a warning to wall street amateurs

8/13/2019 A warning to wall street amateurs

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A W ARNING TO

W A LL STREET

AMATEURS

PETER B. BART

Dreams of the affluent society and the space age

-plus an old-fashioned urge to gambLe-have

brought hundreds of thousands of greenhorns into

the stock market .... Many of them are behaving

so foolishly that they scare even the old pros.v

ONE of the more popular stories making

the rounds of W all Street saloons this

spring concerned the fellow who called his

broker and asked him to buy four hundred

shares of a company called Ultrasonics Precision.

When the broker asked whether his customer

knew anything special about the company the

customer replied: "My barber told me to buy

it-he's given me some good tips lately."The transaction was completed, but two weeks

later, after the next haircut, the customer called

again. "I was all wrong," he said. "My barber

recommended Ultrasonics Industries, not Ultra-

sonics Precision. Sell Ultrasonics Precision and

buy me the right one." The broker did as di-

rected only to find that his customer had cleared

an $800 profit on the "wrong" stock.

The story, and its several variations, may be

apocryphal, but, like most such tales, it tells

something of the tenor of the times. And the

tenor of the times on "Vall Street these days

is deeply disturbing to many thoughtful finan-

cial men because there are too rna ny barbers

and friends of b arbers acting exactly like the

people in the story.In short, Wall Street is worried abou t t he

I .

growing role of the small 'speculator in ioday's

market. It was this sort of worry that led Keith

Funston, the tall and august Presiden t of the

New York Stock Exchange, to flash a warning

signal early this spring. Addressing the public

in t he manner of an impatient parent who had

just caught his child with a hand in the cooky

jar, M r. Funston intoned: "There is disquiet-

ing evidence that some people have not yet dis-

covered that it is impossible to get somethingfor n othing." A month later he warned: "The

behavior of the public makes a mockery of the

word 'investing'."

What triggered Mr. Funston's warnings was the

sudden speculative fever that swept the market

in March, April, and May. Volume soared to


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22 WARNING TO WALL STREET AMATEURS

record levels, the Dow-] ones industrial average

hit a new high, standing-room-only crowds sud-

denly materialized at many brokerage-house

board rooms, and, in the words of one broker,

"people raced around buying stock as if they

feared there wouldn't be any left the next day."

The sudden mass enthusiasm for the stock

market was attributed to several factors-the ap-

parent end of the recession, the change of Ad-

ministration in Washington, the prospect of

further inflation. But it also reminded Wall

Street of. an important change that has taken

place in the securities business in recent years-

namely, that the stock market has become a mass

market. Although Wall Street has worked hard

to bring about this change, it knows remarkably

little about the new "monster" that it has created.

How will the mass market behave in periods

when significant gains in the economy appear in

the offing? How will it respond to sudden down-

turns' and' disappointments? Will it be able

to contain its speculative surges? No_one pre-

tends to know the answers to these questions,

but many analysts are extremely apprehensive

about what the answers may turn out to be.

"We may be about to witness a phenomenon

once deemed inconceivable-a wave of mass spec-

ulation that would have been impossible in the1920s," said Bradbury K. Thurlow, vice presi-

dent and treasurer of the Wall Street firm of

Winslow, Cohu and Stetson, Inc. "The 1929

boom may actually have been only a trial run

for the one now apparently getting under way."

Mr. Thurlow pointed out that in 1929 only

about 1,500,000 people owned common stocks

while today the number of share-owners is esti-

mated at fifteen million. The big brokerage

houses, noting that the number of stockholders

has doubled in less than ten years and that newaccounts are openinp' at ~ '--;LDJrI t'1t~ F-" r ,-

" , '._ ,~ "'" n H' '" ....1.' hVpe lor

a share-owning population of perhaps thirty

million in another five years or so.

The problem with a speculative boom in this

sort of mass market, say Mr. Thurlow and many

other analysts, is that it would inevitably lead

to a spectacular bust-a bust which could destroy

millions of investors as well as speculators and

As a financial reporter on the "New York

Times," Peter B. Bart has been watching the stock

market become a supermarket. He is a Swarthmore

graduate who studied also at the London School

of Economics and has done financial and general

reporting for the "Wall Street J ournal" and Chicago

"Sun-Times."

give the market a "bad name" for at least an-

other generation.

This is a disquieting prospect for Wall Street

leaders who have struggled long and hard to

enhance the stock market's "corporate image."

Thanks to their efforts and expenditures, the

symbolism of the bucket shop and the back-

room manipulator has been banished, and a

new aura of gray-flannel respectability now sur-

rounds the stock market. It is this structure of

confidence and respectability which the outbreak

of mass speculation threatens, and that is why

Wall Street is uneasy.

NO MATTER WHAT,

IF IT'S NEW

AL THO UGH the speculative fever hasaffected all facets of the securi ties busi-ness, it has focused particularly on small,

relatively unknown companies-especially com-

panies selling stock to the public for the first

time. So strong has been the swing to the little

companies that some analysts have labeled it

"the revolt against the blue chips,"

The "new issues" were a fit target for specu

lation. For one thing, companies selling stock

to the public for the first time generally issuea small amount of shares. And because there are

so few shares in the hands of the public the

price can be driven up even by a minor surge of

interest. Moreover, the new shares usually are

issued at prices designed to attract investor in-

terest. In a bull market, these often are bargain

prices indeed.

Finally, many of the new companies "going

public" are in space-age industries and bear such

melodramatic names as Datamation, Electro-

Sonic Laboratorier, ~1eetr5iitl'S' ~~ss'h~sCom-'pany. Corporate names like these have pull in

the market. (Agricultural Equipment Corpora.

tion, a manufacturer of weed burners, re-

cently changed its name to Thermodynamics,

Inc., prior to issuing stock.)

As a result of these various faotors, brokers

have been besieged by customers demanding

shares in the new issues, and the prices have

taken off like rockets. Companies like Packard

Instrument, Renwell Electronics, and Pneumo-

dynamics have doubled within days of the stockissue. Stock in Alberto-Culver, a small producer

of hair tonic and shampoo, was issued at $10

and soared almost immediately to $25 a share,

Shares in one company bearing the .non-space-age

name of Mother's Cookie Company leaped from

$15 to $25 within forty-eight hours. Cove Vita-


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min and Pharmaceutical went from .$3 to $60 in

three months.

"My customers don't even want to know what

a company manufactures or what its earnings

prospects are," said one young Wall Street broker."If it's a new issue they want it, whatever the

case."

Some Wall Street firms have tried to cool

the ardor of their customers. White, Weld and

Company refused to open accounts for customers

who were interested solely in new issues. Merrill

Lynch, Pierce, Fenner and Smith made a sur-

vey of forty-six companies that had issued stock

during the 1945-46 new-issues boom, and found

that only two of the companies now are selling

above the offering price.

These efforts in general, however, were with-

out much effect. "In this kind of situation a

broker is like a prostitute," reflected a high

official of one old-line Wall Street firm. "If we

turn away any business we know darn well they'll

just take it elsewhere."

The basic problem with a new-issues boom,

however, is that it tends to be self-propelling.

Public enthusiasm for the newly issued securities

encourages more companies to bring out stock-

thus there are more new securities registration

statements before the Securities and ExchangeCommission at this time than ever before in that

agency's history. Meanwhile, prestige under-

writers who formerly snubbed smaller issues have

suddenly developed a fondness for them because

of the profits involved. And the small specula-

tor is encouraged all the more to dive into the

new-issues market because he sees such distin-

guished firms backing the shares.

CULT OF GROWTH STOCKS

AN 0THE R reason it is difficult to bringorder to the new-issues boom is that mostnew offerings first appear on the volatile over-

the-counter market, where they are harder to

control than on the exchanges. In fact, it is

here that the most frenzied speculation has taken

place not only in new issues but in established

stocks as well.

The over-the-counter market is something of

a misnomer, since there is no counter and no

clearly defined market-that is to say, no central

place where the shares are auctioned off as in the

case of the New York Stock Exchange or the

American Stock Exchange. The so-called "mar-

ket" consists of some five thousand dealers in

offices scattered all over the country, each of

whom has a battery of phones and a nervous

BY PETER B. BART 23

stomach. Nonetheless, it is the nation's biggest

mechanism for trading securities, with five times

as many stocks regularly traded as on the "Big

Board" of the New York Stock Exchange. It has

long served as a proving ground for small com-panies as well as a pleasant retreat for established

concerns which shy from the publicity surround-

ing the major exchanges or don't want to dis-

close data required to attain a listing on the

exchanges.

However, as a result of the fad for new issues

and the general surge of speculation in relatively

unknown companies, the apparatus for over-the-

counter trading has been strained to the break-

ing point. Dealers in over-the-counter securities

use words like "fantastic" and "unbelievable"

to describe their volume of business, and many

say that they made more money in commissions

during the first quarter of 1961 than during

all of 1960.

If many of the old timers on the over-the-

counter market have been awed by the tre-

mendous volume, they've been equally aghast

at the way in which the public has cast aside

the tradi tional yardsticks used in evaluating

stocks. These yardsticks involved such consid-

erations as the dividend yield (5 per cent was

considered reasonable) or the "price-earningsratio"-the relationship between a company's

earnings and the price of the stock. (1 a stock

sold at more than ten or twelve times the com-

pany's earnings, many brokers used to consider

it overpriced.) In today's market, with attention

focused on so-called growth stocks, people clamor

to buy stocks which have no yields and sell at

fifty or one hundred times earnings. Thus in

May IBM was selling at 75 times earnings, Po-

laroid at 95 times earnings, and Fairchild Cam-

era at 60 times earnings."It's possible to .argue that the IBMs and

Polaroids are well worth their current price,"

notes Stephen H. Weiss of A. G. Hecker and

Company. "But in a market like this one the

good growth stocks tend to cast their aura of

glamour around dozens of small, unseasoned

companies operating in roughly parallel fields.

The result is astronomical and unjustified prices

[or unknown, unstable stocks."

The cult of the growth stock traces its origins

to several sources. For one thing, it's in keeping

with the speculative spirit of the times. For an-

other, most people in the upper tax brackets

prefer to maneuver among the esoteric, low-

yield growth stocks and pay a capital-gains

tax limited to 25 per cent rather than pay higher

taxes on dividend income. Finally, investors


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24 WAR N 1N G TOW ALL ST R E ETA MAT E U R S

fig-urethat the growth stocks hold out the bright-

est prospects for short-term appreciation rather

than the once-popular but sluggishly perform-

ing "blue chips."

The growth-minded mood of the current mar-

ket was effectively, if unintentionally parodied

not long ago by comedians Lou HoItz and Jack

Paar when Mr. Holtz confided to Mr. Paar on a

national television show that he owned a stock

listed on the American Exchange which would

move from $10 to $1,000 in ten years. The follow-

ing day was a memorable one for the Exchange's

$10 stocks. The favorite with the television-

minded speculators was a company named MPO

Videotronics, and trading in that stock couldn't

be opened until a few minutes before the close

because of a rush of buy orders. Alas, the com-pany proved to be a double disappointment.

To begin with, it wasn't the stock Mr. Holtz

had in mind; and its principal product turned

out to be television commercials.

As one Wall Street analyst commented on the

whole episode, "Never have so many people in-

vested so much money so stupidly."

TIGHTENING THE SCREWS

THE Jack Paar-Lou Holtz incident washardly the only case in which stocks sud-

denly took off under mysterious circumstances.

In this case, of course, the underlying cause

seemed to be innocent enough. In a number of

other cases, however, the suspicion of manipula-

tion hung over the market.

There is no way of knowing how much old-

fashioned price rigging takes place in Wa 11Street

today, i.e., the creation of an artificial demand

to buy or sell a stock by influential insiders.

Some financial men scoff at the idea; othersinsist, however, that price rigging persists to an

alarming extent and is a very real threat to

public confidence.

The position of the latter group would appear

to gain credence from several recent actions of

the Securities and Exchange Commission against

prominent Wall Street firms. The most spectac-

ular case involved charges of massive rigging

and illegal distribution of $10 million worth of

securities. In May, these charges resulted in the

expulsion of Gerard A. Re and his son, Gerard

F. Re, from the American Stock Exchange. Re,

Re and Sagarese at one time was one of the

largest specialist firms on the American Ex-

change.

The Re case aroused a great deal of comment

[or several reasons. For one thing, it was the

first time since the establishment of the SEC

in 1934 that the agency had taken action against

a specialist. The specialist's role is a pivotal one

on the exchanges, since he is charged with the

responsibility of maintaining an orderly auction

market in those securities assigned to him.

Moreover, one of the many prominent men

who had been victimized by some of the Re deals

was Edward T. McCormick, president of the

American Stock Exchange.

As part of its crackdown on market manipula-

tion, the SEC announced that it would undertake

an investigation of the American Stock Exchange.

Meanwhile, it brought disciplinary action

against Bruns, Nordernan and Company, for

manipulating the price of shares in Gob Shops

of America, a small chain of Rhode Islandstores, and against an underwriter, R. A. Hol-

man and Company, on charges of holding back

shares in a stock sale in order to create an arti-

ficial demand. The SEC also warned under-

writers against so-called "tie-in sales" in which

newly issued securities are sold on condition that

the buyer later will purchase an additional

amount on the open market.

While the SEC was cracking down on some

of the more blatant market malpractices, the

exchanges also were tightening the screws inother areas. The New York Stock Exchange, for

example, recently stiffened its requirements for

getting a stock listed. The New York and Amer-

ican Exchanges have stepped up their so-called

"stock watching" activities, in which staff mem-

bers quietly investigate situations where prices

suddenly spurt or volume soars for no appar-

ent reason. The New York Exchange also re-

minded companies on the Big Board of their

obligation to disclose immediately any informa-

tion that might have an effect on the prices ofIisted securi ties.

The Big Board's warning was precipitated by

a series of incidents in which important com-

panies were especially obvious in "leaking" in-

formation in advance of official announcements.

One big electronics company, for example, took

groups of reporters and security analysts out to

see an important new computer several days

before the story was to be released for publica-

lion. The visits generated sufficient rumors to

push up the stock by five points during the two

days immediately preceding the announcement.

It is this sort of practice which has given new'

currency to the old Wall Street saying: "Buy on

the rumor and sell un the news." The reason-

ing behind it is that when important news

is brewing about a company-a merger, stock


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split, or important new product-the stock will

rise until the story hits the papers and then will

decline. The effect is to put the squeeze on the

gullible investor who is impressed by what he

reads in the paper-and to increase the flocking

of lambs into 'Vall Street for shearing.Burton Crane, the stock-market columnist of

the New York Times) traced the market perform-

ances of twenty-eight companies which had an-

nounced stock splits and found that nearly all

had climbed in the weeks prior to the announce-

ment. However, far more stocks fell than rose

during the period immediately following release

of the news. Thus some cynical members of the

financial press refer to many of their stories as

"near-news" rather than news. "Near-news" is

information that has been methodically leakedto all persons who might possibly have interest

in the story and who might be in a position to

profit from advance knowledge.

The expanded role of "near-news" has coin-

cided with the growing importance of special

stock deals in that part of the public relations

industry which specializes in publicizing and dis-

tributing financial and business news. More and

more companies now include some sort of stock

arrangement as part of the total remuneration

paid to public relations agencies. For instance,many corporations grant stock options to the

PR agencies which allow them to buy stocks

at their original low prices well after they have

increased in value. The effect has been to focus

the attention of the PR people on the price of the

stock rather than on getting out the news, so that

some agencies have become "stock touts" rather

than publicists.

BY PETER B. BART 25

These practices raise deeply disturbing ques-

tions: Does the small investor or even the small

speculator get a fair break in the market? Does

he have proper access to corporate news? Is he

victimized by market riggers? When speaking

for public consumption on these questions,nearly all Wall Streeters take the position that

(a) the market is basically honest, (b) they are

nonetheless concerned lest arrant speculation or

a few well-publicized cases of price rigging may

seriously shake public confidence in the market.

"You can never do away with the 'insiders,'

and you can never get around the fact that some

people inevitably are going to know things and

profit from this knowledge while others will re-

main in the dark," said one experienced 'Wall

Street analyst. "Thus people are certainly notcompeting on equal terms in the stock market.

But, nonetheless, within this framework we must

strive to make things as equitable as possible.

In the stock market everyone should be equal,

even though some people inevitably will be a

little more equal than others."

It was the great misfortune of Dr. Irving

Fisher, the distinguished economist at Yale from

1893 to 1935, to have achieved immortality with

a misjudgment. Said Dr. Fisher in 1929: "Stock

prices have reached what looks like a perma-nently high plateau."

Not many people talk about "permanently

high plateaus" any more. Many Wall Street an-

alysts currently seem to subscribe to an economic

adaptation of Newtori's law that every action

has an equal and opposite reaction. They the-

orize that every boom runs to excess and inev-

itably generates some sort of "correction" or

"The {locking of lambs into Wall Street for shearing."


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26 WARNING TO WALL STREET AMATEURS

downturn in the market. This principle places

the analysts in something of an ambivalent posi-

tion, to be sure, since, though Wall Street thrives

on booms, it also knows that the greater the

boom, the greater may be the correction.

POISED TO RUN AWAY

AT PRE SEN T, there are fears that WallStreet .may be poised for a speculativeboom of run-away proportions and that the

"shakeout" or "correction" which will' follow

may do a great deal of damage to the investing

public.

There is much disagreement over what may

trigger the "shakeout." It could be an unexpected

diplomatic crisis in Berlin, Southeast Asia, orsome other trouble spot; or a sudden "flood

tide of corporate larceny" -::-the ruilll~~ mtlktng. ri0fcorporate .assets by high executives-which,

according to J . K. Galbraith, was a factor in

the 1929 crash; or a loss of public confidence

due to disclosures of serious manipulation, or

any number of other factors. If conditions were

sufficiently sensitive, it wouldn't require too

catastrophic an incident to set off a shakeout

since the movement of relatively few shares es-

tablishes the prices for all shares of stock. (Onlya small percentage of the total amount of stock

in existence is actively traded in the market.)

if and when a break does occur, the market

will be propelled downward by a number of

forces. For instance, insiders in companies whose

stock has only recently been issued to the public

-and has enjoyed great increase in value-may

well try to unload a good part of their holdings.

And other "paper millionaires" will no doubt

join them.

Whatever the causes, however, surprisingly fewWall Streeters are prepared to suggest steps to

ward off a "bust." In a society of mass affluence,

they reason, there's little that can be done to

prevent people from gambling away their money.

Lifting margins or curbing- the activities of non-

regulated lenders would be of little use, they

argue, because most of the speculation in today's

market takes place on a cash basis. "If the

public wants to shoot craps, there's nothing we

can do about it," says one high SEC official.

There are, of course, several long-range meas-

ures that could be taken and that have the sup-

port of Wall Street: chiefly, increased efforts to

educate the public in the economics of the stock

market and in economics in generaL Secondly,

just as investors should be better informed, so

should their brokers. The big Wall Street houses

have done much in recent years to improve the

caliber of their staffs. But there are still too many

ill-prepared, ill-educated brokers in the securities

business, who mislead their customers-if not

cheat them.

These are problems that must be tackled overthe long term. On the more immediate level,

some Wall Streeters and independent observers

favor several short-term devices to curb the ex-

cesses in the market:

1. A crackdown on the advertising placed by

some investment advisory services which make

get-rich-quick promises.

2. A further increase in the staffs maintained

by the SEC and the major exchanges to watch

for price rigging and other irregularities.

g. Continued warnings to the public by the

exchanges themselves-and even by officials in

Washington-against the dangers of excessive

speculation. (Mr. Funston issued another such

warning in mid-May.)

4. A greater effort at self-policing by the finan-

cial community in general. For instance, prestige

firms should refuse to underwrite stock offerings

for undercapitalized and poorly managed en-terprises.

5. A tightening of SEC rules governing new

issues, which would require fuller disclosure

of financial information. by companies involved,

and the certification of the accuracy of such

information for small as well as large stock

issues. (At present, no certification by account-

ants is required for stock offerings of $300,000

or less.)

6. New legislation giving the SEC strictercontrols over securities trading and over new is-

sues, enabling it, for example, to bar doubtful

companies from selling stocks to the public.

These reforms-not to mention more radical

proposals-are likely to run up against the laissez-

faire instincts of the financial community. How-

ever, there are now increased stirrings in

Washington for Congress to take a hand in the

regulation of the market. W"hether new controls

come from "Vall Street itself or from Washington,there is growing recognition that something must

be done: Having transformed the securities busi-

ness into a truly mass market, Wall Street must

now face the responsibilities which this change

entails. Whether it will or not is an open, and

urgent, question.

a warning to wall street amateurs

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