The Mellon family’s approach to the holding and nurturing of companies was widely known as the ‘Mellon System,’ and was very focused on what would now be termed governance, both corporate and family.
Governance focuses on organisation, communication and succession and these fundamental considerations are enhanced in effectiveness when there are close and well-functioning relationships between investors and managers.
A central component of this system was the retention of ‘closely held’ companies:
‘closed’ corporations in which the shares of stock are not publicly traded, but rather are held by a small group of people, often of the same family. Stock is therefore unavailable to outsiders, though in some situations, minority shares may be available to external investors (leading to light trade volume). Such firms are, by their nature, resilient against hostile takeovers and proxy wars. However, while they tend to be more stable, they are restricted in not having access to as much working capital as listed corporations with their wider shareholder base.
The consideration of ‘all my eggs in one basket’ is nearly related to the closely held structure and is not always a negative consideration of investment approaches. Some may be surprised that two of the most successful investors of the 20th century (Andrew W. Mellon and Warren E. Buffett) held the firm conviction that the best investment approach was to put ‘one’s eggs in one basket’ and then to watch the basket. In Mellon’s case, his great nephew Seward Prosser Mellon, explained that the five main ‘eggs’ were no less than the principal family companies of: The Koppers Co., The Carborundum Co., The Mellon National Bank & Trust Co., Gulf Oil, and Alcoa (all of which were very substantial by the 1930s).
In the beginning
The first true single family office (SFO) in America was established by Judge Thomas Mellon in Pittsburgh in 1868 (the next was Rockefeller’s in 1882), the year before T. Mellon & Son’s Bank (the origin of one side of The Bank of New York Mellon Corporation) was founded in 1869. The Judge acted as banker and financier to many of the great entrepreneurs of his day (ie: Carnegie, Frick, Heinz, Phipps and Westinghouse), but he never co-invested with them. His son Andrew William Mellon (AWM) did take this logical step and in so doing created a far greater fortune than any other Mellon family member.
The Pittsburgh Reduction Company (later to become Alcoa), together with various oil ventures was the first example of the Mellon System. The approach which AWM and his brother Richard Beatty Mellon (RBM) took to nurturing and developing these nascent companies was a consistent and coherent system. Businesses became vertically integrated enterprises from the extraction of raw materials through production, to ultimate distribution. The brothers sought business partners and investors who they were content to finance while allowing them to manage the daily affairs of the business. This was the same business model their father had pioneered. Yet the Mellon System was never static or rigid, it continually adapted to new technologies, markets and ownership structures. For example the Mellon stake in the Pittsburgh Reduction Co was always a minority one, yet it was viewed as a ‘Mellon company’ in as much that their support was crucial to its success.
The Mellon’s involvement in oil enterprises employed a structure unique among all
their industrial ventures for the two brothers provided the majority of the capital and
their nephew (son of James Ross Mellon) William Larimer Mellon (WLM) ran the business in a public way.
This business (that became Gulf Oil) started in 1901 with the discovery of oil at Spindletop, Texas. WLM was the largest of a group of investors who came together to promote the development of a modern refinery at nearby Port Arthur to process the oil. Other investors included many of the Mellon’s Pennsylvania clients as well as some Texas wildcatters. From this time on, Mellon Bank and Gulf
Oil remained closely associated. Gulf later built a network of pipelines and refineries in the eastern and southern US and became the principal competitor of John Davison Rockefeller’s Standard Oil.
In his later life AWM looked back on this period of American commerce as one of transformation, typified by nothing less than a major change in the organisation of companies from ‘thousands of competing units’ to ‘great self-contained’ enterprises thus enabling large-scale integrated production. This had only been possible by a combination of daring entrepreneurial activity and the support from the banks of ‘industrial financing,’ a function in which the Pittsburgh banks were pioneers. The resultant promotion of local businesses was marked and in providing the capital for such enterprises, bankers were drawn more and more into industry. A reciprocal benefit was that industrial leaders placed much of their knowledge and understanding with their bankers, often as board members.
AWM believed greed in business was a sin worthy of Wall Street, but not Pittsburgh, observing:” “I have never made anything myself in speculation.” He rarely sought
fast profits or especially high dividends, being committed to nurturing companies
to prosperity and once profitable, would reinvest profits back in to build up a surplus. Profits were only sometimes distributed to shareholders through stock dividends. It was the principle of rejecting quick speculative success and devoting efforts to ‘make something grow,’ which the brothers even regarded in the patriotic context of increasing the nation’s resources and productive capacity to the wider benefit of all citizens. This was the traditional capitalist argument of the ‘trickle-down’ benefits to society of consumption by the rich. Indeed it could be said AWM considered the making of a fortune as a noble and useful calling.
The Mellons’ disdain for reckless speculators was reinforced in the crash of 1929 when the people who suffered the worst were those who had sought paper profits rather than nurtured real companies. Since the majority of AWM’s holdings were in family companies (Alcoa, Carborundum, Gulf and Mellon National Bank), none of which were publicly traded, his own finances were insulated from much of the effects of the crash. In 1929 the book value of his fortune actually rose from $105m to $112m.
While AWM had an instinctive distaste for ostentation or any visible sign of riches (museum quality Old Master paintings were a dramatic, if unique exception), he inherited the Judge’s approval of acquisition and accumulation, reverence for independence and keenness to assess the vicissitudes of the economic cycle. They both abhorred trade unions. AWM was regarded with awe by the business community in Pittsburgh, who attributed to him exceptional powers of judgement both of people and enterprises. He had the reputation of being a superb listener who would punctuate long periods of attention with astute short questions. His eye for a balance sheet was instinctive.
A perfect example of a Mellon-developed company was what became McClintic-Marshall. This name represented two engineers who approached AWM seeking backing for a business that would produce structural steel for skyscrapers, bridges
and other major projects. AWM and RBM examined their proposal and decided they needed twice the capital requested. McClintic-Marshall became the greatest steel-fabricating business in the world and a conspicuous example of a company nurtured in the Mellon way. No stock was ever sold, listing suggestions refused and during the 30 years of its existence (it was acquired in 1931 by Bethlehem Steel Corporation, now subsumed within ArcelorMittal) it never paid a dividend. The Mellon brothers left the day-to-day management alone but remained behind the scenes advising on policy, strategic capital, structure and acquisitions. As a result of the sale the brothers received about $20m each (about $272m in 2011’s terms) with the two engineers receiving about $13m, acknowledging it was due to Mellon funding they had been able to make their fortunes.
Another benefit of having private companies was that it was possible to sell publicly listed stock to establish a tax-deductible loss and be a legal method of tax avoidance. Needless to say such practices in the year Franklin Delano Roosevelt (FDR) took power were likely to incur the President’s opprobrium.
Any effective business acquisition and growth plan should include likely exit strategies, not withstanding the long holding periods that were typical to the Mellon family. One character of a closely held company is that such transitions can usually be managed smoothly and quietly. The first sale of a major Mellon business (since that of the New York Shipbuilding Company in 1916) was the Standard Steel Car Company. Established in 1902 it was one of their most successful enterprises. AWM and RBM decided a sale was appropriate, given the death or retirement of two of the three principal managers (and the brothers themselves were advancing in age which was a factor in considering asset sales).
Negotiations began before the 1929 crash with JP Morgan’s Pullman Company and although the transfer was not made until March 1930, the valuations remained those agreed before the stock market fall. RBM’s son Richard King Mellon (RKM) joined the new board in 1929, as he had that of, among others, the Aviation Company of Delaware (Avco Corporation). The sale could not have been handled more skilfully or with better timing. Avco was another example of a characteristic AWM approach, namely to overwhelm competitors and to use connections in Washington to obtain preferential treatment for government contracts.
The 1936 Gift Tax (‘The Undistributed Profits Tax’) of FDR’s Second New Deal was directed at making inter-generational transfer of significant wealth much more difficult. For AWM, such enduring fortunes were an essential source of capital and industrial investment and the taxing of retained surpluses struck at the root of the Mellon System, whereby the growing of a company required the laying aside of reserves to survive lean markets. There was other legislation that seemed specifically targeted at both the Mellons and their way of doing business.
The Mellon way had always been to be as discreet, even secretive, as possible, and the requirement, for example, to disclose the salary of the Head of the Union Trust Company, would have appalled them. Even worse, the required separation of investment and deposit-taking banking necessitated the establishment of Mellon Securities Corporation, which took over the underwriting of stocks and bonds from Union Trust. This in effect marked the end of the interlocking financial structures put in place in the early 1900s, which had been fundamental to their subsequent financial and industrial success. In the face of regulation and government scrutiny (rather than market or investment conditions), the heyday of the Mellon family’s accumulation of assets was now waning.
At AWM’s death the combined resources of the Mellon National Bank and the Union Trust Company were one of the top 10 largest banks in the country. The Judge had formed the basis of the family fortune on railroad, coal and real estate whereas his son embraced the emerging technologies of electricity, aeroplanes and chemicals.
Looking at the breadth of the portfolio companies AWM held, he may be seen as a far-sighted exponent of what is now termed diversification, especially in contra-distinction to the other famous American ‘robber barons’ who tended to be associated principally with a single business.
While AWM was a keen believer in the competitive spirit, sharpened by individualism and a tenacious sense of enterprise, his business empire actually became quite monopolistic and it can be argued the family enjoyed a greater degree of control in their state than any other family in a similarly industrialised region. A well-known story in Pittsburgh relates to how AWM rejected an idea for a single building to house all the family interests, seeing such a project as a needless and dangerous way to draw attention to a situation he preferred to keep out of the public eye.
The Mellon System of closely held companies may certainly be stated to have been successful in that it created a substantial legacy, both in terms of financial assets and cultural considerations. AWM eventually became one of the richest people in the United States, but the fact many Mellon companies were closely held frustrated many attempts at estimating AWM’s overall wealth. In the mid 1920s, he was the third highest income tax payer in the US behind only John D. Rockefeller and Henry Ford. His wealth peaked in 1929-30 with a book value of about $140m. The actual worth would have been twice or three times that number, but a conservative doubling to $280m would give a purchasing power in 2011 terms of $3.5bn.
When in 1957, Fortune prepared its first list of the richest Americans, it estimated Paul Mellon, his sister Ailsa Mellon-Bruce, and his first cousins Sarah Mellon Scaife and her brother RKM, were all among the richest eight people in the US, with fortunes of between $400m and $700m each ($500m in 1957 would have a purchasing power of $4bn in 2011).
When Mellon Bank celebrated its centenary in 1969, two years after RKM had retired, most of the great Mellon companies had ceased to be closely held and so faded the old system of interlocking family directorships with dominant Mellon family holdings. In some senses, Mellon Bank was a hub, “an address…a clearinghouse…a place where the Mellons meet” in the words of RKM. In those of his son in later days: a “device for exchanging intelligence, concerting actions and on occasion letting RK speak for all family.” In modern language it was in part, a proprietary investment vehicle for family assets.
These attitudes led to a culture of conservatism and long-term investment and reinvestment of income, which survived in Mellon Financial Corporation through its merger with the similarly conservative Bank of New York and has a tangible existence in that firm’s modern Family Office (FO) Services business. In fact, the then Mellon Financial Corporation had, in 1971, been the first American bank to create a dedicated FO services business to support the SFO of one branch of the Mellon family. This was in response to a far-sighted organisation and evaluation of their affairs, following the death of RKM in 1970.
In some senses AWM was not a pioneer; during his heyday, new methods of business management were emerging, principally the development of salaried managers and attendant corporate hierarchies, separate from innovators, inventors and investors. Rather he stuck in principle to the Judge’s formula, though developing it to a far greater degree and applying it to emerging opportunities and technologies. His own summary was:
“If he (an inventor and or entrepreneur) would furnish the energy and industry to operate the business and carry it on in his own name,
I would become the silent partner with him and furnish the money necessary.”
John K. Barnes described (in an article in World’s Work) the Mellon philosophy of growth and diversification: “Find a man who can run a business and needs capital to start or expand. Furnish the capital and take shares in the business, leaving the other man to run it except when he is in trouble. When the business has grown sufficiently to pay back the money, take the money and find another man running a business and in need of money and give it to him, on the same basis.”
In a Fortune article of 1967, Paul Mellon explained: “We Mellons simply don’t think dynastically” and yet, a generation later, the house and estate of the RKM branch, Huntland Downs, is possibly the last dynastic country house fully lived-in by descendents of the great late 19th century families.
The Mellon’s usage of closely held companies to act as vehicles to grow and store value was remarkable and effective in its prime years between the two World Wars. There is also a modern slant to these observations about such company structures. The recent $2bn purchase of equity in Facebook (which remains a private company with estimates of its value around $50bn) arranged by Goldman Sachs, highlights a small but significant shift in the US capital markets of a tendency for privately held technology companies (and their owners) to sell equity to outside investors, while staying private.
The attractions of retaining a closely held company remain potentially strong, despite the challenges created by the capital requirements to generate growth. One can only ponder how AWM might have applied his financial sagacity to current investment opportunities in technology.
