Mr. KEITH. Thank you very much. Thank you, Mr. Chairman. Mr. ABERNETHY. Thank you, Mr. Bryan. Mr. SPRINGER. Mr. Chairman, at this point, might I make an insertion in the record? Mr. ABERNETHY. Certainly. Mr. SPRINGER. This is not long, but I think it is important. I would like to have permission of the chairman and other members to insert this pamphlet which is entitled "Investors Beware," which won a Pulitzer Prize, by Miriam Ottenberg, a Washington Star staff reporter. Mr. ABERNETHY. I was intending to do that. It will be included in the record. INVESTORS BEWARE (By Pulitzer Prize Winner Miriam Ottenberg, Star staff writer) A SERIES EXPLORING THE PRACTICES OF QUESTIONABLE INVESTMENT FIRMS NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. The series of articles entitled, "Investors Beware" written by Miriam Ottenberg for the Washington Star describes a situation of which every investor in Washington, D.C., should be informed. Growth in the number of securities firms operating here on the fringe of established ethics and the law has been of great concern to the vast majority of firms in the securities busines, the NASD, and the SEC. Increased enforcement activity by NASD and the SEC has been effective; however, this alone can not provide the full measure of protection which is needed. An informed investor is capable of exercising commonsense when approached by a stranger representing the securities business who promises great profits in a short period. Miss Ottenberg's articles contain basic facts which could prove invaluable to investors. Also, an informed investing public is essential if Washington is to have the right kind of securities law, properly administered. If we are to deal promptly and well with the problems created by marginal firms moving into this area and realize the standards for which both the NASD and the SEC are striving, it will be in the light of analyses such as the "Investors Beware" series. These articles deserve careful reading. WALLACE FULTON, Executive Director. [From the Washington (D.C.) Star, Feb. 4, 1962] INVESTORS BEWARE: 1 OF 3 DISTRICT OF COLUMBIA BROKERS FOUND TO BE UNSAFE (By Miriam Ottenberg, Star staff writer) More than 100 firms are dealing in stocks and bonds in Washington, but onethird of them couldn't operate in most of the States. That means the chances are 1 in 3 that the unwary Washington investor may run into a broker-dealer who knows nothing about the business or who pays the rent with his customer's investment money or who applies high-pressure tactics to sell questionable stocks. The present danger to Washington investors is emerging in investigations conducted by the Securities and Exchange Commission, the National Association of Securities Dealers, and the Better Business Bureau. The steadily worsening situation here in the promotion and sale of low-priced, over-the-counter securities lay behind the SEC's recent decision to send a task force of investigators into Washington on a cleanup mission. The National Association of Securities Dealers, self-policing organization in the securities field, reports that, in its regular examinations of more than 100 investment firms here, it has recently been taking action against 1 out of 3 firms. The Better Business Bureau hired an ex-FBI agent to investigate Washington securities firms. On the basis of his findings of shoddy and unethical practices. the bureau called on the SEC and the dealers' association to increase their investigative staffs and step up enforcement activities here. The bureau cited "the promotional activities and business methods of some of these securities firms (that) have resulted in severe losses to the investing public in this area." RELIABLE FIRMS CONCERNED Established investment firms here are seriously concerned by the sudden increase in inexperienced, financially unstable firms as well as the out-of-town promoters flocking into Washington. The many reliable firms welcomed the Better Business Bureau investigation and have labored with the dealers' organization in its self-policing activities as they see the city's reputation for safe dealings in securities threatened. They are aware of the increasing number of victims-the stock-buying customers many of whom are investing for the first time. Nearly 800 customers were caught in the collapse of 1 firm last year and their experience has been duplicated on a smaller scale by the customers of other firms. These newcomer firms have opened their doors with promotional fanfare, accepted money from their customers to buy stock and closed their doors. In some cases, they have protected their investors. But, in other cases, the customers have been seriously hurt. A Star survey of more than 60 firms which have opened for business here since January 1960, showed that approximately one-third of them have already gone out of business or been put out of business by the SEC or the National Association of Securities Dealers. In one recent week alone, two Washington firms were expelled by the dealers' group and three Washington firms were named in actions launched by the SEC. Since the start of 1960, the SEC has obtained injunctions against 11 Washington firms and revoked the dealer registrations of 9 firms. The SEC regional office covers Pennsylvania, Maryland, Virginia, West Virginia, Delaware, and the District, but in the past 2 years, half the SEC actions against broker-dealers throughout the region have been against Washington firms. During the same period, the National Association of Securities Dealers' district committee has filed formal complaints against 44 Washington firms, expelled 18, suspended 1, and fined 20. It has revoked the registrations of 19 salesmen and fined 2 a total of $4,000. The closed doors, the injunctions, revocations, and complaints do not happen overnight. Before a firm's inexperience, lack of operating capital, or questionable activities leads to formal action, plenty of customers have had a chance to lose their savings. Both the SEC and the dealers' association report that evidence of violation of rules designed to protect the investing public is worse here than anywhere else in their regions. Both bodies are aware of the prime cause: Washington has no local law to safeguard investors against questionable or financially unfit dealers. NO LOCAL CONTROL Unlike most States, Washington has no local control over the dealers or the stocks they sell. It has no requirement that broker-dealers be experienced or trained before going into the business of handling other people's money. It has no local control over salesmen. It also has no requirement that broker-dealers have any money of their own before they go into business. With more stringent regulations going on the books in many Eastern States, promoters have gotten out one step ahead of legal action and moved into Washington where they feel comparatively safe until the SEC or the dealers' association catches up with them. Out-of-town firms with no stock exchange connections have opened branch offices here to escape the local controls exerted over their headquarters in other States. Characteristic of some of the newcomer firms are their fancy names, many of which are so close to those of established firms as to be indistinguishable when said fast. The names also are designed to give the impression to customers that a two-room firm has nationwide connections. The lack of operating capital, however, is rated particularly dangerous to the customers. Until the SEC pins down a violation of its rule that a firm cannot owe 20 times more than its net capital, some of these firms use their customers' money to pay the rent, promote their business, and furnish their offices. When their doors close, the customers' money-if there's anything left-can be attached by other creditors. The Star's survey of newcomer firms showed seven had gone into business here in the past 2 years with $500 or less in cash. One of them started with $100. More than half started with less than $5,000. Many were in the hole financially with the costs of launching their business before they even began accepting customers' money to buy stocks. Their lack of experience in the business is equally apparent—and as potentially harmful to the customers. EXPERIENCE LACK SHOWN Of the 45 firms who have registered with the SEC since the start of 1960 and are still in business, the Star's survey showed that 7 had no previous experience in the securities field. Four reported less than a year's experience. Nine got their only training as salesmen for a now defunct firm or in one of the firms stemming from it. In 10 firms, only 1 member of the company had any previous experience. In only 11 of the 45 firms, all the partners had some previous experience but frequently not much of it. [From the Washington (D.C.) Star, Feb. 5, 1962] INVESTORS BEWARE: VARIOUS TECHNIQUES USED TO LURE UNWARY (By Miriam Ottenberg) The techniques for selling low-grade stocks to unwary Washington investors range from elaborate stage settings to fast telephone patter. While the stock promoters pretend the greatest solicitude for the safety of their customers' money and act as though their only concern is to let a client in on a good thing, their actual goal is to make a killing before the stock they tout becomes worthless. They can get away with their gimmicks here longer than in most other places because Washington has no law to assure local controls over the investment firms or their salesmen. Washington has many reliable, firmly established investment firms but onethird of those in business here today would not be allowed to operate in most other cities. EXAMPLES OF TECHNIQUES Selling techniques of some stock promoters are shown in reports of an ex-FBI agent who "shopped" Washington investment firms for the Better Business Bureau, in customer complaints and in reports of unethical practices furnished by Washington's reputable firms. Here's the pattern: (1) To create the impression that stocks of little value are being heavily traded, the promoter installs a blackboard in his office and changes the stock quotations on it hourly. While a customer listens, the promoter calls a well-known investment firm and asks for the latest price on a stock. When the promoter gets the answer, he tells the customer: "See, the big boys are trading in this, too." JUST WINDOW DRESSING The impressed customer doesn't realize that the blackboard quotations are just window dressing. He doesn't know that the answer given by the big firm was simply read from the daily sheet of over-the-counter listings and that a reputable firm wouldn't touch the particular stock. He also is unaware that the buying price of the stock given to him is substantially higher than the price the promoter got over the telephone. Reputable firms are trying to curb this practice by offering to call back with the answer when they suspect a fly-by-night outfit is on the other end of the telephone. If their suspicions are proved correct, they don't call back-but they can't detect them all. (2) To create the illusion of respectability, a shoestring outfit claims it is trading regularly with one of the well-known firms. To prove it, the promoter flashes a bill on the letterhead of the big investment house. The bill was easy to come by. The promoter simply ordered some wellknown stocks or bonds as any customer could do. Even if he lost a little money on the deal, he has evidence to show the doubting customers that he does business with recognized firms. (3) To attract servicemen with a few dollars to invest, the promoters recruit officers retiring from the Armed Forces as salesmen or junior partners. The promoters are attracted by the service contacts of these former officers as well as by their savings. The ex-FBI agent working with the Better Business Bureau reported hearing a promoter addressing several telephone callers by their officer rank, and added: "It has become rather obvious during this investigation that the Armed Forces offer a tremendous market for over-the-counter dealers." A number of the letters from customers who lost their savings in the collapse of one Washington firm came from both officers and enlisted men. ATTRACTING SALESMEN (4) To attract salesmen with some money of their own, the promoters put help wanted ads for salesmen in the newspapers on the same day they advertise spectacular new issues. When the would-be salesmen apply for jobs, they have to agree to invest in these questionable new stocks themselves before they can go to work. They are expected to get their relatives and friends into the deal, too. To milk them a little more, the promoters make them pay various fees as well as a lump sum for so-called training. The wife of one salesman who went into a now defunct firm complained that her husband had given up a good job in another field, invested all their savings in the stocks he was supposed to sell and ended up with neither savings nor job. VARIOUS GIMMICKS (5) To drain the financial resources of their customers the promoters have several gimmicks. One convinced a customer to cash in his life insurance and put the money in low-priced stocks which would grow and grow in value. The head of another firm here told the Better Business Bureau investigator that customers left their money with him and authorized him to use his own discretion in buying and selling stocks. The reputable firms, with plenty of capital behind them, are extremely cautious about accepting any such discretionary accounts and do it only in individual cases for long-standing customers. A similar promoter concentrates on older people who have clung through the years to a few blue chip stocks. They are advised to sell the blue chips because they can get more income out of a lower-priced stock. They are not warned that a promised 8-percent dividend might be accompanied by a greater risk. So they give up safe investments in favor of stock in struggling young companies that can't make ends meet. TELEPHONE USE (6) To promote sales, promoters hire a battery of part-time telephone salesmen. Prospective customers called at random are told a stock selling for $2 has just gone up an eighth and the inside word from New York is that it actually has gone up a quarter. No reputable firm would bother to use fractional changes to interest investors but the salesmen are trained to give the impression that the stock is moving fast and the time to get in on quick profits is now. Or prospective investors are told the salesman has inside information about a contemplated merger, a spectacular earnings report, a new invention, an extra dividend, a big order the company has just received or a successful test of a complicated gadget. Some of the promoters have imported high-pressure salesmen from New York. One of their favorite gambits is the earnest assurance that the salesman has bought stocks in this venture for his mother. Obviously, the customer is led to believe, if a man put his own mother's money in the stock it must be safe. ANOTHER ARGUMENT Or the argument is advanced that low-priced stocks are safer to buy because they can't drop as far as the high-priced stocks. Complaints from the public indicate that many of those fleeced were buying stocks for the first time. Typical of their innocence is one victim's remark that she did not investigate the salesman before she let him take her money because she thought all stock salesmen had to be licensed. In many places, both the investment firms and their salesmen are subject to local regulation, but not in Washington. [From the Washington (D.C.) Star, Feb. 6, 1962] INVESTORS BEWARE: CASE OF 1 FIRM AND 800 VICTIMS (By Miriam Ottenberg) When a Washington investment firm called American Diversified Securities, Inc. closed its doors last year, close to 800 customers were caught in the collapse. Their claims amount to over half a million dollars. Nobody is sure yet what can be salvaged for the customers and other creditors, but the company's ultimate deficit is expected to run over a million dollars. The story of the rise and fall of American Diversified is the story of what can happen in a community without a local law to protect investors from inexperienced and undercapitalized investment firms. OFFSHOOTS SPROUT UP It is a continuing story, because many of American Diversified's former salesmen and associates have opened investment firms of their own-and some of them have already run afoul of Federal regulations. Six have been named in proceedings by the Securities and Exchange Commission or the National Association of Securities Dealers. Four others have closed. At least seven are still in business. Among other newcomers to the burgeoning securities business here are broker-dealers who gained their only experience in firms launched by former American Diversified salesman. Some of these offshoots presumably have learned something from the experience of American Diversified and are trying to conduct a different kind of business. But a survey shows that others belong in the one-third of Washington investment firms which wouldn't be allowed to operate in most States. Most of American Diversified's successors are selling the same kind of stock, using the same sales methods, and operating with the same lack of experience and shaky financing that contributed to American Diversified's boom-and-bust history. BEGAN AS ONE-MAN FIRM American Diversified had its origin in a one-man company launched in February 1958, with $2,200 and no previous experience in the securities business. It incorporated in August 1958. Its cash amounted to less than $3,000 when it launched its plan to raise the capital to keep going. It started issuing stock in its own newly formed corporation and announced its program to organize mutual funds among members of national organizations. During 1959, according to a report of a court-appointed accountant, 49,000 shares of American Diversified stock were sold. Ultimately, this accountant reported, $335,000 was raised through stock sales. People paid as much as $28 a share for American Diversified stock. The mutual fund concept which had attracted stockholders never got off the ground. While waiting for it to materialize, the company engaged in selling overthe-counter securities and started underwriting stock issues. EXPANDED RAPIDLY The company rapidly expanded. From 20 employees in 1958, it had grown to 120 by September 1960. Like similar companies, it took on retired officers from the Armed Forces who could and did interest officers and enlisted men in the lowpriced stocks being offered by the company. |