New York Times quotes Brian Smiley on investment scams.
An investor stampede for mutual funds that invest in “Republican” investment plays? A brokerage firm that cleans up selling its underwritings of Chinese cellular phone companies to United States municipalities? Where will the financial scams, disasters and embarrassments of 1995 be found? And will the D-word — derivatives — stay in the headlines? Derivatives disasters no doubt will continue, the pros say, as will misleading enticements to investors who log on to the financial screens of on-line services.
But, “I promise you there will be a new scam in 1995, because there is one every year,” says Michael Stolper of Stolper & Company in San Diego, who evaluates money managers for rich people. And where might the blowups and shady dealings of 1995 be? The pros came up with their best bets:
- Precious metals scams. Mr. Stolper says it is a no-brainer to predict that investors will be getting cold calls from boiler-room operators pushing the ultimate inflation-avoidance play: gold, silver, and diamond mining companies. “The world is really negative on stocks and bonds,” he says, “and with the Fed raising rates, you can write a pretty good script that plays on the idea that Alan Greenspan knows something” about a looming inflation crisis.
Watch for cold-callers who tell a tale of a great supply-demand picture boosted by everything from the hoarding of gold in Asia to the inability of mines to get production at full throttle. “Whether it’s futures, commodities, options on futures, or some piece-of-garbage company that trades in Salt Lake City, you’ll see the boiler rooms selling the idea over the phone,” he says.
- Initial public offering blowups. The casualties are already being counted, but the real carnage is yet to be seen, says money manager David Dreman of Dreman Value Management. In 1995, “all these sizzling new concepts and funds” will be further humbled, and investors further educated, Mr. Dreman says.
Mr. Dreman is expecting the worst from the companies that went public in 1993 and early 1994 and played on the stories of the day: health care, the information highway, and emerging markets. He says investors were particularly vulnerable to “anything to do with China,” seduced by the notion that a billion Chinese would be suddenly among the world’s consumers. And indeed, “there are billions of Chinese ready to buy something,” Mr. Dreman says, “it’s just that they don’t have any money.”
- Mutual fund surprises. For years, the hard work for mutual fund managers has been finding something to buy. But do they have what it takes to choose what and when to sell? Don Phillips of Morningstar Inc., which evaluates funds’ performance, says fund managers will learn lots about selling in 1995 — particularly the selling of securities in bond and emerging markets funds that have already suffered heavy losses.
And when they do sell, they could lose more than expected because of the glitches in the “matrix pricing” of the securities held in funds. Matrix pricing is the use of computer models to put a price on securities that do not trade very much, allowing funds to set a dollar value at the end of each day’s trading. But those prices are “a best-guess estimate,” Mr. Phillips adds, and 1995 may be an ugly test of the “guesstimates.” If the estimates have been too high, the losses will be an unhappy surprise.
- Stock churning. Investors have caught on to the pitfalls of limited partnerships. They’re even getting wise to the game of mutual fund churning — taking clients in and out of funds and collecting a fat but largely hidden commission with each transaction. But, perhaps, they have already forgotten the lessons of old-fashioned stock churning, in which brokers buy and sell at rapid speed to drum up commissions.
“I’m seeing more flat-out stock-churning cases,” says Brian Smiley of Page Gard Smiley Bishop & Porter , an Atlanta law firm that represents small investors. “Now that it’s not too fashionable to take a large commission bite at one time with one exotic investment, investors are getting nibbled to death with lots of little transactions.”
- Fee scams. As expectations for stock market returns get lower, investors are hearing a pitch to pay for aggressive money management rather than buy and hold, Mr. Phillips says. That increasingly means wooing investors into wrap accounts, in which investors typically pay fees of 2 percent of their assets each year to have someone move their money among individual stocks and bonds and mutual funds.
Mr. Phillips is concerned that investors will wind up paying double fees — as much as 2 percent to the management of the fund, and another 2 percent for the wrap account guru who decides which funds to buy and sell. Considering that even optimists are making predictions of 6 percent annual gains for the stock market, the money managers had better select brilliantly or investors will barely break even.
But investors are falling for it, says Mr. Smiley, the lawyer, who recently attended a seminar pitching wrap accounts that used mutual funds. One manager there boasted that his impressive returns were accomplished with “no risk,” recalls Mr. Smiley, who has his doubts about the claim. Others in the audience were less cynical. “At the end, a woman raised her hand and said she wanted to express her appreciation for the wonderful, clear presentation,” Mr. Smiley says. “I thought to myself, ‘I wonder if I’ll be seeing her in my office in the next couple years.'”
By Susan Antilla