It was rewarding, but also exacting, and even dangerous work. Once they had put together the necessary stake, it made sense for the early returners to hang up their overnight bags, and finance the largest possible groups of new salesmen, to work for them, sharing their commissions through the override system. They were tired of the road, of living out of suitcases. They wanted to settle down in a lakeside villa in Geneva, a London townhouse, or a Paris apartment, and turn themselves into bankers, executives and gentlemen of means.
That was the beginning of Phase Four, when the markets in developed countries that had begun to open up when IOS first followed the European expatriates home became the main fields of IOS’s activity. As market after market in Latin America or Asia closed down or ran into difficulties with the authorities, Europe took over. By 1968, 60% of all the inflow of money into the funds came from four relatively rich countries in Western Europe - Germany, Italy, Britain and Holland. That was Phase Five, and it was, as we shall see, so successful that well over half of all the assets under IOS management at the peak were brought in during 1968 and 1969.
But that does not mean that Phase Four was insignificant.
There is a tendency within IOS to suggest that the capital flight business, while no doubt unfortunate and even deplorable, was more or less a passing episode, the venial sowing of wild oats in corporate youth - as if breaking the currency laws of poor and backward countries may be laughed off as a schoolboy prank. When the Brazilian fiasco was being discussed at a sales meeting, one executive quoted Marlowe: ' 'Twas in another country, and besides the wench is dead.'
The evidence suggests, on the contrary, that without the capital flight phase, IOS would never have become an important concern at all, let alone 'the most important economic force in the free world.'
It is important to be clear about the distinction between 'black money' and 'hot money'. Black money was illegally invested in the funds, in the sense that currency or other laws were broken in the process. But a very large proportion of all the money invested in underdeveloped countries - and in some developed countries as well, as we shall see when we look at what happened in Italy - was 'hot money'; it was flight capital.
Whether sales were technically legal or illegal is, from this point of view, irrelevant. What mattered was that such capital flight damaged the economies of the countries concerned. Some countries had laws against it. Others, often including those who most needed them, did not. In many cases, indeed, it was the activities of IOS salesmen that caused the laws to be introduced. What they were doing was not more harmful after it had been forbidden than it had been before.
Is it possible to put a precise figure on the IOS hot-money business?
Obviously a complete account can only be produced by IOS itself. (All sales have been recorded on a computer since the early Sixties.)
When we first became aware of the scope of the question, we naturally hoped that the new management which took over after Cornfeld's fall would want to make a serious attempt to clear the matter up. The new president of the company, Sir Eric Wyndham White, was a product of the British Treasury and then Secretary-General of the General Agreement on Trade and Tariffs. His chief information officer, Mr Harold Kaplan, had been one of the most respected officers of the United States Information Service. Their proclaimed position was that IOS should be plainer and more straightforward about its affairs.
We therefore asked them to break the silence that had always covered virtually all details of the sales operation, except, of course, for the loudly trumpeted total volumes. Sir Eric and Mr Kaplan invited us to submit written questions, which we did. They were simple enough: essentially we asked for a breakdown of sales by year and by country, and for some indication of the proportion of cash flow that came in lump sums, and the proportion in monthly investment programmes. After some weeks, Mr Kaplan telephoned to say that these questions could not be answered.
It was not altogether surprising, IOS was in most respects a garrulous and gossipy organization. But there was one subject on which people were either studiously vague, or grimly tight-lipped: just where the money came from.
Parts of the sales organization functioned with all the elaborate secrecy of an espionage service. 'Area desks' filtered contacts between the regions and the administrative hq at Ferney-Voltaire. Contacts with clients in two regions, the Middle East and Africa, were further filtered through secret processing centres, staffed with appropriate linguists, in the Swiss ski resort of Flims-Waldhaus and in Brussels respectively.
It was perhaps natural that many customers' accounts were kept under numbers. What was more extraordinary is that many territories were labelled with baffling code-names, which altered from time to time. Israel was called Africa II B. Cyprus was Europe III, and America 23 was actually in Italy. On one occasion, IOS proudly published a photo of a 'Gold Merit Medal' being pinned on the Minister of Public Works in America VI E! Even more oddly, considering their claim to be 'financial counsellors', many of the salesmen were listed in the sales company's records under ludicrous pseudonyms, such as 'Benjamin Disraeli', 'Leonard Vinci', 'Victor Hugo', and ' Jacky Hotelplan.'
In spite of such heavy-handed precautions, the cloak of security can nevertheless be penetrated.
Up until 1962, the sales force was selling Dreyfus far more than IOS’s own funds. The total amount actually brought into the IOS funds up to the middle of 1967, which may be taken as the end of Phase Four, comes in round figures to $700,000,000. So the crucial question, more precisely, is: where did that money come from in those five years, from 1962 to 1967?
A director of IOS who resigned in 1965 told us that in his time Latin America accounted for about half the volume of sales.
Several other officials who have left the company more recently have confirmed that Latin America continued to provide roughly half of sales until after the Brazilian debacle.
Sales in Brazil, between mid-1964 and November 10, 1966, ran at around $5-6 million a month. This was face value. It means that even if selling was stopped then, the total amount IOS would have taken out of Brazil if all monthly programmes had run their contractual course would have been not less than $135 million, and might have been more. What is not easy to establish exactly is what proportion of this was in cash. An IOS sales official who spent six years in Latin America has told us, however, that in Brazil cash was 30-40% of face value (higher than in less dangerous markets) and that assets under management from Brazil reached $45 million at their highest point.
The same man said that assets under management from Venezuela came to $40 million, and from Colombia, where sales had been going on longer than in Brazil, also to some $40 million. If one remembers that Argentina, Chile and Central America were also all major markets, and that sales were bubbling away busily all over the continent for six or seven years, it would seem that not less than $250 million, and perhaps more, of IOS’s first $700 million came from Latin America.
A senior sales official in Beirut has computed for us from memory - the local sales records have disappeared - that total sales in the Middle East between 1962 and 1966, including both the Beirut and Teheran regions, came to some $80 million. In one year, 1964, the Beirut region did $48 million in face value, a high proportion of which, perhaps as much as one-third, would have been in cash. This was not all strictly illegal. But a very large proportion of it, in those unsettled years before the Six Days War, was most assuredly flight capital.
Once a year, from the very early days on, IOS held sales contests. They were important, both as a way of boosting actual sales volume, and even more as a way of giving men and women who were scattered all over the world a sense of belonging to one triumphant army on the march.
In the early days, there was a pleasantly unpretentious and personal touch about these contests: George Landau remembers winning a large salami once. Later the big winners were given blocks of shares in the Fund of Funds, tape-recorders, movie-cameras, and other expensive consumer goods, including zebra skins and on one occasion a 'seven-foot African leopard pelt'.
This was appropriate for the 1964-5 winter contest, which was called the 'IOS Big Game Safari'. The official company report on it begins like this: 'In a roaring windup, 1216 hunters hit the final clearing on the safari - and never in Big game history has there been such a jungle jangle jingle.'
The sales organization's style hardly encourages one to take very seriously the claim that the salesmen were really responsible, cautious 'financial advisers'. Hunters! Yes, indeed, that was much more how they saw themselves…
The report lists the 'contest volume' sold by the 1,216 individual salesmen, and breaks down 'actual volume' between 23 regions, which between them covered every territory where IOS was then operating. Since the figures refer to face value, they do not show exactly how much money was brought in during the contest. But they do give a very clear idea of the breakdown of sales between the different regions. (The proportion of cash did vary slightly from one region to another: broadly speaking, the more dangerous the operation, the higher the proportion of cash.) The figures turn out to fit very closely with the general picture we have described from other sources.
Brazil led the regions in the jungle jangle jingle, with $8.9 million out of a world total of $82.3 million. (Nor was this an isolated achievement: the Brazilians did even better the next year.)
Latin America as a whole contributed some $34 million, or 41%. The Middle East, counting Beirut and Teheran regions, plus Sam Welker's personal fief, accounted for $11.4 million in those particular six weeks, or 13.8%. And Spain and Portugal between them, where the sales were largely illegal, or at least depended upon illegal currency operations, provided another $2.7 million, or say 3%.
Not all the sales in Latin America or the Middle East, of course, were made to the nervous local rich. Some will have been continuing 'Phase One', 'Phase Two', or 'Phase Three ' sales to expatriates with external funds.
But those were the years of roaring inflation and the fear of 'Guevarism' in Latin America, and of growing political instability over all of the Middle East and South East Asia (not to mention Africa, where the Congo figured prominently in the $5.14 million sales of 'Africa I'). It does not seem far-fetched in view of what we know of IOS operations world-wide, to assume that such sales as were made to expatriates in Latin America and the Middle East at this period were more than cancelled out by illegal sales elsewhere.
These were the five crucial years for IOS’s growth. They saw what had been a modest sales organization, selling other people's funds, develop into a world-wide organization by the end of 1966, with more than half a billion dollars under management. It seems safe to say that at least 40 % of that money came from the citizens of underdeveloped countries. Several hundred million dollars was taken from those countries which could least afford to lose it, and put into that notoriously under-capitalized area, Wall Street.
'You must never forget,' we were told by Eli Wallitt, a director of IOS 'that the company developed out of the illegal areas.' That fact influenced its whole character, and evolution.
Chapter Nine
They May be Schmucks -But They're the Government
The clash between
IOS
and the
US
Securities and Exchange Commission. A Cuban lady skindiver enters the stockbroking business. We examine some other things that
IOS
never told the customers, and also a deal that 'scared hell out of the
sec'.
Manuel F. Cohen was born in Brooklyn some twenty years before the Cornfeld family settled there. The district in which he was brought up, Bedford Stuyvesant, was much poorer than the Cornfelds' part. ('You had to have money to live there - at least, to us', he commented once.) Cohen went to Brooklyn College, and then on to Brooklyn Law School and a cum laude degree. After a short period in private law practice in New York, he joined the Securities and Exchange Commission in Washington in 1942. Twenty-two years later, he became its fifteenth chairman.
Cohen, who is a Democrat, retired from the sec in 1968 after Nixon's election, and is now in private law practice in Washington. His clients include a fair number of mutual funds. It is hard to see in him a man dedicated to the overthrow of the American securities industry.
In the market gloom of early 1970, many people in the securities industry were easily seduced by Cornfeld's argument that the sec was out to destroy them. The sec had after all publicly advocated a reduction in many of the charges and commissions. The sec is also a small agency and its budget from the Federal Government is not generous. Some of its methods as a result seem high-handed: brokers and investment managers tend to take offence when, after an sec 'request', they have to take a whole day to go down to Washington, paying their own fares, to be grilled by lawyers half their age.
Nevertheless in one respect at least the sec is a considerable ally of the securities industry. If it were not for its existence as a buffer, the securities industry might well be prey to more ferocious attacks from the anti-trust section of the Justice Department. If the hard-nosed lawyers of that particular arm of the us government were to be let loose on investigating the securities industry and were to attack, for instance, the minimum commission agreements of the New York Stock Ecxhange with the same vigour as they attack the fixing of steel prices, then brokers and fund managers would have something to worry about.