Do You Sincerely Want To Be Rich? (43 page)

    The launch of the Gramco Management shares was managed by E. D. Sassoon, and by Credit Commercial of France. The price of $10 per share was underwritten by seventy banks and the list included many distinguished financial names. From London, there was the Westminster Bank, one of the 'Big Four' British banks; there was Reginald Maudling's firm, Kleinwort Benson; there was S. G. Warburg, Samuel Montagu, and N. M. Rothschild and Sons (the London Rothschilds). There were big Wall Street names, such as Loeb, Rhoades and Bear, Stearns & Co. There was Julius Baer International Ltd., controlled by the biggest private bank in Zurich and there was Banque Lambert of Brussels, who had once declined to act for IOS's 'International Investment Trust'. There was Fleming-Suez, representing the combination of the Compagnie de Suez with the fortune of Robert Fleming, pioneer of the investment company. There was Banque Rothschild from Paris, the Berliner Handels-Gesellschaft, Slavenburg's Bank from the Netherlands, the Vereins-bank from Hamburg, and 53 more. All of them were able to take up Gramco Management shares at $10 less the underwriters' discount of twenty cents, and resell them almost instantly. At one point these Bahamian shares, face value $0.50 were trading at $20 each.

    Eighteen months later, they were worth $2, if you could shift them. But that was after the hurricanes had blown through the offshore world. At the time it was done, the cashing-in of Gramco was a triumph. It gave an air of credibility even to the absurd Hoffman, who, it was thought, might manage some similar feat. It cast some magic on almost every one of the 750-odd international funds that were listed in the Fund Guide directory, from the Antilles Mutual Fund of St Thomas, Virgin Island, to the Casino Fund of Curacao, to the International Whisky Fund, conducted by Highland-Dunes Scotch Investors, of Great Neck, ny.

    But for IOS men, it was galling to have to watch Gramco sprint from launch to cashing in within two and a half years. And what made it worse was the knowledge that Barish and Navarro owed much of their credibility to the very existence of IOS.

    One effect on IOS was to make Cowett and Cornfeld search even more eagerly for new investment devices, ones that would rival the astonishing proposition which Gramco was offering the customers. The threat of being outbid in the offshore competition forced IOS to look for yet bigger, and therefore yet riskier, advantages to offer to its prospects. In the offshore world, if someone offered the investors the moon, you had to offer them the sun.

    Also Gramco shook IOS confidence because a lot of IOS salesmen had been waiting, impatiently, to 'cash-in' with their shares. They were angry that someone else should get in ahead - and it was clear that unless IOS men were able to cash in soon afterwards, the bonds of loyalty might start to fray. (In 1967, IOS had to damp down impatience by offering to buy back 10% of any shareholding at the 'formula price'.) How did it come about that the upstarts from the Caribbean were allowed to get to the market before the pioneers?

    It sounds paradoxical to say that this was because IOS was near to financial collapse in 1966-7. But it is strictly true: on the figures, IOS was in no condition, when Gramco made its dash, to sell off, to other than its own salesmen, the shares of the parent company, IOS Ltd (sa). That year, as IOS was tossed out of country after country around the world, sales of IOS funds fell, while the decline in stock prices further eroded what was left. Nevertheless the sheer bulk of the IOS funds remained impressive. But while even sophisticated financial minds tend to assume that where there is much money gathered, there will be profits also, this is not inevitable. There may well be no profits of the sort that can be set out in accounts and sold off in a share issue.

    When Gramco started operations at the beginning of 1967, IOS was reeling from a series of blows. The era of bold capital flight operations made IOS big - but those operations were getting harder and harder after the series of expulsions, and the loss of Brazil, the biggest market. At the same time came the trouble with the Swiss and the hasty, expensive move to Ferney-Voltaire. Rescuing salesmen, bringing them back to Geneva, and in many cases supporting them till new field operations could be mounted, was an expensive business. And there was also the costly process of bringing in James Roosevelt's lawyers and ex-civil servants. Operating expenses (as distinct from commissions paid to salesmen) took a 74% jump in 1967.

    By the end of that year, too, as we have seen in Chapter 14, IOS was giving away to the Super-general managers, one quarter of its net income from the sales operation. Revenue from sales only went up by 11 %, instead of 40 % as in the year before.

    Like many developments in the IOS saga, the Latin American disaster shows up in the history of the sales force. The force almost doubled in size between 1964 and 1965, and went up 50% in 1966. But during 1967, it only increased by 16%.

    The result of the mid-career crisis was that IOS lost money in 1967, on the item it called 'sale and management of mutual funds'. The loss was quite small - $635,000 - but it was only recouped by the profits of the insurance companies, the banking operations, and by the revenues IOS appropriated from the FOF Proprietary Funds system. This last came largely from 'performance fees' - ie IOS's slice of capital gains made with the fund money, rather than the regular fee for managing the money anyway.

    Sales volume expanded again as soon as the machinery of stock options and overrides could be applied to new markets. And the rate of increase of the sales force recovered also: it was 28% in 1968, and was running at 50% in 1969. The great discovery, of course, was Germany, and by 1968, the sales, in terms of cash and commitments together, had risen to $1.7 billion, with an even more astonishing rise in 1969 to $3.2 billion. But sales volume alone, especially in terms of 'face value' of programmes sold, would never make IOS Ltd itself enormously wealthy, because the greater part of the revenue from sales loads would always go to the salesmen in commissions.

    Indeed, the simple expansion of sales carried great dangers, because as time went on the override system became more and more heavily laden with sales bosses, drawing large sums of money on other people's commissions. Between 1967 and 1969, the percentage of sales charges going in commissions rose from 61% to just over 70%. As IOS's Canadian brokers, J. H. Crang & Co. put it: 'The progressive build-up of a structured sales organization involving multi-tiered management levels increases the proportion of total volume subject to maximum commission rates…'

    Yet even if the sales expansion was becoming progressively more dangerous, there was no possibility that it could be controlled - at least, not before 'the Apocalypse', as IOS men later called the events of 1970. By the latter Sixties the working of the stock option plan had put powerful blocks of IOS shares into the hands of men whose personal income was related very precisely to the sheer volume of sales. Towards the end, in early 1970, there was an attempt to have a 'self-denying ordinance', under which personal commission incomes would be limited to $250,000. But even though the roof was falling in by then, the idea was killed by the sales bosses. And in the logic of sales, they were right, because the whole motivational structure depended upon the idea that any sacrifice was worthwhile to achieve an override structure: that if you sincerely wanted to be rich, you could win a source of wealth which would be limited only by the size of the new markets you co

compensate for the cost of the sales force? It was only a question of organizing the right leverages.

    One basic approach was to search for exciting short term capital gains with the funds, and appropriate 'performance fees' as a reward. This was done at first by putting money into stock market operations, under conditions which virtually forced the managers to speculate.
¹
When it became harder and harder to wring short term capital gains from the stock market, IOS reacted in several ways.

    One was to launch a new stock market operation, which was frankly labelled as involving 'more risk' than previous ones. The new vehicle was Venture Fund (International), launched in April 1969, partly as a response to salesmen who were clamouring for a new vehicle to sell, because they were worried by the rise of Gramco. Venture International quickly attracted over $100 million, and within eight months it had spent $23 million - a quarter of its investments - on unregistered securities.

    Another reaction was to get into real estate promotion, but whether from pride or caution IOS would not emulate Gramco in building an open-end fund around real estate. Indeed, Ed Cowett went so far as to expound the dangers of the practice, and said that it was because of it that he was at odds with his

    

    
¹
See Chapter 17. The Master Financers.

    

    Harvard friend Lew Kaplan, who was general counsel to Gramco. IOS's answer to 'liquid real estate' was launched on June 20, 1969: Investment Properties International, a closed-end property company, with a capital of $100 million in non-redeemable shares. Investments were already to hand for the new fund, because IOS was building a series of costly apartment blocks at Playamar in Spain and Hallandale in Florida. The idea, on the birth of ipi, was neat: the fund investors would own the developments, and the apartments in them would be sold for the fund by the IOS sales force, IOS proposed to take off a 22^% commission for selling each apartment - and on the $46 million involved in the biggest development, The Hemispheres in Florida, that came to a handy $10 milhon for IOS. Out of that, expenses had to be paid, but it was action that even Gramco could hardly sneeze at. The company's own auditors pointed out that this was twice the going rate for such commission. And Martin Seligson, who was in charge of IOS's real estate operations, asked his lawyer to make sure that the level of commissions could be hidden from the buyer.

    Although the ipi shares were received with heated enthusiasm by the sales force in summer 1969, the operation was predicated a little too heavily on there being no limit to the numbers of wealthy Americans anxious to rent retirement homes in the sun owned by the unsuspecting Germans, Lebanese and other IOS customers. The shares did not take long to become virtually unmarketable, and few of the customers can have made much money from their association with ipi. Martin Seligson, who also ran ipi, had happier experiences - especially in connection with the Florida land bought by the fund.

    Next door to the Hemispheres in Hallandale, there was a tract of 173,000 acres of unimproved inland waterfront called the Waterways. A 60 % interest in this land was owned by ipi, and the other 40% was owned by certain 'junior partners', including Martin Seligson, chairman of ipi itself. (Seligson explained that when he joined IOS as a real estate expert, he arranged with Cornfeld that he should be allowed to participate personally in such developments as he fancied.) In early 1970, ipi decided to buy out the junior partners whereupon Seligson made a profit of $80,000 on a $110,000 investment. 'Things like this can be made to sound terrible,' says Seligson, 'but I disclosed my interest. Everybody knew about it.' The value, he maintains, was independently determined.

    Everybody did not include the shareholders. The transaction was not thought worthy of mention in ipi's 1969 report - which indeed, did not even reveal the existence of minority interest holders in the Waterways.

    When the price of ipi shares began to collapse in the fall of 1969, IOS's stern line on the evils of liquid real estate first wavered, then broke. The open-end Fund of Funds began to buy up ipi shares in an attempt to keep up the price, and so FOF acquired in short order nearly half of all the ipi shares. Thus real estate holdings were stuffed into an open-end structure.

    Real estate, however, was only a sideline, although one that fascinated both Cornfeld and Cowett. Their most important response to the thirst for profits was to carry the search for 'performance' beyond the stock market. They organized a section of FOF to invest in 'communications media' and they tried to work out schemes for an art fund, and even a commodities fund which would speculate in cocoa, coffee, rare metals, pepper and so on. The commodities and art funds were still talking points when the crash came, but they did expand into 'natural resources investment' where the performance of the investments, and therefore the profits accruing to IOS, became a matter of their own heady estimates. (This is fully described in the next chapter.)

    Nothing was overlooked that could turn a percentage on the customers' money: brokerage was scooped up, and arrangements were made to make money on lending out fund securities. Although not one of the biggest operations, this was, in a way, one of the most audacious.

    It exploited the fact that a stockbroker may find himself short in a particular security, when he needs to make a delivery. This means he needs to borrow a supply of the shares, and in 1967 securities from FOF Proprietaty Ltd began to be loaned out to brokers. The collateral for the loans was cash, and of course interest was earned on the cash. If such loans - which would have been illegal for a US mutual fund - were to be made, all the proceeds should have gone back into the fund. But naturally IOS kept a slice of this income (called a 'fee for advice') for itself. Indeed, by 1969 the system was refined, and the fund 'agreed to make its securities available for loans' to an IOS subsidiary. The IOS company then held the collateral when brokers borrowed the securities: so, in effect, IOS transferred fund money into its own hands. By this time, IOS was keeping for itself more than a third of the proceeds from the operation, getting on for $1 million a year.

    But the great hope and opportunity lay in the grandiose plans for investment banking, the ultimate expression of Cornfeld's dictum that 'if you want to make money, don't horse around with steel or light globes - work directly with money.' This was what lay behind convoluted deals like Commonwealth United: the idea that the IOS investment banks could underwrite gigantic financing operations, and take heavy fees for doing so, in the knowledge that the power of the IOS funds lay behind them to guarantee underwriting success. Something like a third of all the value of the bond issues underwritten by the IOS banks found its way into the investment portfolios of the funds. More bluntly: the customers' money was used to float securities which were promoted by Investors Overseas Services itself.

    When the market, after its long hesitation, collapsed at last, the securities which the IOS banks had promoted were revealed, as one watcher in Geneva put it, to be 'an unparalleled set of dogs'. Still, in the short term, the policy paid off. Profits from the banking subsidiary, IOS Financial Holdings, were under a million dollars in 1966. They doubled in 1967, to $1.6 million, and more than doubled in 1968, to reach $3.4 million. In the first half of 1969, they seemed to be on their way to something like $10 million. Just at the moment when the sales operation was about to become hopelessly uneconomic, the banks saved the day. By early summer of 1969, even though Gramco had stolen a march, IOS Ltd (sa) was able to present itself, for a moment at least, as a fairly orthodox corporation making substantial profits.

    It was a finely poised moment, IOS could not have cashed in before 1966, because the international financial community was still suspicious of the offshore game. The latter part of 1969 was the first moment that cashing in became possible: but it was also the last. The short term problems were the greed of the sales bosses, and the consequences of speculation. There was also, however, a problem of a more general nature.

    The end of the first decade of the IOS Investment Programme was now in sight, when large batches of ten-year programmes would reach pay-out stage. Nobody who was aware of the set of charges which had been applied to those programmes could be confident about the reactions which would follow. Proceeds from those charges had gone to support the lavish and erratic administration of IOS, and to help provide capital for IOS banks, insurance companies and real estate ventures. The search for performance had in part been an attempt to find gains such as would cover the effect of the charges. It had succeeded only partially, and time was running out.

    Nevertheless, in the last blue summer of the offshore years, the great ramshackle golden galleon was still afloat, and still had steerage way. It should be possible to sell off a part-interest in her fortunes, and experts were invited aboard to sound the well.