(from Dan Solin's Huffington Post blog, 7/12/2011 - click here for the original post)
It's bad enough that Ponzi schemers continue to thrive. The limits these schemers will go to get your money know no bounds. According to a recent report, three former members of the PTA used their connection with a grade school in Los Angeles to bilk investors out of $14 million. The women allegedly represented they had the exclusive right to sell products from a local dairy to various Disney enterprises and others. They promised returns of up to 100 percent.
40 investors used their life savings and took out second mortgages to pony up their "investments." According to investigators, some of the money was spent on vacations, hotels, cars and gambling.
In another scheme, Christopher Pettengill pleaded guilty to a variety of fraud charges. He was charged with concealing information from investors about a foreign currency program, while touting the investment as low risk. Mr. Pettengill admitted making a personal credit card payment of $11,369 from proceeds of the fraud.
These schemes share a common theme: The promise of high returns without commensurate risk. But even if you are too smart to fall for this kind of scam, your investments may still be in danger. You need a morality litmus test before you entrust your retirement savings to any broker or adviser.
A timely case in point is J.P. Morgan Securities. In a release dated July 7, 2011, the SEC charged this venerable firm with fraudulently rigging at least 93 municipal bond reinvestment transactions in 31 states, generating "millions of dollars in ill-gotten gains." According to Robert Khuzami, Director of the SEC's Division of Enforcement, "Municipal issuers and investors didn't stand a chance against the fraudulent strategies JPMS and others used to guarantee profits."
JPMS settled these charges by paying $51.2 million which will be returned to the affected municipalities and $177 million to settle parallel charges brought by federal and state authorities. As is typical in these matters, JPMS neither admitted nor denied the allegations in the complaint.
JPMS and its colleagues in the securities industry manage trillions of dollars of assets. Most of this money is actively managed, meaning they attempt to add "alpha" by beating designated benchmarks. The fact that overwhelming data indicates most active managers add "negative alpha", has had limited impact on these clients to date.
Investors "don't stand a chance" when dealing with brokers who view breaking the law and paying relatively trivial fines as a minor cost of doing business.
Just because it's business as usual for them, doesn't mean you should abandon your moral and ethical principles and continue to patronize them. A collateral benefit of using your moral compass is that your returns are likely to increase when you discover the benefits of a globally diversified portfolio of low management fee stock and bond index funds -- something your local broker is unlikely to discuss with you.
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein. Furthermore, the information on this blog should not be construed as an offer of advisory services. Please note that the author does not recommend specific securities nor is he responsible for comments made by persons posting on this blog.
Showing posts with label Financial regulation. Show all posts
Showing posts with label Financial regulation. Show all posts
Tuesday, August 2, 2011
Monday, June 22, 2009
Casualties of Complexity
At the risk of sounding naïve, I believe that many of the problems we experience as investors and the institutions that regulate us are brought on by complexity.
The book, A Demon of our Own Design, got me started thinking this way. Written by Richard Bookstaber in 2007, it gives an insider’s view of the 1987 Crash and the collapse of Long-Term Capital Management, the hedge fund that took down UBS when it collapsed in 1998. Each disaster, and several others described in the book, was caused by an attempt to use complex financial strategies to circumvent the normal movement of financial markets – and each failed miserably.
None of the designers behind these strategies were intellectual light-weights. The author himself received his PhD from MIT in economics; but in all cases the complexity of the product design (portfolio insurance, currency options, etc.) failed to take into consideration some factor that only seemed obvious in hindsight. There was too much complexity in the plan to take all possibilities into consideration in advance.
Ironically, the last chapter of the book recommended that “rather than adding complexity and then trying to manage its consequences with regulation, we should rein in the sources of complexity at the outset.” This was written before collateralized debt obligations and other complex financial instruments created what some are now calling the Great Recession of 2008.
Not only did we experience a global drop in the equity markets in 2008, but to add insult to injury people had their money stolen from them by people like Bernie Madoff. Now the Obama administration is proposing regulation to prevent what we’ve been through from happening again. While I believe that regulation usually does more harm than good, I understand that something needs to be done.
If complex regulations are proposed to control investment companies then more inventive ways to circumvent the regulations will result. I propose simplicity instead. Make all brokers, financial planners, financial consultants, investment advisors, money managers, etc. follow the same 3 rules:
1. Use an INDEPENDENT company to hold your client’s assets.
2. Hold yourself to a fiduciary standard when you work with your client.
3. No matter what you are doing, or who you work for, follow rules 1 and 2.
There is hope, since the Obama proposal mentions establishing a fiduciary duty requirement for all advisors, but we’ll see if it makes it through a Congress that is heavily lobbied by groups that don’t want to be held to the standard.
People who lost money before these rules were in place might have been saved by them, but they could have saved themselves as well. All of the Bernie Madoff victims interviewed said they did not know how he was investing their money and could not explain how he could give them a steady 10% per month return when markets were falling. Complexity can be very seductive to investors because it appeals to the belief that really, really smart people have secret ways of outperforming the market.
If we don’t understand something because it is too complex, then we risk becoming a casualty of the complexity. My rule – keep it simple enough to know what you have and what you are doing. It works in life as well as investing, but that’s for another day and another blog…
By Jeannette Jones, CFP®
The book, A Demon of our Own Design, got me started thinking this way. Written by Richard Bookstaber in 2007, it gives an insider’s view of the 1987 Crash and the collapse of Long-Term Capital Management, the hedge fund that took down UBS when it collapsed in 1998. Each disaster, and several others described in the book, was caused by an attempt to use complex financial strategies to circumvent the normal movement of financial markets – and each failed miserably.
None of the designers behind these strategies were intellectual light-weights. The author himself received his PhD from MIT in economics; but in all cases the complexity of the product design (portfolio insurance, currency options, etc.) failed to take into consideration some factor that only seemed obvious in hindsight. There was too much complexity in the plan to take all possibilities into consideration in advance.
Ironically, the last chapter of the book recommended that “rather than adding complexity and then trying to manage its consequences with regulation, we should rein in the sources of complexity at the outset.” This was written before collateralized debt obligations and other complex financial instruments created what some are now calling the Great Recession of 2008.
Not only did we experience a global drop in the equity markets in 2008, but to add insult to injury people had their money stolen from them by people like Bernie Madoff. Now the Obama administration is proposing regulation to prevent what we’ve been through from happening again. While I believe that regulation usually does more harm than good, I understand that something needs to be done.
If complex regulations are proposed to control investment companies then more inventive ways to circumvent the regulations will result. I propose simplicity instead. Make all brokers, financial planners, financial consultants, investment advisors, money managers, etc. follow the same 3 rules:
1. Use an INDEPENDENT company to hold your client’s assets.
2. Hold yourself to a fiduciary standard when you work with your client.
3. No matter what you are doing, or who you work for, follow rules 1 and 2.
There is hope, since the Obama proposal mentions establishing a fiduciary duty requirement for all advisors, but we’ll see if it makes it through a Congress that is heavily lobbied by groups that don’t want to be held to the standard.
People who lost money before these rules were in place might have been saved by them, but they could have saved themselves as well. All of the Bernie Madoff victims interviewed said they did not know how he was investing their money and could not explain how he could give them a steady 10% per month return when markets were falling. Complexity can be very seductive to investors because it appeals to the belief that really, really smart people have secret ways of outperforming the market.
If we don’t understand something because it is too complex, then we risk becoming a casualty of the complexity. My rule – keep it simple enough to know what you have and what you are doing. It works in life as well as investing, but that’s for another day and another blog…
By Jeannette Jones, CFP®
Subscribe to:
Posts (Atom)
Posts
