The Central Pacific Railroad was funded privately by four major investors who put their own money on the line until they received government bonds for financing. The Union Pacific Railroad took an entirely different route. Although the infamous Ponzi Scheme came into being in the 1920s, decades after the building of the Union Pacific, it appears it was a cousin to the form of fraudulent financing scheme entered into by some major players in the Union Pacific management.
|Dr. Thomas C. Durant, Union Pacific Vice President
At the meeting of stockholders on October 9, 1863, John A. Dix was elected president. Dr. Thomas C. Durant was chosen as vice-president. Durant turned out to be the real leader of the corporation. He had graduated from Albany College of Medicine at the youthful age of 20 but disliked his humdrum position as assistant professor of surgery. Daring, adventurous, and energetic, he threw all of his constructive genius and fortune into the enterprise of building the Union Pacific Railroad.
To Thomas Durant, the official financial incentives were not enough. As a part of their scheme to take advantage of the government subsidies, Durant and entrepreneur, George Francis Train, joined together in March 1864 in a business venture to buy out the Pennsylvania Fiscal Agency, changing its name to Crédit Mobilier. The company was one of the first to take advantage of the new limited liability financial structures. Previously, investors were responsible for the finances of a company if it had problems.
Under limited liability, their only responsibility was for money paid in. Durant created this limited liability company to encourage Union Pacific investors to agree to take on the railroad's construction after contracted employee, Herbert Hoxie, announced that he would fail to meet his deadline for building 247 miles of track. Investors thought that this contract, given the high construction cost, was too great a risk, but the protection offered by Crédit Mobilier convinced them to take on the construction. Durant then manipulated Crédit Mobilier's structure so that he wound up in control of it. Union Pacific effectively paid him via Crédit Mobilier to build the railroad. Durant covered his tracks by having various politicians, including future President James Garfield, as limited stockholders.
|Members of Crédit Mobilier
This company was supposedly independent, and thus impartial, from the Union Pacific Railroad. In actuality, it was a front company put together to purchase construction goods for the railroad and issue contracts for construction managers. This extra layer of corporate complexity allowed Durant to pay himself and his cronies to build his railroad. Union Pacific directors funneled projects through Crédit Mobilier, which charged inflated prices or its products and services. Many of those directors were also investors in Crédit Mobilier. Those inflated charges were paid to this transparent holding company by the bonds. The true cost of the goods and services were paid, and the investors pocketed the difference. Durant achieved considerable profits for himself by this arrangement.
The Union Pacific contracted with Crédit Mobilier to construct 667 miles of the railroad. The actual cost to Crédit Mobilier was about $44,000,000. The contract, using government subsidized funding, was for more than $94,000,000.
How did they get away with it?
The principal means of the fraud was the method of indirect billing. The Union Pacific presented genuine and accurate invoices to the U.S. government, as evidence of actual construction costs incurred and billed to them by Crédit Mobilier of America for payment. The railroad then prepared and presented meticulously detailed invoices to the U.S. government, requesting payment for these bills, accrued by the Union Pacific from Crédit Mobilier, for the construction of the line. The bills reflected only a small additional fee over the cost stated on the Crédit Mobilier invoices for the Union Pacific's operating and overhead expenses, incurred during the line's construction at a time when no traffic (freight or passenger) was being carried.
The underlying fraud of a common and unified ownership of the two companies, as regards their principal officers and directors, was not revealed for years. Nor was it revealed that, in every major construction contract drawn up between the Union Pacific and Crédit Mobilier, the contract's terms, conditions, and price had been offered by Crédit Mobilier and accepted by the Union Pacific through the actions of corporate officers and directors who were one and the same persons.
|Congressman Oakes Ames, Massachusetts
One of the early Union Pacific stockholders was Congressman Oakes Ames. In the 1860's the attention of Oakes Ames, a congressman from Massachusetts, and his brother was drawn to the Union Pacific and the generous subsidies it was receiving from Congress. The two, having made a fortune in the management of their father's shovel works which boasted of an average yearly production of over 1,400,000 shovels a year, bought enough stock that they acquired control over the Union Pacific.
Ames decided that Crédit Mobilier could not work with Durant anymore. Ames took Durant to court and fired him from Crédit Mobilier in May 1867, ousting Durant from his position managing Crédit Mobilier.
Crédit Mobilier replaced Thomas Durant with the Congressman Oakes Ames. In that year, Ames offered to members of Congress shares of stock in Crédit Mobilier at its discounted par value rather than the market value, which was much higher.
The high market value of the stock resulted from the superb performance of Crédit Mobilier of America as a corporation, which in turn succeeded due to its major contract with the Union Pacific. Crédit Mobilier declared substantial quarterly dividends on its stock.
|Speaker of the House, Schuyler Colfax, later Vice President
In order to avoid Congressional investigation, a large block of Crédit Mobilier stock held by Congressman Ames as trustee was ostensibly "sold" to influential congressmen for one-third of its actual value. Congressmen included Schuyler Colfax, then-Speaker of the House (who, by 1872, was the sitting Vice President). However, the "sale" did not require actual money. The sales price was paid from the dividends resulting from the profits on the railroad construction. The congressmen and others allowed to purchase shares at a discount could reap enormous capital gains simply by offering their shares on the market, knowing that they would be purchased at a higher price by investors desiring to own stock in such a "profitable" company. These same members of Congress made the company appear to be profitable by voting to appropriate government funds to cover Crédit Mobilier's inflated charges.
The Crédit Mobilier fraud orchestrated by Thomas Durant and continued by Oakes Ames came to a head on September 4, 1872 when the New York Sun revealed that several members of Congress had accepted cash bribes or shares of Crédit Mobilier stock.
Although no one was indicted, the scandal resulted in a Congressional investigation. When the scandal became public, Speaker James Blaine of Maine appointed a select investigation committee chaired by Representative Luke Poland of Vermont in December 1872. Speaker Blaine noted that “A charge of bribery of members is the gravest that can be made in a legislative body. It seems to me . . . that this charge demands prompt, thorough, and impartial investigation.”
On February 27, 1873, the House censured Ames and Brooks for using their political influence for personal financial gain. Congressman Ames died several months later, his reputation ruined.
As for Thomas C. Durant, President Ulysses S. Grant fired him from Union Pacific after it was discovered he had violated the 1862 Pacific Railroad Act by using his control of the Crédit Mobilier to become the majority stockholder in the Union Pacific Railroad. There was also suspicion that Durant had taken money from the company, but those around him feared exposing him. Like many others, he lost a great deal of his wealth in the Panic of 1873. He sold his remaining stock in Union Pacific and started a new railroad company, Adirondack Railroad. He spent the last twelve years of his life fighting lawsuits from disgruntled partners and investors. However, he weathered the financial crisis while numerous Crédit Mobilier investors went bankrupt.
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Museum Memories, Volume 1 (Salt Lake City, Utah: International Daughters of Utah Pioneers, 2009), Pgs. 408-410.