed was not settled until 27 July.Cockburn LCJ, at the criminal trial, examined the drafts and noticed that the second deed had been subjectto 'very strict scrutiny into its provisions, for every clause was altered' to which the solicitor, who was awitness, responded that 'scarcely a sentence of the original draft remained ...'. 84 The Gurneys had beenconcerned that the obligations in it may cut across other obligations in family settlements. The 27 July cameto be the date on both deeds but they were not executed by the parties until 8 August. As a result of thisdelay only the first deed was available for inspection at the solicitor's office by possible shareholders.85 Thesecretary of the stock exchange was also called at the trial. He was asked what deeds or documents hewould expect to receive and responded those that supported the correctness of the prospectus and any deedof covenant by a firm which had sold its business to the company. 86 Also unaware of the second deed thestock exchange granted a settlement or listed shares for trading.87

The Economistwelcomed the floating of Overend as it would now have to publish its accounts so 'therewould be revealed what the discerning City man most wanted to know how the firm's extra business bore toits legitimate bill dealing business'. '[I]t was a matter of public notoriety', it reported, that for some time thefirm had transacted 'business not at all in general of an illegitimate or unprofitable character, but still of a sortdifferent from those conducted by bill brokers pure and simple.' 88 But it argued that the company wasprobably not viable as bill discounting could not be done by a limited company. The bill dealer could notafford bad debts but unlike the banker had no ledger of the business to assist them in forming a view of theworth of the business presenting the bills for discounting. This required long experience and unremitting careto avoid bad debts, and a manager, even if conscientious, could not provide this.89

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The market for bank shares was buoyant. The half paid 15 shares offered to the public sold for 24, a 9premium. However in 1866 interests rates began to increase. Overend struggled to obtain funds. Thecompany called on the guarantees given by the former partners in the second deed and news that they wereselling assets to meet their obligations led to a further loss of confidence in the bank. Over 4,000,000 waswithdrawn.90 On 22 May 1866 the company ceased to trade. Turqand and Harding were appointed as official

liquidators.91

The litigation following the collapse of the company

Two faiths I had -- abiding ones --

That Themis' scales were sliding ones;

That Shareholders, confiding ones,

Would bleed, yet stand at ease;

That law kept its fangs and feelers

For small cheats and petty stealers;

And not for daring dealers

With millions like these.92

Litigation followed Overend's failure relating to its incorporation, listing and management. The shareholdersfaced further calls on their now worthless shares. Creditors were anxious to discover what had happened. Adefence committee, established by the shareholders and chaired by a shareholder, Adam Thom, 93

engaged an accountant, Oswald Howell, 'a demon with books', to review Overend's accounts.94 Thepromoters and directors, lawyers and accountants had little to fear. The directors escaped both civil andcriminal liability for the prospectus they had issued which the shareholders now claimed to be misleading.95

Judges were willing to give a wide scope to directors engaged in commercial enterprises with their inherentrisks and were also to be constrained by the finding equitable or criminal fraud against people of similarsocial positions to themselves. The lawyers and accountants who were involved in its flotation were never atrisk of any liability which may confirm Coffee's point that this leads to a reduction in attention to ethical andwider public duties. The litigation again revealed that responsibility for corporate fraud was difficult tolocate.96 The government refused to prosecute the case. By the time the government's inaction was raisedthe Solicitor-General had been retained to act for some of the defendants. The response of the PrimeMinister, Home Secretary and Attorney-General was that was with other ordinary cases of fraud any'prosecutions must be conducted by the sufferers themselves'.97

Civil action against the promoters and directors

Thom brought a civil action for fraud against the directors who had been promoters, 98 which is where thePrime Minister, Gladstone, believed that the issue should have stopped. 99 At the trial Malins VC found thatthe directors were liable:

It was disclosed (to the new directors) that the firm -- the name of which had such a magic charm in commercial circles-- was no longer what it had been; that it had not only ceased to make profits, but had been carried on at an enormous

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loss for several years, and that it was, in fact, at that time insolvent to the extent of 2,000,000, if not, 3,000,000. ... Asthey were about to induce others to advance them money for the purpose of carrying on this insolvent and ruinedconcern, could they, upon any principles of morality and justice, be right in concealing so appalling a fact? I amdecidedly of the opinion that they could not. It seemed that they persuaded themselves that they might rely upon theguarantees of the partners to make good the deficiency of the assets ... But they were not bound to tell those whomthey invited to take share of the speculation in which they were proceeding, and to give them an opportunity of judgingfor themselves whether they could join an insolvent and losing concern in the hope of turning insolvency into solvency,and ruinous loss into profit? I am decidedly of opinion that they were bound. 100

In spite of these findings he then attempted to repair any damage to their reputation by also pointing out thattheir share dealings were different from most promoters:

I think it only an act of justice to the directors to say that I think their conduct shows that they could not have intended todo wrong, and what they did was the result, perhaps, of a too sanguine view of the prospects of the concern, and a toogreat a reliance upon the guarantee of the partners; and, though the shares rose to a premium, none of them sold theirshares.101

The decision was overturned by Lord Hatherly LC taking a robust view that applicants for shares must knowthe risks they were taking:

I must consider the character of the purchase which the directors were empowered to make. They were not to buy anordinary estate. This was a purchase of an extremely speculative nature. Everybody knows that all trades arespeculative, and the trade of bill-broker cannot be considered at the least so. The company was to embark, therefore,in that which must always be a hazardous business -- a business entirely dependent on the prudence and dexterity ofthose who manage it.102

Prosecution of the promoters and directors

The criminal process reflected the legislative changes made after the Royal British Bank scandal which hadcreated a specific offence for directors of making false statements to induce people to become shareholders.There were 31 other counts.103 The claims were that the transfer of the shares had been entered into whenthe vendors were known to be in a state of insolvency and were contemplating bankruptcy,104 were losingmoney at 500,000 per year through 'rotten speculations' which had cost an amount close to 5 million.105

The process was complex for the shareholders in the absence of the government being willing to prosecutethe case on the basis that the criminal law was not a regulatory tool in respect of directors but exceptional.106

The Lord Mayor found a case to answer on the charges, again brought by Adam Thom, after reflecting onthe evidence for a week.107 The Recorder of London conducted the proceedings before a grand jury toobtain the bill of indictment required for trial.108 The directors applied for that trial to by a special jury whichwould remove it into the Court of Queens Bench. The application was granted by Cockburn LCJ who tooknote of the nature of the evidence and the strong feeling against the defendants exhibited by those presentat the inquiry before the Lord Mayor. He found that this would ensure an impartial trial stating: 'There mightbe [an] advantage in a trial ... removed from the excitement which appeared to have existed in the city ofLondon on the subject.'109 At the end of the trial Cockburn LCJ referred to the experience and background ofthe members of the special jury, who were drawn from London businessmen, as he commenced hissumming up:

It is a great satisfaction to my mind ... to think that this case is be decided by twelve gentlemen of this commercialcommunity, familiar with commercial and monetary transactions, conversant with accounts, and thoroughly acquaintedwith all the incidents of mercantile life.110

Later in his summing up he drew to the attention of the jurors the social position of the directors:

Do you suppose that men of business, men of fortune, men of commercial position, would joint themselves to acompany of this kind, in which they were to embark large sums, without going into some calculations to see how far theterms proposed to them by the old proprietors were such as they could, as reasonable men, with prudenceentertain?111

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The biographer of Thom's solicitor, George Henry Lewis, claims that Coleridge, the Solicitor-General, whodefended the directors 'toadied to the prejudices of the Lord Chief Justice on class; repeatedly using wordssuch as "power", "money", "position"'.He also claims that Cockburn LCJ in his summing up repeated hisreferences to the wealth and importance of the accused and 'huffed and puffed about the shareholdershaving the audacity to bring a prosecution at all'. It was to Lewis, a social reformer, a further confirmation of

how entrenched social and political power could prevent justice being done.112 This reflected similar judicialvalues seen in the Royal British Bank case a decade before. There the directors, on conviction, were givenlight sentences.113 It led the Manchester Guardianto write that it provided an example of:

the stock in trade of those agitators who endeavour to persuade the people that the laws of this country have beenmade by the richer classes with a sole view to their own interests, and a contempt of the equal rights of the poor. 114

However not prosecuting was still justified on the basis that there were other punishments for theseoffenders. They faced ridicule and exclusion from polite society, although whether the second occurred hasnever been investigated.115

Cockburn LCJ was particularly incensed that the new directors had been charged and committed for trial. Heused this to raise again the issue of where the power to prosecute such offences should be located and theneed for a Public Prosecutor:

I know of no case which has produced so strong an impression on my mind in favour of what has long been mygrowing conviction, namely, that our system which commits the prosecution of offences against the public to a privateprosecutor, a system which differing from that of every other European nation, is based upon a false principle. I cannotbut think that a public prosecutor is necessary to the due and perfect administration of criminal justice. If there hadbeen a public prosecutor here, I will undertake to say that he would not have put those three gentlemen on theirtrial.116

The gatekeeper groups involved in the float of the company

If the commercial laws of this country were not so complicated, surely the last person that two merchants ought to inviteto step in to arrange their affairs would be a lawyer. 117

The floating of the old partnership as a company involved solicitors and an older branch of the legalprofession, conveyancers, and to a less visible extent, accountants. The role of these professionals isrevealed mainly through the evidence in the litigation which followed the collapse of the company. Thatlitigation revealed how closely accountants and solicitors and barristers worked together although they werealso professional competitors for particular kinds of work.

Any broader public duties and ethical activities for both solicitors and accountants were complicated in the1860s by the competition between the two emerging professions for work, the reverse of Coffee's imperfectlycompetitive markets leading to collusion. Reader noted the multiple functions of the attorney which werereshaped in the 1800s: 'Inside the 18th century attorney, half a dozen later professional men - accountant,company secretary, and others -- were struggling to get out.'118 Sugarman observes of solicitors andaccountants 'their mutual interdependence and cooperation as well as their on-going conflicts.' 119 In the1860s the Law Society took about 10 actions a year against accountants for giving legal advice and drafting

documents for a fee. At the same time the emerging solicitors used the bar and the landed gentry as a socialmodel, reflecting a distain for business with many having little knowledge of commercial law. Solicitors werehappy to depict themselves as bad bookkeepers as this helped their image as learned gentlemen.120 Theresult was that on issues, such as the conversion of a partnership to a limited company, businesspeoplewere often likely to turn to an accountant. 121 Lawyers, however, provided the legal frameworks whichcreated the major work for accountants, insolvency and auditing. Lawyers provided accountants with 'theregulatory context within which they worked, some of the core categories, assumptions and languages oftheir professional lives'. Accountants also depended on solicitors for work to be referred to them, for whichsolicitors charged them.122 In corporate law a requirement for auditors was included in s 108 of the RailwayClauses Consolidation Act 1845. This was extended to other joint stock companies in 1856. Increasingly

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there was an expectation that they would be accountants. 123 A decade after the failure of Overend, in 1879,following the collapse of the City of Glasgow Bank, legislation required professional external audits for banks.There were problems with its effectiveness.124 In the 1890s finally there was a rash of litigation againstauditors which led some in the profession to push for professional bodies to stipulate what an audit meant.They were unsuccessful.125

Accountants and lawyers rationalized and popularized the use of the company as a business form, as shownby their role in the conversion of the Overend partnership into a joint stock company. They continued thetransformation of partnerships into companies as they marketed their skills and services to the businesscommunity. Some of the writers on gatekeeping suggest that lawyers and accountants lost their professionalstanding as they emphasised the business aspects of their professions in the late twentieth century. Bothwere also businesses in the 1860s. As in North America in the twentieth century there was a duality in thelawyers' professionalism as '[t]he ideal model of the lawyer includes both the roles of "zealous advocate" and"guardian of the public interest".'126 At the same time the professions claimed regulatory and protectivefunctions for their expertise which maintained the legitimacy of their respective professions. They appearedto maintain the rules for interaction of participants in the market and in this way fostered markets and thegrowth of capital. They also appeared to protect the interests of individuals as well as preserved the interestsof the community.127 This is an enduring dilemma:

The moral entrepreneur promoting ideas of pure law and professionalism must also show a bottom line profit. Thelawyer must face the related dilemma of fighting for the abstractions of justice or fighting for the particular interests ofclients.In order to be successful, indeed even to survive the lawyer must do both. 128

Lawyers were also active in making the law relating to listed companies. Potentially effective legislation wasoften compromised by lawyers for their interest group clients. Duncan McLaren, a member of the House ofCommons, who unsuccessfully proposed more effective measures for the audit of banks in 1879, observed:

When a bill was passing through Parliament which seemed a good bill, interested parties whose affairs it cut intogenerally got up opposition, and the Government would say to the parties promoting the bill, in order to get rid of theopposition, 'oh, we'll make it optional in regard to so and so', and thus many an efficient and excellent measure wasvitiated in its effect, and rendered worthless.129

Lawyers could justify such roles. Legal forms were adopted not to 'engulf the parties ... in the paraphernaliaof the state legal system' but to secure their autonomy from it through 'the role of the rule of law in thefacilitation and legitimation of a plurality of semi-autonomous realms'. 130 Both lawyers and accountantsargued, consistently with prevailing ideas of laissez faire, that it was impractical to use law to preventdishonest people from deceiving others and that changing the law would weaken those characteristics of theCity which had made it the global financial centre.131 These are familiar arguments in 2011.132 TheCompanies Acts of 1856 and 1862, which removed many of the protections for the public, created the mostpermissive company law regime in Europe. It was done on the basis that the public and shareholders hadthemselves to be vigilant and could not rely on others to do what they should be doing themselves. 133 Itreduced the role of the professions as gatekeepers and the courts as regulators. But their role had anambiguity to it often informed by the cause they were arguing. Those who became judges could be moreindependent in their views. The courts were in the period engaged in administrative activities relating tocompanies. The events surrounding the bubble in limited liability companies and the business of Overend inthe 1860s reveal an administrative system which was under-resourced and which blunted its effectiveness.

The Master of the Rolls, in practice a vice chancellor in the Court of Chancery, had considerableadministrative responsibilities for companies. He observed that his offices were filled with the papers relatingto applications to wind up companies:

that the petitions for winding up new companies were becoming so numerous that there was a great probability of hischambers being choked with winding-up business. There could be no doubt that many new companies were startedmerely for the purpose of being wound up.134

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4 The legal profession as gatekeepers

Lawyers seek only so much justice as the client can afford and persuading clients to accept what the law offersbecame an important facet of lawyer/business relations.135

Coffee claims that lawyering is an old profession136 but, in the context of England, law was re-emerging as aprofession in the 1800s.137 The boom in railway incorporations had enlarged the bar in the first half of the1800s. In the second half it declined and junior barristers lost work to both solicitors and their seniors. In1835 there were, perhaps, as few as 450 barristers and as few as 660 in 1885. By 1841 there were about10,000 solicitors and, in 1881, about 12 500. In spite of the growth in population, the economy andgovernment the number of solicitors was kept in check by insistence on high education standards and awidespread belief that solicitors found it hard to make reasonable incomes.138 Their education did notpromote a knowledge of commercial law. Their ambivalence about appearing too interested in commercehad significant consequences. They relinquished bookkeeping as beneath them, promoting their own socialstatus, but also boosting the emerging profession of accounting. The distain for commerce, promoting theirresemblance to the landed gentry, threatened them with the loss of considerable income. 139 It also put themout of the way of being gatekeepers in many corporate matters. Barristers continued to come from the upperclasses. Solicitors represented a greater social diversity. There were 'eminent attorneys' who advised landed

families who had a status similar to solicitors who acted for railway companies or foreign governments.These had some potential to be gatekeepers. But many solicitors were employed as clerks or as publicaccountants and were so demoralised in waiting to have sufficient legal clients that they developed 'habits ofintemperance'.140 In creating the wealth of the leading solicitors and barristers company law was significant.The incorporation of railway companies 'was a veritable lawyers' paradise: complex and antiquatedprocedures were allied to time-consuming and costly lawyering'.141 The creation of companies and thenlimited liability companies by registration:

created much new work for solicitors. They were required to draft the companies' major constitutional documents,including the articles and memoranda of association; where companies failed, they were obliged to oversee the windingup. Legal confusion concerning the jurisdiction of the Courts of Bankruptcy and Chancery during the period 1848 to1857 produced more rich pickings for the legal profession.142

Having helped to create a very permissive legal regime which had de-emphasised the role of lawyers as

gatekeepers and reduced their exposure to liability lawyers now defended it against reforms which wouldhave better protected investors or have reduced limited liability itself. They influenced law making by servingas members of committees, as expert witnesses, as writers of pamphlets and letters to the press and inpublic lectures. They wrote the textbooks and established the collections of precedent used in corporatelaw.143 The connections between the bar and the Lord Chancellor and Attorney-General gave it a significantinfluence in shaping government policy as did the Law Society through its links with the City and thegovernment.144

Solicitors and barristers did not see themselves as protectors of public and ethical interests. Sugarman, whopioneered work transcending the conception of lawyering as either a business or a profession, revealed how'the relative elasticity of the ideology sustains apparently divergent conceptions of the profession'. 145 Coffee,in the more recent context of the collapse of Enron and WorldCom, notes that lawyers recognised theirethical duties to their clients but that they would be surprised to learn that they were gatekeepers forsomeone else.146 The multiple roles of lawyers not only as legal professionals but as entrepreneurs,

promoters, managers and directors makes common agreement about ethics more problematic. As indicatedby the behaviour of Edwards in his employment by Overend many believed that they were entitled to benefitfrom any conflicts of interest including the use of inside information or usurping business opportunities. 147

It was the facilitative nature of corporate law which made corporate lawyers so useful to business people andmade them so ineffective as gatekeepers:

[it] afforded the parties concerned the opportunity to make their own law (private law-making), and even theopportunity, on occasions, to by-pass or attenuate the state law or equitable obligations established by Parliament orthe courts, that otherwise would apply. ... Facilitative laws illustrate the way in which the form of law itself may, through

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it enormous flexibility and the legal principles that sanction that flexibility, mediate or avoid the legal order. Thus, useand avoidance go hand in hand.148

Limited liability protected shareholders but also transformed the nature of the firm. It meant that shareholderscould more safely neglect to monitor those who managed the company for them. In time the act of

incorporation came to be reinterpreted by lawyers so it ceased to be seen as a collection of partners andmore of an abstract entity. One change was to affect the separation of ownership and control asshareholders lost rights for 'indefinite expectations'. Directors changed from being seen as subject to controlby the shareholders in the general meeting to being a separate organ of the company.149

Lawyers played key roles in the floating of Overend and in suing and prosecuting and defending the directorsin a number of civil and criminal trials. It was a barrister, the conveyancer, who suggested to the solicitor forthe promoters that two deeds be prepared. Conveyancers of the 1800s share some of the attributes ofCoffee's corporate attorneys of the early 2000s. They were transaction engineers who had little contact withlitigation and focused on structuring and drafting. They were 'wise counsellors' more like accountants in theirprofessional approach as opposed to barristers and solicitors engaged in litigation who saw themselves asprotectors and shields for their clients.

The lawyers did little to protect third parties and even detracted from the protection of public interests. Theinability of the conveyancers to put the interests of their clients ahead of their own in getting together to settlethe deeds led to the second deed being agreed and executed after the prospectus was issued which led tothe applicants for shares being misled. The lawyers did something else not noticed in the gatekeepingliterature, they provided the defendants with the appearance of having acted on reputable legal advice and ofhaving been diligent in honouring their limited obligations. This was a point made by Karslake for one of thedefendants, Gordon, at the trial. He reminded the jury that few of the new shareholders had chosen to readthe deed. If they had they would have realised other deeds were required. He went on to say:

The evidence as to the new deeds proves the reverse of fraud on the part of the new directors. They had separatecounsel; and the alterations made by him were for the purpose of ensuring the whole effect of the advantage whichwas to be derived by the company from the transfer.150

Even at the trial it is difficult to see the lawyers for the shareholders as always protecting their interests as

they created their own problems for them. Thom, the prosecutor had finally been able to secure the servicesof Kenealy QC who got the brief late on the Friday afternoon before the trial started on Monday 13 December1869.151 He did not have the same familiarity with the accounting evidence as the instructing solicitor Lewis,who had appeared for Thom in the Lord Mayor's court at the Mansion House against the leading members ofthe bar. In between that hearing and the trial Lewis had successfully appeared for the director of anothercompany, Richard Stuart Lane, on facts very similar to Overend but which had not been well marshalled byan accountant to show that Lane, Hanbury and Co was insolvent at the time it was floated. 152 With theremoval of the trial to Queens Bench Lewis could not appear as only barristers had the right of audience. Inspite of Kenealy's reputation as an advocate the more competent and knowledgeable advocate may havebeen the solicitor, Lewis.

The competition between lawyers and between lawyers and accountants for work could have led them toignore their roles as gatekeepers and their ethical obligations. In respect of the legal profession there is littleevidence of Coffee's four reasons for the common failure of gatekeepers. Edwards does show evidence of

acquiescence in misconduct and collusion. The actions of others point to the fact that Coffee has observedelsewhere that, given their responsibilities and roles, they did not see themselves as having wider obligationsto the public. They also, through their professional activities, provided the promoters and directors with someappearance of legitimacy for their actions which were misleading. Opinions and actions were also likely to beinfluenced by wider questions such as whether shareholders needed to be more alert before becomingshareholders and more active in the supervision of the management of companies in which they wereshareholders.153

5 The accounting profession as gatekeeper

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The whole affairs in bankruptcy have been handed over to an ignorant set of men called accountants, which is one ofthe greatest abuses ever introduced into the law.154

Accountants were struggling towards professional status and autonomy in the 1860s. Lawyers spoke ofaccountants disdainfully and patronisingly. Accountants spoke of lawyers with irony, anger, deference and

courtesy.155 Between 1799 and 1850 the number of practicing accountants in London grew from 11 to 210.In 1854 the first professional association was formed in Edinburgh and in 1880 one in England. Theprofession grew directly from the need for accounting and auditing of joint stock companies. Increasinglyaccounting firms were elected as auditors and appointed as liquidators.156 Accountants distinguishedthemselves from bookkeepers by stressing their independence and their duties to third parties.But from thebeginning corporate auditors were conflicted in serving two masters, the directors and the shareholders. 157

They also served the interests of creditors. Limited liability increased their plight as the majority of newcompanies were wound up in the period from 1866 to 1874. 158 Parker claims that this explains theconservatism of accountants and also the attention they paid to balance sheets, the financial affairs of thefirm at a particular time, rather than profit and loss over a period. This stressed the needs of creditors ratherthan investors.159 At the time of the floating and collapse of Overend the profession was in a period oftransformation from the detection of fraud and error to the verification of financial statements suitable for useby investors who were concerned with financial performance rather than the honesty of management. 160

As with the legal profession there was conflict between advancing the private interests of accountants andthe public interests which they sometimes claimed to promote. It meant that the profession often maintainedonly the idea that it promoted wider civic values.161

Potential litigation against auditors and the unwillingness of the profession to establish standards for auditingled to some considering that audits were worthless but in spite of this the profession maintained its credibilityin this activity.162 In this respect the accountants were partly to blame. The first modern text on financialaccounting by Francis Pixley, Auditors: Their Duties and Responsibilities did not appear until 1881.163 Thefault was largely with the law makers including the judges. The Joint Stock Companies Act 1856 provided amodel 'full and fair Balance Sheet' but gave no further indication of what was capital to be maintained andwhat was profit to be distributed.The judges 'declared that dividends could be paid only out of profits ... thendiscovered that profits was an elusive and baffling concept'.164 Bryer argues that before 1889 and Lee vNeuchatel Asphalte Company165 that there had been some generally agreed standards but these were

destroyed by that and later cases but there is a persistent body of opinion that the standards and rules hadalways been inconsistent or ambiguous.166

The law required audits to be performed but equivocated over the standard to be satisfied and theconsequences of not meeting that standard when shareholders and third parties tried to hold auditors liable.In In Re British Bank, Nicol167 in 1859 a shareholder tried to avoid liability for calls on partly paid shares tomeet the claims of the bank's creditors by asserting that he had been mislead by a deceptive balance sheet.Turner LJ stated that the fact that:

the false and fraudulent representations were discoverable by the auditors as representatives of the shareholders,implied knowledge of the misrepresentations on the part of the latter group notwithstanding the fact that they, theshareholders, had no actual knowledge of the misrepresentations.168

In Spackman v Evans169 in 1868 Lord Chelmsford, considering this statement, expressed the opinion that

the auditor's possible knowledge could not lead to the presumption that a dispersed body of shareholdershad acquiesced 'in the illegal actions of the directors'. He went on to add:

I cannot help expressing a doubt whether he was correct in holding that in the exercise of their duty [the auditors] wouldnecessarily have discovered the fraudulent representations of the directors. 170

As late as 1895 in In re London and General Bank (No 2)171 it was stated that: 'It has never yet been decidedwhat is the exact character, nature, and extent of the duties of an auditor'. In the 1890s the professionalbodies declined to define the requirements of a satisfactory audit although that is also partly explained by

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resistance to the idea that professional judgment should be replaced by rules and the lack of agreementabout approaches to auditing.172 One other relevant factor to their role as gatekeepers is that promulgationof standards may have raised doubts about the ethics of their middle class members. 173

Corporate bankruptcies in the 1860s and 1870s, including Overend, focused attention on the need to detect

fraud.174

It was already recognised that it may be impossible to do complete audits of large companies. TheEconomist, in 1878, expressed the view that the magnitude of the operations of banks made their effectiveauditing impossible.175 Recognising this s 7 of the Companies Act 1879, requiring the audit of the accountsof banks, only required the auditor to examine the books of the company and not the underlying transactionsand related documents.176 Auditors, however, in creating the demand for their profession based on theirskills created expectations that they could detect fraud.177 They were too successful. J G Griffiths claimed in1885:

It appears to me to the rooted opinion of the unenlightened public and of the ignorant portion of the press that auditormust fail in his duty if fraud has been affected, whether it is discovered or not ... The result of this ignorance has beenthat in cases where such frauds have been discovered, an immediate outcry is raised for the dismissal of the auditor ...Now, while all this unreasoning outcry is cruel and unjust, it would be well to consider whether and to what extent weare responsible for the ignorance that certainly exists as to our powers of control, and our ability to prevent and detectfraud by the process of audit we perform.178

Lawyers were also dismissive of the auditors' exaggerated claims. In Arnold v ArmitageLord Coleridgeobserved:

The public has been warned time after time that the signature of the most respected auditor could mean nothing, asthey could only make out the balance from the information, correct or otherwise, given to them. 179

The time of the criminal trial in Overend overlaps with the rising importance of the professional accountant asan expert witness as lawyers expressed a professional distain of commercial knowledge.180 An example, aprosecution similar to Overend, is the transfer of the business of Barned's to Barned's Banking Company, forpublishing a fraudulent prospectus and for conspiring to do so. The summonses were withdrawn after theevidence of the official liquidator, Harmwood Walcott Banner, an accountant from Liverpool, and one of theofficial liquidators, that in his opinion the promoters and directors had acted honourably because they hadalso lost substantial amounts through their own investments in the company. 181

Oswald Howell, 'the demon with books', retained by the committee of shareholders in Overend also becamea witness in the criminal trial in Queens Bench before Cockburn LCJ. Howell's evidence and his treatmentreveals the difficulties in accountants playing a gatekeeping role because of conflict over accountingstandards and the lack of respect for them, or at least one of Howell's social status. Howell reviewed theOverend ledgers brought to the Mansion House in two or three horse drawn wagons and taken back intoofficial custody every evening. He was able to go back a decade in the life of the company and the previouspartnership.182 Finlason in his account of the trial noted that he had 'the zeal of an advocate, and whoseevidence had some fatal defects ... so often observed in the testimony of what are called "experts"'.183

Howell's appearance at the trial had its own dramatic moments.He had published a pamphlet in which hestated that the directors, apart from one, had withdrawn their money before Overend's collapse. TheSolicitor-General had acted for Howell in the resulting libel action brought by the directors. Howell was crossexamined about this by the Solicitor-General, who now appeared for some of the defendants, and agreed he

had published a pamphlet but stated that its contents were true as far as he was aware:The Solicitor-General -- Well, is it true that everyone of the directors (except Mr Gibb) withdrew every shilling he hadfrom the house before the collapse? -- Well, it is not literally so.

There was an action about it, was there not -- an action of libel? -- Yes; and you defended me. (Laughter)

Well, the best thing I could do for you, I believe, was to withdraw a juror? -- I wanted to fight it, but you would not.

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What! I didn't like it eh? -- No. (Much Laughter)

Warned by LCJ'Let me advise you not to publish anything else as to the affairs of other people!

Howell's claim related to companies associated with the directors withdrawing up to 1,455,000 in the periodimmediately before suspension of payments.184 The Solicitor-General continued to cross examine Howell onthe pamphlet, before returning to his main point, that Howell could not tell whether a large profit had beenmade in the legitimate business of the old partnership.185 It was suggested to him that he should not havetreated the 5 million to 7 million of deposits as debts. They would remain as deposits until replaced byothers of equal amount as withdrawals of one customer were replaced by deposits of another. If the depositswere regarded as debts immediately payable the firm had unmet liabilities of 2,000,000 but if the depositswere regarded as floating capital only liable for future withdrawal there was no discrepancy and the firm wassolvent. The patronizing language used in cross examination, like the language of Cockburn LCJ, reflectedthe patronizing view barristers and judges had of accountants:

This partly, indeed, arose from the professional infirmity, common to all accountants, of looking too much at figures,and forgetting that figures do not always represent the realities in fact. This tendency limits, if it does not deteriorate,the value of such professional assistance.186

Cockburn LCJ, in his summing up, said of the accounting evidence:

I confess that I have never been more bewildered in my life than I was by the figures which the accountants put beforeus. I am always unwilling to be the passive recipient of evidence which I do not understand, or to go through themechanical process of carrying into my notes that which is unintelligible in my mind.

Further on in his summing up he stated that preferred the accounting evidence which was more favourable tothe defendants although the witness was subject to conflicts of interests through payments he had receivedin other capacities from the defendants:

A very competent witness, Mr Harding, has told us that in his judgment the profits to be made upon such a businessmay be fairly estimated at from 180,000 to 190,000 a year. Attempts have been made to impugn the evidence ofMr Harding. It is said that he has made money by former transactions with the old firm; I do not mean in commercialspeculations, but in the shape of business done as an accountant. It is said that they have supported his appointmentas one of the official liquidators, and that he comes here, therefore, with a bias in their mind in their favour; but it hastruly been pointed out that no such observations apply to Mr Turquand, and it has not been made to appear thatMr Turquand in any way dissents from the conclusion at which the coadjutor has arrived.187

It was not until the failure of the City of Glasgow Bank in 1878 that banking laws were further revised toprovide for the examination of bank accounts by professional auditors. Even then most audits wereconducted in complete secrecy because the banks feared that their reputations may be damaged by itbecoming known that a public accountant was on the premises. The Company Act 1879 which required suchaudits, however, did not address the problems of how wide the scope of the audit should be or howindependent the auditor should be. Conflicts of interests, compromising the auditors as gatekeepers,

emerged. Directors nominated auditors, in the face of shareholder apathy, who did superficial audits. Theywere made aware that they held their appointments at the will of the board and not the shareholders. Writingin 1894 Kerr claimed:

Theoretically, auditors are chosen as disinterested and competent examiners of the companies' affairs. But in point offact, they are always appointed for very different reasons. It may be safely asserted that not one election in hundredturns either on the candidates' abilities or their moral principles. It is either a case of nepotism, or of one turn deservinganother.188

Accountants in this period were remarkably ineffective as gatekeepers. They were exposed to much greater

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risks of litigation than lawyers were. The profession emerged from the demands of the joint stock companybut was dependent on lawyers both for work and the rules and principles used in it. They had limitedopportunities and poorly developed practices. Those involved in the preparation of the returns to the stockexchange for the listing, or quotation, had done nothing to draw attention to the lack of profit and seriouslosses by the company. In the aftermath of its collapse Turqand and Harding were willing to act as receivers.

Howell was to be troubled both by his passion for the shareholders' cause and the underdevelopment ofaccounting principles by the emerging profession and the uncertainty in those principles created both by thelegislature and the judiciary. Nevertheless accountants overstated their claims to knowledge and skills inwhat they were able to do which appears to have both increased the income of individuals but also advancedand further legitimised the profession, Howell remains a cautionary tale for gatekeepers. He destroyed hiscredibility in the trial by the evidence he gave and appearing to take sides indicating, after the event, theperils for professionals in gatekeeping.

6 Conclusion

The collapse of Overend Gurney not only hurt depositors, the holders of notes it had discounted andshareholders. It led into a financial crisis of a scale not previously seen in Britain. There are limitations to thisstudy. It is based on the evidence left after the collapse of the company and the attempt to lay blame on thegatekeepers who had appeared to fail. There were other gatekeepers in these events who have notappeared in this account. One group were financial journalists. There was an extensive business press inBritain by the 1860s. Through it proprietors and journalists provided a form of soft regulation promotingtransparency and revealing conflicts interests through the voluntary disclosure of information, investigativereporting and naming and shaming. It consciously saw itself as the regulator of financial markets. 189 Manyjournalists agreed that parliament and the courts could not legislate to enforce commercial virtue. Directorshad to police their own behaviour through fear of being publicly exposed in the glare of publicity generated byjournalists.190 Coffee notes in the context of the United States that the predecessor of the professionalsecurities analyst was the financial journalist.191 One gatekeeper who could be claimed to have foreseenthese consequences was Bagehot, in his role as a financial journalist. He criticised the lack of care by themanagement of joint stock companies and in those involved in note discounting in particular, as a businesswhich required a high degree of care and attention to detail. He expressed a concern based on informationhe had about Overend, that it had been conducting business other than discounting notes which needed tobe disclosed.192

A major flaw in gatekeeping literature is its idealization of the gatekeepers at least in law, accounting andauditing as professions which were devoted entirely to public ideals at some time in the past. It fails toobserve how the roles of lawyers and accountants were transformed at the same time as they popularisedthe use of the commercial company, how they developed the skills to service this new form of enterprise andhow they participated in making the law and practices which further transformed these business forms andthe services which they provided. These professions are not the same 140 years later and in differentcountries although there has been some uniformity in developments across jurisdictions. The gatekeepingliterature does recognise features of professional practice which are now different. Accountants mimickedtheir large corporate clients in adopting their structures and management techniques to provide services tothem. Lawyers followed. In large law and accounting firms management techniques were used to ensureworkers were fully productive.

The examples seen in the incorporation and listing of Overend reveal some of the correctives to gatekeepingliterature but also provides some examples of issues which that literature discusses as the two professionswere adapting to commercial changes.There is surprising little concern reflected in the gatekeeping inOverend about reputational capital, a major concern in gatekeeping literature, or possible liability of anygatekeepers. One area of reputational damage is not to individuals but to the accounting professionproduced by the disorder in accounting principles. Individual accountants appear to have been able tonegotiate their way through that. The lawyers and accountants involved in the incorporation and listing ofOverend show the facilitative power of these professions in transforming a failing firm into a listed company.Neither appeared to do much to protect the interests of third parties who were not their clients. Consistentwith the literature on the history of the legal and accounting professions they were able to articulate different

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conceptions of the profession, including the conveyancers acting for the promoters and the old partners.They appeared again in respect of liability in the civil and criminal trials, or gatekeeping after the event, forthe plaintiff and the prosecutor as well as for the defendants. They relied on their expertise to legitimise theirroles but in ways which enabled clients to advance and protect their interests. There is evidence of thetransactional engineering approaches of contemporary company lawyers in the work of the conveyancers. It

was a conveyancer, focused on structuring and drafting, who produced the problems caused by two deedswhich meant that the second deed was not available for inspection by either prospective shareholders or thestock exchange.

There are examples of the collaboration between lawyers and accountants in the civil and criminal trial forboth the plaintiffs and prosecution and the defence. It confirms how lawyers engaged accountants on behalfof their clients to prepare evidence and as expert witnesses and were creating the legal framework withinwhich the accountants practiced their professions. In some ways their obligations were to the legalprofession and their ability to be independent gatekeepers was limited. There is also an indication thatjudges, including Cockburn LCJ, had different views of accountants depending on their social standing. Heappears to have been more willing to accept accountants such as Turquand and Harding who belonged theupper middle classes and were frequently involved in major insolvencies in association with corporatesolicitors. Accountants from the non-elite part of the profession, such as Howell, were treated very differently.Their status as professionals appears not to have been determined by their competence as by their socialstanding.

There is the evidence of the toleration of conflicts of interests and collusion which remains at the heart of theprofessions as gatekeepers. Edwards, the Official Assignee in the Court of Bankruptcy, was an employee ofOverend before its incorporation.While his conduct was criticised it was also tolerated. Also Cockburn LCJwas dismissive about Harding's conflicts of interests as the former accountant and liquidator of Overend.Harding, however, as noted he belonged to the elite of the accounting profession.

Undeveloped and conflicting legal and accounting standards made liability elusive for promoters anddirectors but also lawyers and accountants. Partly this reflected an unwillingness to regulate business butpromote an autonomous regime for commerce in accordance with prevailing views of laissez faire. Neitheraccountants nor lawyers agreed over how the solvency of a bank was to be determined, particularly inrespect of the balances of depositors. Could they be treated as being replaced by other depositors as they

were withdrawn? That was a key issue in determining the allegations against the defendants in the criminaltrial. In the civil trial the standard required for civil fraud was also subjective. Malins VC thought that thedirectors were liable for concealing that the firm was in difficulties at the time of its incorporation and took toopositive a view of the guarantees of the partners and the prospects for the business. Lord Hatherly LCbelieved that all business is speculative and that bill broking was particularly hazardous and that theprospective investors were aware of this.

This unwillingness to impose too close a regulation on business and the corporate form is reflected in thecontinuing literature on gatekeeping. There is an assumption that law is too blunt an instrument to regulateand that softer forms of law, such as discretion vested in professional firms, are more effective. The problemwith that is that the professions developed with the joint stock company and the joint stock company in turnresponded to the availability of their services. Having co-evolved they are mutually dependent which maylimit their abilities to act as gatekeepers in respect of each other or the inclination of their members to act inresponse to wider public interests.

The prospectus for Overend, Gurney, And Company (Limited)

OVEREND, GURNEY, AND COMPANY (LIMITED)

The company is formed for the purpose of carrying into effect an arrangement which has been made for the purchasefrom Messrs Overend, Gurney, & Co, of their long-established business as bill-brokers and money-lenders, and of thepremises in which the business is conducted; the consideration for the good-will being 500,000, one-half being paid incash, and the remainder in shares in the company, with 15 per share credited thereon, terms which, in the opinion ofthe directors, cannot fail to insure a highly remunerative return to the shareholders.

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The business will be handed over the new company on the 1st of August next, the vendors guaranteeing the companyagainst any loss on the assets and the liabilities transferred.

Three members of the present firm have consented to join the board of the new company, in which they will also retaina pecuniary interest. Two of them (Mr Henry Edmund Gurney and Mr Robert Birkbeck) will also occupy the position ofmanaging directors, and undertake the general conduct of the business.

The ordinary business of the company will, in this arrangement, be carried on as heretobefore, with the advantage ofthe co-operation of the board of directors, who also propose to retain the valuable services of the existing staff of thepresent establishment.

The directors will give their zealous attention to the cultivation of business of a first-class character only, it being theirconviction that they will thus most effectually promote the prosperity of the company, and the permanent interests ofthe shareholders.

Copies of the company's memorandum and articles of association, as well as the deed of covenant in relation to thetransfer of the business, can be inspected at the offices of the solicitors of the company. 193

* Professor of Law, Law School, Victoria University, Melbourne, at . I thank the Institute ofAdvanced Legal Studies, University of London, for its hospitality and the use of its library which also made accessible the Britishand Guildhall Libraries. A draft of this paper was presented at the Corporate Law Teachers Association Annual Conference in2009 at the University of Technology, Sydney. I am grateful for the comments of the participants and of the two anonymousreviewers. It was revised and presented, by Professor Roman Tomasic in the author's absence, at a British Council FundedCo-Reach Workshop at Durham University in January 2010. I am grateful for his and Professor Paddy Ireland's helpfulcomments on it.

1 D C Langevoortt, 'Chasing the Greased Pig down Wall Street: A Gatekeeper's Guide to the Psychology, Culture, and Ethics ofFinancial Risk Taking' (2011) 96 Cornell L Rev1209 at 1244.

2 Mr Muntz MP speaking to the House of Commons on the government taking over the prosecution of the Overend, Gurney &Co directors quoted in W F Finlason, A Report of the Cas

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