Do You Sincerely Want To Be Rich? (15 page)

also contained the famous statement of the Prudent Man Rule made by Justice Putnam of the supreme Judicial Court of Massachusetts in 1830:

    'All that can be required of a Trustee to invest is that he conduct himself faithfully and exercise a sound discretion. He is to observe how men of prudence, discretion and intelligence manage their own affairs, not in regard to speculation, but in regard to the permanent disposition of their funds, considering the probable income, as well as the probable safety of the capital to be invested.'

    If there was a light, dry hum to be heard somewhere in Massachusetts in May 1968, it was presumably Mr Justice Putnam revolving in his grave like a high speed gas turbine.

    Recalling his first meeting with Jack Dreyfus in New York, Cornfeld gives this account of the exchange: ‘I told Dreyfus, "Yours is the only readable prospectus in the industry. I sell more funds using it than I sell using our own." '

    ' "Why don't you sell my funds?" Dreyfus asked. I told him, "Because you have no programme." '
¹

    Taken on its own, the Fund of Funds was a device which provided its operators with unusual opportunities for profit and having created FOF, Cornfeld and Cowett fitted it into an operating framework called The IOS Investment Programme -with breathtaking results. It was this combined machinery which produced, from the resources of the customers, the rich and ample fodder on which Bernie's sales force grazed.

    It is one of the features of the open end fund business, on both sides of the Atlantic, that although it is supposed to exist

    
¹
Dreyfus officials had actually drawn up a contractual programme at about this time.

    

    for the benefit of smaller investors, its operators make more money the larger the average holding of the clients. This is because it costs just as much to administer a small account, as a large one. Several methods have been devised to persuade small investors to make larger deposits, and the most potent -which dates from 1930 - is the 'investment programme', or 'contractual plan'. The investor is persuaded to make, not just a single investment, but to pay a regular monthly sum for ten or fifteen years. Mutual fund organizers say that this makes the benefits of stock market investment available to even the most limited incomes, because it makes a smaller initial payment possible. That may be so, but the programme arrangements are so often so complex that the customers do not understand just how much of what they pay over is taken in charges. When they were introduced in the Thirties, 'programmes' involved some truly horrendous abuses. Not only did companies compute inflated charges for themselves: they extracted, in the small print, rights to take these charges out at the beginning of the programme. Sometimes they took the
whole
of the first twelve monthly payments in charges, so that an investor trying to 'redeem' after making his first year payments would get
nothing
back.

    Thus was created the notorious 'front end load'.

    Congress then fixed a maximum charge, something never done for any other kind of shares. It was laid down that no more than 9 % of the total money paid over to complete a programme could be extracted in charges. Further, mutual fund companies were prevented from taking more than half of the total charge out of the first year's payments. Even so, when the Wharton School of Business made a survey for the sec in 1962 they found that about 40% of us mutual fund buyers had not understood the effect of the 'front end load' on their investment.
¹
The thing people find hardest to grasp is that mutual fund sales loads are not a percentage of the sum invested - as are stockbrokers' commissions - but are charges removed before any money is invested. Therefore, in the early stages of his programme the customer is putting up nearly as much money to pay off the salesman as he is actually investing for his own

    
¹
Special Study of Securities Markets, sec 1964. Vol 4, page 107.

    benefit - and if he has to redeem, he will get back less money than he has paid over.

    The effect of this is to add greatly to the risks of investment for the small investor, because he can very easily lose money even when the market is going up. It is hard to assess the workings of these risks, even within the regulated us industry, because the relationship of purchase time to market movement is so complex. Still, in a set of ten-year programmes which ran from 1951 to 1961 - a period in which the market went up 175 % - nearly as many investors came out with losses (24.1%) as came out with profits (27.4).
¹
The majority of investors continued payments, so their fortunes could not be pronounced upon. Of course anyone taking out a new programme in 1961 would have been ideally placed to be hit by the front end load
and
the market break of 1962 during his first year's payments. And the remainder of the decade afforded numerous opportunities for redeeming at a loss. (The sec has proposed the abolition of the front end load, but so far, without result.)

    Bernie Cornfeld clearly grasped at a very early stage the dramatic effects of a front end load in generating commissions out of the money available for investment at any given moment. It worked in this manner:

    An IOS salesman, ego tucked firmly into his pocket, enters a 'prospect's' home, and persuades him that if he pays over $3,000 today for an investment in the Fund of Funds, he will get back $9,000 in ten years' time. If the prospect pays up, a sales charge of $255 dollars is cropped off his money, of which $195 goes to the salesman (less any overrides to which he may be subject) and $60 goes to IOS.

    The prospect may be deeply moved by the 'presentation', by the wonders of Fund of Funds concept, and by the bounding Wall Street market. (Between the end of 1962 and the beginning of 1965, the great years of the Fund of Funds, the Dow Jones climbed almost without faltering from 650 to the magic 1000, and the IOS men were all equipped with charts which showed FOF ascending yet more speedily.) But the prospect still might say: ‘I don't have three thousand bucks, I've only got a

    
¹
Special Study.

    hundred.' If the salesman takes the $100 as an outright payment, he will earn only $6.50 for his evening's persuasi