Is My Money Safe? Part II

In my last blog I discussed the safety of investment custodians such as Fidelity and Schwab, after I received a concerned email from a client.  After watching Jon Corzine, the former CEO of MF Global, trying to explain how $1.2 billion was missing from their clients’ brokerage accounts, he was worried about his own.

The next important question to ask is whether you can trust your advisor.  Research indicates most investors believe their advisor is very trustworthy, even if the evidence shows otherwise.  It’s great to have an advisor you feel you can trust, as long as that trust is backed up by checks and balances, facts and reality.  Investment scams seem so obvious after they’ve been exposed, but most of those affected weren’t suspicious of their advisor until it was too late.

Investors disappointed in their returns over the past decade are more likely to be taken in by what appears to be a chance to make great returns.  Tough investment markets bring out the emotions of fear and greed, and make people more vulnerable.  Based on my study of advisors and investment scams, if your current advisor exhibits one or more of the following characteristics, you should be very concerned:

1.      There is no independent accounting of individual investment holdings, portfolio account balances or returns.  As a former KPMG auditor, this one is so obvious to me it’s frustrating.  However, it’s been ignored by everyone from the very wealthy to low income individuals. Bernie Madoff was able to report consistently positive, long-term investment returns because he was the one preparing the reports, and we all know how that turned out.   

But here in Cincinnati we have our own example as well.  In February 2001 Stephen G. Donahue, owner of SG Donahue Securities, was found guilty of taking over $6 million from nearly 250 clients by supposedly investing their money in a tax free bond fund that never existed.  Instead, he used the money to pay his personal taxes, buy a condo in Florida, and cover other personal expenses.  The theft was hidden because the company did not use an independent custodian like Fidelity to report on client holdings.  Instead, statements were prepared internally and mailed to clients by the SG Donahue Company.       

2.      They guarantee investment returns. Registered Investment advisors like The Asset Advisory Group are barred from using the word “guaranteed” when we discuss investment performance with current or potential clients.  The Firefighters’ Retirement System of Louisiana, along with two other Louisiana pension funds, is now trying to recover a combined $100 million they have invested with Fletcher Asset Management, which had guaranteed a 12% minimum annual return. Their withdrawal requests have been met with only IOUs at this point.  The FBI and SEC are currently investigating, so this story may just be getting started.   

Our local example is George Fiorini and the 10% Income Plus Plan. His investment scam was first brought to my attention in 1995 by my administrative assistant, who gave me a mailing she received that was also circulating among her retired friends. Fiorini’s advertisements were on radio, TV, and bus benches, and featured local celebrity Bob Braun as his chief spokesman.  Over 170 investors lost $5 million, most of whom could not afford to lose anything.    

3.      They report returns that are significantly higher than market conditions would indicate. Bernie Madoff was able to deliver consistently positive investment returns for decades while S&P 500 returns were negative, but if you questioned the validity of the returns, he returned your money and fired you as a client.  This worked until too many people asked to cash out.  Allen Stanford, CEO of Stanford Investment Bank, reported returns of 15% or more on the bank’s high rate CDs, until the SEC decided to investigate after Bernie Madoff’s Ponzi scheme unraveled.  Remember Home State Savings Bank’s higher than market CD rates here in Cincinnati? 

A December 27^th Wall Street Journal article, SEC Ups Game to Find Rogue Firms, indicates that the SEC is finally wising up and using performance data to screen out investment management firms to investigate.  They have announced four civil-fraud cases so far as a result. 

4.      They use wealth, connections to the rich and famous, or exclusivity to give them credibility.  George Fiorini would show up for meetings in a chauffeured black limousine.  Allen Stanford sponsored cricket teams in the West Indies, and his friend pro golfer Vijay Singh promoted Stanford’s company by wearing the firm’s logo on his apparel and golf bag.

The aura of exclusivity was used to promote Ben-Mar Investments in the early 1990’s in Cincinnati.  Ben Schmidt and Mark Gatch used country club connections and their relationships with Bengal players to promote an investment fund that supposedly used a sophisticated investment strategy in which only a select few could participate. Investors lost over $17 million.   John Brinker defrauded 600 greater Cincinnati investors of about $20.3 million using Wellington Capital Holdings, a fictitious offshore investment bank that promised 100% returns through exclusive investment opportunities.   

5.      They use religion or other affiliations to build trust.  George Fiorini would begin meetings with a prayer, and named one of his investment companies IGW Trust (In God We Trust).  Over $2.2 billion was taken from investors through the Baptist Foundation of Arizona, IRM Corp. used face-to-face recruiting through church-based organizations to solicit over $400 million, and Greater Ministries International promoted “Christian Social Security” to take $580 million from investors.  Deep religious beliefs are admirable, but they should not be the primary reason to invest with an advisor.     

After reading all the horror stories you might begin to wonder if you can trust anyone.  But you can build wealth, and maintain it, by working with an advisor who tells you the truth vs. telling you what you want to hear.   

Jeannette A. Jones, CPA, CFP®
jjones@taaginc.com
http://www.taaginc.com/

Is My Money Safe?

That’s the question a client asked me last week, after he watched Jon Corzine, former CEO of MF Global, testify to a Congressional committee about the $1.2 billion missing from MF Global client brokerage accounts. He wanted to know if his investment account at Fidelity was at risk.

The MF Global collapse is similar to that of Lehman Brothers and Bear Stearns that occurred during 2008, when brokerage companies traded to make profits for themselves and made poor decisions that led to their undoing. During the same time we watched Bernie Madoff's long- term Ponzi scheme unravel, and read about other investor losses here in Greater Cincinnati. Taken together, it’s no wonder he’s worried. In my next blog, I’ll discuss the common elements of investor scams that have occurred nationally and locally. Today I’ll address brokerage account risk, and compare MF Global to Fidelity Institutional Wealth Services and the Charles Schwab Corporation, the two brokerage firms we use to custody our client accounts. There are four major differences in MF Global operations and those of Fidelity and Schwab:

Company Focus
MF Global’s core business was providing brokerage execution and clearing services for derivatives traded on global exchanges and over-the-counter markets, and many of their clients were hedge funds and institutional money managers. It was in the process of trying to diversify into other areas, but was not as diversified as Fidelity or Schwab. Both Fidelity and Schwab provide retail and institutional brokerage services for a broad variety of clients as well as mutual fund management. This diversification of revenue sources helps to make them stronger.

Financial Strength and Regulation
The Standard & Poor’s ratings analysis on MF Global published on December 13, 2010 assigned the company a –BBB rating (the 10th S&P rating level, almost ‘junk’ ). S&P pointed out that the company had suffered losses for the year 2010 and for every year going back to 2008. For the first six months of fiscal 2011 they reported a net loss of $29.9 million. At the time, the company held only $253 million in excess capital over the regulatory minimum. Fidelity and Schwab have much stronger financial profiles. Fidelity had equity of $2.4 billion as of June 30, 2011 and carried a rating of A+ (the 5th level) from S&P, while Schwab held $6.7 billion in equity capital and an A rating (6th level) for the same period.

Even though MF Global was also a registered broker-dealer, the company primarily held commodity accounts, not securities accounts, which are supervised by the Commodity Futures Trading Commission. The Securities Investor Protection Corporation (SIPC) offers $500,000 protection on securities accounts, like those held at Fidelity and Schwab, but there is no equivalent insurance for commodities accounts. In addition, both Schwab and Fidelity have private insurance coverage in excess of the SIPC limit.

Client Agreements
Commodity brokerage firms are permitted to use cash in client accounts for their own trading, subject to certain restrictions. In fact, MF Global’s standard client agreement permitted the firm to “borrow, pledge, repledge, transfer, hypothecate, rehypothecate, loan or invest any of the collateral” in customer accounts. This practice has been an additional source of revenue for the commodities industry for decades, but companies are supposed to segregate client money from company funds. In the final days of MF Global, when Mr. Corzine was scrambling to cover proprietary trades he had made on behalf of the company, his accounting apparently got sloppy.

Schwab and Fidelity client agreements do not permit them to borrow funds from client accounts.

Regulatory History and Character
According to the S&P financial report I referred to earlier, MF Global had more regulatory actions than other rated brokerage companies. In addition, in 2008 the company suffered an “unusual” loss due to unauthorized trading inside the company. They didn’t exactly have a stellar track record. Both Fidelity and Schwab have respected regulatory records.

John Corzine held the office of both Chairman and CEO at the company, and had lots of concentrated power with little oversight. He was CEO of Goldman Sachs in 1999 before he was pushed out, but had been out of the financial industry for 12 years while he worked in politics. He was anxious to make a name for himself and took increasing risks with the company’s proprietary trading to increase profits at the firm. As I wrote in my November 8th blog, that did not work out well.

It’s important to know the companies you do business with, and the people who stand behind them. No matter how sophisticated the world gets, it’s the strength of character of the people you work with that still matters most.

Jeannette A. Jones, CPA, CFP®
jjones@taaginc.com
http://www.taaginc.com/

What Can We Learn from MF Global?

Over the past two weeks, while the Greek Prime Minister tested the patience of Germany, France and other countries in the European Union, there was another drama playing out.

MF Global Holdings is described on its web site as a brokerage firm that provides ‘indispensable, well-timed insights and hedging solutions’ for its clients. They go on to say their ‘relentless pursuit of market opportunity separates us from the pack. We help clients find an edge in today's fast-paced, ever evolving markets.’ In so many words - we don't just sit around and watch the market, we DO something!

The company's CEO and Chairman, Jon Corzine, was the former Chairman of Goldman Sachs, and had decades of industry experience. He also had significant hubris about his ability to invest based on his ‘well-timed insights’.

Last Friday Corzine resigned from the company after a $6.3 billion bet the company made on European debt did not go the direction his insight told him it would. Now the company has declared bankruptcy, and the FBI is investigating $593 million in client funds that remain missing.

You’re probably tired of hearing about Wall Street financial failures; but MF Global along with the Merrill Lynch, Lehman brothers, and Bear Sterns failures that came before all share a common lesson.

Even the smartest, most well connected investors in the industry are wrong about which way the markets will move, when they will move, and what you should do about it.

Sometimes our clients ask where we think the market is headed and what we should do to prepare, and they are frustrated when we tell them we refuse to offer up predictions or opinions. We don’t refuse just to be difficult; we do it because we realize the next logical step after a prediction is the temptation to do something to avoid what you think is going to happen. But for each and every economic or political issue, there are multiple known and an even greater number of unknown possible outcomes. When Greece agreed to a debt bailout deal with the EU, and the Dow responded with a whopping rally, who anticipated the Prime Minister would decide to put a referendum vote on the decision – causing another drop in the market? We realize that we cannot anticipate every outcome, and we are honest enough to admit it. It doesn’t mean you can’t be a successful investor.

Investors have been taught to look for advice on when to jump in and out of stocks, and the media has reinforced it. Over and over again we have seen people hurt by promoters who sell products that promise to out-perform the market based on an ability to out-maneuver the market. We’ve even seen people hurt by attempts to avoid losses by moving their funds into ‘safe’ investments that can’t keep up with their spending or inflation. None of these tactics are successful, long-term strategies for growing and maintaining your wealth.

Building an investment plan based on what you want to accomplish financially; using low cost investment options to implement your plan to keep more of what your investments earn; and using the jumps and drops in the market to rebalance works. You will rarely hear someone on TV or radio talking about it, because it does not provide the same excitement and drama that MF Global’s strategy did. Somehow I don’t think you would miss it.

Jeannette A. Jones, CPA, CFP®
jjones@taaginc.com
http://www.taaginc.com/