CHAPTER I

INTRODUCTORY

Status and Requirements of Financing

There is no phase of business activity of greater dramatic interest than the financing of enterprises. There is no other phase of greater importance to the progress and welfare of the world. The miracles worked by Aladdin and his wonderful lamp are surpassed by those of the financiers of today. A new fertilizer is put on the market, and two blades of grass grow where but one grew before; an automatic loom is developed, and one man does the work of twenty; an aeroplane is perfected, and man outflies the birds. The basic enterprise exists, inert and useless; over it the financier waves his golden wand; it is vitalized, becomes productive, and the whole world is better fed, clothed, warmed, and sheltered.

But there is perhaps no phase of business activity in which a "knowledge of the art" is more essential; in which mistakes are more common or more costly. Its work must be done in strict accord with established rules and principles. Entirely apart from the fraudulent schemes which draw so heavily upon the resources of the country, tens of millions of dollars are annually lost or frittered away through the ignorance, the inexperience, the general lack of ability, or the almost criminal indifference of would-be financiers. Case after case can be cited where thousands and hundreds of thousands of dollars have been raised for the development of enterprises and have been expended in entire good faith without increasing the present worth of the undertaking a dollar. Honesty of purpose was there, but some vital element was lacking. Some essential requirement had been disregarded, and whenever the promoter or financier departs from

the basic principles of sound finance, whether through intent, through ignorance, or through error; whenever he floats enterprises unsound or not worth while, enterprises too scantily financed, or poorly managed; disaster awaits him—or his enterprise -and the world is the poorer for what he has done.

Fraudulent Financing

It may also be said that there is no phase of business activity in which the impostor and swindler are more active. The annual loss to the country through fraudulent stock-selling schemes has been roughly estimated at over $120,000,000. What it really is cannot, of course, be told but the estimate can hardly be excessive.

This prevalence of swindling operations obtains here because no other phase of business activity offers such opportunity for fraud. The stock-selling impostor is a psychologist who knows and plays on the weakness of human nature.

Mankind likes to take a chance. It is the romantic impulse, the rebellion against order and conservatism. To the poor driven mass of humanity the occasional risking of something on some issue, no matter how quixotic, is the color and thrill to light the drabness and dullness of life. And the outcome of the gamble matters little in terms of satisfaction. It is pleasant to win, but better to lose than never to know the explosive sensation of having something at stake. . . .

Here is epitomized the mind of a large part of the American public. People who work hard for small pay, see no light ahead, and do not understand how to save, are natural chance takers. A few dollars out of a month's earnings do not matter. They may be risked on the most outrageous gambles, the most impossible speculations. Betsfor they are no more are put down on oil wells in Timbuktu, pirates' treasure in the Caribbean, the hoard of the temple of Quetzalcohuatl, the gold dust from the loins of El Dorado, under the waters of Guatavita, the mines of the moon, and the pot at the end of the rainbow. The public lends its money in small individual amounts, but enormous totals, to all such fancies and does not often complain if there is no yield.1

I W. C. Crosby and E. H. Smith, Saturday Evening Post, February 14, 1920.

But the appeal goes further. The comparatively small class "who work hard for small pay" are not the only victims of the stock-selling swindler. Nowadays the masses have money and something must be done with it. The savings bank with its modest 4 per cent per annum is not attractive. The idea that $100 of his earnings deposited in the savings bank will in a year's time bring him $4 in interest does not appeal to the man who is making $6 to $10 a day. The suggestion of the stock salesman that $100 invested in his oil leases may in six months' time bring him in $1,000 or $10,000, or even make him independently rich, does appeal. True, he may lose even that which he had, but meanwhile he has had a "run for his money," and he prefers the elusive but rose-colored vision of the oil scheme to the somber security of the savings bank. For most of these small investors, through ignorance of the possibilities or because of lack of investment opportunity, there is no middle course.

The following quotation from a recent letter to a financial publication puts the matter very clearly and also brings out another of its phases:

I am a locomotive engineer on the shady side of 60-43 years in the service. I have had my pay raised twice in two years. Now I ask myself, "How much can I save? Where shall I put it?" I go to the president of a national bank and a judge of the court and say, "I have a little money I can save every month. Where shall I put it?" They say, "Put it in the Savings Bank." But I can only get 4 per cent there. I ask them, "Do you put your money in the Savings Bank?" "Oh, no." "Why not?" "Don't get interest enough." So there

you are.

Stock-Selling Swindlers

The desire for larger returns—even though they entail a larger risk-is human nature and, until the risk becomes too large, is good business as well. But it is difficult for the man of small

2 Financial World, October 4, 1920.

means to purchase the fairly safe dividend-paying stock-stock from which he can get a fair return on his money, and at the same time an attractive possibility of profits from an increase in its selling price. The dealer in worthless stocks is very familiar with these conditions and is always ready to turn them to his own profit.

There exist so-called banking houses with fictitious names, investment companies, incorporated fiscal agents and the like who stand ready to distribute worthless securities at an exorbitant commission. Very often the enterprises have a sound economic basis, such as the manufacture of candy or automobile trucks, but are incorporated in such a flamboyant manner, and the stocks offered to the investor at such prohibitively large commissions, that the enterprise is doomed to failure no matter how plausible it may appear. The fact that the enterprise has to some extent an economic basis often gives the advertising material distributed by these fictitious "banking houses" or "investment bankers" a very plausible ring. And furthermore there is usually some clever writer in the organization who acquires a devilish skill in preparing circular advertising matter well suited to deceive the credulous public. For these reasons the fraud perpetrated by these fictitious investment bankers is usually more artistically executed than is the case when the corporation, or its promoters, seek to distribute the securities by one of the more direct methods heretofore described. The commissions exacted by these swindlers are usually enormous, representing the major part of what the public pays for the securities. 3

The Speculative Investment

What shall be done about it? The writer just quoted-an authority on finance says:

The question naturally arises as to the proper means of selling securities of highly speculative enterprises if successful direct selling requires the use of methods now frowned upon because used by swindlers. One observation is surely true. The highly speculative enterprise should not be backed by the general public. It requires too

3 Dewing, "Financial Policy of Corporations."

much investigation and discrimination. The chances of loss are too great. For this reason the stock of a highly speculative enterprise, no matter how meritorious in itself, should not be advertised for indiscriminate investment. It should be backed in the early stages by a man or group of men of wealth who have the time for a careful and exhaustive investigation and who, should their investment prove a loss-as it probably will even after the most painstaking investigation -are able to stand the sacrifice. But to take the savings of hardworking men and women to develop a speculative undertaking, no matter how meritorious in itself and honestly managed, is little short of a social crime.

While every right-thinking person must heartily agree with this general sentiment, it is not practicable, even though it were desirable, to keep speculative offerings from the general public. Also, from the individualistic standpoint, it overlooks the very trait of human nature that makes the field so productive for the swindler. "Mankind likes to take a chance" and the average working man, clerk, or bookkeeper can afford to risk $10, $50, or even $100, in a legitimate speculation with just as much propriety as the wealthy man can afford to risk $10,000, $50,000, or even $100,000. If the working man denies himself the pleasure of a parlor chair, a Victrola, or perhaps an automobile, to indulge in the pleasure of investing the money in an oil company, a mining proposition, or a new invention, who shall say him nay? Eventually he will probably lose his money, but likewise, by reason of wear and tear or other contributing causes, he will eventually lose his chair, his Victrola, or his automobile. In either case he has had value received for his money and in the case of the speculative investment-if the scheme is an honest one-he will on rare occasions receive the wonderful returns of his vision. And on those rare occasions when he does profit from his speculative investment—and here is where it differs from ordinary everyday gambling-no one else has lost because of his gain, but the world is the richer by a "gusher," a producing mine, or a useful invention.