As of press time, 3:05 P.M. Eastern Time, stocks had given up most gains from the morning session. The Dow was at 9,509, up 3 points; the Nasdaq was down less than 3 points, holding at 2,017; and the S&P 500 had given up less than one point to hold at 1,025.

Advances lead declines on the NYSE and Amex while declines were just edging out advances on the Nasdaq.

Crude oil futures were up nearly half a dollar to $74.37 and August gold was trading down at 943.60 per ounce.

Small-cap gainers trading over 1 million shares include Mercer International (Nasdaq:MERC), up 71%; Charlotte Russe Holding (Nasdaq:CHIC), up 26%; and Electro-Optical Sciences (Nasdaq:MELA), up 20%.

*****On Friday, I wrote about how difficult it can be for investors to discern if the information they are receiving is valuable, or even trustworthy. Over the weekend, I read an article from Bloomberg that made my stomach turn. 

Apparently, as institutional investors began to suspect there was trouble brewing for many finance companies back in 2007, they stopped buying these companies' bonds. And by "these companies" I mean companies like AIG, CIT Group, GMAC and even Lehman Brothers.

When finance companies can't sell their bonds to institutional investors, we hear in the news that "capital markets are getting tight" or "disrupted." Of course what that actually means is that institutional investors, the ones who are most "in the know", won't lend money because it's too risky.

So what do companies like AIG or CIT Group do when the institutional investors they've been doing business with for years suddenly decide it's no  longer worth the risk? Why they go too individual investors who won't ask too many questions… 

*****There's a company in Chicago called Incapital, LLC, that underwrites corporate bonds intended for sale to individual investors. Founded by Tom Ricketts, whose father founded TD Ameritrade, Incapital controls 75% of the retail bond underwriting market.
 
In February of 2008, an unnamed Fidelity broker recommended CIT bonds to a customer instead of Freeport McMoran (NYSE:FDX) bonds because at the time CIT bonds were rated higher. The Fidelity broker reportedly said that the CIT bonds were pre-screened.

Less than a month later, credit default swaps (which is basically insurance for bonds in case the company goes bankrupt and defaults) on CIT Group bonds were already at distressed levels. Bloomberg reports that credit default swaps sellers wanted "…$1.75 million upfront and $500,000 a year to protect $10 million of the company bonds from default for five years…"

In other words, the institutional crowd knew full well that CIT bonds were highly risky, as evidenced by the 42.5% insurance cost. And yet that Fidelity broker was selling them to a retired customer as a safe "pres-screened" investment at the exact same time.

In all, CIT Group sold $600 million worth of bonds to unsuspecting individual (retail) investors in the first quarter of 2008. They've traded as low as $0.42 since.

Unfortunately, the story gets worse…

*****Incapital was selling Lehman Brothers bonds to individual investors three months before it went bankrupt. It also helped AIG and Freddie Mac raise money from individual investors.

The Financial Industry Regulatory Authority is investigating whether the "risks to these securities (cutely named InterNotes) were adequately disclosed…"

Sounds like and open and shit case to me.

And as for Ricketts, the owner of Incapital, he and his family are the proud owner of a 95% stake in the Chicago Cubs, Wrigley Field and a 25% percent interest in Comcast SportsNet. The cost: $845 million.

*****On Friday, July 17, rumors of CIT Group's imminent bankruptcy swirled. CIT Internotes were the most heavily traded bonds that day. Hundreds of millions worth of these bonds changed hands. And as you might guess, it was the individual investor who lost the most money during the panic sale.

Individual investors were selling one particular CIT bond that matures in 2016 for $0.42 on the dollar. Institutional investors were selling the same bond for $0.52 on the dollar. And yes, once again, it gets worse.

Traders were taking a 6% commission on the CIT Internotes trades that day, while all other trades were generating a 1% commission.

So not only were individual investors getting worse prices, they were paying higher fees. It's appalling. And there's really only one lesson: be careful out there.

If you're looking for honest advice and want to invest alongside an investment expert, I encourage you to check out my Recovery Portfolio service. I'm putting $100,000 of my own money where my mouth is. So when I tell subscribers we're buying XYZ stock, I'm buying it, too. No hype, no fluff, just real investing with real month. And I'll get you started with the five funds that these jokers on Wall Street won't share with you. Click here to find out more.

Until tomorrow,

Ian Wyatt
Editor
Small Cap Investor Daily

P.P.S. My book The Small-Cap Investor: Secrets to Winning Big with Small-Cap Stocks is coming out on September 14 - visit www.smallcapbook.com to learn more. You can also follow me on http://twitter.com/ianwyatt 

Ian Wyatt is the Chief Investment Strategist of SmallCapInvestor.com and author of The Small-Cap Investor: Secrets to Winning Big with Small-Cap Stocks. You can learn more about his book and receive small-cap stock picks at www.smallcapbook.com.

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