Investment Clubs

[ April 4, 2000 ]

The Great Paper Chase

By Mark Goodson (TMFFatBlokeMarge)

Phew, what a market! would scream the headline (if there were one) when the dust eventually settles after probably the most extraordinary few months in Stock Market history.

"Old Economy" shares, at incredibly low "value" levels last November, continued to plunge through the first 2½ months of 2000, while the overvalued and overheated tech sector continued to overheat and sent certain stocks into the far points of the universe at Warp Factor 10. OK, some have crashed back, not to Earth exactly, but certainly now only as far as the outer reaches of our solar system. Simultaneously, the Old Economy shares have enjoyed a bit of an upswing, and are now showing good gains for investors. But only for those who bought them about a month ago. The fact of the matter is that even despite the recent selective "correction", anyone who bought TMT stocks at the back end of last year is still massively up, with the old traditionalists, into banks and other fuddy-duddy companies at the same time, being pretty well down.

However, within this crazy period, there have been a couple of events that have perplexed, confused, and more importantly cheesed off the private investor, and it set me to thinking about how investment clubs would be affected in similar circumstances.

The events I refer to are the craze of applying for IPOs in the hope of making a quick buck by "stagging the issue" (selling as soon as possible), and the mass boycott of dealing in residual stocks by most UK brokers.

Now as far as clubs are concerned, the way that they hold their shares is crucial to how either of these events will affect the club. Legally, it is not possible for Clubs to own shares in the name of the Club itself, so there are basically only three options for them to take when deciding how to hold their shares:

1. Individual with designator. This involves one member dealing on the club's behalf and applying a 3 letter designator (i.e. MIC for the Moneybags Investment Club) after his name, to indicate to the Registrar that the shares are not held for the absolute benefit of the individual. The member will possess the paper certificates, and a Deed of Trust should be set up to safeguard the club. However, the main pitfall to this is obvious -- the club is wholly dependent on the member for its portfolio. The death or long term incapacity of this member scuppers the club completely. However, the club can apply for IPOs using this method.
   
   
2. Club members as Trustees. This is where 2 members hold the shares on the club's behalf as Trustees for the club. The members hold the paper, a Deed of Trust will still have to be set up, and the club has a little more protection in the event of one of the Trustees dying, as there will then be an additional Trustee who can appoint a successor. However, this will cause additional expense for the Club, and will bar the club from participating in IPOs.
   
   
3. Using a broker as Nominee. This is the most widespread, and by far the easiest, way for clubs to own shares. The clubs don't own the paper and IPOs cannot be applied for. However, it is infinitely easier -- no Deeds of Trust are required, all the paperwork is transacted by the broker, and there are no problems in the event of crucial members dying, becoming incapable of dealing or even just leaving

Let's look at the craze surrounding IPOs for a moment. In recent weeks, there has been massive hype regarding the flotation of iii (LSE: IIN), lastminute.com (LSE: LMC), Regen Therapeutics (LSE: RGT) et al. The first "biggie", iii, caused annoyance to potential investors because of the scaling back of the application due to massive oversubscription. The second, lastminute.com, was even worse. Apart from being massively oversubscribed, the price was raised mid-issue and the applications were even more scaled back than with iii. To add insult to injury, certificates did not arrive on time, and it would appear that many investors have bailed out of the stock at all/any cost. The share price has dropped since day 1 and is currently (at the time of writing) showing a meaty loss. Regen Therapeutics, although free of the hype surrounding the other two, was still 10 times oversubscribed and a 1-in-10 ballot for shares was held. Various European IPOs have launched and the market has reacted in a very underwhelming way.

Now are IPOs the sort of thing Investment Clubs want to invest in? I would suggest not, certainly at the moment. H&G investments took part in the National Power and Powergen flotations in 1995 using method 1 above, but we held the shares for some time. The present fashion is to buy IPOs and sell immediately -- called "stagging" -- which is hardly a Foolish philosophy. But this mania has created a bit of a bandwagon, and when too many people leap on a bandwagon the wheels tend to come off. Far better to research the company and, if it seems a company you want to invest in, buy shortly after flotation. Much less hassle, too. Notwithstanding all that, if as a club you wish to go for an IPO using method 1, then it may be possible to transfer the stock into either your Nominee account or to your Trustees once you have the certificate, thereby eliminating any future hassles when you come to sell.

So, on to Residual stocks. These are stocks quoted on the UK exchange but which are not members of CREST. Apart from attracting slightly higher stamp duty (it is rounded up to the nearest £5 on these stocks) many brokers now do not deal in them. The reason for this is that there have been many complaints about investors not receiving certificates. Let me explain why.

Because these stocks are not in CREST, when shares are purchased it is the Market Maker's responsibility to manually register the deal with the individual company registrars. On many occasions, this was simply not happening, and investors were not in possession of their certificates. This of course caused huge problems if the investor wanted to sell. Consequently the brokers were under massive pressure from their investors to chase up the issue with the Market Makers, causing grief for the back office staff, and the end result is that many brokers now just will not deal in this type of stock, except perhaps to close existing positions for their clients.

To illustrate the point, let me tell you about one chap in our club who purchased shares in a residual stock, Petra Diamonds (LSE: PDL), last November. As of the 30th March he had still not received his certificate. Petra was suspended in mid-March, and is expected to re-list on the back of good news at a substantial premium. Because he was going to the USA on holiday, he wanted to leave a sell instruction with his broker on some of his stock if it hit a certain price while he was away. The broker said that because he did not have his certificate, he could sell but would not receive any money until the paper came through. After a few days of chasing his broker and pointless phone calls, he actually rang the Companies Registrar, who advised him that he wasn't even on the register. This was some FOUR MONTHS after "owning" the stock!

He took the matter up with his broker, who wanted to absolve themselves of responsibility. Interestingly enough, though, they informed him that if he had used their nominee service, then they WOULD be liable. His argument was that he had no contract with the Market Maker, and it was only after making noises about complaining to the SFA that his broker gave ground and agreed to deal with it for him.

Now, if clubs own Residual stocks, and if they use options 1 or 2 for the method of holding shares, then the likelihood is that the club has not yet got a certificate and may therefore have problems if it wants to sell. Certainly some heavy negotiation with your broker will be necessary. However, most clubs use option 3, the nominee account, and so the residual issue would not seem to cause many problems to clubs who own this type of stock (although it will be unlikely that your broker will currently buy them for you).

All in all, it would appear that clubs would probably have fewer problems by using the broker's nominee service.

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