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OPERATION OF A SYNDICATE

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in to share its risks and profits. For such marketing of securities banking syndicates are formed, a syndicate being an organization of bankers, each of whom binds himself to buy, sell, or be responsible for, an agreed amount of securities, the sale or the distribution to be made under the absolute control of one banking firm, known as the syndicate manager, the expenses and profits, or losses, to be borne according to agreement. The advantages to banking firms of syndicate operations are apparent. Each firm gets the assistance of others, and is in turn called on for help. The risk is diminished even if the aggregate business is no larger. The clients of each firm are given diversified investments with scattered risks. The investment market is widened. If there is a glut in one city, the supply for sale can be shifted to others. There are five types of these syndicates:

(1) A syndicate may guarantee to the corporation the sale of the entire issue at about five points less than that for which the corporation sells them. The managers of the corporation do the selling. This is not a good way because, as before stated, the corporation has no expert selling organization.

(2) The syndicate may take the entire issue on consignment at a fixed price, and pay the corporation for the sales as made. This eliminates all risk for the syndicate, but throws it upon the corporation.

(3) One large house may buy outright at wholesale prices a large issue of securities. In order to facilitate the sale at retail and scatter the risk, this house may offer blocks at attractive prices to coöperating bankers.

(4) One house may contract with a corporation, guaranteeing an entire sale, and payment therefor at agreed times, for a certain profit, or a certain commission. This house as manager forms a syndicate to guarantee the sale and advance the money to the corporation. The sale is

made by the manager, who gets a managing profit. The proceeds, or the unsold securities, are then divided pro rata among the members, the manager also ranking as any other member. In this case the selling is pooled.

(5) The syndicate guarantees the sale as before, and advances the money therefor as agreed, but the securities are allotted pro rata among the members, each of whom sells his own. It is necessary in this case to have an agreed price for resale. Each house interests its clients, and public sales are made according to agreement. Each firm may take its turn at the general market.

If any member of a syndicate finds his guarantee or allotment too large, he may organize a sub-syndicate to share his venture. In no case will an investment banker offer a speculative security as an investment to his client. The sale of this is pushed in the general market, and the banking house will not advance them as its own purchases.5

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258. Appealing to speculators. Whether securities are sold to the public direct or through bankers, a great aid is the organized market. Exchanges for convenience and regulation of the sales of securities are usually known as stock exchanges. Rigid requirements must be met before a security can be offered for sale on an exchange." If the securities are listed they are dealt in on the floor of the exchange. It is through the exchanges that speculators are chiefly attracted to a security. How is this accomplished? The prospectus helps. Advertising helps. The campaign manager has only started when he has done this. He permits rumors to sift through the street and into the less careful newspapers. The tip is great bait.

5 The method of underwriting the sale of the securities of the U. S. Steel Corporation is described in the Report of the Commissioner of Corporations on the Steel Industry, p. 244.

6 See the Requirements for Original Listing of the Committee on Stock List of the New York Stock Exchange.

DILEMMA OF THE INVESTOR

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Next the broker is interested. If he can be persuaded that the security is good, and if its collateral value can be established, the broker will advise purchases or sales according to his judgment. The backers of the sale must see to it that the price does not fall below a certain figure. The only way to accomplish this is to buy in large blocks if a bear raid (selling short for a lower price) starts, or if the holder begins to sell. This steadies the price of the security and attracts attention. The sales managers may manipulate the market so as to advance the price and arouse expectations. People invariably buy on a rising market. The task of the manipulator is to feed in his supply so gradually that the advance is not checked.

259. The dilemma of the investor. There are securities which are known to be good. Trust and savings funds may be invested in government bonds, certain railroad bonds, certain public utility bonds, and properly secured real estate bonds. But the demand for generally known safety and marketability has enhanced the price, and diminished the net income of the investor. There are others just as safe, but not so well known, which would yield a higher income. On the other hand, there are railroad, public utility, and industrial bonds which are very unsafe. In 1916 one industrial bond produced seven cents on the dollar after a receiver's sale. Many railroads and public utilities have bonded themselves to their full physical value. If the earnings are sufficient, there is no trouble; otherwise there is. Not all industrials have been bonded as carefully as real estate, nor has the sale value of fixed assets been heavily discounted. Such bonds are dangerous. Some of the industrial preferred stock has demonstrated its ability to pay 6% and 7% through hard and lean years, but a stockholder is an owner, not a creditor. There is no claim unless the earnings warrant it and then cretion of the board of directors. A preferred stock

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holder's only safety lies in such a large equity that the common stock is profitable. Most industrials do not possess such a large equity. Often bonds and preferred stock have been issued to equal the purchase price, which was itself inflated, the common stock being created to represent the hoped-for profits capitalization of anticipated earnings and now and then all the preferred stock has been water. The value of preferreds often rests upon earnings which it may be impossible to continue. What is the investor to do in his search for securities that will give him at least the safety of his principal and a fair but certain, income??

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260. The way out. Most securities cannot be analyzed from the outside. It is an inside operation. For a bond the underlying properties must be carefully studied. For a preferred the accounts must be critically analyzed; but that is not enough. The entire project must be studied by an engineer, a manufacturing expert, a selling expert, a traffic expert, and an administrative expert, each thoroughly posted as to the conditions to be met by the business. It is very essential to know whether the business is being efficiently conducted and that it already has a wide margin of earnings above expenses. All this the average investor cannot do. He can, however, choose an investment banker who is an expert in his field. Especially to be shunned is a dealer who (1) offers big returns, (2) handles securities of companies without large net earnings, (3) is reticent as to the details of earnings and expenses, and (4) talks most about what similar successful businesses have earned. The investor's problem resolves itself into

7 Chamberlain in his Principles of Bond Investment gives the other qualities of a good investment as marketability, hypothecary value, exemption from taxes, freedom from care, acceptable duration, acceptable denomination, and potential appreciation. The same statement of qualities is followed by more recent writers.

THE WAY OUT

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picking his banker. There are unreliable vendors of securities who try to make an appearance of permanence and honesty. Nearly every city is infested with investment fakers, sharks who feed upon the savings of the inexperienced and the inheritances of widows and orphans.

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