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.
 |
| Congressman James Brooks, New York |
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.”
 |
| Political cartoon depicting Uncle Sam telling Ames he should commit hari-kari |
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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Sources:
Museum
Memories, Volume 1
(Salt Lake City, Utah: International Daughters of Utah Pioneers, 2009), Pgs.
408-410.
http://www.wyomingtalesandtrails.com/sherman3.html
Wikipedia
