Do You Sincerely Want To Be Rich? (38 page)

    For its help in arranging the two placements with Alger, and for agreeing to convert some of the notes it owned into shares, Sam Clapp's Fiduciary Trust - of which Ed Cowett was by now a director - received a 'finder's fee' of $70,000. Fiduciary Trust was rather active in Resorts shares, and just before Alger's deal, it acquired a parcel of 56,000, also unregistered, at $7 each. The Trust was acting as nominee for a private family interest, and for Clapp's Fiduciary Growth Fund. (Nearly a year later, the Growth Fund sold 25,000 Resorts shares to the Stamo Foundation, in which C. Henry Buhl III of IOS was a participant.)

    The Fund of Funds' customers would have received a swift profit on their Resorts shares, if the fund had only been able to sell them in 1968, when the price hit $50. But the stock could not be sold through the exchanges until it had been registered with the sec, and registration was held up while the Commission looked into a couple of dealings in the shares.

    The first trouble came in summer 1968. The sec learnt that some of the Resorts stock which had been issued as promissory notes and then converted into shares, had been sold while still unregistered through the American Stock Exchange, the second and less prestigious of the New York exchanges. (This was done without the knowledge of the Resorts management, who were furious.) The Commission obtained consent injunctions against Fiduciary Growth Fund and Fiduciary Trust making any such sales in future.

    A larger row came to a head on March 10, 1969, when the American Stock Exchange suspended trading in Resorts shares for three weeks or so, while Resorts clarified some transactions in the shares of Pan American World Airways. Resorts was proposing to buy up two huge blocks of Pan Am shares, with options to buy still more which would have made it the airline's biggest shareholder. The take-over fever was still active in the stock markets - and suddenly the story spread that Resorts International was going to make a bid for Pan American. At that time, it seemed just credible that a newborn casino company might take over the world's biggest international airline. Bills were quickly introduced in Congress to prevent anyone doing such a thing: the fuss only died down when Resorts' management declared that it had no interest in acquiring Pan Am stock, except as an investment.

    The story of Mary Carter's translation into Resorts International, and its subsequent career, is representative of the investment business in the Sixties, and especially of that part which most fascinated IOS and its friends, advisers and executives. Virtually all the elements are present: there is the ebullient young money manager, eager to make the value of his funds grow fast; there is the inside tip to a developing bonanza; there is the 'special situation', in which stock is created as promissory notes, and then switched by complex means into shares. There are the expansive deals in unregistered securities. There is the network of private contacts and suggestions, with those 'in the know' busily exchanging paper and 'finder's fees'. There are the wild takeover rumours and, as always, there is a 'concept' at the heart of the enterprise: in this case, the idea that a gambling licence bestowed by an acquiescent government would cause sensational adjustments to the value of a strip of sand and palm trees. There was also the problem of legislative and governmental interference, preventing the master financiers from reaping their full reward - although, as was mostly the case, the financiers did rather better than the customers.

    After its rise to $61 and the suspension of trading the price of Resorts International was never quite the same again. Eventually, it emerged that the tourists were not quite as compulsively attracted to Paradise Island as had been anticipated, and a new government appeared in the Bahamas and decided to increase the dues on the casino licence. By September 1970 Resorts International had fallen below $10, and the Fund of Funds' investment was worth less than half its purchase price.

    Still, there were times when the breaks, by accident or design, went the other way.

    Fred Alger's interest in gambling stocks was not confined to Resorts International, and by the end of 1968 he had 20% of his Fund of Funds money in gambling. He bought a large stake in Parvin/Dohrmann, the onetime Los Angeles supplier of hotel equipment which became the operator of three casinos in Las Vegas, and turned into one of the most controversial stocks of 1969.

    Alger was introduced to Parvin/Dohrmann by Delbert W. Coleman, a lawyer from Ohio who made a fortune with a jukebox and pinball company; Seeburg Corporation, which we shall encounter later in this chapter. In late October 1968 Coleman agreed to buy 300,000 shares in Parvin/Dohrmann, effectively the controlling interest. He was not acting alone, but with and for a group which included Allen & Co the New York investment bankers, the actress Jill St John and a Chicago lawyer, Sidney Korshak. It was natural that Coleman should offer Alger, the purchaser of Resorts, the opportunity to take up some of the block of shares. Alger bought 81,000 for the Fund of Funds at $35 each: a $2.8 million investment.

    To run the company Coleman brought in William Scott, who had been the youngest partner in Arthur Andersen & Co, Parvin/Dohrmann's auditors. They bought another casino, the Stardust, for which Sidney Korshak got a finder's fee of $500,000. The stock took off - possibly those in the know on Wall Street were calling it 'a moon job', which was the jargon of the time. In Spring 1969 it reached its peak of $141 per share.

    Just before the peak, the Nevada State Gambling Board declared that the Fund of Funds must sell its Parvin/Dohrmann stock. The reason was that FOF had a large stake in another gambling company outside Nevada, namely Resorts International. The board did not want gambling companies in Nevada to have any connections with others out-of-state.

    The forced sale meant that the Fund of Funds had to accept $90 per share, instead of the market price of $126, but this still left a tidy profit of $4,455,000 on the deal. And in this case, regulatory action had prompted a sound financial decision - because in May 1969, the sec suspended trading in Parvin/Dohrmann shares for a week, complaining that Delbert Coleman had made insufficient disclosures at the time of his acquisition. When trading was resumed, the price slipped until it reached $65, at which point the sec suspended it again, with the allegation that the stock had been manipulated. The charges were settled by means of a consent injunction, but early in 1970 Coleman resigned, in order to improve relations with the sec and the American Stock Exchange. By March 1970, Parvin/ Dohrmann's price was down to $31. The large profits made at various times on deals in Parvin stock remained a sore point with the sec and with the company's new management, who proceeded to file suit against several people and institutions. The Fund of Funds was among them: Parvin sued for return of the $4,455,000 profit on the ground that the deal involved insider trading.

    There was little in the original concept of the Fund of Funds to suggest that it would turn into the kind of speculative investment that was epitomized in the stormy history of the gambling stocks. Originally, it was invested only in large, strictly controlled public mutual funds. We have already seen how this was changed with the introduction of the proprietary funds, with short-selling techniques and a system of performance fees. The IOS funds, which were virtually unregulated in comparison with domestic us funds, thus became a magnet for every stock market operator with a 'special situation' to promote. But the commitment of IOS to the cult of 'performance' - to short term capital gain, at all costs - went further than that.

    As 'Adam Smith' recorded in The Money Game, the idea of 'performance' crystallized in the public mind at the moment when Gerry Tsai left the Fidehty Group of Boston early in 1966 to launch his own Manhattan Fund. The young investment adviser from Shanghai became the first of a galaxy of money management stars: from that moment on, running investment funds was a matter of acute personal competition, in which each man strove to make the value of his fund rise faster than the next man's. The implications soon went beyond anything Jack Dreyfus had done with the Dreyfus Fund.

    Fred Alger grasped the situation soon after he arrived in New York. He set out to promote himself as a hot money manager, and get his fund right to the top of the growth table: that was the only way to get the dealers to sell it. He succeeded - but it was a business in which new stars were continually being outshone by newer, brighter ones. There was Fred Carr, working from Los Angeles, applying an invention of his own which he called the 'risk/return formula', and which looked marvellous while Carr was building up his Enterprise Fund from under $30 million to almost one billion dollars by the end of 1968. (It looked less marvellous in 1969, when the value per share of Enterpris

Meid carried on at the Winfield Fund, which Fred Alger had left to go to New York. Meid once said that he could beat the Dow Jones market average by 30% in any given year. He did not specify whether he meant going up or going down, and perhaps it did not matter, because he did both. The net asset value per share of the Winfield Fund increased by 80% in 1967 and by 30% in 1968. It dropped by 32% by the end of 1969.

    Cornfeld and Cowett adopted the star system with unsurpassed enthusiasm. They hired a number of the hottest money managers, including both Fred Carr and David Meid, and made them compete with each other while working for IOS. Each was handed a chunk of money, and told that he had a free hand, so long as he produced large capital gains. The managers were not only rewarded according to how much gain they made: also, those who recorded the biggest gains were given more money to handle, while those who made smaller gains had it taken away.

    'You cannot imagine the demands that were made on us for performance,' said Fred Alger ruefully after he had been abruptly fired by IOS in March 1970. The effect of IOS's super-competitive system was of course to eliminate any practical possibility of fund managers working for the long term capital growth about which IOS talked to its customers. The only way to achieve 'performance' was to buy into the right hot stock at the right time, sell out of it before its collapse, and then be on into the next hot stock before anyone else. What kept prices up was other funds buying, and what knocked prices down was funds selling. There was, of course, an actual company behind each hot stock-but what that company was doing, if anything, ceased to matter.

    One of Alger's competitors at managing a slice of the Fund of Funds said: 'We bought stocks at $90, not because they were worth $90, but because we knew that tomorrow they would be at $120. When we went home nights, we just hoped the goddam company would still be there next morning.' The real pressure fell on those who slipped behind in IOS's lists. One of their investment managers in London, where the same competitive system was used, said: 'If you were bottom one year, and knew you would have all your money taken away unless you came up with a real winner, the only thing to do was to punt it all on some outside chance, like Poseidon, in a last desperate attempt to catch up.' (Poseidon was the classic share of the boom in Australian nickel mines. It went from twenty Australian cents per share to £140 on the London Stock Exchange, then fell back to a low of £15 per share.)

    The life of an IOS fund manager certainly had its ups and downs. Alger was originally given $5 million of the Fund of Funds in December 1965. By the end of 1967 it had become $82 million, and by the end of 1968, $95.9 million. Then by the end of 1969 it was down to $40.3 million, and he was fired in March 1970. David Meid started with IOS in October 1967, and by the end of the year he had $22 million to handle. At the end of the next year it was up to $81.2 million. In addition, he later received a large chunk of the new special risk Venture Fund International. By the end of 1969 Meid's piece of the Fund of Funds was only just over $19 million. Dean Milosis and Carlyle Jones, managed the first of all the FOF Proprietary Funds, the York Fund, which had $61.3 million when they gave up. Martin Solomon, who ran the Hedge Fund Account of the Fund of Funds, had $48.3 million at the end of 1968, but only $9.3 million at the end of 1969.

    Both Fred Carr, the man with the 'risk/return formula' and Douglas Fletcher, his colleague at Shareholders' Management in Los Angeles, also handled money for IOS. Up to the end of 1968, anyway, the markets were mostly rising, and there was plenty of money for everybody.

    'It was a beautiful period,' Fred Alger remembered. 'We were impressed with the war-babies. There was a new individualist sense, a greater sense of competitive enterprise, a sense of armies of entrepreneurs. You could see them.'

    'Of course,' he added, 'some of them were good, some of them were bad, like any people.'

    But no matter if some of them were bad, there were always new promotions, new hot stocks to take the place of the ones that turned cold. There were computer companies, and leasing companies, and gambling companies. There was franchising, and fast food, and modular building, and prefabricated homes to beat the housing shortage. There were more nursing homes (shades of Geriatric Services) and even real hospitals, followed by environmental stocks and the anti-pollution companies. And of course there were the conglomerates, who were in everything.

    The underlying cause of the euphoria Fred Alger felt was the flood of money pouring into the markets from 'institutional investors', of which the pension funds were the largest, and the 'performance-oriented' mutual funds were the most aggressive in their investment policy. This certainly created a remarkable demand for shares. In 1950, institutional investors spent only $700 million on buying stock. In 1968 they spent $12.6 billion. According to IOS and the other enthusiasts for equity shareholding by the common man, this process was 'investing in the development of American industry' - but it was not quite as simple as that. During 1968, when the funds put up so much money, American corporations bought back, or cancelled, more equity shares than they issued, so that the number of shares available actually declined. Indeed, over the whole of the Sixties, institutional investors' purchases were greater than the net amount of new stock issued. Therefore, much of the trading consisted of existing shares changing hands at higher and higher prices, a process which perhaps contributed more to the development of the securities industry than of any other.

    It therefore appears that the funds were preaching the idea of the widest possible participation in equity shares, or common stock, at a time when American corporations were increasingly reluctant to raise money by issuing them. Many large corporations were able to finance themselves out of profits: in general, corporations preferred to raise money by issuing fixed interest securities, or 'debt' securities, such as bonds and debentures in various forms, while restricting the supplies of their common stock available on the market.

    It was because of this desire for restriction that a substantial part of the equity shares which were available came out as 'unregistered' stock, or 'letter stock', of the kind created in Fred Alger's deal with Mary Carter Paint, and of which IOS funds were enthusiastic buyers. One advantage, from the viewpoint of a corporation issuing unregistered shares is that it avoids the tedious and possibly embarrassing process of getting the sec's approval on the prospectus necessary for a public issue. Another advantage arises from the dynamics of the market.

    A company raising capital by the public issue of new shares obviously increases the supply of its shares on the market. The effect of the increased supply may be to cause the price of the company's existing shares to drop on the exchange: an acute embarrassment, when a high quoted price may be the index of corporate potency, and the crucial weapon in a takeover battle.

    By placing a large block of shares with a fund manager, in a private sale, new cash is raised while the market price is left undisturbed. And this helps the fund manager, who cannot normally finish buying a large block of some attractive security without his own increased demand pushing up the price against him. In an unregistered purchase, the fund manager can buy a large block at an agreed price below the market rate. He then hopes to see the company's quoted price move up, through the effect of demand on a still restricted supply. All going well, the shares can then be registered and sold at a profit.

    The danger of unregistered shares is that until that moment the fund can only sell them in another private transaction -which may mean, in effect, not at all. Thus they can seriously compromise the basic liquidity of the open-end fund concept. (In December 1968, the Mates Fund of New York had to suspend redemptions of its shares for some time, as a consequence of heavy investments in unregistered shares.) The managers of ordinary us funds, however, found letter stock an attractive idea, because it offered the rapid capital gains, or 'performance' they were seeking. Of course, the other risk involved was that a collapse of confidence, while eroding the values of publicly quoted stock, might altogether destroy the value of letter stock, thus adding to the dynamics of speculative collapse. Despite this, it made a powerful appeal to any fund manager, aware that he stood to receive more investment from the public if he showed better short-term performance.

    And letter stock was almost irresistible for an IOS manager. Not only was he required to out-perform a number of other managers just to retain his position: also, he was directly rewarded by performance, IOS took 'performance fees' out of the fund money, at the rate of 10 % of all gains recorded and passed a large slice of this to the managers. This money was paid even if the gain was purely in terms of boo