Read an Excerpt
A Warning to Investors from Mr. Bernard Cornfeld
In which we introduce Bernard Cornfeld in the role of international economic statesman and give a preliminary statement of the real nature of Investors Overseas Services.
It was Bernard Cornfeld's declared ambition to make Investors Overseas Services the most important economic force in the Free World.
The game was mutual funds. Thousands of salesmen, calling themselves "financial counselors," combed the earth for people's savings, and put them into the funds which IOS managed, creaming off enough in the process to make the most successful of them wealthy men.
Mutual funds in themselves are an old and well-tried form of investment. A special variant was that IOS was the biggest and best-known of the "offshore" funds. That meant that these funds, and the companies that managed them, were carefully registered and domiciled wherever in the world they would most avoid taxation and regulation. There was nothing new about that either.
What was phenomenal about IOS was its success. On the foundation of its offshore mutual funds it built up a complex of banks, insurance companies, real-estate promotions, and every other kind of financial institution you can think of. "Total Financial Service" was the slogan. By the end of the 1960s, Cornfeld's men had a shade under two and a half billion dollars of other people's money to manage, and Cornfeld was publicly announcing plans to push that to $15 billion by the mid-1970s.
By the end of the 1960s, IOS had also made a fortune valued at over $100 million for Bernard Cornfeld personally. It had made around a hundred of his associates millionaires as well. Cornfeld was the most talked about financier in Europe since the Great Depression, and IOS was insistently--and on the whole successfully--asserting the right to sit at the golden table of the world's most respectable financial institutions.
The only trouble was that IOS was not a respectable financial institution. It was an international swindle.
That is not a word which should be lightly used about any organization, let alone one which acquired control over more than two and a half billion dollars of other people's money. We must, therefore, explain precisely what we mean by it.
IOS was the creation of Bernard Cornfeld and Edward M. Cowett. Together these two men built up an organization so steeped in financial and intellectual dishonesty and directed so recklessly that it was absurd that it should have been entrusted with so much of other people's money, let alone praised for the brilliance with which it was managed.
The organization which they built up has not, of course, disappeared without a trace, although the two men no longer have any say in it. At the time this is being written, men sit on the board of IOS Ltd. in Geneva who are responsible for safeguarding well over a billion dollars--which is what remains of the money that hundreds of thousands of investors were induced to part with. And of course IOS did a great deal of business which was perfectly honest in itself, and continues to do so. We have talked to many of the people who work for IOS, and there were a lot of decent, even idealistic, people among them. Few were aware of the essential dishonesty of the thing they worked for.
Most people have a good deal of difficulty in accepting the idea that a large and well-publicized international business could have been run in such a manner. "It can't be true," is the natural reaction, "because if it was true, how did they get away with it?" There are many answers to that question.
Charles Dickens suggested one, looking back on the career of the financier in Little Dorrit. "The next man," he wrote, "who has as large a capacity for swindling will succeed as well. Pardon me, but I think you have really no idea how the human bees will swarm to the beating of any old tin kettle; in that fact lies the whole manual of governing them. When they can be got to believe that the kettle is made of precious metals, in that power lies the whole power of men like our late lamented." The one thing IOS always did best was to beat the old tin kettle.
But there is another answer to the question why Cornfeld and Cowett were able to create the edifice they did. It can be summed up in the single word "offshore." By working in the interstices, so to speak, between the world's legal jurisdictions and administrative systems, they were able to do with impunity things that would have been illegal had their enterprise been located in any one place. Below are just some of the kinds of misbehavior that IOS committed under Cornfeld and Cowett:
1. Money which they said was held on trust for the customers was used to finance maneuvers for the benefit of IOS itself, its directors and employees, and their friends.
2. At many times, and in many parts of the world, the IOS sales force engaged in illegal currency transactions on a massive scale. Attempts have been made to pretend that this was somehow peripheral to the company's main activities--but as late as 1970 the IOS Board still acknowledged in their meetings that important sections of the IOS sales operations were illegal.
3. IOS consistently misrepresented the investment performance of its largest fund, and used the misrepresentation to sell hundreds of millions of dollars' worth of fund shares.
4. The basic nature of the best-known IOS fund, the Fund of Funds, was systematically disguised. It was supposed to offer the investors a diversity of investment advice. For most of the time, it did nothing of the kind--it merely charged its investors a double fee on the pretense of doing so.
5. The customers' money, in the funds, was frequently invested in unmarketable shares, and often in securities which IOS was floating for its own profit. There was a series of reckless speculations that culminated in a catastrophic venture into oil and gas exploration rights in the Canadian Arctic.
6. IOS paid itself a fee of nearly $10 million for having "revalued" those Arctic rights. Not only were the grounds for revaluation dubious, but in some cases the rights had not even been earned at the time they were "revalued."
7. As well as selling shares in the funds it managed, IOS eventually sold $100 million worth of its own shares to the public. These shares were sold on the basis of prospectuses which were misleading by reason of omission and misrepresentation.
8. Cash raised in this manner (see 7) from the public was used for the personal benefit of directors of IOS--and in the end the controllers of the company lent to themselves so large a proportion of the company's liquid cash that they brought it to the brink of collapse, and damaged the interests of thousands of their customers.
9. Ed Cowett, who had already left the IOS Board after an episode involving financial impropriety, was restored to power and given, by Cornfeld, complete day-to-day control of IOS and its system of banks and investment funds.
Bad as the particular items in this short summary of IOS's misdeeds are, they are only individual instances of a general proposition: IOS pretended to be creating wealth for the many when it was really making money for the few. That proposition will be demonstrated again and again in this book. But now it is time to take leave of generalities and to take a closer look at the remarkable figure of Bernard Cornfeld. There can be no better moment to savor the full absurdity of the contrast between the facade that IOS presented to the world, and the reality backstage, than the zenith of Cornfeld's power and reputation.
In the first week of February 1970, Cornfeld flew to New York to be the principal speaker at a conference organized by a periodical called the Institutional Investor. The invitation was a remarkable enough accolade in itself: the use Cornfeld chose to put it to was a breath-taking illustration of his nerve.
It is important to understand the setting, the occasion, and the time.
The setting was New York, the true test and only stage for success in Bernard Cornfeld's world. He had first come to the city as a child from Turkey in 1931. He was nearly thirty when he left to seek his fortune in Europe. It had been one of the proudest moments of his life when he came back to New York in 1960, as a rich man, and the New York papers interviewed him as the latest verification of the American dream. Making it in New York, he told the reporters then, was what counted. But in 1967 he had been banished from New York. Or rather, while he himself could go there as often as he liked and could cut a flamboyant figure in the East Side discotheques, his firm was banned from doing business there by order of the Securities and Exchange Commission, because of certain irregularities and deceptions. Now he was back in New York again, and with the financial community literally at his feet.
The Institutional Investor is a plump journal, whose elegant pages are not available to the general public. You may subscribe to it if you belong to a firm that is a member of the New York Stock Exchange or if you are otherwise engaged full time in the investment business. Its editor, George J. W. Goodman, is a friend of Cornfeld's and has written for the IOS magazine. But his chief claim to fame is the authorship, under the pseudonym Adam Smith, of the best seller, The Money Game, in which he described the antics of the new generation of Wall Street money managers. He called them "the gunslingers" and it was a good name, because they brought to the responsibility of managing other people's money roughly the degree of prudence which cowboys brought to town on a Saturday night in the Old West. (It should be said that Goodman was not especially wide-eyed about the atmosphere he described, but the market was still buoyant when the book came out, and the customers were more amused than alarmed.)
Naturally, there were "gunslingers" among the "institutional investors" who gathered to hear Cornfeld on February 4. Not that it was in any sense a disreputable audience. Far from it; all who were there were citizens of the highest probity and reputation--as Wall Street measures those values. It was a gathering of men, and some women, who were collectively responsible for managing tens of billions of dollars of other people's money entrusted to the insurance companies, pension funds, and mutual funds which they advised on investment. But where the word "institution" in New York, in a financial sense, had once carried connotations of staid conservatism, by 1970 many "institutional" investment professionals were committed to "aggressivity," "performance," and the other slogans and catchwords of the peak market years. Risks which had seemed daunting ten years or even five years earlier now seemed commonplace. For twenty years, share prices on Wall Street and indeed on most other exchanges in the world had risen with only brief interruptions, and there was a growing confidence that they would go on rising forever. "These guys," reflected one old Wall Street reporter, "really thought they had repealed the law of gravity."
By the time Bernard Cornfeld appeared before them, it is true, this professional optimism had been considerably shaken. The market had passed its peak, with the Dow-Jones index a fraction above the magic 1000 mark, just over a year before; and since then it had fallen by an uncomfortable 15 per cent.
That was not, in itself, a disastrous decline. What was more worrisome was that the particular category of stocks on which the institutional professionals had put their main hope of getting the all-important "performance" had begun to slither down faster than the index or the market as a whole. There were the jerry-built "conglomerates," piled up through takeovers mainly paid for with inflated paper. Many of them were collapsing like so many card houses.
Among the more intelligent of Cornfeld's listeners, therefore, there was a sense of unease about the market. But prices had only slipped. They had not yet crashed, and the fashionable attitude was to see what had happened as a minor setback. Few of them seemed to have any serious forebodings about the market; fewer still saw anything fundamentally wrong in the feverish atmosphere and gunslinging techniques of the Great Bull Market which--though a very few were willing to acknowledge it--had now come to an end at last. It was easier to look for scapegoats and, for this mood, Bernie Cornfeld was their man.
With a salesman's flair for divining what an audience wants to hear, Cornfeld plaited his speech out of two themes. One was Messianic confidence about the potential glories of the market. And the other was denunciation of the agency which he blamed for the market's immediate difficulties: none other than his old antagonist, the Securities and Exchange Commission.
Short, plump, with a wide mouth, Bernie Cornfeld speaks in private for the most part in an intense whisper. On the platform, his manner is evangelical and his language grandiloquent. "I am convinced," he told the Institutional Investor's conference, "that the American securities business is at the heart of what makes this country vital and dynamic." The years of the bull market, he said, had seen "an extraordinary creative development of new ways of marshaling the money which is the lifeblood of enterprise." He did not stop to say whether he was thinking of the conglomerate, the offshore mutual fund, or the hedge fund, or which of the other new ways of marshaling money looked rather less creative today. He swept on into a passage of prophetic eloquence.
"This is the promise," he declaimed, "that everyone who is willing to work and to save can participate in economic development. . . . That the dream of a more equitable distribution of wealth can be realized within the structure of the free-enterprise system. It is also the promise that the dynamism of our economy will result in the knitting together of the shattered bits and pieces of our society. . . . This is why I am convinced that what is good for the American securities industry is good for the country."
But then he turned to his second, less optimistic theme. His own company, he predicted, would have $15 billion to invest by 1975. In the past, it had invested overwhelmingly in Wall Street. But now he could give no guarantee that this would continue. "From our vantage point in Europe, we sense a malaise within the investment community here. . . ."
What was the cause of that malaise? Fear that the market might continue to fall, as it had been falling for about a year? An uneasy recognition that much of the rise in the market in the last years of the boom had been due to reckless speculation in largely worthless paper? Nothing could have been further from Cornfeld's mind. He spoke of the Vietnam war, of the decay of great American cities, of the alienation of the blacks, and of atmospheric pollution. It was not too much to say, Cornfeld thought, that America was in a state of crisis. And it was at this moment that the Securities and Exchange Commission had chosen to make its spring. The SEC, he said, had "adopted the simple device of attacking virtually every sector of earnings in the securities business. And a weak, unprofitable securities business means a weak, unprofitable market." The point had been reached, he said, when "the public interest seems to be the least of all considerations when the Commission moves into action."
From the Trade Paperback edition.