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New development such as the rapid development of conglomerate companies, franchise operations, and other relative novelties in business and finance, which include a number of tricky devices such as the letter stock, proliferation of stock-option warrants, misleading names, use of foreign banks, and others have been there since the 1960s.

Our recent reading what brought this upon was the enigma of why the US Securities and Exchange Commission (SEC) brought down a private transaction and is now no longer of concern to the investors. Quite engrossing isn’t it?

“Letter Stock” is a stock not registered for sale with the Securities and Exchange Commission for which the buyer supplies a letter stating the purchase was for investment. But this isn’t the same now. As said earlier it is now no longer of concern to investors. So as of now “Letter Stock” is known as ‘Restricted Stock’ or ‘Section 1244 Stock’. Restricted stock is used as a form of employee compensation, in which case it typically becomes transferrable (“vests”) upon the satisfaction of certain conditions, such as continued employment for a period of time or the achievement of particular product-development milestones, earning per share goals or other financial targets. It typically becomes available for sale under a graded vesting schedule that lasts several years.

These are unregistered shares of ownership in a corporation that are issued to corporate affiliates, such as executives and directors. Restricted stock is non-transferable and must be traded in compliance with special Securities and Exchange Commission (SEC) regulations.

Restricted stock became more popular in the mid-2000s as companies were required to expense stock option grants. Insiders are given restricted stock after merger and acquisition activity, underwriting activity, and affiliate ownership in order to prevent premature selling that might adversely affect the company. An executive may have to forfeit restricted stock if he leaves the company, fails to meet corporate or personal performance goals, or runs afoul of SEC trading restrictions. The SEC regulations that govern the trading of restricted stock are outlined under SEC Rule 144, which describes the registration and public trading of restricted stock and the limits on holding periods and volume.


But this information can be availed from anywhere, why are we reading this?

During the mid- 1960s, the mutual funds bought the “Letter Stock” in a private transaction, then immediately revalued these shares at a higher price. This enabled these “go-go” funds to report unsustainably high returns in the mid-1960s. The U.S. Securities and Exchange Commission cracked down on this abuse in 1969 and brought upon some regulations and restrictions making it no longer a concern for fund investors.

Let us understand the enigma how these privately placed shares were giving such unsustainably higher returns.

Earlier, In case of letter stocks, the companies had the sole discretion in the method adopted for valuing the shares. Therefore, in order to inflate return the companies used to value their shares at a price substantially lower than the market value of the share. For e.g. a company declares dividend of INR100,000 and the market price of share is 1,000 then Return on Investment will be 100% , However in case of letter stock where the valuation is done by the company, and the shares are valued at INR500, then Return on Investment takes a stride to reach 200%, indicating erroneously high return by the company. The agenda behind this false defalcation has been only lure investors to infuse capital, for their future ventures.

Following is the one of the prominent cases arose during that period:

In June 1969, the Commission established an administrative proceeding against Frederic S. Mates (“Mates”), Mates Financial Services, Among other matters, it was alleged that, contrary to representations to Fund shareholders, Mates caused the Fund (a) to possess a considerable amounts of restricted securities, (b) to impede its shareholders’ right to redemption, and (c) to obtain from banks loans of more than $7 million secured by a lien on the Fund’s entire portfolio.

It was further alleged that Mates inflated the restricted securities and defalcated Fund of shareholders and clients, as well as prospective clients of Mates Financial Services subsequently, leads to an increase in the net asset value per share.

Security Exchange Commission came into notice of this fact and in order to curb this scenario of false returns, the Commission made a conscious effort of studying the valuation of restricted securities by investment companies, giving attention also to the correlated problems of liquidity and restraint of investment judgment which may arise when open-end companies acquire restricted securities. Consequent to the end of the fiscal year, the Commission issued a statement setting onward its views regarding the issues integral in the acquisition of restricted securities by investment companies.

Henceforth, we can settle with the fact that even in the financial history of the world there have been instances to deceive investors, but in one or other way, whether it is SEBI/RBI/NCLAT in India or the SEC in the US, find its way to fill up the breaks, in order to strengthen the pillar and  at times, warrant the financial security of the depositors.


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The Intelligent Investor – Benjamin Graham

About Rahul Jindal

Bachelor of Commerce (Hons.) graduate from University of Delhi. I am enticed with the world of finance, taxation, economics and business management. Core areas of interest are Finance and Economics. Being a commerce student, I look for a better future in Financial Markets and Entrepreneurship opportunities. I love teaching people. Apart from all these I am a foodie, and love to play basketball.

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