Stocks, Bonds & Taxes: Textbook Edition:A Comprehensive Handbook and Investment Guide for Everybody

SECTION I

INVESTMENTS

PART ONE

EQUITIES

Equity capital is the stockbroker term for corporate stock issued for cash. Thus, it is outside ownership in the corporation. This interest, usually expressed as voting common shares, is sold through various financial firms that are authorized through the Securities Exchange Commission (SEC). Equities are the common currency of the average citizen today. Stocks are owned by all pension/retirement plans, in individual portfolios, and in everyday economic discussions. Several television stations are devoted full-time to live trading and ecommerce discussions. Economic events such as a large company layoff or merger are transformed into headlines of stock market movements that appear in newspaper headlines or bylines on the hourly news. Equities are the stock market and woven into the fabric of daily American life. Although the top 5% of the population owns 90% of all wealth, there is enough left for trading, investment, pensions, and speculation by the typical middle-class citizen today.

Accessibility of the equity markets by individual Internet trading has expanded public awareness and participation to an extent never imagined by the cyber dreamers of these times. The Internet stocks themselves have added fuel to the fire that has driven the NASDAQ and Dow Jones Industrial Average Composite (DJIA) to unheard of levels. The swift driving forces behind modern computerized equity trading operate without historic reference to the times when the Chosen Few Bankers, behind closed boardroom doors, traded stocks until Thomas Edison invented the ticker-tape machine.

The Financial Industry Regulatory Authority (FINRA), formerly the National Association of Securities Dealers (NASD), is a Self-Regulatory Organization (SRO) in which stockbrokers and dealers pay all the dues and expenses. The organization strictly monitors the professional conduct of the Broker/Dealer (BD) firms and account executive representatives through their licensing and audit functions. FINRA, under the umbrella of the Securities Exchange Commission (SEC), is the investigative and compliance function for security sales and trading. Their sanctions and penalties are quite harsh in comparison to other professional organizations, which tend to act fraternally for member protection. Because of the fiduciary exposure of individuals to securities representatives and their firms managing client funds, the FINRA is a welcome ally for the average investor.

CHAPTER ONE

INITIAL PUBLIC STOCK OFFERS, SECURITIES EXCHANGE COmMISSION REGISTRATION

The SEC subjects new Initial Public Stock Offerings (IPO) going public to the sale of their shares of corporate stock for operating capital, to intense scrutiny. The company must have been in business prior to the offer, complete registration questionnaires, disclose antecedents about the management, satisfy capital requirements, and provide certified financial statements to satisfy the SEC that the business is a viable going concern and that the offer is not fraudulent. After registration, all corporations must file periodic form 10Q every three months to report earnings. Since the underwriting process is complex and expensive, only large brokerage houses and a few specialized banking institutions manage new issues. The UNDERWRITER charges about 7% of the new issue and sets the price for the Initial Public Offering. This offering is a selective offering, which is sold in blocks to large brokerage firms and institutional buyers such as mutual funds. These funds and firms are advised to hold the stocks, for a month at least, to avoid speculation. What really happens is that they FLIP the stock over and sell it on the secondary market for a quick profit after a minute or two.

The corporate seller usually authorizes common voting stock, which has no-par value. By not having a stated value, such as $10 per share, the stock sale price per share can vary and will be booked at the actual amount sold instead of a fixed price. If it were fixed at $10, the stock could be sold for only $10 initially, a move that would create corporate accounting and tax problems if the public would not pay cash price; defined as two unrelated parties paying for any item in an open arms-length transaction that much or it could be sold for more on the open market.

A Committee on Uniform Securities Identification Procedure (CUSIP) nine-digit alphanumeric number is assigned and noted on the left-hand top corner of the stock certificates. Every time a security including bonds is traded, this number is used. The agency has assigned the numbers to all North American U.S. and Canadian financial instruments since 1962.

NEW ISSUES are always a highly speculative venture and subjected to much fraud. First, why are we buying a new issue? We are speculating that the price we pay for the shares of stock will increase dramatically once offered. We are hoping it will run away next week, after buying it (buy low, sell high)! Now we join the line of speculators. First, is the guy who owns the STOCK OPTIONS of the company before it goes public, if privately held, along with his VENTURE CAPITAL investors. He then sells his shares or new shares (might be restricted to one year after the IPO) that will pour money into his business and generate higher salaries and benefits for him and create an increase in the value of his original holdings. Next, there is the underwriter institution that creates a huge commission to issue the stock. The underwriter sets the initial price, which can create much speculation if it is priced under the perceived market value. Then, there is the brokerage or institutional firm who buys an allocated block of the stock for them, unless they know it is an illusion. They control the now secondary speculative market prices, after it is first offered, by calling their list of investors and telling them how great it is. This stock is not listed on the open market yet, so the few brokerages or investment bankers really control the issue. Then, you buy the remaining public shares. Did you buy it when it was first sold on the secondary market at $7.50 by the initial institutional while $5 buyers were taking their first profits, or a week later when it was at $10, when everybody was now reselling higher? Or the next month when the same shares are bidding for $23.50, or the next year when they bottomed out at $2.50? The first Broker-Dealer or institution who buys the allocated block of shares at $5 for their own account hopes to sell when the market is higher. He becomes in a great position to know when to move because he is actually making the market by controlling the limited and allocated issue.

The STOCKBROKER sales rep is not forgotten in the feeding frenzy arrangement since he can earn a maximum commission on the deal, both when the issue is first sold to the investor, by the investor, and when it is resold to another investor. He can also allocate new issues to selective clients, which enables him to sell doggy issues along with potential HOT ISSUES or set the investor off for the next good deal. Although rarely done, most market-making brokerage or investment firms are asked to hold the initial issue up to a month to discourage excessive trading and speculation.

Most of the IPO trading traffic these days is done on E-stocks, which are internet-related speculations. The venture capitalists deal in three basic categories leading to the IPO. These are vertical portals, business-to-business portals, and e-commerce superstores. These are not technology issues, but purely over-the-Internet electronic speculations.

All IPOs must be registered and approved by the SEC before they can be sold to the public. Many fraudulent stock offers are now appearing on the internet. The best way to buy any stock on the Internet is to work through a broker. This is the only official control over legitimate offerings. Many new internet hot issue publications can exaggerate new issues with fantastic predictions. Beware of people offering the issues who may pay them off or be connected insiders. Be cautious also of continuous fortuitous statements issued by principals about their holdings and undisclosed options. Actually. the SEC receives hundreds of calls each day from investors who are concerned about dubious internet offerings. It used to file formal charges against one fraud case per month, until late 1998 when they filed 44 in one day, but still only a fraction of the actual total. Sometimes they only order the peddler to cease and desist, which is another way of saying your money is gone forever and the bad guys are leaving on vacation. This means that you are on your own if you buy any security or investment not offered through a reputable firm. Do not invest money for any IPO that you cannot afford to lose, because IPO is another word for SPECULATION. Best to let it age a little while and settle down.

There are many good companies that are helped by going public because they have large capital requirements for expansion, equipment or other needs besides speculation or profit-taking. Only exceptionally large issues will be accepted for sale over the New York Stock Exchange Big Board in public trading. IPO’s will not be listed in the financial section of your local newspaper under NASDAQ, NEW YORK, or AMERICAN exchanges, unless they are large private companies going public. Some newer stocks are now listed in the NASDAQ Small Capital Issues section.

PLANNING TIPS

New initial stock issues should have two key points. The first is the INDUSTRY the company is in, and the second is why the company should be especially successful as a competitor in that industry. Gather information, if possible, on the industry. Is it a growth industry like software or a dying industry using Bessemer steel furnaces? Ask the sales rep for data on the company and its officers. He can send it by fax or e-mail if he wants to make a sale. You will not have much time because he will be working the phone, so be brief and call him back on the same day (keep in mind that they may close early because most trading halts at 4 PM New York time and these reps start early at 9:30 in the morning).

Some IPOs are solid gold, and the stock shares are allocated to the BD’s best clients, meaning large trades, sales, and commissions. Evening trading under the NASDAQ, although automated, will certainly result in much loss of sleep by brokers, as well as clients. Moreover, we all know that the more stocks are traded, the higher the prices can go!

Because of intense speculation during late 1998 and early 1999 shares of stock, new issues were traded over ten times daily and some of the large brokerage firms closed out MARGIN ACCOUNTS for all Internet stock trades. The volatility of the prices caused too many margins calls on these accounts whenever the prices dropped.

Most stock issues are packaged with financing leverage by huge, institutionalized broker firms and associated banks.  Like most individual stock issues, they are available for purchase through mutual funds and investment advisor fiduciaries.  Individual stocks traded over the market sells for about 1% commissions, which is down from the traditional 5% before discount brokers took over the trading business. Some discount brokers in 2020 sell for zero commissions on stock trades.  They simply make money on other security products, especially insurance related and advisory clients’ accounts which charge large fees based on portfolio value.

Internet trading firms are now entering the IPO market and will be offering smaller offerings directly to the investor on a Dutch auction which means that each person bids separately eliminating some of the excessive middleman profit-taking between investment bankers and brokerage or institutional firms. It also brings a higher price and more cash to the corporation owning the stocks that are being offered because the price corresponds to the market and is conservatively underpriced benefiting the controlling first buyer brokerage firms and institutions. Some of these new offers spends multimillions on advertising a software application, which may not have any value if it does not fly.

TAXES

All stock sales are subject to rules on profits or losses. The gains are the greater of the selling price over the purchase price. Commissions and ticket charges reduce selling prices or increase purchase costs. SHORT-TERM GAINS, which are sales of investments held less than one year, are taxed as ORDINARY INCOME, your highest tax bracket. For LONG-TERM GAINS of over the one-year holding period, the tax rate will be maxed out at 0 to 20% according to the applicable tax rates on an individual’s tax return (which have a new high of 37%). If your taxable bracket is a lowly 10%, then the long-term capital gains tax is reduced to only 0%. All short-term and long-term losses will offset capital gains and are subject to a loss deduction limit of up to $3,000 per year against other income. Excess losses can be carried forward to future year tax returns, never backward. Capital Gains tax brackets at the time of printing (2020) begin at 0%, 15% and 20% depending on taxable income and filing status. Qualified dividends, which are dividends from equities--not bonds, are also taxed at capital gains rates.

TAX TABLES FOR CAPITAL GAINS AND QUALIFIED DIVIDENDS

Effective 2020 the breakpoints are:

Brokerage tax statements usually list the sales of the securities or bonds and the costs.  Sometimes the costs are not all identified because the securities were transferred from a different broker account and the purchase amount is unknown to the new dealer.  In that case, the costs are undisclosed, and the clients must identify or estimate their original costs to fill in the cost space. Never leave it blank because it may result in taxes on the sale amount.

Stock options are issued by management agreements which generally allow future taxation as wages or taxable gains. The kill price and dates are set at the time of employment agreement. They are not usually exercised unless there is a gain on the value of the equities.  Some broker firms handling the transactions note the individual wage tax treatment on the year-end broker statements at tax time. Other brokers leave it off with questionable results because the brokerage tax statements show the sale as a taxable event, causing immense conflict between the tax preparers and clients.

To compute taxable capital gains profits (or losses):

Compute for each security transaction, then segregate all SHORT TERM under one-year holding period from LONG-TERM CAPITAL GAINS OR LOSSES.

* When scheduling these items on Schedule D of the individual tax return, it is best to show the selling price alone so it matches the 1099 form with the IRS computer and add the selling expenses to the cost-basis purchase price. Fortunately, all broker firms segregate the data under short term, long term, income, and purchase or unallocated cost for stocks moved into their brokerage with unknown costs. Bonds are usually segregated from equities.

LEGAL COMPLIANCE

SPECULATIVE ISSUES CANNOT BE LEGALLY SOLD to low income, uneducated, small net worth, no prior experience with stocks or elderly individuals who do not have a stock portfolio. Some brokers tell great stories over the phone to sell an issue, even though insider information is illegal for securities trading. A tape recording, (which is also considered illegal) or another person listening to the conversation on another phone would be helpful if the issues were misrepresented.

Sales spiels are supposed to be reviewed and approved by the SEC and the broker-dealer compliance principals. If you experience a loss and feel you were misinformed, call your sales rep to find out what happened and get the facts straight. Although a telephone complaint may be ignored or misconstrued by the sales rep, a written complaint to the broker-dealer must, by securities compliance law, always generate a serious response if you have a loss and you feel you were misinformed. If their response is inadequate and you still feel you have suffered real losses directly due to their activity and want commissions or losses repaid, then write directly to NASD at 1735 K Street NW Washington, D.C. 20006 or their replacement FINRA at 100 F Street, NE Washington, D.C. 20549. These organizations are Broker-Dealer Self-Regulatory Organizations (SRO) that will immediately query the BD who will talk to the sales rep and responds in writing both to the FINRA and you. This is a profoundly serious business at this level and can endanger licenses, so the response is appropriate. It is also important that your complaint be accurate and documented. They will arbitrate the claim, if reasonable. The Securities Exchange Commission, using government funds, will also respond to complaints of official or national importance.

A large brokerage firm in Beverly Hills, California, advertised that they would not charge commissions for trades made to certain stocks. The slick professionally prepared booklet offered many deals to new clients, who were supposed to save a ton of money by not charging commissions. Well then, how do they make enough money to pay for the beautiful advertising and overhead? The SEC investigated it and found that they were simply marking up the prices on some stocks by making the market they were buying for customers. There was a million-dollar fine connected to the cease-and-desist order from the audit so the firm may now need a novel approach to finding new clients or making money on them.

About suing the broker-dealer on the above issue. Most broker-dealers require an ARBITRATION AGREEMENT from clients before they will open an account. This eliminates frivolous and nuisance suits from unscrupulous lawyers and their clients. In-house broker-dealer attorneys estimate it costs over $25,000 to successfully defend any suit, no matter how small or absurd. New clients who do not sign do not become new clients. The FINRA would recommend an arbitration panel hearing with you if the issue remains unresolved. You will have your day in conference with their retired or independent professionals within a few short months.

Some unregulated or sparsely unregulated Hedge Fundsor other firms acting on the edge of the law sometimes come to light like the Bernie Madoff Ponzi Scheme in 2008, which reached National province after the lawyers got busy and resulted in tax code changes afterward to account for losses from claw back restitutions paid to other investors for prior years.

SUCCESSFUL STRATEGIES

There can be no greater success story than of a person who bought Dell Computer when it first went public. The legend of college student Michael Dell, building computers in his garage and selling them directly to consumers still holds true today as his huge firm now sells them over the Internet and by other DIRECT SALES methods. By building a reliable product and eliminating retail outlet costs, he capitalized on a fundamental advantage as well as maintaining close contact with his customers. Without being blinded by component manufacturing giant IBM’s leasing philosophy, or Apple Computer’s creating the software to sell hardware, he adhered to the philosophy that a computer is a metal box filled with basic components, which can be bought on the street. The fast-changing computer component business was a challenge he was able to master by shortening the gap between customer orders and manufacturing, thus avoiding finished goods inventory buildup. By carefully crafting a selling philosophy of avoiding intermediary retailers such as Radio Shack which sold the first micro-computers (Tandy), he stuck to direct sales by media advertising until achieving NIRVANA (not a stock issue but an elevated state of being) on the Internet that connected his clients directly to him. Now his international firm assembles computers to the wholesale and retail seller’s specifications in short order from parts manufactured overseas and south of the border. Other computer manufacturers are attempting to copy his mode of operation. An investment in a VISIONARY person, not just the firm, is the true test of entrepreneurial investment when the business comes out the chute as an IPO.

A Dell investor, careful of his small retirement savings, took advantage of his sound investment luck by selling off his original investment shares) periodically. Thus, he TAKES SOME OF HIS PROFITS out as the stock runs up the ladder. No matter what happens to the market, he will have covered his end if it declines. This careful person will keep most of his profits, whatever happens to the market or his investment. Instead of a STOP-LOSS on the price, he simply limited his holdings.

I did sell a lot of Tesla when it went out the door at $20 and now it floats between $500 and $900 still without making any profit. Musk applied the First Principle of Aristotle which is to change things, you must go back to the beginning and change the old approaches to the project. Everything must be new; do not apply old solutions to recent problems. And do whatever is in your power to make it work.

Elon Musk is currently the CEO and founder of several successful companies including Tesla and Space X. Elon Musk realized that nobody had an electric car and designed his Tesla from the ground up changing manufacturing, design, and sales techniques anew. He threw out the Wernher Von Braun's rocket technology used by NASA from WW II and designed his fabulous rocket program including the recovery of major components, from anew. He created the Boring Company to drill underneath Los Angeles for a limited low-cost transportation solution. This visionary can start new business concepts from the First Principles theory of tossing the accepted handed down theories and reinventing the wheel.

Elon Musk’s first principles:

Identify and define your current assumptions. Find your root problem.

Breakdown the problem into its fundamental principles. Ask yourself powerful questions about the problem. Break it down into basic truths.

Create innovative solutions from scratch. If you ask yourself powerful questions about your problem, then a new unique solution may come to you.

Elon Musk’s 6 hiring tips for leadership principles:

Move. The ability to keep up with current trends and stay competitive.

Do the Impossible. Think creatively.

Constantly Innovate

Reason from First Principles. Identify root problems and solve problems

Think Like Owners. Leaders should be supportive in business development like an owner would be.

We are all in. Teamwork.

HORROR STORY - BAD IPO

A friend who is tired of buying losing California Lotto tickets, invested his small savings into an IPO, which purported to generate a KILLER PROFIT. This person was in bad shape financially and based his future on this hot deal. The IPO went up a little, then down a little and settled on a trip to nowhere. The person was lucky to have relatives take him in afterward when he was between jobs and broke.

This item should be labeled Future Horror Story. There is always a loophole to every rule and law of the land because lawyers for lawyers write them. The Securities Act of 1933 (Truth in Securities Law), which covers the registration of securities and new offers, had a small business registration exemption for offerings under $1 million with only minimum restrictions. This was a useful measure allowing small businesses to incorporate and issue their stock. The result, however, was a recent Fortune Magazine article that showed a small storefront retail business selling shares of stock to school children and people off the street. The article indicated that this small business focus was not to make money from operations but was in the business of selling its stocks. Only the future will tell if the business succeeds in either, but the eye should always be set on EARNING PROFITS, not taking money from lenders or shareholders because there is always the day when all accounts must be satisfied and reconciled.

SECOND HORROR STORY - CRITICAL PATH INC

Another IPO example is Critical Path Inc., which had a market capitalization (the value of all shares outstanding at a current market price) of $1,400,000,000 and lost $11,400,000 on sales of less than one million in 1998. What will happen if the company continues to lose money? For every dollar, in sales, they lose eleven. A corner liquor store or gas station can easily do a million dollars annually in sales. Where did the money go? How was it use? Why are people buying the stocks?

PROS AND CONS ABOUT IPO

Do not speculate with money you cannot afford to lose.

Be wary and cautious about telephone sales spiels.

Most IPOs are old and tired by the time the general trading public gets to trade them.

Do your homework about the new firm before you invest.

Find out if your Broker is trustworthy.

Brokerage firms make a market with new issues and have great control over the sales method and pricing.

Do not use borrowed money for speculation. That is money you do not have to lose.

Remember always that all firms must earn a profit to survive in the end that includes Tesla Motors.

TAX TIPS

The good news is that there are no tax problems with losses.

Tax gains or losses are not recognized until the equity is sold or exchanged so it is a clever idea to sell losers before year-end (November, not December because of tax rules).

Stocks with large gains might be sold at the same time (not same stocks) that have big losses and if the trading expenses are small, they can be bought back again later in the next year. Be careful of exchange trading the same stock.

Exchanges (selling a security for losses and buying it back right away) create tax problems.

Capital losses are limited to maximum offsets of $3,000 per year against ordinary income after offsetting other capital gains.  The remaining losses carry forward to future years.

If the $3,000 capital loss cannot offset income in any year, it still reduces the loss carryforward while the losses did not use that year become a part of a Net Operating Loss, which is a separate loss to carry back or forward to other tax years.

The Wall Street Journal lists valuable trading information and closing prices daily for the largest 1,000 companies in the USA.

CHAPTER 1: APPLICATION EXERCISES

True or False

1. Tax gains and losses are not recognized until the equity is sold or exchanged so it is a clever idea to sell losers before year-end.

2. IPO’s are always a highly speculative venture and sometimes subjected to loss or fraud. 

3. A CUSIP number is noted on each stock certificate. 

4. Selling a security at a loss and buying it back within 30 days creates tax problems.

5. Which tip(s) are included in Elon Musk’s leadership principals?

___ A. Think creatively

___ B. Teamwork

___ C. Keep up with current trends

___ D. Aristotle’s first principles for success

___ E. All the above

6. The NASD and FINRA are

___ A. divisions of the SEC

___ B. self-regulatory organizations

___ C. funded by the U.S. Treasury

___ D. managed by elected officials

___ E. all the above

7. Fiduciary responsibility is

___ A. the problem with on-line trading

___ B. only a broker-dealer management concern

___ C. the sole responsibility of the Registered Representative salesperson

___ D. joint responsibility of the Registered Representative and the Registered Principal representing the BD firm

8. New public stock registrations (IPO) require

___ A. an underwriter

___ B. certified financial statements

___ C. common voting stocks

___ D. a viable going concern

___ E. all the above

9. Margin Accounts

___ A. provide leverage

___ B. are secured by the investor’s portfolio

___ C. enhance speculation

___ D. can result in a call to close the account and sell all securities

___ E. all the above

10.Securities are not taxed (check all that apply)

___ A. on appreciated values at year end

___ B. on sales gains of short-term ordinary income tax tables if held less than a year

___ C.on sales gains of long-term capital gains rates if held longer than a year

___ D. on gains within pension funds or IRAs

___ E. none of the above

CHAPTER TWO

SMALL CAPITAL STOCKS

Small company stocks, a.k.a. SMALL-CAPS, are growth stocks. They are traded on the National Association of Securities Dealers Automated Quotations (NASDAQ) Exchange, which handles the newer (smaller) publicly traded issues. The initial private offering, after stabilizing and reaching a certain size, aspires to public trading which puts upward pressure on the price and guarantees press coverage of the principals and future financial activity, good or bad. An example of how large a company must be to jump into public trading and rub shoulders with IBM and Microsoft, are those in large company that holds over 1/3 billion equity position in real estate and is always THINKING about going public. Because the company is not publicly held, I cannot disclose the name here.

Some successful firms reverse their public exposure by buying back all their shares to go private and take the pressure off quarterly earnings reporting and public exposure of liability and risk.

Small caps are growth oriented. They actively seek growth capital through stock issues or alternate financing. Because they are focused on growth and capital formation, they do not pay dividends. All earnings, if any, will be plowed back into internal growth or debt reduction. These are the exciting issues, highly traded and fresh in the public mind. Microsoft is an example of how a company with intense visionary leadership under Bill Gates, started out by working with the giant old Blue-Chip Company, IBM, but grew larger than them are by focusing on mind-ware software instead of hardware. The results are in the papers every day.

The Civil War, over a hundred years ago, changed our economy into a manufacturing economy, leaving farming behind as the basic economic structure of the nation. A hundred years later, companies such as Microsoft grew out of nowhere, usurping the industrial giants in size and scope with nuclear growth unheard of in an economy where health is measured by the size of the manufacturing assets section of the balance sheet. This change was so profound that the Dow Jones Industrial average stock listing has been changed to include software and mindware such as Facebook business in the Industrial Index of thirty largest traded stocks. 

What does it all mean? To the investor, we have companies not paying dividends, which is interest on capital related to earnings; paying investors back instead by the growth of stocks expressed by price changes in the public marketplace. Truth is, in reflecting the fundamental changes in the economy, there are much greater future returns on reinvestments. This highly volatile investment area, holding massive amounts of public capital including most mutual funds and pension money, can change in value overnight on a press release or a distant world event. This is where the true focus of capitalism rests today with investor confidence, leading the sum of the values to all-time highs.

Small caps are subject to stock splits. A stock split is created when the price of the stock has reached a remarkably high level and the Board of Directors of the firm meet to decide that they can sell more shares if the offering price were less. Then, they do the official paperwork and issue new shares to shareholders on record and the owners now have two or more shares for every old share they held. The equity position is the same, because the transaction merely creates more certificates much like breaking a ten-dollar bill into two fives. Investors usually love stock splits because it increases the number of shares held proving that the price has been rising and makes the stock more affordable again. These are referred to as diluted shares by the market. A stock that never splits is successful Berkshire Hathaway where Warren Buffet is the chairman and chief executive. It would take a mortgage refi to buy a share at present highs. On 12/31/19, the closing price of the Berkshire Hathaway stock was $339,590 per share.

Stocks are usually sold in round lots of one hundred shares, so being able to buy a hundred shares for half the money has an appeal to the trading public, especially small investors. Of course, investors can do a number on their uninformed collegiate when they inform their economic rivals at the Saturday party that they now own over (1,000 or more) shares of XYZ company instead of the five hundred they held the week before. These are diluted shares. That is, each share is worth only half as much as it was before the split. It also makes tracking difficult because if you own ten shares of stock, were they ten shares before they became a hundred or a thousand?

Small stocks do not issue preferred stock shares that guaranteed dividends. (They act like bonds without maturity dates.) They also issue millions of shares to distribute to management in one form or another. Different classes of stock can be divided into voting shares and non-voting shares (a.k.a. A shares or B shares). Some preferred stocks can be exchanged into common shares.

The actual certificates of stock purchased can be held by the investor or at the brokerage firm. The sales rep will always ask you if you want the shares held in-house or not. It is best to leave it with the broker to save handling because if you decide to trade it later, the certificates must be properly endorsed on the back and sent to the broker before the trade can be properly completed. The settlement time for a trade is now one business day (T plus 1), so there is not much time to fool with the certificates if you are a serious trader. This really brings us into the electronic age for trading. Of course, many investors hold older certificates good for pinning on the den wall, because they have no value at all. Clients leave them with me so I can wallpaper the hallway in my office. Most people without walk-in safes simply lose them and need to sign a lost certificate affidavit when sale day happens. Newer stock certificates may have an electronic copy of the stock sent when purchased.

Corporate mergers create unique situations where the old certificates trade for new certificates or are bought outright. Many elderly people scramble to locate these certificates when the certified letter comes in the mail. Best to keep them in a bank safe deposit box or a home safe that is big and heavy enough to offer fire protection. If the merger cashes out the stocks of the registered owner, simply get a check in the mail and another reporting line on the tax return.

The securities’ Corporate Secretary dutifully records all certificates in an official register. This can be automated today, instead of the black fountain pen of yesterday, and the Secretary can be in a broker office or a bank investment department.

Trading can be monitored today while watching the television's financial channels or on your computer. This brings the market literally to the doorstep. It is incredible to watch a billion shares of stocks change hands in a single day. Sometimes the market will begin in highly negative territory and turn completely around before the day is over. The trading results are delayed by twenty minutes to slow down speculation from the media watchers. The New York Stock Exchange hours are from 9:30 am to 4 PM Eastern Standard Time, three hours ahead of the Pacific Western states. NASDAQ hours are the same but will probably be extended into the evenings one day so that day traders can become night traders.

Stock reverse splits have been in the news recently. This event happens when companies issue fewer shares to replace outstanding shares. Thus, if 100,000 shares were outstanding at $1 each, a one for ten would result in 10,000 new shares of stock outstanding valued at $10 each. This can be an attempt to keep the stock listed on the NASDAQ exchange by keeping the value high enough to trade. Remember when Ford Motor Company was in danger of being delisted and the common stock was trading at just over two dollars? Naturally, I put a lot of clients into it because I had faith in the new aerospace management, while GMC and Chrysler kept with their old management in place. I was chewed out for bringing clients into a possible bankruptcy but saved when the shares recovered to $14 the next year.

A company can also buy all outstanding shares of stock and delist itself by going private with few founder owners again. A business buying its own stock creates treasury stock. This reduces the pressure to issue dividends, keeps the corporate affairs away from the public eye, reduces SEC scrutiny, and puts a wall around the company which is now closely held by few related family members. By not issuing dividends, required by the IRS code, the company can hoard cash although also subject to tax codes of holding company concerns. A holding company, according to the IRS, is a corporation that hoards cash and fails to pay taxable dividends. The management of a delisted private company can consist of fewer members who lack the normal controls for shareholder and public involvement.

Some companies sell their shares directly to the public as an effort to reduce investor load or commission expenses. These companies will manage the actual registration of the shares and issue the shares to people investing on a one-for-one basis. These are in addition to the corporations that allow shareholders to reinvest dividends without paying brokerage commissions. Be sure of the financial strength of any firm doing this because they may not be strong enough to be listed on the stock exchanges and quite risky. Any transactions away from the licensing and controls of a broker-dealer should be suspect. Naturally, they would be located on an Internet trading site.

Stock repurchasing is a rare event where a company decides, usually because of close family or management ownership, to repurchase all the publicly held shares and become a privately owned and operated corporation.  This keeps the pressure off management to appease public shareholders with short-term positive events that increase costs in the long run. A true example of bad public stewardship was a major firm near San Francisco, which traded higher present earnings for a long-term expense. They sold a large transportation terminal to boost current earnings a few cents and creating a tax liability from leasing it back unprofitably in the future.

PLANNING TIPS

Keep in mind that commissions are usually charged on every transaction, usually from 1% up to 5%, the legal limit, plus ticket or delivery charges. It is true that some brokerage firms do not charge commissions but not the big reputable ones. Thus, to buy a small lot of stocks one day and sell them the next and go on a wild trading frenzy can consume the entire investment with costs and make the sales rep happy until you disappear. Best to hold securities long enough to see if there is a trend developing rather than sell and buy at a panic or whim. Buying and selling on short notice using arbitrageis truly speculative, so keep in mind that there are costs involved. The larger the purchase, the smaller the commission percentage charged. Odd lot purchases of less than 100 shares have higher charges to offset trading difficulties. Discount brokers charge fewer commissions than regular brokers. Know what stock you are buying, that is, do your own research. Investors sometimes do better on their own knowledge than the sales rep on the phone exaggerating his hot deal of the day. Insider tips are always illegal. Most public data about corporate events are old and public before you hear about it, which leaves the average investor behind the curve. The magic trick is to be predictive, that is to see and read or feel trends, instead of history. It helps to be psychic but reading the Wall Street Journal daily will help a lot.

Upon becoming a shareholder, many firms invite their new owners to participate in a corporate dividend direct stock-purchasing plan. You have now joined their mailing list. This plan allows shareholders to buy shares of stock directly from them with your cash dividends, without paying any commissions or ticket charges. This is a safe way to save money on B/D commissions and charges in a small way if you wish to increase your holdings in the firm. Your purchases will also reflect dollar-cost averaging [DCA] because you will be averaging the difficulties of the market by buying at three-month intervals.

TAXES

As with small caps, all stock sales are subject to the capital gains rules for gains or losses. Most broker-dealers are now using sophisticated software to track purchases through sales to provide 1099 B forms at year-end with both costs and sales data for the sale. This is a lifesaver because it is very confusing to match confirmations with 1099 forms, especially on some of the trades made many years ago. Short-term gains from securities held less than one year are taxable as additional income at the highest rate on an individual’s tax return. Long-term gains from securities held more than one year are taxable at more favorable tax rates.

LEGAL COMPLIANCE

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