State and federal securities law enforcers complain that they have been hamstrung in efforts to shut down so-called "boiler room" operations in Southern California because two recent appeals court rulings have created a no-man's land in the regulation of gold and other commodities they call "exotic securities."
However skeptically an enterprise may be viewed by the public watchdogs, pitchmen who sell such investments over the telephone now are sheltered from the enforcers. It's back to "let the buyer beware" when considering an investment in gold ore or other commodities, authorities say.
Regulators use uncommonly harsh words about the two court rulings, one federal and one state:
"An invitation to commit fraud," said W. G. McDonald, assistant commissioner of enforcement for the California Department of Corporations.
"A license to steal money," said Irving Einhorn, regional administrator here for the Securities and Exchange Commission.
As the result of earlier court decisions, federal and state regulators had formerly been able to ride herd on all sorts of so-called exotic securities.
These encompass precious metals, gemstones, oil, real estate, cattle, beavers and a variety of manufactured products--including such unlikely investment vehicles as tractor-trailer trucks, motion pictures and master recordings of music, which unsophisticated investors rarely think of these as securities.
"Typically," regulators recently argued before the California Supreme Court, "it is unregulated promoters, and not representatives of legitimate business, who offer these 'exotic' investments, which are highly prone to fraudulent abuse."
The types of abuse include such things as overvaluing the underlying asset, unfeasibility of the proposed venture, nonexistent tax benefits and misuse of investor funds, the court was informed.
Boiler rooms, with salesmen operating banks of telephones, are known for using investment ideas that seem timely or alluring to hook unwary investors.
The two court decisions represent a sharp departure from the way the law had been interpreted on exotic investments, according to regulators.
The first of the two involved contracts sold by Belmont Reid & Co. for specially minted gold coins, but for which the gold was to be mined at a future time. The firm was sales agent for a Nevada corporation that was to produce the gold, Continental Minerals Corp. Continental failed to deliver the coins and later was forced into involuntary bankruptcy.
The SEC filed the Belmont Reid case in 1984. In July, 1986, the 9th U.S. Circuit Court of Appeals upheld a federal judge in Northern California who had ruled that the investments in 1980 were not securities under the law.
No Appeal Made
Einhorn says other federal appeals courts around the country have ruled differently in similar cases.
But the SEC did not appeal the Belmont Reid ruling to the U.S. Supreme Court, and the case has now come back to haunt not only the SEC but state regulators.
The fruits of the federal court ruling popped up 13 months later in a significant state case. The California Court of Appeals overturned a lower court ruling and voided a desist-and-refrain order issued by the Corporations Department. That order had stopped sales of an unregistered gold-ore investment promoted last year by R. G. Reynolds, a radio-television financial adviser who operated out of Burbank.
Persuaded that it should follow the 9th Circuit's ruling in Belmont Reid, the appeals court decided that, in the Reynolds case, investment contracts in "gold-bearing dump ore" were not securities. The California Supreme Court refused on Nov. 10 to review that decision.
The SEC and Corporations Department say that, since the two court rulings, gold ore and gold mining interests have quickly become popular with the infamous boiler rooms of Southern California. McDonald says the Southland now has more of such telephone investment operations than any other place.
More Shops Opening
"The boiler rooms are not stupid," McDonald says. "In the last two months we've seen six to 10 boiler rooms start offering mineral aggregate and gold mining, including coins."
Einhorn, too, says that "a number of shops are opening up, patterning themselves after" the setup in the Belmont Reid case.
Regulators are seeking ways to rectify the situation. McDonald may seek the re-enactment of the state's old commodities law. It was scrapped after the federal government preempted the field in the 1970s with the Commodities Futures Trading Commission.
But two notorious gold scams of the early 1980s cost public investors a total of $160 million and revealed gaping holes in federal commodities regulation, McDonald says. They were Alan Saxon's Los Angeles-based Bullion Reserve of North America and Florida-based International Gold Bullion Exchange.