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[If the SEC charges you with running a boiler room operation] denounce the allegations as tired, unsupported, and completely unfair. Issue your denunciation through your attorney, preferably a former high official of the SEC.
7
INSIDE A BOILER ROOM
"This room is what we consider a boiler room, [but]
what takes place is more like a sweat shop.
-- Undercover New York State Investigator #117(64)
So You Want to Be a Broker? Beware The Boiler Room!
"The job ... is tedious [and] monotonous ... but ... the payback would be enormous."(65)
There is an appealing ad in the newspaper for a "Broker Trainee" position at an impressive Wall Street address. You respond to the ad and the very next day the firm schedules you for an appointment with a dozen other people. The job requires aggressiveness, determination and commitment, but is also very tedious. A broker (not the firm) pays the initial salary of $250.00 a week directly to you. You are told that a broker, on average, can earn $150,000.00 a year. Desiring to become a broker, you are lured with the promise of unlimited earning potential if you just tap into your resources, put in the time and work hard.
Once hired, you fill out the paperwork, which can be done with fictitious information that will never be checked. Training is less than six hours long, during which time no specific instruction is given on the proper methods of qualifying data on a prospective client (other than getting on the phone and giving the sales pitch). Other "trainees" talk publicly about past conduct as unlicensed brokers or committing crimes such as tax evasion. These are not people of the highest ethical standards, but before you know it, you are all on the phone making cold calls in an attempt to secure client leads.
"You are subjected to long hours, short pay and I guess cruel punishment."(66)
You are now on the job. Fast paced meetings are held before the market opens and after the market closes. They are a blend of motivational speeches and constant criticism that not enough leads were obtained. Training is nothing more than learning cold-calling tactics. Be aggressive and do not let people off the phone. Stay on the phone and get the information. No matter what, get the lead. Supplied with a script, you engage in rehearsing and role playing to find out what the problem is. Why can't you keep people on the phone? Why are you not getting leads? You practice rebuttals to maintain people on the line. You are never instructed on proper sales practices and risk disclosure, but you are told that you cannot say anything about stock on the phone. This is despite the fact that the script and solicitation materials you use contain many references to stock.
The firm keeps you cold calling for long hours by publicly berating you about not producing enough client leads because you do not stay late enough and you are not dedicated and aggressive enough. Accommodations are less than ideal. You sit in a packed room of more than forty people. You dutifully use the script and you make at least three hundred phone calls a day. People walk the aisles and monitor you and your progress constantly. Ever vigilant, they question you whenever you are not actually on the phone cold calling for clients. As a firm tactic to motivate you to work harder and commit more, the firm partner will yell and curse at you, and you, in turn, will yell and curse in order to produce client leads. At the end of the day, you write up your leads and give them to a broker. At the end of the week you are paid $250.00.
This is a true account of being hired and trained for employment as a cold caller in a boiler room operation.(67) Unfortunately what is recounted is not an exception to the rule. The industry is plagued with similar operations throughout New York. Is it a great opportunity? Perhaps a great opportunity for dishonest opportunists to commit fraud.
" . . . recruiting process for a trainee to learn, basically, is just to get on the phone and call."(68)
These firms do not in any way train "securities professionals." A broker needs to be properly registered and properly trained in order to advise clients of suitable investments. Instead, what is exhibited in these scam operations is an utter disregard for the interests of the investor. It is simply a game -- a game in which irresponsible operators are systematically defrauding investors -- and "Lucky" Luciano's vision is realized on a massive scale.
Contrast this with the training a broker receives at a reputable firm, where the words "compliance" and "client focus" take on a different meaning. Barry Mandell, of Merrill Lynch, Pierce, Fenner & Smith, Inc. ("Merrill Lynch") testified at the public hearings about Merrill Lynch's "Professional Development Program," which lasts over two years. He stated that:
... the scenario described earlier in these hearings by former cold callers and brokers involving a new hire at a telephone making hundreds of calls a day to pitch mysterious stocks after a few brief hours of training, which, as described, wasn't training at all, but rather indoctrination in patently improper practices, would simply never happen at Merrill Lynch or any other reputable firm. Let me repeat, it would never happen.(69)
Nonetheless, the credulous investor will find both types of brokers -- the shakedown artist and the trained professional -- to hold the same licenses. Thus, it can be extremely difficult to distinguish them in terms of competence and ethics.
Tactics of a Boiler Room Broker
"A high school drop-out . . . could sound like the Chairman of the Fed with these scripts."(70)
Sales scripts can be powerful tools that allow a broker complete control over a conversation and the ability, it seems, to sell anything to anyone. If, at any point the client turns off the conversation, the broker can return to the exact point where the pitch was led astray. With enough practice, anyone can be a good salesman in the securities industry. The nature of the product and the quality of what is being sold simply do not matter to a boiler room broker.(71)
Every pitch is the same for every prospective client. The concentration is on securing the lead, not on an investor's needs. The emphasis is to stick to the script and open an account. Rebuttal books commonly used with clients who do not want to buy stocks are filled with pre-written answers designed to impress and rebut any response a client may make. False names and senior positions are commonly built into the script. Sales pitches contain misrepresentations that can include, among other things, falsehoods regarding mergers with large companies, buyouts, and listings on major exchanges.(72)
"...[D]ialing, constantly dialing for dollars, staying on the phone."(73)
Cold callers are constantly on the phone and attempt to keep clients from hanging up. They have little or no prior experience in the securities industry. Expected to make hundreds of calls a day, they are typically on the phone opening accounts within a few days of being hired and sometimes using the name of a broker as their own.(74) There are no official instructions on how to get clients and it is more or less understood on Wall Street that what has to be done can be achieved in any way possible.(75) This includes practices such as using illegal client lists procured from other brokers. Investors from all over the country, lured by the New York address, speak to these cold callers with the mistaken impression they are dealing with experienced securities professionals.(76)
"[Brokers] knew these were not good investments."(77)
While using aggressive sales tactics and little product research, many brokers have no knowledge regarding the securities they offer and their chances for success. Therefore, recommendations are made with no adequate basis to support them. Nor do brokers have much empathy for clients who lose money. Some actually "laugh when a guy would send in $50,000 or something."(78) Essentially, their pitch appeals to greed by insisting that investors need to get in on the ground floor; that profits are made now, before everybody else invests. The reality is that 90% of the companies being "pitched" are not going to produce profits.(79)
Stock is sold at prices that are unrelated to any traditional measures, such as earnings or revenues. Prices are propped up by buying and accumulating stock. There is no real marketplace for these shares. If a client buys a number of shares, and later wishes to sell those shares, there will not be any buyers for the stock, and therefore it will result in an inevitable loss. Basically, these shares have an unsustainable value inflated by a group of brokers, acting in concert, buying for their own clients.(80)
The value of the stock, however, is not an issue. With a "no-net-selling"(81) rule in place for most of these firms, brokers go through a variety of machinations to avoid a net sales position. They will convince, cajole or simply ignore a client's request to sell stock or they will "park" securities in a series of unauthorized transactions. Thus, if a client wanted to sell a house stock, which did not have real value or liquidity, a broker would have to find another client to buy such stock. If no buyers could be found, the stock would have to be put into another account without authorization. If the second client complained, the transaction would simply be canceled and rebilled into another client's account in order to find yet another parking spot for these shares.(82) In fact, sometimes all the brokers in a firm would be working in unison to sell a position in one stock at one time in order to completely liquidate shares in a company or to move them around. This manipulation could either inflate the price of the shares or decrease it, depending on what the broker wanted.(83) In other words, the market did not price these securities; the brokers did.
"Pound him until you . . . get a second trade."(84)
Once an account is opened and stock is purchased, the broker will wait for the first check to come in and then get back on the phone and "pound" the client until a second trade is completed. It is a game for the broker. If the client hangs up first, then the broker has "lost" and did not do the job. In an attempt to secure a second trade brokers will do anything, including yelling and screaming at a client.(85) Even if the first purchase yields a profit, the client will only lose money in the end. The shell game can only be played for so long. Ultimately someone will have to bear the loss.(86) The result is a lack of repeat business from solicited customers. With the inevitable complaints of unauthorized trading and failure to execute customer sell orders (see Chapter 4, INVESTOR COMPLAINTS, supra), it is necessary for brokers constantly to find new investors and to string along existing customers for more transactions.
"...[T]here is not a lot of direct supervision in any way, shape or form."(87)
Boiler room operations are often staffed with unregistered brokers or with brokers who pay others to pass the Series 7 exam for them. Fifty employees, all unregistered, may use one broker number. Each month, this "one broker" could earn as much as six to seven million dollars in commissions. Managers are aware of these practices, but condone them if they result in money making.(88)
Management's overall message and main purpose is always to sell the firm's "house stock." That is the extent of the direct supervision at such firms. Managers do not sign order tickets and will even refuse to execute client sell orders if brokers attempt to sell stock back to the firm. Therefore, brokers do whatever is necessary to ensure that the stock is not sold back to the trading room. Any stock purchased by a client becomes the responsibility of the broker who made the commission on the transaction. If shares are sold back to the firm trading department, the firm takes back the commission, the stock value drops and the client takes a big loss in the account. The withholding of brokers' commissions if a sale cannot be matched and "netted out" creates a disincentive for brokers to carry out their clients orders.(89)
"Tell him you are not a mailman, you don't have time to send out [paperwork] to every client."(90)
Boiler room broker will go to great lengths to avoid giving information to clients. They often rebuff investors who request a prospectus with slick answers and slick maneuvers. They must persuade investors not to request materials by shifting the emphasis to highlighting positive aspects of the company, without properly disclosing the risks involved. They may even tell investors that brokers do not have the time to mail out information or that if a stock could be picked according to a prospectus, then just about anybody in the country would be a millionaire by now.(91)
Out of 500 clients, maybe 50 actually walked away with money.(92)
The potential payoff for a boiler room broker can be very large. In a private placement offering for twelve million dollars, a company might only see three million dollars. The rest of it is disbursed to promoters and brokers.(93) On the brokerage side, brokers can earn commissions as high as a couple of million dollars.(94) What is apportioned to brokers is undisclosed to clients. It is not unusual to see up to 40% of the gross purchase price of a stock credited to individual brokers and to the firm.(95) Thus, a $6 house stock can have $1.50 built into the price as commission for the broker. If a client purchases 50,000 shares, a broker can make more than $50,000 in commissions. If the client sells tha stock thirty seconds later there is already a significant loss (since the value of the $6 stock is actually closer to $4.50).(96) A customer's statement does not reflect the price at which the house bought the stock and as a result customers are unaware of the excessive markups charged to them.
Boiler room operations, in fact, exist only for the benefit of the firm and its brokers. Clients pay for overvalued stock, only to lose money when trying to sell it (assuming they can sell it at all). Market manipulation and stock markups make it unlikely that customers will see a profit in any of these transactions.
Why Boiler Rooms Persist
Regulators are faced with a myriad of problems in connection with boiler room operations. Since cold callers are unregistered and fraudulently use names of registered brokers, they are difficult to track. Sales scripts may be filled with misrepresentations but pressured investors will never discover them before their money is lost. Even though the entry barrier is relatively low, many registered brokers obtain their licenses through illegal means. Brokers build a clientele from lists purchased illegally from other brokers and by other means intended to come up with well-off investors, and transactions are executed at prices that are artificially propped up by manipulative market practices. The investor is the only guaranteed money-loser in these scenarios.
These firms are fully aware that they are operating outside of the legitimate investment business. They hold "regulatory drills" to test how quickly their brokers can rid the offices of all sales scripts and other incriminating materials.(97) Many firms are so bold as to simply change the plaque on the door when they sense it is time to close down the old identity and open a new shop.(98) They seem to operate on the theory that they can commit fraud undetected because of the enormous amount of fraudulent activity that already exists and the limited resources of regulators. They believe that the downside risk consists only of civil lawsuits and revocations of licenses. If they are held accountable for anything, it is likely to be only a small fraction of what they have obtained.(99) By their calculus, the rewards far outweigh the risks of detection, prosecution or punishment.
State securities regulators need to address the issue of detecting and uncovering these boiler room operations in an effective manner that will serve as a deterrent to other such firms. Regulators must get into these offices if they are to stop or curtail these abusive practices. Criminal prosecutions, undercover operations and surprise examinations are but a few of the effective techniques cited by other securities regulators.(100) Boiler room operations will continue to proliferate until investors are made aware of scam investments sold by high-pressure salespeople, who do not research, grade, or analyze an investor's need. Investor education is paramount to stem the burgeoning tide of boiler room operations.
A chapter in the book Investment Illusions(101) provides a somewhat satirical (although fairly accurate) guide to running a boiler room or a bucket shop:
To get started in the bucket shop business, you first take over the offices and personnel of another bucket shop that has recently been shut down by the authorities. Not only will you economize on organizational expenses, but you can recruit some highly seasoned hands in the process.
* * *
You build your customer base through a massive cold-calling effort. Encourage brokers to make 100 to 400 calls a day. (Experts differ regarding the optimal level.) Reinforce the brokers' dedication to their task by having a manager patrol the sales floor, checking on tallies of completed calls. Punish those who are not either dialing or talking to prospects by suspending their telephone privileges for one day. Establish the guideline that callers are not to hang up until the prospect either buys or dies.
* * *
On newly floated penny stocks (those typically selling for less than $3 a share), 200% markups are not unprecedented. To maximize your profit margin, have brokers at one branch stampede customers into dumping the same stocks that brokers at another branch are talking up. Your trading profit is the product of gross margin and turnover, so remember to keep churning those accounts.
* * *
Now you're ready for some advanced market techniques. For example, push the stock of a company that claims to have a secret process for turning sand into gold. If a geologist denounces the claim as "a scam and a fraud," pay no heed. Instead, tell customers that the process is producing substantial amounts of gold and that they should hang on to their stock. Meanwhile, unload your own shares at a handsome profit.
* * *
Associate any stock you are promoting with some hot new product. Suppose, for example, that a company distributes tapes and records. If compact discs represent a higher-growth business, tell customers that the company also sells those, whether or not it's true .... Tell customers that your investment ideas originate with a brilliant in-house research analyst. Describe him as being fat, bald, and slovenly, but possessing one of the keenest minds on Wall Street.
* * *
[If the SEC charges you with running a boiler room operation] denounce the allegations as tired, unsupported, and completely unfair. Issue your denunciation through your attorney, preferably a former high official of the SEC.
* * *
No matter how tenaciously you attempt to undermine the regulators' efforts, they may in the end succeed in closing down your operation. It's one of the hazards of being in the boiler room business. So when the boom gets lowered, immediately reopen under a new name with the same facilities and personnel. (See "Getting Started.")
Boiler rooms and bucket shops use the same techniques year after year, name change after name change, for two basic reasons. First, the tried-and-true methods get results. If a particular strategy succeeds in permanently separating customers from their money, don't ask questions. Just use it. The second reason that the best ruses never go out of style is that there are always new sheep to be shorn. For every victim who has wised up, there are many prospects who have not yet been burned in a boiler shop .... With any luck, the opportunity could last forever.
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46. See Letter from Mark J. Griffin, President of NASAA, to Belinda Blaine, Senior Special Counsel, Division of Market Regulation, U.S. Securities and Exchange Commission (June 2, 1997). ("The NASDR does not, for example, consider the thousands of state administrative actions taken annually, or the thousands of arbitration actions.")
47. As Mark Griffin has stated:
NASAA believes that systematic fraud within firms is facilitated by associated persons; that actions against firms are only part of the investor protection equation. The other part is to deny licenses to those individuals contributing to the wrongdoing within their respective firms. Without such oversight, individuals with significant disciplinary history and those with recent regulatory problems, would be continually re-licensed and able to do additional harm to the investing public.
oag.state.ny.us |
