Financial Advisors, Brokers & Bankers Slammed In New Poll

Here is a different type of story for you (no price charts) but might be one of the most important ones you read this week. No one else seems to be trying very hard to make you aware of an issue that has grown into a huge battle in Washington D.C. It is an issue that relates to the core of a principle that should be basic and fundamental in our society, but all too often is sadly missing. It is because the outcome of this battle will ultimately impact you that we take time now to tell you about it.

Consider a news report from earlier this month (July):  A respected (but not widely known) law firm has published its second annual survey of active “players” within a particular industry. A complete analysis of survey responses revealed the following results:

Image below from flickr.com
1)    23% have firsthand knowledge of wrongdoing by colleagues;
2)    25% confessed they would be willing to break “the rules” (or even “the law”) if they could get away with it;
a.
   Within the youngest tier of these employees, the percent willing to break the rules/law rose to 38%;
3)    A majority (52%) indicated their conviction that competitors break the rules/law in order to “get an edge”;
4)    26% reported that compensation structures/practices incentivize unethical (even illegal) behavior.

This is a pretty dismal picture of an industry, isn’t it? Based on the news media and recent events, which industry do you picture it being?

I see lots of hands being raised, so evidently you think you know from which industry this report has come. Let’s consider some of your answers:

a)    Ah…  Major League Baseball – with its drug abuse scandals (HGH, steroids, spitballs, pine tar, sign-stealing, etc.)
b)    Oh… the National Football League – with its own drug abuse issues, “stick um” on receiver gloves, inter-team spying, team cover-ups about concussions, and recent rash of player arrests for domestic abuse, drunken driving, and even murder.
c)    Government bureaucrats – such as in the IRS, the GSA, the NSA (the list goes on).
d)    Interesting… the legal profession – with its regular obfuscation of “the truth”, countenancing of corporations that just “barely” fall shy of violating laws related to financial regulation, GAAP reporting, environmental safety, etc.
e)
    Oops, members of Congress – with gross violations of campaign contribution laws, violation of basic standards of decency (Twitter photos, etc.), violation of the obligation to maintain total confidentiality on certain issues, etc.

Isn’t that interesting!  All of those responses are insightful and valid. However, this survey (sponsored by and executed through the law firm, Labaton Sucharow) polled professionals within the financial services industry. The firm solicited and received responses from across a broad spectrum of professionals – including stockbrokers, assets managers, financial advisors, financial analysts, investment bankers, and even hedge fund executives!

These folks are the very people with whom we entrust our checking and savings account(s), our invested assets, our retirement account(s), our mortgage(s), and (just as importantly) our personal and financial information. And yet a frighteningly high percentage of these professionals are not only aware of professional wrongdoing (including law breaking), but are willing to engage in such behavior her or himself (if they can get away with it!). Making matters worse, the numbers this year were worse than from last year’s survey. For example, last year’s survey revealed that 12% of participants felt that the financial industry requires unethical (or illegal) activity and another 10% reported that staff persons in their company have violated rules or the law. In sharp contrast, 27% of this year’s respondents believe the industry requires bad behavior and 24% report that other professionals in their company have engaged in violations!

Embellishing a sad picture, Columbia University (NYC) has released results from a study of its graduates that reveals two findings: 1) 40% of graduates had been rewarded for ethically troubling actions, while 2) 31% of those who refused to engage in misconduct felt penalized for that ethical choice(s). An overarching finding from the Labaton Sucharow  is that fully 28% of those surveyed believe that the financial industry does not put client interests first!! It is that simple, but shameful, insight upon which I want to build the remaining content of this blog post.

Let me offer you one illustrative example of the basic issue at hand. This example is not one I “made up”; it comes from a recent arbitration case brought to the Financial Industry Regulatory Authority (FINRA) by Bryant Tuchan.  Mr. Tuchan, a broker in Irvine, CA., inherited a number of clients with stock-heavy portfolios that were not sufficiently diversified within an appropriate asset-allocation plan (in keeping with “best practices”). Therefore, Mr. Tuchan developed a plan that incorporated some of the industry’s best funds (including well-respected funds from PIMCO) to create a more balanced portfolio with an improved risk/return profile. Surely you will agree with me that it appears as though Mr. Tuchan was placing the client’s interests first! So what was the problem that led to an arbitration case being filed?

Mr. Tuchan’s employer was JP Morgan Securities. As revealed in an expose published by the New York Times one year ago (July 2012), the JP Morgan business model relies on strong incentives to push its brokers to sell in-house funds (and products), even if outside funds could better serve a client’s interest! Therefore, JP Morgan “flags” non-JP Morgan products and requires brokers to justify the use of such non-JP Morgan funds before they get compensated for any related transactions. Embellishing the practice, the financial planning software used by JP Morgan brokers directs client funds exclusively toward JP Morgan funds.  Mr. Tuchan was confronted by his direct supervisor and the branch “compliance officer” (whose function is to ensure regulatory compliance, not JP Morgan sales) who informed him that his use of outside funds was not acceptable and “implied” that he could be fired.  Needless to say, Mr. Tuchan left that firm (calling it a “hostile workplace”) and now works for a different one.

Why is this issue particularly important now? After all, legal and news archives are full of stories about financial firms that abuse “client trust”, à la Bernie Madoff, Lehman Brothers, mortgage bank “robo-signing”, etc.  So why is this important now ?

You have surely heard of the (now three-year old) Dodd-Frank Wall Street Reform and Consumer Protection Act. The intention of that law was to enhance consumer protection across a wide spectrum within the U.S. financial industry. One of the provisions of this act directs the Security and Exchange Commission (SEC) to create a “unified fiduciary standard” (a simple definition of “fiduciary” is someone who is bound to act only and always in the “interests of the client”) that applies to both financial advisors and registered representatives (ie. brokers).

“Ah,” you think, “that sounds very good! In fact, that’s the way it already should be! What on earth is the issue here?”

“Bingo!” Currently, there is no “uniform fiduciary standard”!  Registered investment advisors (RIA) are regulated by “The Investment Advisors Act of 1940” – at the heart of which is the obligation to act only in the “interests of the client.” Any RIA shown to violate that standard is subject to scrutiny – often leading to censure, fines, and/or removal.  In contrast, registered representatives (RR) (ie. brokers) are employed by a dealer/firm licensed through the SEC and FINRA and must adhere to applicable securities laws and regulations (including passing challenging securities law tests, such as “Series 7”, “Series 63”, etc.). The primary standard to which brokers are held accountable is “suitability” – do the client’s financial circumstances/profile make her/him a “suitable” buyer of any given security under consideration. [If you are confused, think “bond” versus “hedge fund” – a bond is “suitable” for virtually anyone; a hedge fund is “suitable” only for a person with substantial net worth.]

Are you catching on to the distinction? If I am your advisor, everything I do for you must be guided by what is in your “best interests.” If instead, I am your broker, I must only establish, based on extensive paperwork filed by you, that any given security I am selling you is one that meets your “suitability profile.”  If I was your broker, I would voluntarily choose to meld “best interests” and “suitability”; but legally, I am not obligated to meet both standards.[1]

Once again, I hear you thinking: “What’s so complicated? Just insist that brokers apply both standards in their daily interfacing with clients!”

You just forget “Tom’s Basic Law” of life and investments: nothing is quite as simple as it first appears!  First, the “Advisor” and the “Broker” industries look at this issue from perspectives that are practically 180 degrees apart, and second, their respective (highly-paid) lobbyists have been diligently at work muscling Congress to see things “their way”.  The result is a royally muddled “hodgepodge” of myths, mysteries, meddling, and “Machiavellian Mischief”. With all due respect to all parties involved, none of them are “telling the truth” in any objective sense.

So what are some (not all)[2] of the factors that complicate the creation of a “uniform fiduciary standard”? (I don’t necessarily agree with them, I just report them.)

1)    Many (most) brokers relate to clients on an episodic basis, while advisors have a continuous relationship, changing the dynamics of the basic broker/customer interaction and impacting realistic expectations;
2)
    (Believe it or not) The SEC asked brokerage houses to offer feedback regarding a “cost/benefit analysis” of a “uniformed fiduciary standard”.
a.
   Not surprisingly, the responses I saw ranged from $1 million to $6 million for each firm (average $5 million) for just the first year!
3)  
  The “Broker” industry has, in many different forums and at many levels, warned that increasing the “burden” upon them will raise costs and make it more and more likely that persons with low net worth will be “priced out” of access to the wisdom and guidance they can provide.

You have been extraordinarily patient, and I appreciate that. Admittedly, this has been a “thumbnail account” of a much more complicated issue. But I feel very strongly that you need to know (and deserve to know) that a mega-battle is now waging in Washington D.C. that will directly impact your relationship with most of the financial professionals with whom you work. Billions of dollars are being spent to secure a “win” for one side or the other. But as you’ve noticed, hardly anyone has tried to bring YOU into the conversation.  That is wrong! The central bedrock upon which the financial industry must be built is the sacrosanct obligation professionals have to serve and uphold a client’s best interests.

Yes, that “bedrock” sits in sharp contrast to the survey I detailed at the start. But that speaks to the very point of why you need to be aware of this “great fiduciary battle”.  I think financial executives and politicians would rather not air this “dirty linen” in public. But I agree with the famed Supreme Court Justice, Louis Brandeis, who once wrote that “sunlight” is the “best disinfectant”!

INVESTOR TAKE AWAY: “Fiduciary Standard” or not, you should always be skeptical of anyone with whom you entrust your assets (unless or until they satisfactorily demonstrate to you that she/he is worthy of your trust).  Even then, you should regularly review statements, ask questions, and ensure to your satisfaction that all is as it should be. No one elsecan adequately perform that due diligence for you!

Finally, if you would like to be updated on this process in a month or two, please either write a “response” below this blog article. I can also, if you’d like, share with you the fascinating details of a suit brought against UBS Financial Services in California, seeking restitution of $6.85 million of losses from utterly inappropriate (and very aggressive) investments a UBS broker chose for (now retired) five-time all-star Kansas City Royals and Seattle Mariner first baseman, Mike Sweeney (see photo).  Or I could share the story of Sergio and Tina Alvarado from northern Illinois (see photo) – who were officially promised (through FINRA arbitration) almost $750,000 in damages because of broker misconduct last fall, but are unlikely to see one dime of it, ever!  Sergio (age 58) had to retire, in part, to care for his chronically ill wife, and the absence of income from his hard earned savings jeopardizes their welfare. I am here to help keep you informed because the good folks at MarketTamer care about your entire financial wellbeing… not just about enhancing your trading or investing skills!

DISCLOSURE: The author is a fee-only Certified Financial Planner (CFP). He earned that designation in 1992.  He is not looking for new clients but is very interested in keeping as many folks as possible better informed about the real world of finances, investments, trading, and planning.

Submitted by Thomas Petty MBA CFP


[1] The stereotyped “worst case” scenario of a broker abusing the very loose “suitability” standard is as follows: a broker sells an 88 year old widow (who inherited millions of dollars) a high cost, high commission hedge fund that has a “lock-up” provision for several years following purchase – causing complications should the widow die during that period.  It meets the “suitability” standard, but miserably fails all possible interpretations of “best interests”.

[2] Trust me, folks, you don’t have the patience for “all” the reasons!

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