The Burger court said in 1977 . . . that 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 violation of law. Howard B. Sirota, Wall Street attorney
When John Muir & Co. collapsed last month, it seemed to spell the beginning of the end of another Wall Street craze.
For nearly two years, investors have been gobbling up shares of stock in unknown companies, many with negligible assets but high hopes. Muir, under the direction of its general partner, superpromoter Raymond L. Dirks, had led the field underwriting these new issues, pumping out an amazing 43 in just 18 months.
As if to underline the risk of investing in the new-issues market, Muir was driven into liquidation at least partly because investors alleged that claims made in offering prospectuses were fraudulent. A spate of class-action lawsuits, along with a massive Securities and Exchange Commission investigation, was apparently more than Muir could stand.
Dirks was one of the first to realize that investors were ready to gamble on new issues, but the word soon got out, and a wide array of deal-makers flocked to the Street to capitalize on the trend. And while some of the little companies taken public by these promoters were seeking funds to finance legitimate business expansion, many more have been corporations in name only, devised to sell stock that would enrich the brokers and the promoters.
At least that's the contention of one unusually candid Wall Street attorney, who is himself a prime example of how a small circle of insiders gets rich on new issues -- often at the expense of the investing public.
Howard B. Sirota is 32 years old, out of law school about three years, in his own Wall Street practice less than two years. He made "more than a hundred thou" the first year and expects to make "probably twice as much" this year.
Not bad for a former organizer of the Students for a Democratic Society, who less than a decade ago wanted to overthrow the very capitalism he now enjoys.
Sirota learned to appreciate finance from his step-father, a bookie who Sirota says went off to the track one day and never came back. He began reading stock prospectuses in high school and continued the practice sub rosa during his anticapitalist, SDS phase. Before going to law school, he earned a living as a "hired gun," using his financial expertise to dig dirt on corporations for law firms and brokerage houses.
His Afro hairstyle, which once stretched from here to there, has been shorn, tattered blue jeans have given way to finely tailored Brooks Brothers suits, and meals of bean sprouts and brown rice have long since been replaced by perfectly prepared steaks at his favorite East Side restaurant, the famous and expensive Christ Cella.
In terms of money, Sirota is a tremendous success. His cab fare home at night from Wall Street to Flatbush, he says a bit uncomfortably, is more than his father made in a day working as a presser in the garment district.
But Sirota, for all of his new trappings of success, has not totally abandoned his rebellious ways. While other young attorneys in big firms walk cautiously along the gray-flannel road toward a partnership, Sirota is a loner, openly disdainful of the system that is making his fortune possible.
The story of Sirota's overnight rise to riches on the Street, told in his own unvarnished, Brooklyn-accented words, is enough to make a cautious investor nervous about the stock market.
Sirota makes his money giving legal advice to clients who want to "take public" little, capital-hungry businesses -- that is, raise money by selling stock to the public. If investors ever bothered to read the prospectuses prepared by Sirota for some of his clients, they would find that in some cases the companies don't have any actual products -- only promises of products. But as any stockbroker knows, it's a rare investor who reads an offering statement.
"Ultimately," says Sirota, "I'd like to put a legend up on these things, 'Warning, persons considering an investment in these securities should see a psychiatrist.' But people would still buy it."
The hottest new issues usually are in companies that claim to be involved in some trendy product, Sirota says. His clients, for example, have started up companies in such Wall Street pop items as solar energy and gene-splicing, cancer cures and oil and gas tax shelters.
Sirota reviews the securities offerings to be sure they meet the requirement of law before they are submitted to the SEC, the federal agency that oversees the securities markets. Once the securities registration statements clear the SEC -- a modest hurdle, Sirota says -- then his clients are free to sell the stocks or bonds to the public. If his clients follow his advice, they can unload the stock at a quick profit and still stay within the letter of the law.
As it happens, Sirota started his practice on the eve of the biggest new issues craze since the early 1970s. According to the publication "Going Public," in the first six months of this year 259 companies sold new issues of common stock and raised nearly $2 billion, up from 237 companies raising $1.4 billion in 1980, and 81 raising $506 million in 1979.
While allowing that the new-issues market has been staggered by the Muir collapse, Sirota believes that it still has some life left. "The new-issues market attracts the least knowledgeable investors. These people have to be killed before they give up and get out of the market," he claims.
Reaching into his desk drawer, Sirota pulls out a stock prospectus for one of his clients, a solar energy company. (It was agreed that none of Sirota's clients would be named in this article.)
The prospectus didn't reveal precisely what the company manufactured, so he is asked: "Is there any product?"
"Are you crazy?" Sirota replies in mock amazement. "These guys have a fantastic product. It converts sunlight directly into money for the investors and promoters. And it's fully reversible. It converts the investors' money into sunlight. It's a remarkable chemical achievement."
But surely such chicanery violates the securities laws.
"Thanks to Richard Nixon's Supreme Court, it's completely kosher," says the former student activist with undisguised glee.
For example, Sirota reads the "risk factors" listed in the prospectus of the solar energy company, the very same "Santa Fe" disclosures that save him and his clients from being accused of violating the antifraud statutes of the federal securities laws. If investors read it, they would learn the following about the company: "No record of sales or earnings . . . no manufacturing facility . . . possible infringement of a patent . . . inadequate funds . . . management salaries to be paid from proceeds of stock sale . . . no orders or contracts for products . . . ."
Another Sirota client sold interests in an oil-drilling venture. Says Sirota: "This guy acts as the general partner, the promoter, the underwriter, the explorer, the finder, the contractor. And if you imagine a circular conference table, he jumps from seat to seat, negotiating with himself, paying himself exhorbitant fees for his services. So when he's done, maybe the only way he'd find oil would be to drill in a gas station and hit a tank. But if he does hit oil, he gets half the profits. It's all perfectly legal. And that's how he can afford to take his lawyer to lunch at Lutece."
How do these deals come about?
"Promoters . . . have brainstorming sessions where they chew over trends," says Sirota. "Some will just do oil deals until there is no more energy crisis. But the more imaginative ones decide the real money is to be made in something new -- say, gene-splicing. They come to me and ask if I've done a gene-splicing deal. And I say, 'No, but I'm sure you will be covered if we include the usual laundry list of warnings to the investor that it's an utterly worthless offering and that they'll lose all their money if they invest.' "
"Then," continues Sirota, "the promoter goes out and hires some guy, preferably with a Ph.D. in molecular biology from MIT who is more interested in making money than getting a Nobel Prize. They make him president, give him assistants, fill a lab with glass beakers and microscopes and, insto-presto, you have something called New Life Biology Corp. Inc. The professor is given 1 million shares of stock, and told it would be taken public at a dollar a share. And if it works, and the stock can be kept up long enough, the professor is told he can sell his shares and make a fortune."
Sirota estimates that there are "at least $100 million in worthless new issues" sold to the public each year, but he adds, "If you told me that it was five times that, well, I wouldn't argue with you. The fact is, nobody knows."
The vast majority of new stock issues is sold on the huge, unwieldy over-the-counter market. When Sirota graduated from Brooklyn Law School in 1978, he went to work in the enforcement division of the Washington-based National Association of Securities Dealers (NASD), the self-policing arm of the over-the-counter market.
"Self-regulation means never having to say you're sorry," says Sirota.
After 18 months, Sirota passed through the NASD's revolving door to Wall Street. He solved the problem of being unknown by simply sending out announcements to all those stock manipulators he had been chasing while he was at the NASD.
"Boom city from the beginning," is how Sirota describes what happened next as his one-time investigative targets became his valued clients. "One guy said to me, 'You kicked my ass but you were a gentleman,' " says Sirota with a laugh. "Another said, 'You're tenacious, tough and smart, and I want to sic you on someone I don't like.' "
As for the future, when the new-issues craze inevitably passes, Sirota claims he will switch sides and become a plaintiffs' lawyer, representing aggrieved stockholders in suits against corporations. That's the kind of law he went to law school to practice, he says. But he needed a bankroll to finance the normally prolonged court battles against powerful corporate legal staffs. His piece of the new-issues action will help, he says.