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The Truth about Stockbrokers

And why I don't have one anymore...

Rafe Mair 11 Sep

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They want you to get and bet often.

There is a lot of legalized gambling going on in this country and all forms have one thing in common: someone who isn't in the game but runs it makes a piss pot full of money -- at the consumer's expense.

Let's compare the major stock markets to horse racing. The owner of the racetrack couldn't care less who wins because he gets his slice out of each bet no matter how the race turns out. If favourites win it might encourage others but the fact remains that the consumer always loses even when he wins, because the track owner and the government have taken their share up front. So it is with the stock salesman. He's the middleman who snaps up a fee whether you have won or lost.

And like the racetrack owner, your broker offers you incentives to play. The horseman offers you different ways to lose your money with quinellas, daily doubles, exactors, trifectas and so on. The broker offers common stock, bonds, mutual funds and so on to encourage you to make "bets."

Here's the rub -- even though he wears the best bespoke suits, $200 ties and silk underwear, the broker, like the horseman, or Lotto Canada for that matter, wants you to get and bet often.

It's helpful to track owners and brokers if their clients win often enough to keep coming back, but that's not because they like to see people win. The crucial part is that they play. The broker doesn't like the comparison with the horseman so he pretends to be part of the upper crust whereas in fact he's no better than that lottery ticket salesmen in the Third World flogging hope to the poor or the man who runs the numbers racket in the Bowery. (I should say "used to" because the racket has been taken over by the government whose payoffs make the salesman of numbers look like Santa Claus by comparison.)

Escape from the market

Let's start out with the mutual fund. The theory is that with mutual funds you participate in many companies running from the shaky to the sure thing. This minimizes your chance for losses. It also minimizes your chance for profits but the salesman is not big on telling you that! With many mutual funds you're behind the eight ball from the start as the broker grabs his take off the top. Having said that, there are mutual funds that have done well. But here's the question you might ask yourself: who do you think is paying for all those expensive and exotic trips fund management continually sends their brokers on?

Let's look at buying and selling stock. As mentioned, it matters little to the broker what your stock does as long as you keep playing and keep the commissions rolling in. Let me illustrate.

A couple of years ago Wendy and I, given our ages and what we wanted, instructed our broker to sell everything and put it in Treasury Bills. I was then, as I am even more now, scared stiff of the market for many reasons. The U.S. is the biggest debtor nation in the world where it once was the biggest creditor. Oil will, in my opinion, go sky high. Helmut Pastrick, the distinguished economist for B.C. credit unions, says that if it hits $100 all economic predictions are out the window. The Chinese economy -- like the Japanese economy of 20 years ago -- is, in spite of the glitz, based upon a foundation of quick sand. It's riding for a fall that will hit all of us -- hard.

But the main reason we wanted out of the market was to keep our capital secure.

Our broker, much against his will, sold, all the time bleating that we were making a big mistake because "in the long run etc., etc." I simply could not make him understand that I don't have a long run and that I needed my capital safely tucked away.

They suck you back in

After we had sold out our broker got heat from his superiors. "How come all that money is lying there when it could be out making commissions?" The pressure was on and we started to get phone calls. This was a "bull" market and he would put us only into the very safest investments. Next thing we knew, little by little we were back in and feeling very stupid for abandoning our own instincts and listening to the securities tout. Well, we were hardly back in when the type of stock we were in went into the toilet and we lost what for us was a lot of money. So convinced were we that this was a good time to stand on the sidelines and watch that we sold out again and stayed out.

This is not a "poor Rafe and Wendy" story because we were the ones who gave in to the pressure when we should have known better. What this is, is a statement of fact. Brokers make money out of an active portfolio and all else is of secondary importance.

(By way of aside, let me tell you what happens if you complain. The company uses its own in-house lawyer who talks to everyone, then, surprise! surprise! finds the broker and the company absolutely innocent!)

Let's suppose your broker tells you to buy a stock that his company is very high on. Does he say this is because independent researchers have investigated the stock? Not likely. What is more likely is that the brokerage house has underwritten the stock -- meaning that they have paid the company for stock, kept a bundle for themselves and wants the stock to go up so they can cash in. In short, they want to move the risk from themselves to you and make a bundle in the process. Who better to raise the cash from but their clients? The concept of "conflict of interest" is unknown in the stocks and bonds business. Moreover, stocks salesmen simply do not understand that for some people -- Wendy and me for example -- preservation of capital is far more important than making money.

Nudge, wink

Let's look for a moment at "insider trading." The case most know about is the call made by Herb Doman to Russell Bennett that Louisiana Pacific was not going to buy Doman Industries so Bennett should dump his Doman shares before the news became public. Bad business. No one can condone it. But it's child's play compared to what happens every day in the big kids' stock market.

First there are share options given to CEOs and directors. The game is that they can, over a period of time, buy shares at the current price so that if the shares rise in value, they can flog them and make a bundle. Now think of that for a moment. Is any CEO or director going to call his options and sell them unless he knows that it's a good business move? And isn't it obvious that the only way he knows this is insider information?

There is a common scam by which President Bush, amongst others, made a killing. Like most stock scams, it's simplicity itself. You take a company -- making widgets -- which you control and whose stock is trading, let's say, at a dollar. You and your fellow executives issue yourselves a bundle of options to buy company stock at a dollar. You then find another company that you control to offer to buy a million widgets. You make this wonderful news available to the public who drive the stock up to $10, you call your options and sell them for a nine dollar profit per share. There's one more thing, of course. You must announce, alas and alack, that the company that was to have bought the widgets quite suddenly went bankrupt.

Sharks and minnows

Prosecutions for breach of insider information rules are rare and non-existent with the big boys and girls. This is what's so unfair. On the old Vancouver Stock Exchange, stock hucksters were held in contempt and even sometimes charged. From my own unhappy experience I can tell you that most players in those stocks are gamblers. They know the game and don't care if a company is honest as long as its story runs the stock up so they can make money. In the words of W.C. Fields, you cannot cheat an honest man. The VSE was the crap game where "investors" understood the rules, or lack of them. But the public has been led to believe that the Toronto Stock Exchange, the New York Stock Exchange and other major players are run by pillars of honesty and moral rectitude. In fact they are big time pickpockets.

Finally, let's blow to smithereens the notion that brokers are extremely well educated and spend most of their waking moments analyzing the companies whose shares they flog. If they know their stocks so well, why don't they ever advise their clients to sell short? (Selling short means you sell what you believe to be overpriced stock you don't own, buy it after it goes down and pocket the difference.) They don't do this because the stock market is supposed to be a jolly place where ne'er shall be heard a discouraging word of pessimism. Nortel is a good example. Everyone knew after it went down the tube that it was overpriced, yet brokers kept getting clients to buy all the way down. But the bad things about Nortel were just as easy to see before it crashed, when it was the darling of the TSE, as they were with hindsight.

The central point is this. To the broker, be he Slippery Sam the flogger of Consolidated Moose Turds or the man in the three-piece suit in the exclusive club talking up a "blue chip" stock, the name of the game is transactions for which they are paid commissions and make profits on stocks they themselves own. The guiding axioms are these: you don't have to be mad to be in the stock market -- but it helps. And always remember, to the broker it isn't so much what the dice read. For him it's how many rolls you throw.

Rafe Mair writes a Monday column for The Tyee. His website is  [Tyee]

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