Do You Sincerely Want To Be Rich? (21 page)

    The brokers, investment managers and security dealers to whom Cornfeld was speaking in New York in February 1970 were probably also sympathetic to his attack on the sec because they had been subjected to the constant blare of the IOS version of the dispute between the two. IOS tried to refer to the sec case as little as possible at first but when it became unavoidable they set the machine to work to present the interpretation which would do them least harm. It was not strictly in accordance with the facts.

    The standard explanation of the sec battle put out by IOS ran like this:

    'At the heart of the dispute was the sec's demand that IOS supply it with a full list of the company's clients regardless of their nationality. This demand was made because of the sec's contention that under us law any company selling securities to Americans was compelled to open its records to the Commission.

    'The basic IOS position, as stated in court, was: us securities laws do not apply to purchase and sales of securities which occur wholly outside of the United States. Transactions outside the United States, IOS contended, are subject to the laws of the countries wherein such transactions occur.'

    This statement is factually wrong in one respect: the sec did not demand a full list of the company's clients regardless of their nationality. In their own words, the Commission demanded that IOS produce 'its customers' records
or
its records of all transactions or accounts effected by IOS with or for United States citizens or nationals,
whichever
IOS
preferred.'
More important however are the subtle implications of the emphasis used by IOS: for the IOS version suggests that the sec was interested in the misdemeanours of IOS’s clients - tax and exchange control evasion for instance - and not those of IOS itself, and that IOS regarded its clients' right to secrecy as a matter of principle.

    There were undoubtedly many IOS clients, both American and other nationals, who would have been acutely embarrassed if the details of their dealings with IOS had fallen into the hands of the us government. But no matter of principle was involved. The job of the sec is to protect us investors whether at home or abroad. It cannot of course stop us citizens living abroad from squandering their savings on investments completely outside its control. But IOS, it felt with some justification, was not outside its jurisdiction; investigation showed that they had ignored a number of the provisions of the securities laws, to the detriment of their clients; therefore the sec had no alternative but to charge it with those offences.

    Like most people in the us, even in the financial world, the sec had heard little of Cornfeld or IOS before 1965 - although Cowett and Cohen had met when Cowett was working on
Blue Sky Law
with Loss. What first brought IOS to their attention was the huge holdings that the FOF was building up in a selection of funds which were registered with the sec and very much their concern. By the end of 1964 FOF owned over 40% of one us fund, over 20% of two more and over $19 million dollars worth each - or about 8|% - of the two giant Fidelity funds, Capital and Trend. So early in 1965 the sec decided to investigate IOS, with two aims: to assess the impact of IOS and FOF on the us securities markets and particularly on registered funds; and to find out whether IOS or FOF had violated the federal securities laws.

    The sec investigation was started
before
IOS tried to invade the American fund market: it was not until the end of July that year that Cornfeld bought out Walter Benedick, the man who had launched him in his fund career, when IOS took over ipc.

    So the sec investigators had precious little they could latch onto: the bulk of IOS’s records were kept in Geneva, an arrangement which the sec had ironically approved five years before, without realizing the trouble they were storing up for themselves.

    But IOS had an Achilles heel. On the top floor of a converted brownstone on West 57th Street, above an art gallery, there was an uncharacteristically shabby office belonging to a company called Investors Continental Services, ICS belonged to IOS, and it had been registered with the sec as a broker dealer since November 1958, and it was through this company that IOS sold to Americans abroad and serviced them when they returned home, ICS was also a member of the National Association of Security Dealers, the trade body in the us which issues a set of Rules of Fair Practice which representatives of its members must comply with. It also has policing duties under the securities acts. That meant that the sec could turn up at any time without warning and ask to see the books.

    This is precisely what the sec did. One day in late May of 1965 a couple of sec investigators, Dan Schatz and Hal Halpern, rode the rickety elevator to the top floor, presented their identification cards to Hy Feld, who ran the office for IOS with one secretary, and asked for the files. The two investigators were not quite sure what they were looking for. But the moment Schatz saw the following letter in a file in a back room he saw its significance:

    February 10, 1965

    Mr. Larry Rosen

    Geneva

    Dear Larry,

    This is intended simply to illustrate an additional problem created by the entire ICS-nasd situation.

    Whenever an incorrect commission statement comes into New York, whenever a letter written on ICS stationery by someone who is not an nasd registered representative finds its way into the New York office, or whenever there is any correspondence relating to any person who is not nasd approved, Hy attempts to remove such commission statement, letters, or other paper from ICS files. However, there is a strong probability that Hy will not be able to catch everything which should not be put into the ICS files…

    … As you are probably aware, the ICS files are always open to complete examination by the nasd or sec. One improper paper in the file, if discovered, could lead to a complete investigation of the entire workings of ICS. Such an examination would include, in all probability, a review of all correspondence coming into the office over a protracted period. Since the correspondence in any period of three or four or five days is bound to include at least one daming
[sic]
letter, you can see that the results could be disastrous.

    I do not mean to panic everybody involved by this letter and my letter of even date. I can ask no more than that each person involved do his part in cutting down the extent of our obvious violations.

    Best regards,

    c.c. Bernard Cornfeld Hy Feld emc:aw

    The letter was clearly written by Cowett. Reacting to some well-trained instinct Schatz took out a notebook and jotted down the wording of the letter. When he got back to Washington there was great excitement. He was soon on his way back to New York for a second visit; this time he could not find the letter.

    An employee of IOS in New York at that time who tried, for personal reasons, to find out whether the letter had been intentionally removed, was unable to reach any firm conclusion. Cowett says that it was not taken out and that when the sec men came back to fetch papers for Xeroxing, for some inexplicable reason, they just missed it.

    Cowett's explanation of the letter is that some of the commissions of salesmen were being recorded by mistake on ICS-headed paper. ‘I discovered that for three or four months the office had been sloppy with commission statements on business that was not subject to us regulations. I got pretty angry and sat down and typed two letters myself - one to Lawrence Rosen and one to Kent Gordis, the head of the computer processing department.' In other words, it was purely a technical error.

    The full text of the letter would appear to imply considerably more than that. In the event, however, the sec never proved that IOS had been selling its unregistered funds -FOF and IIT - to

    Americans
within
America, and ICS did not feature prominently in the charges. The principal impact of the letter was, frankly, in its publicity value to the sec: because it did not form the basis of any of the charges, Cowett denounced its publication as 'McCarthyism'.

    The real weakness of IOS’s position is that Cornfeld had registered IOS itself as a broker/dealer with the sec on June 10 1960, shortly after he had incorporated the company in Panama. Again he had done this, no doubt to be on the safe side, because he was selling a us registered fund - Dreyfus - to Americans abroad. In cases where a broker/dealer has his main offices abroad, the sec allows him to keep his records there, and not in the us itself, as long as he undertakes to produce them on request, IOS had given that undertaking.

    Fairly quickly, the sec discovered that IOS was not going to produce any of its customer records at all. The furthest they were prepared to go was to produce a statistical breakdown of them, which would have been virtually useless. So on November 29, 1965, the sec formally demanded that IOS produce its books and records relating to customers who were us citizens. It also served a subpoena on the one branch of IOS that was within its grasp, that in Puerto Rico. Again the sec asked for records of the branch's dealings with Americans.

    IOS retaliated by filing an action on December 14 in the District Court of Puerto Rico. The company argued that Swiss industrial espionage and banking secrecy laws prevented it from producing any of its records and IOS claimed that anyway it was not under the jurisdiction of the sec and wanted to withdraw its broker/dealer registration without prejudice.

    After months of litigation IOS suffered a humiliating defeat, IOS produced the view of a leading Swiss lawyer Robert Turretini, to support their claim that they would be infringing Swiss secrecy laws. The sec expert said they would not. Judge Hiram R. Cancio decreed, on October 3, 1966, that even if Turretini were right, IOS was 'nevertheless under an obligation to comply with the United States Law to which it has submitted.' IOS’s complaint to quash the subpoena on its Puerto Rican branch was also dismissed, IOS appealed and sought an injunction: the Appeals Court turned it down with the comment '… it is unthinkable that an administrative agency cannot even institute a proceeding until it has had, in effect, the permission of the district court and of the court of appeals whenever the parties to be investigated choose to deny its jurisdiction.'

    Our intrepid sec investigator, Dan Schatz, spent a good deal of time on the air shuttle between Washington and New York in the early summer of 1965. On one of these trips he was despatched to the offices of a reputable, 'white shoe' firm of stockbrokers called Jesup & Lamont, on Broadway near Wall Street. He was not, at least as far as he knew, on the IOS chase. He was there to look into that firm's methods of handling institutional brokerage business. Schatz started with the usual interview with the senior partner who told him that the firm had no branches. He then checked the list of the firm's employees, asking for addresses as well as names. He was struck by one name, that of Mrs Gloria Martica Clapp, with an address in the Bahamas. So he asked for the details of her accounts and her commission statements.

    Recalling the occasion Dan Schatz nostalgically told us: 'I remember after I asked for the information and before they brought me the files, I felt like Babe Ruth when he was playing in the Yankee Stadium, and he pointed right over the middle flag of the grandstand to show where he was going to hit the ball out of the park, and the next ball he hit it right over the flag. When the files came, there it all was. I called Washington and they were so excited they told me to come right on down.' It is one of the deepest regrets of the sec investigators that they never got to meet Mrs Clapp.

    Gloria Martica Clapp is a Cuban who became a citizen of Bermuda and then went to live in the Bahamas with her first husband. He was an underwater diver in Nassau, who guided visitors on walks over the colourful Caribbean sea bed, while Martica sat in the boat above keeping them supplied with air.

    Her way of life seems to have changed considerably when she and her first husband parted and she married Sam Clapp, an astute Boston lawyer who was among IOS’s tax advisers and who had set up in business in the Bahamas. Mrs Clapp entered the securities business by becoming a registered representative of New York brokers: what Dan Schatz had discovered is that she had received $750,000 from Jesup & Lamont as her share of brokerage commissions that IOS had requested be 'given up' to that firm.

    Before the end of 1968 the practice of giving up commissions was common on us stock exchanges. Many brokers found that they could buy or sell large blocks of securities so profitably on the minimum commissions set by the exchanges that they would rather part with a proportion of their commissions than lose the business.

    The New York Stock Exchange strictly prohibited its members from giving up any of the commissions to the customers themselves; that would mean its minimum commission rules were being broken. They could only be given up to other brokers. This position was not fully approved either by some fund managers or by the sec: their view was that anyone who runs a mutual fund has a fiduciary duty to keep the costs of that fund to a minimum, and therefore the fund should receive the rebates.

    Where the sec and nyse did agree was that in no circumstance should the management company benefit from given up commissions. That would be abuse of the customers' money. The danger of this led the sec to recommend the abolition of give-ups. This was accepted by the nyse and they were made illegal as from December 1968.

    Jesup & Lamont provided IOS with research services and kept half the commissions directed to them, allowing Mrs Clapp to keep the other half. This she placed on deposit with Fiduciary Trust, a Bahamian company of which her husband was a director, IOS denied that the company or any of its principals benefited from these commission payments, and the sec never proved that they did. Nor indeed did the sec ever charge them with violations of securities law on this count. The Commission merely listed the events under the heading, 'With respect to the public interest'.