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Archive for September, 2010

No one will dispute that investors are entitled to receive objective advice when they consult an investment advisor. Advisors should serve only one master — their clients — and no one else, if for no other reason but that they are paid for that service.

The Conflict
However, the retail brokerage community operates in an environment where there are two masters, not one. Like the client, the second master also pays the broker. But not for advice. Instead, the second master pays the broker to induce him or her to sell its product, in lieu of another’s product, to the client.

For example, a second master can be a mutual fund company that pays a handsome commission, while other mutual fund companies do not. Another example is when brokerage firms sell investments that are “proprietary” or “syndicated”. In these cases, firms basically are “insiders”. This can include the brokerage firm’s being an owner, principal, distributor or investment manager of the investment product.

There are two problems with having this kind of second master. First, it creates a conflict of interest. Second, the brokerage firms, and their employee brokers, do not act as independent, objective advisors, for which their clients are paying them. On the contrary, they are parties interested in consummating the sale, for which great profits can be made.

At a minimum, brokerage firms and brokers should fully disclose that they have a conflict of interest, and they should discuss why the conflict will not obscure their objectivity. Nonetheless, we find that often there is no disclosure. To the extent that disclosure is made, usually it is not communicated sufficiently for clients to understand.

Fee Only
Approximately 40% of money managers and financial planners (not retail brokers) charge “fee only” for their services. They receive no commissions. Their fee is a small percentage (1.5% or less at Advocate Capital Management, Inc.) of the assets that clients place with them to invest.

Is fee only better than sales commission? Consider these opinions. Jane Bryant Quinn stated in Newsweek that those who “take commissions have a built in conflict of interest … even with disclosure, my choice would be a fee only planner”. Similarly, Money Magazine counsels, “Start with the general practitioner, a financial planner whose compensation should be from fees alone”. Finally, Forbes advises, “The most important matter is how the planner is compensated. Hire the planner who has no financial stake in your investments”.

Fee Only Versus Fee Based
Savvy consumers have begun to realize that sales commission relationships may not be in their best interest. Wall Street has reacted to this sentiment by offering what it calls “fee based” compensation programs.

Name the retail brokerage firm and, chances are, it will have, or plans to roll out, a new fee based compensation program. For instance, A.G. Edwards has “Spectrum”, Dean Witter has “Choice”, Everen has “Fund Allocation”, Paine Webber has “PACE”, Prudential has “VIP”, Smith Barney has “Asset One”, and Merrill Lynch has “Financial Advantage”. Each charges (with the exception of Everen) a 1.5% or less asset based fee.

However, fee based compensation is not fee only compensation. Conflicts of interest still exist. Objectivity still may be obscured.

Consider one of these fee based programs. This program allows clients to select no-load and non-proprietary mutual funds. Will their brokers steer them in that direction? Probably not. Brokers may focus their clients’ attention on the proprietary, syndicate funds. Why? Extra compensation! Indeed, not only does the broker receive a portion of the 1.5% asset based fee, he or she receives additional money — a sales commission — from the firm (up to several percent) for selling those proprietary, syndicate investment products.

Is this good for the client? John Markese, president of the American Association of Individual Investors (AAII) commented about the program, “There is a built in potential for bias that can cloud the relationship. I think the SEC could recognize that this could be a case where there is an incentive [for brokers] to push product, and that may not be in the best interests of investors in the long run”.

The retail brokerage firm defends itself by claiming that it discloses the extra compensation arrangement to clients. Specifically, the following brief disclosure is made within a lengthy account agreement: “…[the firm] will receive a selling concession, or other compensation … in addition to the [account] fees payable hereunder”. However, the disclosure does not alert clients to the broker’s conflict of interest, and no disclosure whatsoever is found in the mass marketing materials disseminated to the public.

In conclusion, fee only compensation (not fee based) continues to be the only arrangement that provides investors with truly objective investment advice.

Congratulations! Your newest client is a company retirement plan. Now let’s talk about your newest responsibilities under ERISA – the Employee Retirement Security Act of 1974.

Most brokers know that ERISA covers large company pension plans. But many brokers do not know that ERISA covers all qualified employee retirement plans, with as few as one common law employee.

Why should brokers care? ERISA imposes personal liability upon those violating the statute – stripping away any kind of corporate liability shield that might exist. And the statute imposes high standards of care. In fact, as one court stated, ERISA imposes the “highest [standards of care] known to law”. Now that I have your attention, let’s outline how ERISA applies to your business.

ERISA applies to plan fiduciaries. Not everyone qualifies as a plan fiduciary, but most brokers do qualify. Under ERISA, all that is required is that the broker either have discretion over the purchase and sale of plan securities, or that the broker render investment advice for a fee, which includes recommending the purchase or sale of securities. Please note that brokers who provide only investment allocation advice may or may not be considered a fiduciary. In this event, brokers should consult a lawyer to draft contract language that outlines the respective roles of the plan and the broker.
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Most stockbrokers and financial planners work hard to earn an honest day’s pay. Unfortunately, too many do not do so. As a result, investors need to be alert for abuse.

How can investors protect themselves? Before we discuss our 15-point checklist, let’s examine two preliminary safeguards. First, you must clearly communicate your needs and objectives to the broker in opening your account. To ensure that the broker understands those needs and objectives, you should request, obtain and maintain a copy of the “new account form” or “account agreement”. This business record will detail what the brokerage firms understands your needs and objectives to be, as well as other pertinent information. If there is a discrepancy, report it in writing and request appropriate changes.

Second, you should promptly examine all “confirmations” (which confirm that a trade has been made) and monthly account statements. Be sure to keep copies of all confirmations and monthly account statements. Additionally, you should maintain copies of any documents that the broker sends you in connection with recommending a particular investment.
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A loan may have been to buy a car, finance a child’s education of university still pay back the mortgage. Although this means that you can never really have to go without the money due to the availability of both cash ready with their own terms of course, there are always times that you can not be in a position to repay all its loans in a timely manner.

Imagine a situation where you are in the middle of three to four loans and has defaulted on payment of atleast two due to a drop in the flow of steady income. Now you need a loan from the fifth. You may think that you are not entitled to one, but you really are.

Lenders always look creditworthiness before giving out a loan to check the risk involved in the same. The risk associated with giving a person who already has a bad credit history, loan, is definitely higher, but not impossible. Which is why such loans are called Unsecured Financing? People who have arrears, suffering from any kind of bankruptcy, has made late payments, which are involved in a court case or the other, or have a poor all the credit account is entitled to such a loan.
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There are many changes in store for the financial services industry in recent years. Some of these changes will be good, and some of them bad, for investors.

The Gramm-Leach Biley Act of 1999 officially terminated the Glass Steagall Act (which had separated commercial banking from securities underwriting for more than 65 years). As the New Millennium unfolds, we will continue to see a blurring of roles in the once familiar roles of securities firms, banks and insurance companies. The “one stop shop” is the marketing marching order, and consolidation is the perceived road to riches for the providers.

In addition, we will see commissions charged for securities transactions continue to decrease, if not decrease all the way to zero. But brokerage firms will not go out of business. In fact, for year 2000, analysts are predicting another good year for the brokerage industry as a whole. According to the industry publication, On Wall Street, the consensus of earnings estimates is for aggregate earnings to grow 18% over 1999. Underlying fundamentals are favorable, even though there are concerns about the costs of adding on-line trading and about the potential for weakness in the fixed income markets. In fact, many firms are hiring more stockbrokers – such as Merrill Lynch, which is on track to meet its goal of 3% to 4% growth.

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Consider the Bad Advice Regarding Employee Stock Options

As a “Millennium Prediction”, I predicted that brokerage firms increasingly would make mistakes as they ventured into financial planning areas. One and one-half years into the new millennium, we clearly have witnessed those mistakes with respect to employee stock options.

The range of mistakes has been wide. For example, we have seen brokerage firms fail to exercise employee stock options, letting them expire worthless. Additionally, we have seen brokerage firms not understand basic principles, such as the fact that certain employee stock options are taxed upon exercise of the options. Finally, once stock options have been exercised, we have seen errors involving investment management, such as failing to diversify concentrated positions, failing to hedge (for example, through the use of options) and recommending the use of margin to pay taxes or other expenses with the value of the shares as collateral. These errors have been especially egregious when dealing with volatile, technology company shares.
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Stockbrokers Must Perform Their “Due Diligence” Before They Invest Your Money

As stockbrokers and other advisers search for investments to beat the current flat market, they are turning to alternative investments such as hedge funds, private equity investments and real estate. But these investments often lack regulation and can be highly risky. Before you invest, insist that your financial adviser perform his requisite “due diligence”.

In its Policy of the Board of Governors on Fair Dealing With Customers, the National Association of Securities Dealers (NASD) cautions brokerage firms and brokers that:
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Margin investing is speculative and involves high risk. That is why most investors should not buy stocks on margin. But for those who do, NASD Regulation, Inc., has issued important investor guidance about purchasing securities on margin, and the risks involved. Investors should heed this guidance, which is set forth below.

Use of Margin Accounts
A customer who purchases securities may pay for the securities in full or may borrow part of the purchase price from his or her securities firm. If the customer chooses to borrow funds from a firm, the customer will open a margin account with the firm. The portion of the purchase price that the customer must deposit is called “margin” and is the customer’s initial equity in the account. The loan from the firm is secured by the securities that are purchased by the customer. A customer may also enter into a short sale through a margin account, which involves the customer borrowing stock from a firm in order to sell it, hoping that the price will decline. Customers generally use margin to leverage their investments and increase their purchasing power. At the same time, customers who trade securities on margin incur the potential for higher losses.
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It’s hard not to read a daily newspaper without noticing a news story about a broker or brokerage firm doing something wrong. Consider some of the recent news:

Frank Gruttadauria of Lehman Brothers purportedly created phony account statements to dupe customers and his firm failed to supervise him in allowing him to use fictitious mailbox addresses to send the real account statements;

Salomon Smith Barney is under investigation purportedly for not conducting adequate due diligence in its underwriting shares of Adelphia Communications Corp. for sale to the investing public, and failing to disclose material information, including certain borrowing arrangements that its parent Citigroup, Inc. had extended to the company as one of the primary creditor banks;
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Mutual funds are not supposed to be traded, or bought and sold regularly. They are meant to be held as long term investments. Indeed, securities regulators presume that a switch between mutual funds is unsuitable. Brokers have the burden of rebutting that presumption, and it is difficult to do.

For example, recently the Securities and Exchange Commission (SEC) upheld a decision by the National Association of Securities Dealers (NASD) to censure, fine and suspend a broker who, on average, held his clients’ mutual funds only for 11 months. Investors should consider the defenses that the broker raised, which both the SEC and the NASD rejected.
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