Wall Street History
The Fund Industry's Black Eye
Once again, a study of Wall Street history reveals that the more
things change, the more they stay the same. Case in point, the
story of Bernard “Bernie” Cornfeld.
Born in Turkey, Cornfeld was the former social worker, turned
mutual fund huckster, who helped set off a huge scandal in 1970,
that of Investors Overseas Services.
By the 1950s, the mutual fund industry was beginning to boom,
growing assets by tenfold in the decade, a pace that then
continued into the 60s. Hundreds of new funds were created and
a mutual fund was often sold like an insurance policy, with
salesmen even coming to your house for that personal touch.
Bernie Cornfeld, who had been a fund salesman himself in the
50s, may not have had a lot of financial acumen, but he was a
smart marketer and knew a trend when he saw one. So he
decided to start his own operation, but with a twist, Investors
Overseas Services (IOS).
One of the problems with mutual funds during this time was that
the fees were exorbitant. Up-front commissions in the
neighborhood of 8% (which was the case for some “load” funds
well into the 90s), as well as high operating expenses, eventually
led to many complaints at the SEC, particularly when you
coupled the fees with sub-par performance.
But Cornfeld saw a way around this, that being to incorporate
outside the U.S., where the business wasn’t as regulated and
where he could blatantly appeal to those looking to avoid income
taxes in the States. IOS set up shop in Geneva (with the funds
incorporated in Canada) and Cornfeld quickly built a sales force
that he once estimated at 25,000 (mostly full-time employees)
who then basically went door to door throughout Europe and
elsewhere drumming up business in his 18 mutual funds.
IOS targeted ex-pat Americans, as well as servicemen and
foreign nationals (almost half the investors were Germans),
anyone looking to participate in the Go-Go Sixties. Labeling it
“people’s capitalism,” Cornfeld promoted the benefits of mutual
fund ownership to even the smallest investor. You could be a
winner! After 10 years, IOS had raised $2.5 billion, at a time
when the entire fund industry was under $50 billion in assets,
and had 1 million shareholders. The corporate goal was to hit
$100 billion in the following decade. As market historian
Charles Geisst writes of IOS, “Not since the 1920s had such
hucksterism been seen in the securities business.”
The era was characterized by hot IPOS, soaring prices and
unbridled optimism. Some of the big issues of the day included
Solitron Devices, Syntex, Teledyne, Control Data, Dome
Petroleum, Litton and Gulf & Western, the last two being
emblematic of another trend of the day, the conglomerate. In ’68
the Dow Jones was at 985 on December 3, before it began a long
slide to 631 on May 26, 1970, a decline of 36%. The raw
numbers for the bear market were bad enough, but what
compounded it was leverage. Everyone seemed levered to the
hilt, including IOS, its employees, and its shareholders.
As Cornfeld’s profile in the investment world rose, he felt
compelled to show off his success and his ostentatious lifestyle
became legendary. At one point he appeared on the cover of a
leading German magazine in a velvet coat and with a cheetah at
But as the market began to tank at the end of 1968, one of
IOS’s revolutionary investments really was taking a big bite out
of performance, that being its “fund of funds,” which simply
invested in the shares of other IOS offerings. It had been
marketed with tremendous success, with Cornfeld claiming that
sales actually hit $100 million one day. [Bernie was the king of
the sales contest for his employees.] But what investors initially
lapped up in the bull market, quickly became poison as the
market tumbled exorbitant fees, while the “guaranteed”
dividends, a key to the sales pitch, were actually paid out of
capital. Ye olde Ponzi scheme.
Cornfeld faced a dilemma. IOS had a stock-option plan which
employees at every level were allowed to participate in. But the
complexities of the plan, as well as the investment fraud, were
such that IOS was forced into a public offering to meet some of
its costs. Employees, directors, and outside investors purchased
shares in this hot IPO (shares of which were traded in the U.S.),
but most everyone levered up to get in on the action. After all,
the sales growth was phenomenal and there was no reason to
doubt that IOS couldn’t keep it up for years to come.
Of course as the bear market hit and investors focused more on
fees, as well as lousy performance, many cashed in their funds,
which wasn’t real good for IOS’s stock either.
Cornfeld later claimed in an interview that the IPO had created
143 millionaires (many on paper), but suddenly IOS was faced
with what he labeled a bear raid, a group of German banks
selling the stock short.
IOS shares plunged from $18 to $12 in the spring of 1970. At
this point Cornfeld, as well as some directors and outside
investors, had agreed to form a pool and support what they saw
as a bargain, but, to make a long story short, after the purchases
(including $300,000 by Bernie himself), the stock resumed its
dive to $2.
As you can imagine the employees were panicking and selling
what holdings they had, while some of the key portfolio
managers were also cashing out and heading for greener
IOS needed outside help, and after a fellow named John King
was turned down by the SEC (the agency threatened to stop
trading IOS shares in the U.S.), the company looked to one
Vesco had a New Jersey-based conglomerate called International
Controls Corp. (ICC), which invested in some 24 companies and
was also highly leveraged. [As you’re reading this, I’m
assuming you have picked up more than a few similarities to the
last few years on Wall Street.] But as long as the bull market
was in place, rising values outweighed the crushing debt load.
When the market turned, however, Vesco was in deep trouble.
He needed a bailout and spotted it in the form of IOS.
After King was denied control, Vesco approached Cornfeld with
the offer to be the white knight and Bernie found it hard to
refuse. Vesco had ingratiated himself with the directors,
promising to cover their losses in tax shelter deals, and we all
know, a happy director is a compliant director.
What Cornfeld and the boys didn’t see, however, until too late
(or so Bernie claimed) was that Vesco was looting IOS’s cash
stockpile to the tune of up to $500 million for the purposes of
covering his investments in ICC. When this was discovered,
Vesco fled the coop and became one of the better known
fugitives in the world.
With all of the leverage that was involved, and the Ponzi scheme
that IOS was running with the fund of funds and the guaranteed
returns, Cornfeld’s creation collapsed of its own weight, taking
down more than a few European banks (and Franklin National in
Meanwhile, our fugitive Vesco, who was hiding out in the
Bahamas (and later Costa Rica and Cuba), thought he figured out
a way to get back to the States. It was 1972, Richard Nixon was
running for a second term, and Robert Vesco, who had been a
leading contributor to the Republican Party in the past, decided
to get $200,000 in $100 bills into the hands of Maurice Stans,
Nixon’s chief fundraiser. Surely, Vesco thought, this ought to
grease the wheels with the SEC and allow him to return,
particularly since former attorney general, John Mitchell, was the
campaign director. Well, when the whole situation was brought
to light, Stans and Mitchell were indicted (as Vesco remained
offshore), but they were acquitted in April 1974.
Cornfeld moved to Beverly Hills, setting up shop as a movie
producer, but when at one point he returned to Geneva,
authorities there arrested him for past shady dealings in his own
IOS holdings, whereupon Bernie served 11 months before
making bail. He then returned to Beverly Hills to live out his
life, shacking up with Heidi Fleiss (the “Hollywood Madam”) at
one point, before dying in 1995.
Cornfeld and Vesco became synonymous with fraud at the
highest corporate levels and it took a number of years before
confidence in the mutual fund industry returned.
There was another story of this time, Equity Funding, that met
with similar results, something we will explore in a few weeks,
but next Friday we need to look at the seasonality issue, as the
month of April draws to a close.
“Wall Street: A History,” Charles Geisst
“Eyewitness to Wall Street,” David Colbert
Jay Shartsis / Barron’s Oct. 11, 1999
“Manias, Panics, and Crashes,” Charles P. Kindleberger