tomer who later attempted to sell his shares would find that his brokerdealer could not sell at the bid price quoted in the sheets, or if the distribution were completed, his broker-dealer would probably find that the market for the customer's shares had disappeared.187 A recent Commission proceeding illustrates the manner in which fictitious quotations were used to facilitate a large distribution of worthless stock.188 Scott Taylor & Co. ("Scott Taylor"), a broker-dealer, acquired large blocks of unregistered stock of Anaconda Lead & Silver Co. at less than a dollar per share. The shares were then sold, principally by means of high-pressure sales tactics and fraudulent misrepresentations on the long-distance telephone, to investors in at least 29 States, mostly at prices of $4.75, many at $4.60, and a few at $4.25. While the distribution was in progress, Scott Taylor asked Landau Co., another broker-dealer, "to go into the sheets," generally at a price of $4.25; this was done for a continuous period of 4 months. The testimony of Theodore Landau, proprietor of the firm, illustrates the technique: Q. Now, Mr. Landau, we would like to have you tell us, to begin with as a starting point, how you first became interested in this security, Anaconda Lead & Silver Co. A. *** Scott Taylor asked me to go into the sheets for him and then I went into the sheets with him. That was the way it started. Q. You mean, that you first went into the sheets at the request of Scott Taylor & Co. A. That's right. * Q. At the time that you were going to go into the sheets with Mr. Stevens of Scott Taylor, was any price mentioned at which you should go into the sheets? A. He said to go in at that particular place in there. There was somebody else in the sheets at around that price and we went into it. Q. He suggested that you go into the Daily Quotation Sheets? A. I think it was at $4 or $44. I don't remember exactly what it was. He also gave me an order that if any stock came in, to buy-I believe he gave me an order of about 100 shares. Q. Well, now when Mr. Stevens of Scott Taylor gave you this order to buy 100 shares, was that a standing order to buy these 100 shares? A. A day. * Q. At the bid price? A. Yes. In its decision revoking Landau's broker-dealer registration, the Commission stated: * Landau's continuous bids in the daily sheets during a period extending from April to August 1959 * ** materially assisted Scott Taylor to distribute the stock to the public by providing the appearance of a "market" at artificially high prices in the stock on the basis of which the shares could be sold. Therefore, Landau's actions here were in clear violation of section 10 (b) of the Exchange Act and rule 10b-6.18 189 In the case involving the distribution of Diversified Funding shares, referred to earlier,190 the broker-dealer, F. S. Johns & Co. ("Johns"), also arranged for the placement of fictitious quotations in the sheets while the selling campaign was in progress. 187 See the discussion of firmness of markets in sec. 2.b, above. 488 In the Matter of Theodore Landau, Securities Exchange Act release No. 6792 (Apr. 30, 1962). 180 Landau had also inserted quotations in the sheets in connection with a number of other "boiler room" distributions under circumstances similar to those in the Anaconda Lead & Silver Co. case. 190 See sec. 2.a, above. A trader from one of the firms inserting quotations in the sheets upon instructions from Johns, testified as follows: Q. I notice that in almost every situation the sale was to F. S. Johns. Is there any reason for that? A. He was the only real market for the stock. Q. Why did you engage in this first transaction, dated October 23, 1961? A. I don't know the reason for it, but I was given the transactions to put through by Mr. [T.] [the controlling person of Johns and Diversified Funding]. Q. At a guaranteed profit or a commission of one-sixteenth? A. That is correct, one-thirty-second. I believe that is it. He gave me both sides of the transaction. * Q. Is this the first transaction that you enaged in in this stock? Q. Now, prior to this time, why did you appear in the pink sheets commencing October 12, 1961? A. I was asked to go into the pink sheets by [T.). Q. Approximately when to the best of your recollection, sir.? A. It would undoubtedly have been just the day or so before the first day of our appearance in the pink sheets. Q. Did he give you the price at which to go into the pink sheets? A. Yes, he did. Q. Were you to receive any compensation for appearing in the pink sheets? A. Mr. [T.] was ready to purchase it at a price he previously agreed on with me. Q. What was that price? A. Either an eighth or a sixteenth of a point higher than the price at which we appeared in the sheet. * Q. Did [T.] indicate to you why he wanted you to drop out of the sheets when he so requested you to do so? A. No. Q. He just called you up and said no more sheets any more? A. Yes. Q. Did you ask him why? A. No. Q. Did [T.] or anybody else at F. S. Johns ever refuse to take back from you any of the shares you purchased as a result of being in the sheets? A. No, they did not. Q. Did they ever complain to you about the quantity of stock that you were turning in to them? A. Yes, they did. Q. About when was that? A. Whenever we had more than a couple of hundred dollars worth of stock, they would complain. Q. Was there a market independent of F. S. Johns in Diversified Funding? A. Not that I know of. If a broker-dealer interested in the distribution of a block of stock by "boiler room" techniques did not have, or could not obtain, a subscription to the sheets, it has not been difficult to get a subscriber "to go into the sheets" at a fictitious quotation prescribed by the brokerdealer interested in the distribution. The firm inserting the quotation was, as described in the Diversified Funding case above, usually guaranteed a profit on each trade in which it was to take or furnish stock. One of the more audacious schemes involved the insertion of fictitious quotations in the sheets to give the impression of increased value of stock pledged or to be pledged with banks as collateral for a loan. A number of subscribers to the sheets entered fictitious quotations for unregistered and worthless stock of Imperial Petroleum Co. and then sought to borrow money from banks in Miami, Fla., by pledging Imperial Petroleum shares as collateral on the basis of their quotations. One bank which was victimized by the scheme actually lent $25,000. The participants in the scheme were later indicted for conspiring to violate the antifraud provisions of the Securities Act and the mail fraud statute. Of the six defendants, five were convicted and sentenced; the charges against one defendant were dismissed.191 The testimony of the proprietor of one of the firms appearing in the sheets for Imperial Petroleum is illuminating. Q. Tell me how you happened to go into the pink sheets in Imperial Petroleum? A. Well, while I was in the hospital, I got a letter from Alex [F.]. He was out in California. In this letter, he described this new deal that he had arranged with Tom [C.] and he praised this deal very heavily. He said that it was a wonderful stock and had a lot of properties and, in fact, some of these properties were adjacent to a well-known oil company and they were interested in it and he thought it was one excellent deal for us to go into if I got better. *** I was going to get out of this brokerage business, not only because of my illness, but because of the fact that we weren't doing very well. As a matter of fact, there hadn't been any income for the last 2 or 3 months and I had already dismissed my employees and I was contemplating liquidating my business, and so when I received this letter, I practically ignored it. *** [H]e asked me to do him a favor and go into the sheets and bid on the stock at five and a quarter, thereby helping him promote a block of his stock which he had a deal going down in Florida. * *** Mr. [F.] told me that if this deal went through and he was able to sell the stock, he would give me $500. At that time, being that I was not having any income, $500 sounded pretty good to me and I agreed to go into the sheets for him. I still had several months to go on my subscription to the pink sheets and he knew that and he asked me to put these bids in for him. I agreed to do that and I did go into the pink sheets and I quoted a bid of five and a quarter. Might I mention before this that Mr. [F.] told me that I didn't have to make any physical effort to do this for him, I could do it at home and use my home telephone number in the pink sheets, which I did, and he said that this would be the easiest $500 I ever made. Well, I finally agreed and, as I say, I went into the pink sheets and I received calls from about a dozen people and these are the names of the brokers from whom I received calls. There is one thing I want to bring out and that is that Mr. [F.] when I asked him, "What happens if I get a call and somebody wants to sell me some stock," he said, "This is very simple. All you have to say is that you filled your quota for the day and you don't have to buy any. The insertion of fictitious quotations in the sheets has appeared in other situations. For example, in one situation a broker-dealer entered fictitious quotations in the sheets over a 2-month period for the debentures of a company in order to induce another company to accept a block of the debentures in payment for cash and shares of stock of the second company. The tactic worked. Broker-dealers could also insert fictitious quotations prior to a registered public offering to create the appearance of a rising and active market,192 or to increase the price of a security prior to merger negotiations. The insertion of quotations may also be used to qualify a security for re 101 See litigation releases Nos. 2079 (Aug. 2, 1961) and 2273 (May 24, 1962). 102 See Floyd A. Allen & Co., Inc., 35 S.E.C. 176 (1953); Gob Shops of America, Inc., 39 S.E.C. 92 (1959). tail quotation on one of the NASD lists and to provide a basis for a fictitious retail price to be used in a selling campaign.193 A recent case indicates the manner in which unreliable wholesale quotations may infect the retail quotations systems. On April 19, 1963, the following item appeared on the financial page of the New York Herald Tribune: General Economics Corp., a securities broker-dealer, announced yesterday it has withdrawn market support from two issues it brought to the public less than a year and a half ago. General Economics Corp., a cornerstone of a securities-mutual fund-insurance combine, itself plummeted to 75 cents a share from a $5 opening bid price yesterday. It had sold above $6 on Tuesday after hitting 64 Monday. GEC later recovered yesterday to $1.50 a share bid in the counter market. On January 22, 1962, the common stock of the General Economics Corp. ("GEC") was approved by the New York Quotations Committee of the NASD for inclusion on its eastern list of retail quotations.19+ At the time of its application, seven dealers appeared in the sheets quoting the stock at about 612 bid, 73% asked, creating the appearance of a broad and active market for the stock. GEC was a holding company for a complex of corporations engaged in the underwriting of over-the-counter securities, financing, real estate and insurance. Through one of its broker-dealer subsidiaries, GEC employed a sales force of at least 350 salesmen to sell, among other things, its own securities and those of several companies underwritten by the subsidiary. It would appear that an intense selling campaign was employed in the sale of its stock extending into 1963. During early 1963, some 16 dealers inserted 2-way quotations in the sheets while GEC appeared on the eastern list of the NASD with retail quotations in the range of 5 bid, 7 asked. On April 17, 1963, the retail quotation for GEČ stock on the NASD eastern list was 5 bid, 534 asked. On the following day the retail quotation declined to 12 bid, 2% asked, when GEC withdrew market support for its own stock. It appears that many of the wholesale dealers inserting 2-way quotations in the sheets for GEC stock during the first 3 months of 1963 (the quotations which formed the basis for retail quotations disseminated to the public), sold most of the shares purchased by them to a GEC subsidiary. Several firms indicated that they appeared in the sheets at the behest of the GEC subsidiary with the understanding that they would be guaranteed a commission or markup of one-eighth of a point on all GEC stock purchased by them. Others stated that they showed the GEC subsidiary their positions each day or that they based their quotations on the price at which the subsidiary had previously agreed to purchase stock acquired by them. b. Other wholesale quotation systems There are several small wholesale quotation systems serving brokerdealers in certain regions of the country. For example, "Wants and Offerings," is published in Los Angeles and contains quotations for securities for which there is an interest in southern California. It has been operating for approximately 25 years. "Wants and Offer 103 See pt. D.4, below. 194 See the discussion of the retail quotations system in pt. D.4 and pt. F, below. ings" was organized after the National Quotation Bureau refused the request of Los Angeles broker-dealers to move its Pacific Coast office from San Francisco to Los Angeles. For a period, "Wants and Offerings" operated as a free service. At the present the service is sold on a subscription basis to broker-dealers who are members of the NASD and to banks. According to its management, the service is not made available to the public. With the expansion of the over-the-counter markets a few new systems have attempted to compete with the Bureau, but none has been successful. With the market decline of early 1962, at least one system apparently went out of business. Recently another group unsuccessfully attempted to establish a system to provide nationwide service, using more modern communication, data processing, and reproduction techniques. There is an established service, "The Blue List," specializing_in municipal bonds and also quoting some corporate bond issues. Its operations were not included within the scope of this study. Several electronic systems are now being used to disseminate retail quotations.195 As described below in the discussion of the possible impact of automation upon over-the-counter markets, these systems could be readily adapted to the circulation of wholesale quotations. These electronic developments suggest the possibility of other wholesale quotations systems under different management and control from the Bureau's. D. RETAIL MARKETS 1. INTRODUCTION There is a dichotomy in the over-the-counter markets between the wholesale or interdealer markets and the retail markets where public investors buy and sell securities. Information about the interdealer market in which over-the-counter trading is principally conducted is generally not available to the public as a result both of its trading mechanisms and of industry policy. The absence of a central marketplace where trading can be observed and supervised and of a tape which reports and publicizes consummated transactions, the use of a farflung wire and telephone network in which wholesale dealers communicate bilaterally and privately with one another and the emphasis on the merchandising of over-the-counter securities, are some of the factors which result in fewer disclosures to investors about the trading markets for over-the-counter securities than are normal for exchange. securities. There is, on the other hand, a close and continuous relationship between the wholesale and retail over-the-counter markets. Retail quotations and prices, the quality of retail executions and the marketability of securities are all related to the underlying trading market. At present, in the absence of uniform standards prescribed either by the Government or industry, there are wide differences in the manner and costs of execution of retail transactions and the amount of disclosures afforded investors in over-the-counter securities. The first sections of this part discuss some of the factors affecting the manner in which a public customer's order is executed by his 195 These systems are described in pt. E, below. |