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A Synonym for Fraudster
Written by Brandon Grundy, CFP®
Tuesday, 15 December 2015 08:24
This week's financial advisor joke comes from none other than Jerry Seinfeld:
"Financial advisors, financial planners, CFAs, CPAs... What's up with that?
What I really want is a financial thesaurus."
What's a synonym for "fraudster"?
While writing this week's post I'm trying hard (and failing) to not write about the Fed's upcoming
interest-rate setting meeting this week. Fed Chair Janet Yellen and crew appear to be ready to
start raising interest rates and many market prognosticators are filling the financial airwaves
with near endless chatter about what the Fed will do, when, and even how they'll say it. Next I
wonder if analysts will infer Fed policy moves based on the color combinations worn by the Fed
Chair during her press conference.
I'll bet I'm not the only one at this point who just wants the Fed to get it over with. Investor
anxiety about Fed policy has been reaching a high point lately and the markets have been
feeling it. Through Friday the S&P 500 is basically flat year-to-date at -0.27%. Developed
foreign stocks are down 2% and emerging markets are down 17% year-to-date. Bonds are up a
smidgeon. This also has to do with oil falling to the mid-$30's per barrel, but by in large
everybody is waiting on the Fed. They end their meeting Wednesday and their press release
should be out that morning. If 80% of analysts are right, the years of anticipation will finally be
over. What will all those financial talking heads have to go on and on about? I'm sure they'll find
something...
One potential topic for them is the number of claims being made lately against brokerage firms
by clients who say they've been wronged by their broker. Almost every week I read stories
about this. Just last week FINRA, the brokerage industry's self-regulatory entity, awarded a
92-year-old widow just over $1 million in compensatory and punitive damages after being used
and abused by her broker. This was a large award and half of it was for punitive damages.
According to Investment News, an industry news website, FINRA's arbitration panel found that
the widow's Morgan Stanley broker strong-armed his unwitting client into buying annuities she
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A Synonym for Fraudster
Written by Brandon Grundy, CFP®
Tuesday, 15 December 2015 08:24
didn't need, paying management fees she didn't need to pay, and "churning and reverse
churning" her accounts to generate more fees. This seems to have been a case of, as the
saying goes, maximizing "yield to broker" versus yield to maturity (a bond market term).
The client's claim was apparently not about losing money and then wanting Morgan Stanley and
her broker to pay up. Instead the client's claim was about being flat out wronged by her broker.
According to the article, the bad behavior started after the client's husband passed away. The
broker began a "systematic" process of churning the client's portfolio to generate excessive
commissions. Apparently much of this was done without the client's consent, sometimes with
the broker forging the client's signature. The client is likely a very nice lady who thought her very
nice broker was treating her right and wouldn't do her any harm. But the whole time he was
fleecing her.
But how is something like this possible? Government and industry regulators are out there but
are multiple steps behind the crooks. At brokerage firms like Morgan Stanley the individual
broker has a lot of leeway in how they work with clients. While this can often be okay there's lots
of room for funny business to take place. In theory and reality there is a back office within a firm
that supervises brokers. The office's primary job is to ensure the firm's brokers don't get the firm
into major trouble by recommending "unsuitable" investments to clients. But that office within
Morgan Stanley must have been on vacation during the years this broker worked with this
particular client. Here's how it is supposed to work. A broker works with their client, finds out
what the client's goals are, and then recommends the best product possible to enable the client
to help meet that goal. Sounds simple, right? It is, but simplicity in this case masks a lot of
complexity.
Most of the complexity is caused by how brokers are compensated. At a firm like Morgan
Stanley, or any brokerage firm for that matter, the typical "financial advisor" is really an
investment salesperson. They should be labeled "salesperson" because the overwhelming
majority are paid based on commissions, and because they are, first and foremost, obligated to
serve their employer. The client is second in line.
Additionally, a broker's commissions are not level across all products. For example, within a
single firm one broker might favor selling annuities because of the larger upfront commission
they can earn. Another broker might favor selling "loaded" mutual funds to earn a commission
on each transaction. Still another broker may favor selling investment advisory services, or even
selling individual stocks and bonds by commission. There are a variety of ways for brokers to
generate commissions and this is often referred to by the firm as "open architecture", implying
that since the broker doesn't just sell one type of product they must, by default, be offering you
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A Synonym for Fraudster
Written by Brandon Grundy, CFP®
Tuesday, 15 December 2015 08:24
objective advice. What they don't tell the client is that the architecture is open only within the
realm of what the firm incentivizes its brokers to recommend.
This damage award demonstrates the fundamental flaw within the brokerage environment: the
need to generate commissions gets in the way of the client's relationship with their advisor.
Fortunately the client prevailed in her claim against broker and firm. But what a waste of time
and resources! Unfortunately this situation seems to need to get worse betfore it gets better. Have questions? Ask me. I can help.
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