Quarterly Reports You Really Should Read the Prospectus--Really

a timely accounting of timeless principles of personal finance

Jack Frost roasting on an open fire, chestnuts nipping at your toes; although it's been said many times, many ways: It's not enough to rely on the soothing sales pitch of a grand old name in finance--read the prospectus.

To which you reply, very reasonably, that it's not Jack Frost roasting on an open fire this time of year, it's Jack Frost nipping at your chestnuts--and there's no way you have the time or expertise to read some enormous long prospectus. Or even some enormous short one.

I'll start with the short one, just to get your toes wet (we can toast them over the open fire); and then, because you're desperate for some last-minute 1985 tax shelter, I'll tell you about a deal that comes highly recommended.

The Enormous Short One

This example comes courtesy of Jane Bryant Quinn's column in Newsweek. It regards an ad that ran in various newspapers for the Oppenheimer Special Fund, which "touts an annual return of 21.5 percent and invites you to compare that with the rate you get at banks."

Now, you may be no Ivan Boesky, but you know that 21.5 percent is a heck of a lot better than you could ever get from a bank. You also know that Oppenheimer is German or Yiddish or South African or something for "smart with the bucks." There are not a lot of pro ballplayers named Oppenheimer, but who wants Matty Alou managing his portfolio? So, while you know that a mutual fund can't guarantee returns like this, of course, and that you may have to pay a sales commission to buy into this fund (you do: one to eight and a half percent, depending on the investment), you figure that this has got to be one hot fund. Up 21.5 percent compounded for a decade? Why, that's enough to turn a $10,000 IRA into a $500,000 IRA in 20 years, even if you never add another cent to it!

Anyhow, you know there are a lot of mutual funds out there, but this one certainly sounds as good as any, so in you plunge. Oppenheimer sends you a prospectus along with the application papers, and as prospectuses go, it's not even all that enormous. But what are you--a lawyer?

Jane Bryant Quinn isn't a lawyer, either--just magna from Middlebury--but she read the prospectus and reports that "the big gains that Oppenheimer packs into its alluring yield of 21.5 percent came long ago. Between 1974 and 1980, share values rose an average of 39 percent a year. But zigzag performance from 1980 to 1984 brought an average annual loss of four percent. In the first quarter of 1985, the Special Fund measured 519th out of 773 funds tracked by Lipper Analytical Services."

Maybe the fund will regain its touch, Quinn concludes, "but its ad (and similar ads for other funds) would lead you to think it has been making a lot of money lately which is not the case."

The Enormous Longer One, Highly Recommended

OK. Get the idea? It's a jungle out there. You've simply got to read the prospectus. And since you won't--most prospectuses are all but unreadable--you've got to stick to sensible investments recommended by competent, disinterested parties. Not competent or disinterested, competent and disinterested--which very likely leaves out tips from your dentist (other than the tip about flossing) and may even leave out advice from your accountant, who may be getting a commission for steering you into the deal.

If only you had access to an expert you could trust. Someone who did know how to read a prospectus.

With that in mind, pour yourself a beer and get out your letter opener,* for what we (continued on page 256)Read the Prospectus(continued from page 195) have here--delivered by hand to our door--is a fat manila envelope from United States Trust, one of the oldest, classiest, most exclusive banks in the country. ("When you do something very well, you simply cannot do it for everyone.")

Inside is everything you'll need to evaluate and sign up for the Samson Properties 1985-A Drilling Program. U.S. Trust describes Samson 1985-A as "a quality oil-and-gas investment with relatively moderate risk, inherent tax benefits and the potential for significant upside economic gains." (As opposed, one presumes, to downside economic gains.)

The bank's cover letter outlines the deal. With it, in your envelope, come a colorful Samson sales brochure, a deadly 165-page Samson prospectus, a huge U.S. Trust business-reply envelope for your signed papers and $25,000 check and a form you sign agreeing to pay the bank a five percent "advisory fee" for bringing the deal to your attention.

There is already a 7.5 percent sales commission built into the deal, but the bank can't touch it (it's illegal for banks to sell securities like these), so, instead, it charges this five percent advisory fee. The bank's not selling anything--merely recommending that you buy it and enclosing all the papers you need to sign and send to effect the purchase.

By paying the "advisory fee," you are essentially getting the deal at 105 percent of retail. You could avoid the fee by purchasing Samson units directly through a stockbroker, but when you deal with a classy bank--this is not a bank that's out hawking car loans--you should show a little class yourself.

Participations in Samson 1985-A run $25,000 and up. Much of that money will go toward the drilling of development wells--the kind of wells you drill in proven fields, even if they won't make you a fortune--and 90 percent or more of what you put in will be deductible in 1985. There are aspects of the deal designed to make it attractive for the limited partners, but what really matters in an oil deal is how much oil you produce. Tax deductions are peachy, but not if you never get your money back. (How rich could you get giving everything to the Red Cross?)

These are Speculative Securities and Involve a High Degree of Risk, Cautions the front page of the prospectus. The SEC makes 'em say stuff like that. The bank prefers to describe it as "relatively moderate risk." And, as only clients with net worths of $1,000,000 or incomes of $200,000 are advised to participate, it's true. What's an extra $25,000 or $50,000--tax-deductible, to boot--to somebody like that?

Even so, as a potential investor, you might reasonably want to know whether you'll make any money investing in Samson. And you have a choice:

You can read the three-page analysis from the bank.

You can read the colorful six-page Samson brochure.

Or you can read the 165-page prospectus.

I know most of you would lunge for the prospectus, but let's start with the brochure.

Under the heading Prior Program Performance, the brochure explains that by mid-1984, "Samson's 1973-1981 programs had distributed cash equal to 127 percent of total cash invested" and would distribute a further 226 percent over the life of those programs.

The brochure says you shouldn't count on future programs' all doing so well, but, hey, 127 percent and 226 percent--that's like three and a half times your money back! Plus, U.S. Trust likes the program and Samson must be getting more experienced each year and drilling costs are really low these days and the Samson guys themselves are committed to investing in the deal and boy could I ever use the tax deduction where do I sign?

The brochure does say, "These figures assume an equal investment in each of the programs offered from 1973 through 1981," but that sounds sensible enough.

So much for the brochure.

Now let me tell you how to read an oil-and-gas-deal prospectus:

Says one prominent tax accountant who would steer clear of Samson (and most other oil-and-gas deals), "If their average program isn't paying back in three years, forget it."

In Tulsa-based Samson's case, it turns out that its very first program, a teeny-tiny deal in 1973 that involved a total of just $325,000, has paid off like gang-busters--around nine to one. But all its subsequent programs, ranging from three to 30 times as big, have had less spectacular results.

(Funny how often that first deal, which helps sell all subsequent deals, is a lot more successful than the rest.)

So, in the first place, if you didn't assume "an equal investment in each of the programs" but, instead, assumed the amounts that were actually invested, the return on those 1973-1981 programs by mid-1984 would have been not 127 percent--all your money back and then some--but 45 percent.

Now, I'll grant that's extreme. The newer deals have had fewer years to produce revenues than the older ones, and Samson's deals got bigger and bigger as the years went on. So my number, a 45 percent pay back, is heavily weighted toward the 1980 and 1981 deals. Of the $30,000,000 that investors handed Samson in 1981--not to mention the $70,000,000 since then--less than $1,000,000 had been paid back by September 30, 1984.

Of the three 1980 deals (one private, two public), one had paid back 74 percent by September 30, 1984, two had paid back 17 percent and nine percent, respectively. Guess which one was the private deal.

And, understand, these numbers are not return on investment (with luck, that comes later); they're return of investment.

If there were a cynic in the room--and I trust there's not--he might suggest that Samson raised $100,000,000 in drilling investments from 1981 through 1984 not unimportantly on the strength of one crummy little $325,000 program it had drilled ten years earlier.

If so, it would by no means be the only oil-and-gas promoter that had followed the same pattern.

It also leads one to wonder whether that first little program was of the same conservative character as the ones being presented now. Perhaps it was riskier--and one of those risks paid off. And it leads one to remember that that first deal had the benefit of two-dollar-a-barrel-era drilling costs--the deal actually closed at the end of 1972--but 20-odd-dollar-a-barrel-era revenues. Certainly, its success bears no resemblance to any of the subsequent deals.

Having said all this, I hasten to add that there are many drilling companies whose records are at least as uninspired (anybody else out there in a Buckeye deal?), and that Samson's 1973--1981 programs still have a lot of hydrocarbons in the ground.

You will recall that according to the brochure, those deals are projected to return yet a further 226 percent of investors' money. Oh, OK, so maybe it's 220 percent or 215 percent--it's still pretty good, no?

For all I know, the programs will gush aplenty. But according to the prospectus, that 226 percent is based on the assumption that oil will continue (continue?) to sell for $29.50 through the end of 1986 and then climb over the following 16 years to $75 a barrel. ("It should be noted," notes the prospectus, "that no consideration has been given to recent price declines.")

But even using these assumptions--which might be considered just a smidge optimistic--that 226 percent still leans pretty heavily on the first teeny-tiny program. Dropping that one from the calculation brings the estimated future return from these programs not to 226 percent but to 147 percent.

Nor does either of these numbers--the 35 percent of their money investors have gotten back over the past several years or the additional 147 percent they might hope to reap as oil climbs to $75--take into consideration the extra five percent you might have paid a bank for bringing this opportunity your way, nor the time value of money. Doubling your money in oil and gas sounds great until you consider that it might take 15 years to do it.

Yes, oil-and-gas investments are largely deductible; but so are oil-and-gas revenues largely taxable (and likely to become more so).

Ho-kay. Now that you've listened to all my carping--exactly the kind of negative attitude that did not make this country great--if you still want to pony up $26,250 for a $25,000 unit in Samson 1985-A, and you've got diamonds and a dinner jacket, I'll put you in touch with my bank. (Please, oh, please, let it remain my bank after it reads this.) One of the nice things about going through the bank (and it actually is a very fine bank, which I actually owe a lot of money) is that you get the benefit of its independent analysis.

"In addition to the information contained in the enclosed Offering Prospectus, supplied by [Samson]," writes the bank in its cover letter, "certain other facts should be made known to you."

Oh, boy: the dirt.

"In particular, our analysis has established" Samson's competence and qualifications, the equitability of the deal, Samson's drilling philosophy and its track record.

Under Track Record, the bank states, "Through June 30, 1984, Samson's 1973--1981 programs have distributed cash equal to 127 percent of total cash invested and had estimated future cash distributions equal to 226 percent of cash invested." Period.

Somebody at U.S. Trust should have read the prospectus.

*Excuse me for interrupting, but if you open an envelope with a letter opener, wouldn't you open a can of beer with a beer opener? Is this not precisely the sort of thing the analogous-thinking section of the SATs was supposed to prepare us for? A bison is to a bos'n as a bassoon is to a blank? Is it possible that the inventor of the letter opener, rich beyond imagining though he must be, is one of those guys who got, like, 300s on their aptitudes, man, and got sent to work in the mail room--like, this was all he'd ever amount to, man--and then, stuck there in the mail room dreaming great, unconventional dreams, he one day invented, and misnamed, the "letter" opener?

If you think this footnote is bizarre, wait till you read some of the ones in financial prospecti.

"So much for the brochure. Now let me tell you how to read an oil-and-gas-deal prospectus."