Mutual Funds and Boca Brokers: Harmful to Your Wealth? – Part I

Is your stockbroker or representative a “plate licker?” That’s the epithet used in the investment industry to describe those stockbrokers who try to entice prospective customers by offering free investment seminars that happen to be accompanied by the real inducement, a free lunch or dinner. Most of these affairs are held in places that range from cheap diners to expensive steak restaurants, depending on the clientele the licker is attempting to attract. However, regardless of the venue, most take place in affluent communities because, as Willy Sutton the infamous bank robber once said about banks, “that’s where the money is.”

At least some of these plate lickers resemble Mr. Walton who invited their new neighbors to meet his family over dinner at his house. During dinner Mr. Walton was asked what he did for a living. Eight-year-old Brian Walton jumped in and said, “Daddy is a fisherman.” To which Mrs. Walton replied, “Brian, why do say that. Your daddy is a stockbroker, not a fisherman.”

“No mom, every time we visit dad at work and he hangs up the phone he laughs, rubs his hands together and says 'I just caught another fish'.”

Obviously, it would be hyperbole to imply that all stock brokers fit that categorization, however, last month’s Wall Street Journal (WSJ) published the results of a country-wide examination of stock brokers to determine where brokers with the highest degree of questionable practices congregated. The investigation analyzed 87% of the nation’s 630,000 brokers (a total of 550,000) working in 50 states, seeking records identifying material considered by most regulators to be “red flags.” This included regulatory actions, criminal charges, client complaints, recent bankruptcies, and terminations.

It identified 16 such U.S. localities that it it termed “hot spots.” Five of the 16 were in the southern part of Florida. Would you like to guess what the top hotspot area in the nation is? The highest percentage of what the WSJ termed “troubled” brokers was located in Boca Raton and surrounding environments like Delray Beach. This is not surprising since from the late 90’s through the beginning of this decade, Boca Raton was a hot spot for the notorious investment boiler room crowd as well.

Seniors, especially retirees are obviously the main target, not only because of their abundance in the area, and that’s where the money is, but apparently one of the afflictions that seem to accompany retirement results in multiple cases of onset gullibility that make Boca a hot spot ripe for pillaging. If you think otherwise, consider this: According to the WSJ report, within a radius of some 10 miles of Boca Raton, there are about 3,000 brokers. “One in 17, or some 175, own the dubious honor of having three or more disciplinary red flags over the course of their careers. That is three times the nation’s average. These are infractions that they are required to report––an industry measure of a troubled broker.”

The WSJ article describes a typical incident involving one Rafael Golan, a stock broker with an office in Delray Beach, who invited a group of elderly (assumedly retired) people to a financial seminar at Burt and Max’s Bar and Grill (a pretty good restaurant by the way; my restaurant review for the day.) The article stated that, “After his hour long talk on topics from real estate to annuities (the biggest money maker for brokers) the free food arrived. Dinners like this have landed him clients before. Some later lodged complaints against him, making him part of a cluster of brokers with troubled regulatory records identified in this corner of Florida.”

Among those clients was an octogenarian couple that became Mr. Golan’s customers in 2003 after a similar dinner, and later filed a complaint with regulators alleging he mishandled their account. The article reports that, “He paid them $125,000 settlement this year. He denies any wrongdoing in this or any other case.”

Another, much better known broker, David Lerner Associates, with branch offices in New York, New Jersey, Connecticut, and Boca Raton, and well known for its radio shows has a much more colorful and checkered history. FINRA’s (described below) “Broker Check” website (more on that next month) lists some 30 occasions where censures, sanctions or fines were imposed on Lerner for varying infractions. Ironically, that has not stopped the chicken dinner seminars since the Lerner website listed one held in early December at Seasons 52 (classy) in Palm Beach Gardens––where the money is.

The Journal article went on to describe several more similar unsavory situations, throughout the country, that resulted in varying punishments to both brokers and brokerage houses. Some monetary penalties awarded were in the many millions of dollars; some brokers were dismissed from their firms, others were banned from the industry, and a very few were sent to jail.

The organization charged with overseeing broker conduct is called the Financial Industry Regulatory Authority, or FINRA. It is not a governmental agency, but essentially is Wall Street’s self regulator for all securities firms doing business in the United States. Based in New York and Washington, the seven-year-old organization has some 3,000 employees and 20 regional offices overseeing 4,525 brokerage firms, 163,530 branch offices and 631,085 registered securities representatives. (These numbers are about three years old.) Now you may be sanguine abut your relationship with your broker because he or she is associated with a major brokerage house. However, the WSJ article reports that, “Brokers at the nation’s five biggest firms are more than twice as likely to be troubled if they work in a hot spot than elsewhere.”

Considering the implications related to stock broker misconduct in the area, how well do you know your broker, and even if he or she is performing within the legal prerequisites of the position, is your wealth accumulation being maximized or endangered? For example, it is critical for you to know the true title of your broker since that provides the most significant clue as to where that individual’s loyalty resides. The vast majority are actually registered representatives––primarily securities salespeople that often adopt titles such as financial advisers, securities broker, investment analyst, investment banker, financial consultant, or investment consultant, but remember, regardless of title, they are still salespeople. Almost all rely on commissions from products they sell.

There is another higher level of investment advice that can be accessed through those holding the title of Registered Investment Adviser. FINRA states that, “This is a legal term that refers to an individual or company that is registered as such with either the Securities and Exchange Commission or a state securities regulator. Common names for investment advisers include asset managers, investment counselors, investment managers, portfolio managers, and wealth managers.

While the title differential between the Registered Representative class and the Registered Investment Advisor class might appear to be a superficial and unimportant factor, your choice of one or the other could be one of the most important investment decisions you make. That’s because of what I called “The Rule Game” in a column that appeared in the May 2012 issue of Viewpointe. (I’m reemphasizing this as a result of the Boca hotspot exposé described above.)

FINRA has imposed two different sets of rules, one that applies to Registered Representatives or stock brokers, and another, much more stringent, for Registered Investment Advisors.

Rule #1 is known as the “Suitability Rule,” and is applied to stock brokers. Whatever investment decision the broker makes on your behalf must prove to be suitable to the client’s interests and goals. In other words, when a registered representative suggests that you buy or sell a particular security, he or she must have reason to believe that the recommendation is suitable for you based on a host of factors, including your income, portfolio, overall financial situation, your tolerance for risk, and your stated investment objectives.

Rule #2 applies to registered investor advisers, imposing an additional component of “fiduciary” responsibility. It demands that this class of advisers who must register with the SEC (Securities and Exchange Commission) is bound to a fiduciary standard that was established as part of the Investment Advisers Act of 1940. They can be regulated by the SEC or state securities regulators, both of which hold advisers to a fiduciary standard that requires them to put their client's interests above their own.

Obviously, Rule # 2 sets a significantly higher standard, one that eliminates any inclination by the adviser to slant an investment decision he makes for you (suitable that it may be) that could provide morally inappropriate personal benefits. For example, a financial advisor may consider two different mutual funds as suitable for your portfolio. One has a better performance history, and better growth or income prospects, but he chooses the other one because it pays him a higher commission. Immoral though it might be, under FINRA’s rules it is not illegal. (Why was a mutual fund selected to begin with since index funds and Exchange Traded Funds (ETF”s) have been proven far superior to mutual funds. Could it be that mutual funds provide stockbrokers with compensation, while index type funds and ETF’s do not? (Much more on that next month.)

So how do you avoid getting suckered into a potentially vulnerable position by a plate licker who will at best abide by the “suitability rule,” and at worst, where you become a victim of one of the 175 brokers in the Boca area with a red flag next to their name? Next month’s article will provide two simple procedures to follow that should eliminate those harmful to your wealth possibilities.