I learned the news the morning of September 29 last year while at a suburban Los Angeles airport. Alan Saxon, the president of Bullion Reserve of North America, had committed suicide. Bullion Reserve had already closed.
I felt sick at Saxon's death; the man's personal charisma had affected me deeply. But his house of cards had collapsed. I knew his company would never reopen without first going through the bankruptcy court. The only questions remaining were how many investors had been victimized by this fraud and for how much (first reports were that between $57 million and $61 million owed to investors was missing, and it may end up to be much more).
I couldn't help remembering my ratings of 24 leading silver and gold dealers published only seven months earlier in Futures magazine. I had been on the mark when I gave negative ratings ("we do not recommend you buy from this firm," I had written) to International Gold Bullion Exchange (IGBE) and United Precious Metals (UPM), both of which subsequently went bankrupt. But I thought Bullion Reserve was very different. A "young, fast-growing, aggressive" firm, I called it. "Good dollar cost-averaging program. Well-conceived double removed storage programs.…" Something had gone terribly wrong.
Darrell Jobman, the editor of Futures, asked me to write a follow-up article for publication last February that would answer these questions: What was there about Bullion Reserve that allowed them to fool me? What eventually tipped me off to them and led me to withdraw my recommendation before they went under? How did I know in the first place to warn investors away from IGBE and UPM? What can the average investor learn from this that will help him spot a dealer to avoid?
First, let's answer the question, How did I know to warn investors about IGBE and UPM? That's the easiest, IGBE and UPM were offering to sell you krugerrands "at spot," that is, the wholesale price for gold in the cash market.
Now, when you buy a krugerrand, that coin has moved from Intergold, the marketing arm of the South African Chamber of Mines, to one of three primary wholesalers (J. Aron, Mocatta, or Republic); from them to the secondary wholesalers like Deak-Perera, Manfra, Tordella & Brooks (MTB), and Western Federal; and from them, either to retailers or directly to you. The markup charged to the primary wholesalers is generally at or around 3 percent. They in turn mark up their krugerrands anywhere from 0.5 percent to 1 percent. Thus, by the time secondary wholesalers or retailers get a krugerrand for you, they've typically paid 3.75 percent or more over spot.
So when IGBE and UPM offered to sell krugerrands at spot, they were not just undercutting their competition dramatically. They were actually selling krugerrands for 3.75 percent less than what Deak-Perera—or even they themselves—could buy them for. Clearly something had to be rotten. The at-spot offer was earmarked for aficionados of the tooth fairy.
Another offer of the tooth-fairy genre was a "free" Apple II computer that Krugerrands Unlimited offered with a purchase of 100 krugerrands. The only problem with this munificent offer was that the firm's phone was disconnected before we could finish evaluating it.
The case of Bullion Reserve was not really so transparent. Alan Saxon, the late president, first approached the Silver & Gold Report, which I edit, early in 1982. He wrote a very thoughtful letter discussing client safeguards and possible loopholes in the ones we advocated. In subsequent conversations and correspondence, Saxon continued his thoughtful input and, needless to say, spoke glowingly and convincingly of his own firm's storage program. The client protections he offered included:
• a third-party trustee to store all client silver and gold;
• clear physical separation of client silver and gold from the firm's own metal, with appropriate markings;
• ounce-for-ounce, coin-for-coin, bar-for-bar coverage of metal owed to clients; and,
• 100 percent coverage for clients against possible loss of silver and gold from all normal hazards.
But unlike a lot of dealers, Saxon didn't just talk about his firm's program. He put it in writing for us. The attractiveness of the program, along with Saxon's willingness to spell it out in black and white, was the major point in Bullion Reserve's favor.
Next, and even more convincing to us, was Saxon's reaction when I asked him to send us "copies of the segregation agreement, insurance policies, and outside (third party) verifications—such as an audit—that the silver and gold is there." Saxon said, "Absolutely! It's readily available. I'll be happy to."
The third and last convincing point was Bullion Reserve's track record with subscribers to the Silver & Gold Report. It was excellent. We received far more laudatory letters than complaints. And when we did get a complaint and contacted the firm, they'd have it corrected at once. Sometimes they'd tell us that it had already been handled. When we followed up with our subscriber to confirm that the problem was indeed solved, we always learned that it had been. So in terms of customer service, we had to give Bullion Reserve high marks.
All this was the situation in December 1982, when I was putting the February 1983 dealer-ratings for Futures magazine to bed. I was awaiting the documentation for Bullion Reserve's policies, which Saxon had promised to provide. But December and January came and went, and then February, and still no documentation. So I phoned Saxon and said, "Alan, you probably forgot about the documentation. I know you're busy, but would you take care of it?"
He told me, "Yes, yes, you're right. It slipped through the cracks. I'll get on it right away." And that's the way it went. He'd put me off; I'd phone again; and he'd put me off.
Now, during all this time, the great bulk of subscriber correspondence about Bullion Reserve remained very positive. And our own blind purchases from them had been handled well. Nonetheless, their failure to send the independent verification of their storage claims Saxon had promised was making us more and more nervous. So when my book The Insider's Guide to Buying Silver & Gold was published in May 1983, it contained a mild warning about Bullion Reserve. It said simply that we hadn't received most of the promised documentation and that the little we had received was unconvincing.
This brief negative commentary raised enough questions about Bullion Reserve to impel the firm to adopt a more open policy. Saxon gave carte blanche authorizations to Perpetual Storage, Bullion Reserve's supposed warehouser, and to West Coast Bank, Bullion Reserve's main bank, to "answer any questions that Mr. Rosenthal may have to the fullest extent of your knowledge." After I visited those two firms, I would visit Saxon in his Beverly Hills office and he'd give me the rest of the information I needed. Or so they promised me.
Those letters authorizing Perpetual Storage and West Coast Bank to divulge previously confidential information to me were very reassuring. When we tried to get this sort of information from IGBE and UPM, they stonewalled us. So my fears were calmed down; I planned to visit Perpetual Storage, but it wasn't on the front burner.
A call from Howard Ruff moved the visit up to our front burner again. He had been in the vaults of Perpetual Storage on other business, having nothing to do with Bullion Reserve. What he saw about Bullion Reserve disturbed him greatly. He said he didn't feel he could properly go public with what he had seen, because his visit had been on other business. But he urged us to go forward with our own investigation quickly.
I visited Perpetual Storage the next week. I found, as I wrote elsewhere, that "the highly romanced double segregation storage program wasn't worth a wooden nickel." The trustee was nonexistent as a functioning entity; client metal wasn't held apart from the firm's own metal, as advertised; the insurance policy listed the warehouser, not the clients, as the beneficiary; and all the silver and gold was not there, contrary to what was advertised.
When we published our findings in Silver & Gold Report, we didn't mince words. The headline was: "SGR withdraws its recommendation of Bullion Reserve in North America. If you have silver and gold 'in storage' with them, we now recommend you get it out immediately."
Even so, I confess I was fooled at the time. I did not think Bullion Reserve was an out-and-out scam. I believed—preferred to believe—administrative sloppiness was at fault. Yet, a month later, I changed my mind and came to believe that the reason was fraud.
What changed my mind was our September price survey of silver and gold dealers. We found that Bullion Reserve was selling krugerrands for 3.43 percent over spot. Yet, if you remember the calculations discussed above, you'll realize that was just a dot below their cost. But a dot below cost was the only tipoff we needed. After all, how could they pay their overhead when they were losing money with each krugerrand sold?
The numbers didn't make sense, so once again, as with IGBE, I knew something was rotten. And indeed it was. Two weeks later, Bullion Reserve closed its doors in what has proven to be the largest silver and gold fraud in history.
Is there anything that can be learned from the Bullion Reserve debacle? In fact, there are eight lessons that careful investors might heed. They are:
• First and foremost: If a silver and gold dealer is making an offer that looks too good to be true, it almost certainly is. This simple rule will keep you free and clear from at least half of the frauds and scams in the world of silver and gold.
• Second: The numbers must make sense. Sometimes inexpensive is good; sometimes it's very bad. If you can't see how a dealer is making money, he may not be making it—he may be stealing it.
• Third: All the dealer promises in the world, plus a token, will get you on the subway. If you're at all like me, you have an almost irresistible urge to believe dealers. They're nice people. You hate to think they are just plain old simply lying to you. But they may be. You have to get independent third-party verification.
• Fourth: If a dealer promises you third-party verification and it doesn't come when it's supposed to, find another dealer. It doesn't matter whether you were promised references, contracts, audits, or whatever. Failure to supply promised materials is a big red flag.
• Fifth: Ask friends and associates for references. If a dealer gets bad referrals, move on. The converse, unfortunately, doesn't hold. As Bullion Reserve proved, a dealer can get great referrals and still be a scam.
• Sixth: If you're not sure about a dealer, don't buy. Why take chances? Things can happen very fast in the silver and gold industry.
• Seventh: The only totally safe ways to buy silver and gold are sight-drafts and cash-and-carry. Both feature simultaneous transfer of funds and metal.
• Eighth: Nonfungible storage of silver and gold is the only fully safe storage. That's when your metal is stored in units marked with your own name and stored in a third-party warehouse.
To follow through on these eight lessons, you need to ask dealers a lot of questions—before you deal. My own checklist of questions is presented on pages 58–59.
The primary reason most investors buy gold is that they do not trust the government. "The dollar is fiat currency," they say, not without justification. Gold, on the other hand, "retains its value through wars, revolutions, recessions, depressions, and inflations." Give or take some day-to-day fluctuations, I agree.
However, when you buy gold and trust the unbacked promises of a dealer (or the unproven promises, as in the case of Bullion Reserve), you're not buying gold. You're buying fiat gold—gold that exists only in the word of the dealer.
Why trust the promises of Bullion Reserve—or any dealer—more than the promises of the United States government? Or vice versa? If you're buying gold to protect yourself against promises, then protect yourself against promises: take delivery. Get your silver and gold in your own sticky fingers. Then you know it's there—no promises, ifs, buts, or maybes.
I love the silver and gold industry, but I like to be realistic about it. And realistically, the silver and gold industry is still not clean. There are so many sharks, crooks, and frauds out there that unless you know exactly what you're doing, the odds are too much against you.
It's not worth the risk. Your whole investment can be gone in the twinkling of an eye. So, if you don't know how to buy, where to buy, and what to buy, don't buy. Put your money in a money-market fund and you'll probably be better off. You'll certainly be safer.
Daniel Rosenthal is editor of Silver & Gold Report and enjoys ballet, books, and babies.
What to Do Before You Deal
For people contemplating investment in silver or gold, I have devised a checklist of questions to ask a dealer. It should give you a reading of the firm's integrity and financial health—and it should also give you what you need to spot an unsound dealer before you buy.
1. How long has your company been in business?
? Over six years ? Three to six years ? One to three years ? Less than one year
This seemingly innocuous question actually tells you quite a lot. Clearly, if a company has been in business for six years, it's a far better risk than if the answer is six months. But more important, if the firm has been in existence at least since the beginning of 1980, it's survived the greatest bear market in the history of silver and gold prices. The dealer's been through the "valley of the shadow of death" and survived. In this case, there can certainly be some presumption of the dealer's financial solidity.
On the other hand, don't let the newness of a company totally discourage you if the other signs are good. Today, in the wake of three major bankruptcies, some new companies are stressing investor safeguards that outweigh any disadvantage of newness.
2. What is the net worth of your company?
? Over $5 million ? $1–$5 million ? $200,000 to $1 million ? 0-$200,000 ? Negative
If the company has negative net worth, you probably don't want to do business with it except by sight drafts. If your funds are commingled with its funds, you may be out 10 cents, 50 cents, or even 90 cents on the dollar as soon as the company gets your money.
3. What will you do with my funds before you ship my silver and gold? Deposit them in:
? A trust/escrow account where my funds will be released to you only upon proof of shipment?
? A separate segregated account where they will be held as investor funds apart from company funds?
? A general company checking account where they will be commingled with company funds?
The last two arrangements, commingled and segregated accounts, are the most common. Unfortunately, the safest arrangement, a trust, is very rare.
A commingled account leaves you vulnerable to bankruptcy or fraud until your silver and gold is shipped. A segregated account for investor funds can be a good shield against dealer bankruptcy, but it's no protection against dealer fraud. (I believe that's what happened, at least to some investors, in the Bullion Reserve bankruptcy.) A good trust arrangement can protect against both fraud and bankruptcy. But if the trustee is an employee of the dealer, much of your protection against fraud is open to question. So if the dealer answers "trust/escrow" to the above question, ask:
Who is the trustee?
? A bank? ? An independent attorney? ? An employee of your company? ? Other? (please specify)
4. How long will it be before your company ships my metal if I send you a personal check?
? Under nine business days ? Nine to fifteen business days ? Over fifteen business days
Under nine business days indicates the dealer's not waiting long enough for the check to clear. This is a danger sign. Nine to 15 business days is reasonable. Over 15 business days is unreasonable, unless the check is drawn on an out-of-the-way distant bank.
5. How long after receipt of good funds will you ship my silver and gold?
? One business day ? Two to three ? Four to five ? Six to ten ? Longer
There is a direct correlation between safety and shipping time. Two days is twice as risky as one day; four days redoubles your risk; and eight days doubles, redoubles, and redoubles your risk again.
Generally speaking, one or two business days to ship is quite good. Few dealers offer such fast service. One week is common; two weeks is the longest acceptable period.
One problem is that dealers may promise and have a track record of fast delivery. But if their business turns sour, delivery time may lengthen. You probably won't know about it until your silver and gold does not arrive within the promised time. If this happens to you, phone the president of the company and request immediate delivery. Follow up that same day, if possible, with a letter reiterating your request. Send it by registered mail with a return receipt requested. Make it clear that you will inform the appropriate authorities if you don't get your metal soon. The loudest squeak gets oiled first.
6. Do you guarantee the authenticity, fineness, weight, and hallmark of the bullion you sell? Do you guarantee the authenticity and quality (grade) of the coins you ship?
? Yes ? No If "yes," ask:
How does your guarantee work? Will you:
? Replace the metal? ? Refund the purchase price? ? Other? (please specify)
I have been taken by one supposedly reputable dealer on the "guarantee." The coins shipped were over-graded, according to an independent appraiser. The firm offered to refund my money, but by then the value of the gold pieces had risen so much that the refund was $9,500 less than the true value of properly graded coins. There's no doubt about it—refund by replacement is the fair deal.
7. Do you accept sight drafts?
? Yes ? No If "yes," ask:
Do you have a minimum purchase for sight drafts?
? No ? Yes (how much is the minimum?)
Do you charge for a sight draft?
? No ? Yes (how much do you charge?)
Do you ask for a deposit before making a sight draft?
? No ? Yes (how much?)
A sight draft means the dealer ships your metal to a bank of your choice. You go to the bank and verify that the silver and gold you ordered is all there. Then you release good funds to the banker who simultaneously releases the silver and gold to you.
If a dealer does not offer sight drafts, you should not necessarily consider this a negative reflection on his business's overall "cleanliness." There are valid reasons not to offer them, most notably that they're a pain in the neck. On the other hand, sight drafts are extremely effective for investors. If you want to deal with a dealer but are not sure, the availability of sight drafts could override almost all negative aspects.
However, if the firm wants to charge you more than $50 or a percentage of the transaction greater than 0.5 percent, the availability of the sight draft is cosmetic. The firm is trying to discourage your use of this powerful safeguard. Moreover, if the firm demands a deposit greater than 5 percent to initiate one, it is defeating the entire purpose of the sight draft. In either of these two cases, go to another firm that treats your desire for safety more sympathetically.
8. Are all the employees who handle funds, silver, or gold bonded?
? Yes ? No If "yes," ask:
What does the bonding cover?
? Everything ? Fraud ? Embezzlement ? Theft
For how much is the company covered per incident?
? $0 to $100,000 ? $100,000 to $500,000 ? $500,000 to $2 million ? Over $2 million
Bonding is important to protect the firm—and, in turn, you—against crooked employees. If a couple of employees ship 3,000 krugerrands to Brazil without payment and then fly to Rio the same afternoon, chances are that the company could easily go under (in fact, there are very few dealers that could survive such a catastrophe). With adequate bonding, the company and its clients are protected against that kind of loss.
9. Are you audited by an independent certified public accounting firm?
? Yes ? No If "yes," ask:
May I have a copy of your audit, or a short statement prepared by your auditors, that confirms the financial information you've given me?
? Yes ? No
If the answer to either of these questions is "no," you should tend to discount the financial information given to you by at least 98 percent. It was Bullion Reserve's stubborn resistance to giving Silver & Gold Report an audited statement that led us to warn our subscribers to "get [your silver and gold] out immediately."
Remember, an unverified trust arrangement may not really be a trust arrangement. A "profitable" company that won't release an auditor's statement may be losing money hand over fist. Don't believe everything you're told.
May I have a copy of the segregation or trust/escrow agreement?
? Yes ? No
Refusal to disclose the segregation or trust/escrow agreement makes us nervous, but less nervous than refusal to produce audited verification of basic financial figures. The difference is that the former may reveal legitimate trade secrets involving operating procedures.
Furthermore, a firm may have paid literally tens of thousands of dollars in legal fees working out the details of the arrangement. The company has a natural reluctance to reveal this to everyone who asks for it, because sooner or later their competitors would get it for free. (This, by the way, is one of the reasons that the Silver & Gold Report can sometimes get information unavailable to individual investors. By now, many firms realize we don't reveal one firm's operating procedures to another.)
10. May I have references?
You should obtain the names, official titles, addresses, and phone numbers of several of the dealer's business associates. Among these references should be an official at the dealer's bank; two of the dealer's principal suppliers of silver and gold; the dealer's insurance agent; and the dealer's auditor.
© 1984, all rights reserved, Precious Metals, Inc.
This article originally appeared in print under the headline "How to Avoid Tarnished Dealers".