The Selling Lies of Investment Advisors
To be successful, an investment advisor service must tell people what they want to hear, not necessarily what is the truth. Here is the hard truth. Wall Street firms are paid a lot of money to create and distribute many questionable investments that ultimately end up in the hands of individual investors. Most of the times they get away with acts that border on fraud, but sometimes the losses are so large that politicians demand investigations.
In 2002 alone, two major Wall Street firms paid fines of $100 million each to the federal and state governments to settle misrepresentation and fraud charges out of millions in fines for misrepresenting the prospects of several investments and has also promised to change the way it sells products to the public. While a $100 million fine sounds like a lot of money, it is a slap on the hand of big firms like Merrill Lynch, Credit Suisse First Boston, and Citigroup. Those firms made far more money when they sold the investments in question than they will never pay in fines. (As a matter of record, none of the settlement money is being paid back to investors as restitution. The cash goes into government coffers).
Over a period of years, the U.S. economic system has experienced a gradual breakdown of the institutions that investors relied on for accurate financial information. Research analysts on Wall Street have promoted rather than analyzed companies. This has occurred because underwriting new investment banking business generates bigger profits than giving accurate information to consumers. When the fellow on the Morgan Stanley Dean Witter commercial says, “We measure success on investor at a time”, he is not talking about you or me. He is talking about profitable investment banking clients.
Anyone Could Pose As An Advisor
You may not believe this, but anyone can get paid to give investment advice. You do not need a license and do not need to take any exams. You do not need a background in the subject, or a college degree, or special training. Heck, you could have flunked out of the third grade, gone bankrupt seven times, lost everything you ever owned to a Ponzi scheme, and still make a great living managing other people’s money.
An investment advisor is a person who claims to be one: it is that simple. Once you have a certain number of clients who pay you to manage their money, then you need to register. That means sending in a form to the state or federal government with a modest filing fee and possibly raking a state test. If you are selling investment advice through a newsletter or a Web site rather than managing accounts directly, there are not registration forms, fees, or tests, regardless of how many subscribers you have.
In this surreal would of investment advice, anyone can claim to be an expert and get paid for it. The problem is, most investment advisors are borderline incompetent. Thousands of them lack the basic investment skills and knowledge of a first-year business student.
With so many investment advisors running around claiming to have unique insight into the financial markets, how do you tell a good advisor from a bad one? Most people start by checking an advisor’s education, experience, and references. This is possible only if you understand all the titles and acronyms in the business and can separate fact from fiction.
There are literally hundreds of investment titles used in the investment business, but only a few have real meaning and denote years of study and professional commitment. The best designations include Certified Financial Planner (CFP) and Chartered Financial Analyst (CFA). Unfortunately, most designations and titles represent very little academic work and can be purchased by paying a fee to a marketing organization or by selling a lot of high-commission products. For example, the title of Vice President (VP) is the most overused and meaningless title in the financial services industry. The title is earned based on the amount of commission dollars a salesperson generates, not by exhibiting skill or expertise. It seems that every salesperson at every brokerage firm and insurance company sports a VP title.
Improper training in the investment industry is widespread. This leads to poor advice, misrepresentation of products, and a genuine lack of business ethics. As a result, thousands of individuals file complaints and claims against their financial advisors each year. These claims involves everything from peddling inappropriate products to excessive trading (churning). According to the National Association of Securities Dealers (NASD), broker-customers claims alone rose over 40% in 2001 and climbed steadily higher in 2002. Most of these cases tend to fall into three main areas: unsuitability (brokers placing clients in investments clients later deemed too risky), misrepresentation (brokers misleading clients on the nature and risk of the investments sold), and breach of fiduciary duty (brokers misusing customer funds). Each week, The Wall Street Journal lists the settlements and penalties of these cases; recently the section has taken up nearly a full page using microprint. It is not a pretty sight.
I believe the large numbers of cases against financial advisors occur for three reasons:
- Investment advisors are poorly trained by the firms they work for.
- Advisors become overly greedy and opt to sell high-commission products that are inappropriate for most clients.
- Management pressures the advisors to sell certain products without the advisors knowing or understanding the inherent risks.
As a general rule, most financial advisors know about enough to be dangerous to their clients. To become a salesperson for a Wall Street firm, you simply need to be a U.S. citizen, be able to read and write English, have no criminal record, and pass one basic investment exam. Depending on what products the firm wants you to sell, the licensing exam is either a few hours long or all day. These NASD administered exams are designed so that anyone with a high school equivalency can pass, although you do not need a high school diploma to take the exams. If you fail an exam, you can retake it every 30 days forever until you pass.
Once you pass an NASD exam, the next step is to attend a short, in-house sales training course. Training is provided over the course of a few weeks and it is all about selling investment products. That means learning about the products the firm wants to you sell and learning how to overcoming a client’s objections to buying. After this training period is over, the brokers are let loose on the public to sell investments that they barely know anything about.
Since it is easy to make a lot of money selling investment products, the greed has spread from brokerage firms and insurance companies to banks, accounting firms, and law firms. The partners at some accounting firms and law firms can become intoxicated with the idea of adding quick and easy revenue to their bottom line by selling investment products and insurance directly or referring to someone who does and collecting a cut of the fees. Industry professionals will tell you that most accounting and law firms should not be in the investment advice business. It is a huge conflict of interest.
H&R Block used to be an income tax preparation firm. It is now H&R Block Financial Advisors. The advisors now sell tax preparation services along with a range of investment and insurance products. That is a great combination for H&R Block, because the investment advisors have full access to a client’s financial information. However, it is lousy deal for unsuspecting tax clients who visit the firm to get their taxes done. Many end up buying high-commission whole life insurance, variable annuities, loaded mutual funds, and other products that have high fees and commissions. This is all done under the banner of “independent financial advices”.