Five years ago this month, the staid 78-year-old brokerage house of John Muir & Co. was sliding quietly into oblivion.
Today, the firm has opened 11 offices around the country, including a major branch in Georgetown, and its annual revenues reached $40 million in 1981, up from $1 million in 1976.
The reason for this overnight success, his critics and admirers agree, is 47-year-old Raymond L. Dirks, the roly-poly general partner of Muir who is neither staid nor quiet.
Dirks is the former insurance stock analyst who in 1973 exposed the $2 billion fraud at Equity Funding Corp. of America and who has been parlaying the event into fame and fortune ever since.
While technically the firm is still called John Muir, it might as well be Ray Dirks & Co. He is the self-appointed star of the firm's costly advertising campaign to publicize Muir's new stock offerings in tiny, unknown companies, many of which have turned to equity financing because they have difficulty getting funds due to high interest rates, among other things.
Muir, under Dirks' guidance, has become the leading underwriter for "taking public" (selling stock to the public) these firms. In just 18 months, Muir has brought out new stock offerings for 43 different companies -- a staggering record. According to Dirks, the market prices of the 43 stocks are up, by an average of 20 percent.
But the manner in which Dirks and his 250 salesmen promote and sell some of these stocks is the subject of several lawsuits and an investigation by the Securities and Exchange Commission.
Recently, the stock prices of several of these companies, after enjoying a quick rise only months earlier when Muir took them public, have plunged after management announced unexpected reversals.
As a result, disgruntled groups of investors in these companies have filed suit naming Muir, among other defendants. These angry shareholders in court papers say the firm did not practice due diligence in reviewing the companies' financial records before selling stock to the public. Dirks denies the allegations in the stockholder suits, and states: "We performed the underwriter's due diligence, as required."
For example, earlier this month two Numex Corp. shareholders filed suit claiming the company and Muir issued a false and misleading prospectus last September when they sold 750,000 shares of stock at $4 each. The lawsuit was filed after the management of the Hartford lathe manufacturing company had unexpected bad news for investors. It announced that the company had a loss of $2.4 million for the year ended March 31. Numex shares are now selling at about $1 each.
Dirks said the firm will file an answer to the suit denying the allegations.
Another law suit naming Muir was filed recently by investors in Security America Corp., a Chicago mail-order insurance company Muir took public at $6 a share last November, raising $14.7 million from investors. Then, in May, Security America disclosed it would lost "at least" $3.6 million in fiscal 1980. Trading in the stock remains suspended. The announcement came only two months after a "Ray Dirks Research" report, published by John Muir, said the company expected to earn a profit of $2.2 million in 1980 and $5.5 million in 1981.
Beginning about a decade before it went public, Security American had been obligated to put up extra reserves to cover anticipated claims on workmen's compensation policies, according to the Illinois Insurance Department. Providing for those same reserves out of profits is what caused the company to report the unexpected loss in May. Because Dirks is well-known as an expert on insurance companies, a number of insurance sources wonder why he failed to spot the problem with the reserves at Security America.
As in the other suits, plaintiffs in this one claim the offering prospectus was false and misleading. But Muir has denied the allegations in court papers, and Dirks says, "There's no way we could have spotted the problem. "We haven't got the expertise."
He blames the failure to detect troubles early at Security America on the company's former auditors, Coopers & Lybrand, which ultimately spotted the problem. "The stockholders may or may not end up with worthless pieces of paper," he says. "But we feel that they should recover from Coopers & Lybrand."
Coopers & Lybrand general counsel Harry L. Amhowitz said, "It is revealing to learn of Mr. Dirks' view of Muir's responsibility as experts in insurance companies and lead underwriter for the sale of this stock to the public. C&L acted responsibly with respect to its association with offering. It withdrew as auditors for Security American when it could not obtain the information it sought as to the magnitude of the adjustment and its timing."
Muir has filed its own suit against Security America, seeking a stockholder meeting to discuss reorganization of the company's management.
In yet another suit filed last month, shareholders Basic Earth Science Systems Inc. sued Muir, the company and others, claiming a prospectus dated Dec. 18, 1980, was "false and misleading." The suit was filed shortly after the company announced that the present value of its oil and gas reserves was less than 50 percent of the value stated in the prospectus.
Dirks denies Muir was at fault and says the firm relied on experts for the information. He also claims Basic Earth officials believe oil-well production in recent days will justify the claims in the prospectus.
But Dirks' troubles extend beyond disgruntled stockholders.
Attorneys in the New York office of the SEC are looking into whether Muir, in exchange for taking some small companies to buy unsold shares of other companies that Muir had taken public. The SEC reportedly wants to determine whether Muir is using this and other devices to prop up the prices of stock they have been unable to sell. Such practices, if they occurred, could violate federal securities laws as well as the rules of various exchanges.
Recently three executives of Basic Earth Science disclosed in SEC filings that they had paid a total of $728,000 to acquire stock in Digital Switch Corp., another company underwritten by Muir. The stock was acquired five days after Muir underwrote Basic Earth and at a time when Digital Switch's stock price was declining.
Both Muir and Basic Earth deny there was any connection between the two transactions.
There is another instance somewhat similar to Basic Earth.
About a year ago, Dirks and Las Vegas developer Jay Sarno (Caesars Palace and Circus, Circus) shook hands and agreed that Muir would bring out a staggering $250 million stock offering to finance Sarno's plan to build Grandissimo in Las Vegas, the biggest hotel-casino in the world. At the same time, Sarno bought $50,000 worth of Digital Switch stock.
Sarno says Muir did not require him to buy Digital Switch as part of the Grandissimo scheme. "They never laid it on the line that strong," said Sarno. "They just told me that Digital Switch was a good buy and that it would be nice if I bought some."
Sarno says that when the Grandissimo deal fell through, he wanted to sell the Digital Switch stock. He says he could not find a buyer; then Muir took it off his hands. But a check for the stock never arrived in Las Vegas and, Sarno says, he went to New York and in an angry confrontation at Muir's office demanded his money . . . or else.
Dirks denies there was any such confrontation, and says Sarno bought Digital Switch simply because he thought it was a good investment. He says he is confident that the SEC will find no improprieties.
Actually, the SEC and Dirks have been at odds since 1973, when the agency issued a complaint charging Dirks with disclosing his discovery of the fraud at Equity Funding to his clients and the press before the authorities. Dirks denies any wrongdoing and says proudly that he has spent $500,000 on legal fees in fighting the agency. Indeed, last week his Washington attorneys asked the U.S. Court of Appeals for the District of Columbia to reverse a censure of Dirks handed down by the SEC on Jan. 22, 1981.
As if his problems with the SEC and angry shareholders were not enough, Dirks says he also has been plagued by phantom nay-sayers telling unflattering stories about him and his firm to the press, the SEC and the New York Stock Exchange. Dirks and Muir managing partner John D. Sullivan answers inquiries about the criticisms by denying the truth of the stories and raising questions about the moral, sexual and psychological stability of those they suspect are the critics.
Frustrated by anonymous allegations of questionable dealings at Muir, Dirks has sought to unearth the fifth columnists he claims are causing unrest among the firm's highly charged, richly rewarded sales force. Dirks and Sullivan have taken the extraordinary measure of requesting that many of the top employes take polygraph tests.
"It gets to the bottom of the bullshit," says Sullivan, a holdover from the old Muir operation who favors the use of expletives to make his points.
The lie-detector tests apparently failed to uncover a single leaker, but Dirks and Sullivan think the bad news is now being spread by disgruntled ex-employes, not from within the firm.
One former Muir employe, who asked that his name not be used, alleges that in October, 1978, Dirks on his own sold more than 300 shares of Reliance Insurance Co. stock the employe owned and 200 shares owned by a customer of the employe. Dirks reportedly took similar actions with customers of other Muir salesmen at the same time. Most salesman got Dirks to reverse the Reliance sales when they discovered them, but the former employe says he could not because he was out of the country when the sales took place. What is more, he says he had not given Dirks permission to trade his or his clients' accounts while he was away.
When asked about it, Dirks accurately guessed the name of the former employe and recalled that he had complained to him upon returning from his trip.Dirks said, however, that he believed the employe had asked him to watch over his accounts while he was away.
New York Stock Exchange Rule 408 makes it clear that permisssion to trade another person's account must be in writing. The rule states: "No member, allied member or employee of a member organization shall exercise any discretionary power in a customer's account . . . without first obtaining written authorization of the customer."
"I like people who are interesting and creative," says Dirks, who has managed to surround himself with a cast of characters who are at least unusual for Wall Street. For example, a while ago he hired former Yippie Jerry Rubin, an action so incongruous that it resulted in a stream of articles about Muir -- valuable publicity for Muir that dwarfed whatever salary the firm paid Rubin.
A. Joseph Tandet, a close friend of Dirks' and occassionally his attorney, has long dreamed of producing "The Little Prince" on Broadway. So the resourceful Dirks came up with the idea to raise $1.5 million for his friend last October, by selling stock in a Broadway show for the first time. Little Prince Productions Ltd., which was offered at $2, now sells for about $1.
"I thought it was a pretty good shot, a creative idea," says Dirks, who allows that Tandet has yet to pick a cast for the show. Dirks says the stock offeringf sold out, but one former customer of Muir suggests how this happened.
This person says that as a regular Muir customer, he had purchased some of the firm's hot new issues that were almost guaranteed a quick price rise. Then one day his salesman told him that if he wanted to continue getting hot stocks, he first had to buy some shares in the Little Prince. The customer says he canceled his account at Muir and has never gone back. Dirks says salesman are instructed not to use such techniques.
Another of Dirks' friends who regularly vists the Muir offices at 61 Broadway is a man who calls himself John du Pont, a heavyset man in his 50s who favors casual clothing and who wears long hair in a ponytail that hangs half-way down his back.
Du Pont reportedly has directed rich clients to Muir, especially from show business. Dirks describes him as "basically a consultant" to the firm. Ever since Dirks came to the firm, Muir has been picking up the tabs in New York and elsewhere for the free-spending du Pont, including his living and entertaining expenses at such posh hostelries as the Beverly Hills Hotel and the Windows on the World restaurant atop the World Trade Center.
The SEC has subpoenaed du Pont in its investigation of Muir.
In this part of town, however, it's the botton line that counts, and under Dirks' direction the old Muir firm has gained new life. Dirks boasts that his 350-person sales force earns the highest commissions on the Street. In line with his role of a Wall Street Maverick, Dirks is proud of his "free form" operation, which to a reporter appeared to be chaotic. "I'm a free-form person," says Dirks. "I like people to do what they want to do. I don't try to control them like a Merrill, Lynch."
What Dirks does demand is productivity, for which salesmen are handsomely rewarded; many earned between $100,000 and $1 million in commissions alone during 1980, according to firm records. Even secretaries at Muir are encouraged to sell stock, and two former secretaries earned six figures in annual commissions.
Dirks' hard-driving sales techniques have not been universally admired, however. He acknowledges that before coming to Muir, he was fired from his last job with Fred Alger & Co. because he sold about 4,000 shares of stock in a company called Dynatech Corp. from his own portfolio without telling his client that he was the source of the stock. It was a technical problem, explains Dirks. "Fred Alger's got a big compliance thing. Fred said, 'Why don't you leave?' So I left."
Dirks is a latecomer to the risky business of new issues, for in his investment book, "Heads you Win, Tails You Win" published in 1979, he advised readers to invest in more conservative, tested stocks. His new investment philosophy will be spelled in a new book, to be called "How to Get Rich Before You Get Old," which Dirks says he is writing with Eric Weber, author of "How to Pick Up Girls."
Like most successes, Dirks spotted a trend and capitalized on it. For more than a year, many American investors have gone on a bender buying stock in new, mostly unknown companies. With meager or nonexistent profits, these low-priced shares lure market plungers who hope for quick profits on a Xerox of the 1980s.
According to the publication "Going Public," there were 237 new underwritings of common stock in 1980, up from just 81 the year before and the largest number since the last new-issue craze in 1972. At least one reason for the surge is that small companies cannot afford to borrow money from banks at annual interest rates of 20 percent or higher. So these companies turn to firms like Muir to raise the money by selling stock to the public.
Most of the new issues underwritten by Muir and others are sold on the over-the-counter market (OTC), a cast martketplace for the stocks and bonds of some 30,000 companies. The OTC market is loosely regulated by a Washington-based industry group called the National Association of Securities Dealers (NASD).
The only real protection for investors buying OTC stocks is the offering prospectus. Under the 1977 Supreme Court decision, Sante Fe Industries v. Green, so long as selling company makes full disclosure of real and potential problems there is no violation of the antifraud statues of the federal securities laws.
Howard B. Sirota, a former NASD attorney and now Wall Street counsel to little companies that seek to go public, puts it this way: "If you fully disclose to people in a stock prospectus that you're cheating them, then you're not defrauding them. So if you tell them in the stock offering, 'This is utterly worthless,' and they buy it, then there's no vilation of law."
Why do investors plunge into such long shots, despite warnings?
"it's the Atlantic City mentality," says Sirota. "These types of investors would never buy 10 shares of IBM at $50 each because they can't make any money. But they'd gladly buy 5,000 shares at 10 cents each of some solar energy company because they might make a quick killing if it rises a few cents. And if the lose $500, well, they would have blown that much on a weekend at Atlantic City."
Many of the small companies underwritten by Muir are involved either in the development of high-technology products or oil and gas exploration, both recently trendy industries on Wall Street but industries whose performances are difficult to predict. Investors in high-tech stocks are dabbling in the twilight zone.
As virtually all the prospectuses make clear, Muir makes heavy demands of the companies it takes public. These include generous expense accounts for the firm and warrants equal to 10 percent of the new issue. These are granted after one year at the original offering price. In turn, Muir's salesmen, who have a reputation on the Street for hard charging, sell the stock to the public, with Dirks doing his part to hype the new shares.
When Dirks appeared on the television program "Wall Street Week" on March 13, the irrepressible salesman seized the moment to tell the national TV audience about 10 mostly unknown stocks -- without saying the Muir was the underwriter on just about all of them. And in the time since, two of the 10 have reported unexpected losses and resulted in stockholder suits naming Muir.