This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
If one banking house closes a good contract with an excellent chance of profits, others are usually invited to come in as members of the underwriting syndicate to handle the contract. In this way all of them more or less take part in all the important underwritings. There is, of course, no formal agreement to this effect but it is tacitly understood that when one house permits its neighbor and rival to join in a profitable underwriting, the favor is to be returned at the first opportunity. So well-understood is this arrangement, that frequently - in the Wall Street district at least, and probably in other centres - the firms which become members of an underwriting syndicate are scarcely consulted. The banking house which has made the agreement with the corporation and which is managing the syndicate, simply distributes the issue as it thinks best and notifies each of the participants making up the syndicate. Most of these somewhat peremptory invitations are profitable, and it is safe to say that invitations of this kind from one of the three or four most important banking houses are seldom, if ever, refused. In testifying during the insurance investigation some years ago, J. P. Morgan, the elder, explained that some highly important syndicates involving tens of millions of dollars were organized by his firm through the simple process of calling up the selected list of participating houses on the telephone and advising how much each was expected to subscribe.
An important result of this "community of interest" arrangement is that it removes the occasion for keen competition among the leading banking houses. It is comparatively of minor importance whether one house or another carries through the negotiations with the issuing corporation and becomes the active manager of the syndicate, because in any case each of the important houses will participate in the syndicate and in a fair share of the profits.
In New York it is well understood that negotiations for the flotation of an issue of any size should be taken up with only one of the important banking houses at a time. In case negotiations with one house fail definitely, they may possibly be taken up with another house. But the important banking houses will not directly compete with each other; nor will one of them even interfere with suggestions or investigations while another has the matter in hand. No doubt much the same kind of a tacit understanding exists in most financial centres. Many business men who are accustomed to dealing under highly competitive conditions resent the existence of this invisible and indefinite bond union among the large underwriting houses. If they are bringing an issue into the market to be sold, naturally they would like to have it eagerly bid for. They are looking for competition and they find a silent, but inflexible, understanding. Much of the outcry of the last few years against the so-called "money trust" is an expression of this resentment.
The bankers, on the other side, claim first of all that unchecked competition would be disastrous not only to them, but also to the whole business community which they serve. It would invariably mean reckless extension of credit, over-financing, and disregard of conservative principles. They advance the claim, further, that they make no oppressive terms or restrictions and that the present situation leaves room for difference of opinion, thus preventing the establishment of a complete monopoly. Finally, they assert that the relations between the financial managers of a corporation and the banking house which handles the security issue ought to be of intimate, permanent, and semi-professional nature. A corporate official ought to pick out a banker in whom he has implicit confidence, just as he picks out a physician or a lawyer in whom he has confidence, and ought to stick to the man or the firm he has picked out until that confidence is shaken or there is some real reason for disagreement. In that case, he should cut off all relations as quickly as possible and entrust his financial affairs to some other banking house. In other words, the banker feels that he is rendering a personal and partly professional service rather than merely buying and reselling a certain commodity.