Somebody Else’s Money©: Wall Street Tango

By John Lohr and Ian Lohr

Material is taken from The Fiduciary Sale and Investing as a Fiduciary, now available from Isle Press, and the forthcoming Somebody Else’s Money, by John and Ian Lohr © 2003, 2004 Howling Wolf Enterprises.  THIS MATERIAL MAY NOT BE REPRODUCED IN ANY FORM.  Authorized reprints are available at reasonable rates.  For information please contact Isle Press at www.islepress.com

NOTE AND DISCLAIMER:  Information about wrongdoing and misbehavior by financial professionals contained herein is taken from the SEC public record and news service reports.  Charges listed are allegations by Federal or State Regulators, and are not an indication of guilt or innocence.  Amounts are estimates from Federal or State Regulator publications or News Service reports.

FIDUCIARY MELTDOWN ©2004 HWE

2003 to 2005 is witnessing the most dramatic reform ever in the treatment of fiduciary responsibility with dynamics on 3 levels:

1. Corporate
2. Investment Management
3. The Financial Advisor

The Perpetrators:

• On the Corporate level:  Companies of all sizes and forms are being found liable for defrauding shareholders for lying about the financial condition of their companies.  The breach of fiduciary responsibility knows no discrimination—it encompasses big corporations, small corporations, foundations, endowments and trusts.
• On the Investment Management level:  Share holders have been taken advantage of by mutual funds, broker dealers, investment management firms, independent RIAs, celebrities like Martha Stewart and industry insiders like Rich Grasso, former head of the New York Stock Exchange.
• On the Financial Advisor level:  Clients have been ripped off perhaps intentionally, or even unintentionally, by untrained financial advisors, rogue financial advisors and in some cases, criminals.

Who is affected?

• On the Corporate level:  It is not just the crooked perpetrator who is liable for these fiduciary injustices.  Ultimate responsibility rests at the highest corporate levels—CEOs, CFOs, Presidents, officers, Boards of Directors and Trustees.  Liability extends to their paid service providers, and sometime cronies—money managers of employee benefits funds and various financial advisors.
• On the Investment Management level:  Shareholder abuse has been inflicted by custodians, broker dealers, investment advisors, financial advisors, investment consultants and private placement hedge funds.
• On the Financial Advisor level:  Everyone is affected as reforms will change the way business is done.

Who is safe?

• No one.

Where is the reform headed?

• To the financial advisor level.  When the “Name” defendants have been dealt with and the Putnams, Martha Stewarts and Dennis Kozlowskis have paid their debt to the regulators, the next witch hunt that the SEC and States’ Attorney General will engage in will be directed at the individual financial advisor.  Be Prepared.

Who will benefit?

Ultimately reform will be good for the industry, will be good for shareholders and will benefit you.  It has long been regarded that the financial services industry needs some weeding out.  Clients and the real professionals are tired of reading about Joe Nobody in Yeehaw Junction, Florida, bilking millions from the former Orange farmers and earth tillers.  So, the long term benefit will go to:

• clients.
• the victims.
• Mom and Pop shareholders.
• Financial service providers.

White Collar (with an Hermes tie) Crime

Corporations have breached their fiduciary responsibility to shareholders by deliberately misstating the financial conditions of the company.  Victims strewn from the toney condos to the trailer parks include:

• Employee 401(k) participants who dutifully followed the urgings of their management to continue investment in “The company”, because its “good for everybody”.  Presumably by “Everybody”, CEO Bullmoose meant “Me and my fat cat cronies”.
• ESOP participants, socking nickels and dimes away for retirement blindly believing the financial lies being pandered to them by the Company ivory tower elite.
• Shareholders who hate the reams of proxy voting garbage they get every February, and don’t read it, only to find out later that obscene bonuses have been authorized to Corporate bigwigs who have pandered away the company coffers, while gifting huge consulting contracts to their Saturday morning partners at Dead Possum Country Club.

The resulting fraud being perpetrating upon the shareholders is being dealt with by fines and firings, although Dante would have dealt with it differently by turning up the heat.

The Corporations:

“Billion Dollar Train Wrecks”, Orlando Magazine, Feb.2004

Enron

• Ken Rice, CEO E/Broadband
• Kevin Hannon, COO, E/Broadband ($1 civil penalty, $2.2M disgourge, $8 M DC)
• Principals:  Andrew Fastow (CFO)
• Leah Fastow (Spouse)
• Richard Causey (Chief Accounting Officer)
• Kenneth Lay (Chairman)
• Ex-CEO Jeff Skilling (awaiting trial)
• Charges:  misleading shareholders, insider trading, 90 counts of fraud, breach of fiduciary responsibility
• Estimated damages:  5 billion dollars
• Status:  in litigation, unresolved

Fastow and Fastow copped a plea, but Leah, with echoes of, “You first dear” still ringing in her ears back pedaled so fast she passed Lance Armstrong descending the Alps.

Causey is in trouble, but they are after a bigger prize, where the real targets of the litigation Lay.  Will the principle of “Ultimate responsibility” prevail?  Stay tuned.

WorldCom

• Charges:  They allegedly did it all—breached their fiduciary duty to 401(k) participants, breached their fiduciary duty to ESOP participants, misled investors, lied to shareholders and committed fraud while the company slithered down the sewer of Chapter 11.
• CEO Bernard J. Ebbers charged with conspiracy and fraud; pleaded not guilty.  “We do not believe Bernie Ebbers ever committed any crimes” (His lawyer).  Also accused of freewheeling spending and aggressive dealmaking, contributing to World Com’s demise.
• Employee Benefits Manager Dona Miller had control over the EB plans.
• CFO Scott Sullivan pleaded guilty to conspiracy and agreed to testify against Ebbers.
• Estimated damages in loss to shareholders:  11 billion dollars.
• World Com was wiped out and 20,000 lost their jobs.
• Status:  Can Bernie Ebbers pick the handcuffs he was led away in and vindicate himself to the 20,000 employees who lost their jobs and saw their 401(k)s wiped out?

Quest/US West

• Charges:  Breach of fiduciary duty to shareholders regarding value of company, breach of fiduciary to 401(k) participants, breach of fiduciary duty to ESOP participants.
• CEO Joseph P. Naccio.
• Various members of the Investment committee.
• Quest Asset Management (a money manager subsidiary).
• Estimated damages: 2.5 billion dollars.
• Status: in litigation.  Naccio, a former dodge ball champion in the 4^th Grade has, so far, lost none of his former skills.

Viviendi

• Charges:  Breach of fiduciary duty to shareholders, regarding value of company, as they issued news releases downplaying the companies liquidity crunch and debt problems.
• President:  Jean Marie Messier gives up his meager $25 Million severance pay package plus pays a $1Million fine.
• CFO Guillaume pays a $300,000 penalty.
• Estimated damages:  50 million.
• Status:  The Company pays a $50 Million fine.  Messier said it was, “Balanced and reasonable.”  The criminal probe is ongoing.

Tyco

• Charges:  Breach of fiduciary duty to shareholders regarding value of company, misuse of shareholder and company funds.  The company was painted as a “Personal piggy bank” for the CEO and CFO.
• CEO Dennis Kozlowski accused of looting Tyco of more than $600 Million to fund yachts, mansions, parties (A $2 Million birthday party for MRS K.) and jewelry.
• CFO Mark Swartz wrote the checks, but said that a dead Board member authorized it.  Attempts to reach the Board member have so far proven unsuccessful.
• Estimated damages: 1  Billion dollars.
• Status:  Hung Jury (they hanged the wrong people).  Will be retried, as Juror #4 says “O.K.”

ImClone

• Charges:  insider trading.
• Martha Stewart (shareholder) found guilty of insider trading for lying to SEC.  You NEVER lie to the SEC.
• CEO Waksal currently serving an 87 month sentence.
• Merrill Lynch Broker Peter Bacanovic was convicted.
• Damages:  3.5 million dollars.
• Status: The newspapers have had their sensationalism with this celebrity slugfest, but what Martha did was peanuts compared to the others listed in this section.

The small company president that thinks it’s his/her money

• Charges:  401(k) failure to provide appropriate choices.  401(k) failure to provide any choices.  401(k) failure to perform due diligence on funds.  ESOP failure to diversify.  Misleading employees on the value of the company, selling and ramming it down the small investors’ throats.
• Damages:  Millions and Millions and Millions.
• Status:  They will be in litigation and they will get more that what the big guys got because they can’t afford the $6000 New York Suits to defend them.

How does this affect you?

The corporate dynamic is changing.  The formerly hands off DCC is modifying their decisions on Corp F responsibility.  Formerly, Business judgement Rule.  Now:  We won’t Q your business judgement, but we will Q your process.  There will be liability, there will be litigation.

Money managers are held accountable for accurate financial analysis; due diligence on the level of manager analysis must be done.  The consultant must provide advice and recommendations and be a fiduciary.  Stay tuned.

 The Wall Street Tango (“OOOH, I love a little sidestep”)

Mutual funds have breached their responsibility to shareholders:

• Late trading allows favored investors to take advantage of after hours activities and trade on information not known by us.
• Market timing gives certain firms an undisclosed advantage by allowing them to get in and out quickly while us poor long term investor slobs are waiting for tomorrow’s USA Today to see how we’ve done.  We, of course pay the added expenses, lowering our already paltry returns.
• Front running portfolio managers who so fervently believe in their own research that they must trade ahead of the rest of us to test it out.
• Regulatory sales practice rules have been blatantly been disregarded.
• Revenue sharing deals have not been withheld from investors.

Firms charged to date (February 2004):  494

Principals arrested:  20

Principals barred from the industry:  18

Total estimated damages:  more than ten billion dollars.  ($2.6B fines to date)

AIM / INVESCO      $480M

FLEET BOSTON

Cut special deals to allow some investors to market time their funds.

Damages:  $70Million in restitution.

Reduce fees going forward by $160 Million (With BoA)

Status:  Settled

ALLIANCE CAPITAL

Charges:  Late trading mutual funds, Fraud

Damages:  fined $250 million; required to lower fees by $20 million

Status:  Settled

JANUS CAPITAL

Charges:  Late trading mutual funds, Fraud

Executive Vice President Lars Soderberg on leave of absence.

Damages:  Currently will pay $100 Million to fund or shareholders.  More to follow.  $15 Billion in lost assets.

Status:  In settlement discussions.

MORGAN STANLEY

Charges:  Undisclosed revenue sharing arrangements.

Damages:  Fined $50 million.

Status:  Settled

ALSO:  $750K:  Failing to provide docs.

Merrill Lynch

$750K failing to provide docs.

Analyst Henry Brodgett $50M fine.

PRUDENTIAL (NOW WACHOVIA)

Charges:  Annuity sales violated NASD rules.

Damages:  Fined $11.5 million.

Status:  Settled.

Also:  $800K misconduct in account management.

PUTNAM

Charges:  Market timing mutual funds, Front Running.

General Counsel William Woolverton retired.

Damages:  $110 million in Disgorged Profits and fines.

Directed Commissions dropped.

Cut fees by $35 Million.

Major corporate reforms underway by new CEO Charles (Ed) Haldeman to change its former, “Cutthroat culture” (USA Today).

Status:  Settled

FRANKLIN TEMPLETON (Franklin Resources)

Charges:  Civil Fraud Allowed market timing in exchange for investment in Hedge Fund.

Damages:  More than $10 Billion.

Senior Executive William Post arranged deal, left company after being put on administrative leave.

Status:  In discussion with SEC.

MFS

Charges:  Market timing funds, not disclosing payments to brokers for promoting their funds

Damages:  $225 million in Disgorged Profits; required to lower fees by $125million.

Paid back to the Fund $50 Million for paying undisclosed 12b-1 fees.

CEO John Ballen was fined $300,000 and barred from doing business in the securities industry for 3 years.

President Kevin Park was also fined $300,000 and barred from the industry for 3 years.

Status:  Settled

SECURITY BROKERAGE, Inc.

Charges:  Civil Fraud. Late trading mutual funds, Market timing.

Damages:  $175 Million.

President Daniel Calugar, arrested.

Status:  In Litigation.

CANADIAN IMPERIAL BANK OF COMMERCE

Charges:  Financed $1B to investors making improper mutual fund tardes; aided Canary Capital.

Paul Flynn, arrested, charged with 5 felonies, 2 counts of Grand larceny, faces 25 years, if convicted.

Damages:  Undetermined.

Status: In Litigation.

BANK OF AMERICA

Charges:  Cut special dealt to allow some investors to market time their funds.

Broker Theodore Sihpol indicted, faces 25 years, maximum.

Damages:  $250 Million in restitution.

$125 Million in fines.

Reduce fees going forward by $160 Million (With Fleet).

TOTAL:  $515m.

Status: Settled

BANK ONE

Charges:  Market timing.

Damages:  $50m.

Status:  In Litigation.

STRONG CAPITAL

Charges:  Market timing.

Damages:  $90m, Richard Strong barred.

Status:  Settled; firm sold.

PILGRIM BAXTER

Charges:  Late trading by Hedge Fund (President had interest in).

Damages:  Undetermined; Gary Pilgrim, barred; Harold Baxter, barred.

Status:  In Litigation.

SECURITY TRUST CO

Charges:  Aided in late trading.

Damages:  Undetermined; shut down.

Status:  Settled

JAMISON EATON AND WOODS

Charges:  Paid higher commissions on broker-assisted transactions.

Damages:  $100,000.

Status:  Settled.

FEDERATED INVESTORS

Charges:  Improper trading of mutual funds.

Damages:  $20 million in Disgorged Profits.

LaBranche &Co.                     $63.5 Million fine

Fleet                                        $59.1 Million fine

Van der Moolen                      $57.7 Million fine

Sleer Leeds & Kellog  $45.3 Million fine

Bear Wagner                           $16.3 Million fine

Charges:  Improper trading at the expense of customers, various trading abuses including specialists buying ahead of customers.

Status:  Settled.

CITIGROUP, Analyst Jack Grubman $50M

CREDIT SUISSE FIRST BOSTON

GOLDMAN SACHS

AND 7 OTHER FIRMS

Charges:  Made misleading stock recommendations to promote investment banking business.

Damages:  $1.4 Billion.

Status:  In Litigation.

WACHOVIA SECURITIES,

UBS FINANCIAL SERVICES,

AMERICAN EXPRESS FINANCIAL ADVISORS,

RAYMOND JAMES FINANCIAL SERVICES,

LEGG MASON WOOD WALKER,

LINSCO/PRIVATE LEDGER,

HD VEST INVESTMENT SECURITIES

Charges:  Failed to disclose and deliver breakpoint discounts to mutual fund clients.

Damages:  $21.5 million in fines and disgorged profits

Each customer gets approximately $243.00 (the average price for a Wall Street lunch for two)

Status:  Settled

LEHMAN BROTHERS,

BEAR STEARNS,

CRESAP,

SWS FINANCIAL SERVICES,

SOUTHWEST SECURITIES,

DAVID LERNER ASSOCIAITES,

BRECEK AND YOUNG,

KIRKPATRICK PETTIS SMITH POLIAN

Charges:  Failed to deliver breakpoint discounts on mutual funds to clients.

Damages:  Approximately $1 MIllion in fines and disgorged profits.

Status:  Settled.

450 VARIOUS OTHER SECURITIES FIRMS

Charges:  Failure to provide Mutual Fund Breakpoint discounts to clients.

Damages:  Fined $86 million.

Status:  Settled.

The Financial Advisor Level: (The Financial Advisor Hall of Shame):

4384 Arbitration cases 1^st 6 mos, 2004:  7% Settled.

 

Canary Capital Hedge Fund

• Charges:  Late trading.
• Damages:  $40M.
• Status:  Settled.

Cantella Securities

• Charges:  Breach of fiduciary responsibility.
• Estimated Damages:  3.5 million.
• Principals:  James Pangione, Timothy Rassiss had no formal training or background in running hedge funds. (After all how difficult can it be to manage a hedge fund?)
• Status:  In Litigation.

Heartland Group

• Charges:  Insider trading, fraud.
• Estimated Damages:  $125 million.
• Status:  Funds liquidated.

Carolina Investors and Home Gold Financial

• Charges:  Undisclosed sub-prime bad loans.
• Principal:  Earl Morris Jr. (arrested).
• Estimated Damages:  $275 million.
• Status:  In Litigation.

Atlantic Portfolio Analytics and Management

• Charges:  Theft of $6.5 million from investors using Ponzi Scheme.
• Principal:  Daniel Callagan (arrested).
• Status:  In Litigation.

Asset Management and Research

• Charges:  Creatively misused funds, lied to clients.
• Principal:  Marshall E. Melton (barred).
• Estimated Damages:  $3.5 million.
• Status:  In Litigation.

 Financial Advisory Consultants

• Charges:  20 year ongoing Ponzi Scheme.
• Principal:  James Paul Lewis Jr. (arrested).
• Estimated Damages:  $800 million.
• Status:  In Litigation.

Evergreen Securities (British Virgin Islands—NOT the Money Market expert funds)

• Charges:  A ponzi scheme which defrauded 2000 people around the world out of $214 Million.  Now bankrupt.
• Parties:  J Anthony Huggins and Jon Knight accused of stealing $6.5 Million from the fund while investment advisors.  (Even the crooked get ripped off)
• Status:  6 criminal cases rage.  In litigation.  (You can’t get blood out of a stone.)

Garrett Van Wagoner

Inflated security value.

$800k, resign as Pres, barred 7 years (still gets to run fund).

Dir Robert Coleman:  $25k, $16.8K fees

Analyst Audrey Buchner:  $35K.  Improper trading of securities held by fund.

 Deutsche Bank   

$100M stock analysis buy recommendations based on investment banking.

Thomas Weisel Partners

 JB Oxford    

12000 illegal trades.

$8M profit to client.

$1M profit to firm.

Pres. James Lewis called late trading “A great opportunity”.

17 regulatory actions.

57 arbitrations.

Now “Leaving the business”.

The Totals:

• 2 billion dollars in estimated damages.
• 20 arrests.
• 35 individuals barred.

And this is only the beginning…

Where will it end?  “It looks like a small patch of icy water”, Captain of the Titanic.

Where is it going?  To the individual financial advisor level.

The Prevailing Regulatory Environment (Trust us, we’re here to help you)

 The New Wall Street Untouchables:

• Elliot Spitzer (New York Attorney General)
• William Donaldson (chairman, SEC)
• William Galvin (Massachusetts Secretary of State)
• Henry McMaster (South Carolina Attorney General)
• Paul Roye (SEC Division of Investment Management Director)
• Stephen Cutler (SEC Division of Investment Management)
• Peter Fitzgerald (Senator, Illinois)
• John Corzine (Senator, New Jersey)
• Christian Dodd (Senator Connecticut)
• Carl Levin (Senator, Michigan)
• Susan Collins (Senator, Maine)
• Ralph Lambiase (NASAA President)
• Arthur Gabinet (SEC District Administrator, Philadelphia)

Their proposals:

SEC—disclose broker’s compensation on confirms, establish IA code of ethics, disclose broker’s payout differentials, disclose mutual fund breakpoints, disclose mutual fund fees and expenses (per $1,000.00), ban 12-b-1 Directed Brokerage, make fund boards 75% independent, disclose all sales charges to clients.

Congress (four separate bills)—show payout comparison on various products, disclose revenue sharing, ban revenue sharing, ban 12-b-1 sales / distribution payments to brokers, establish an SRO for IAs, disclose fund holdings quarterly, ban soft dollars.

Sarbanes Oxley bill passed corporate reforms, holding Boards more responsible for the actions of their companies.  Expect to see More independent directors (Watch Disney as a bellwether), with Board members being held personally liable for the misdeeds that occurred on their watch.  The always corporate friendly Delaware Chancery Court will lead the charge to ignite the hot coals under Directors’ feet.

 Where is it Headed (in terms of general consensus)?

• Rules and standards will apply to all products.
• Fee-based accounts will come under scrutiny as to customer suitability; their appropriateness must be reviewed regularly.
• Wrap Fee programs will come under particular scrutiny.
• Stockbrokers and Investment Advisors will be held to the same standards.
• Fund fees will come down.
• Managed account fees will come down.
• Consultant’s fees will come down.
• Brokers will no longer be given incentives for selling one product over another.
• “Pay to play”, revenue sharing, and 12-b-1 payments to brokerage firms will die.
• 12-b-1 sales and distribution payments to brokers will die.
• The 1% add-on consulting fee will die.
• Product sales are already dead.
• Higher payout on “B” Shares vs. “A” Shares will die.
• Index fund and ETF fees will face intense scrutiny.
• Index funds paying for research will face intense scrutiny.
• Selling index funds with “B” Shares will die.
• Ibbotson and Morningstar will not recommend any funds that have had abuses.
• Fund abuses will be found in three areas: failing to manage expenses, allowing excessive growth and launching new funds based on market factors instead of investment expertise.
• FUND REQUIREMENTS
• Chief compliance officer (Personal liability).
• ¾ independent board.
• Advisor fees reasonable.
• No dirested brokerage.
• Update holdings quarterly.
• Disclose Manager comp., holdings.
• User friendly disclosures.

 An Introduction to Fiduciary Responsibility (or Who, Me?)

The Basics:

Who is a fiduciary (basically everybody we discussed above).  A fiduciary is someone who is responsible for somebody else’s money.  In prior texts we exhausted the legal definitions and interpretations of fiduciary under ERISA , the UPIA, and UMIFA, here we simplify it as the courts have.

It is “The Duck Theory”.  Courts have been consistently more eager to apply the “Duck” theory (although not actually by that name).  If it looks like a duck, walks like a duck, smells like a duck and acts like a duck, it’s a duck.  A fiduciary status will be defined by the actions of the party in question.  If the client believes the party is acting in a fiduciary capacity, it will be one.

In his excellent article, “The Fiduciary Trap”, noted ERISA authority the late Matthew McArthur, Esq., recounted the case of a company bookkeeper merely doing his job who was found to be a fiduciary of the company retirement fund because he was responsible for disbursing its assets.  Under some financial duress, the company principals instructed the bookkeeper to advance fund assets to the company in the form of a loan.  The loan significantly drew down plan assets so that the bookkeeper was unable to collect his own plan benefit when he left the company.  When he sued for his benefit, the courts not only denied his claim, but held him liable for the losses.

 

A key case that established the prudence standards later incorporated into Federal and State was the 1971 decision in Blankenship v. Boyle (329 F.Supp., 1089) where trustees of the United Mine Workers (Yes, THAT Tony Boyle) were found to have breached their fiduciary responsibilities by letting substantial cash accumulate interest-free in a Union owned bank and also directed retirement trust funds to be invested in electric utility companies in order to give the Union proxy control, forcing the utilities to buy Union mined coal.  Even though the beneficiaries’ interests were clearly served because retirement contributions were directly related to Union mined coal, the trustees’ investment activities were found to clearly advance the Union’s interests first.  The aid to the fund was only incidental to the Union enhancement.  The court found the trustees’ activities were clearly imprudent in accumulating excess cash and in directing investments not solely in the interest of participants.  (But the unions pushed a lot of coal.)

Fiduciary Liability:

Liability is personal and impersonal.  Impersonal in that courts don’t care WHO is responsible—they’ll get anybody, (even Martha Stewart).  Personal, in that fines and penalties are assessed, and have to be paid directly by the perpetrators.  For instance, a Seattle Union’s trustees were fined $74,000 for having all $9 Million of the plan assets in a local bank, paying slightly below market CD rates.  The court said it was “too much risk”.

In GIW Industries v. Trevor Stewart, Burton and Jacobson, a money manager was liable for not inspecting the investment objectives of a fund.  Trevor Stewart invested 75% of GIW’s portfolio in long-term government bonds.  GIW knew of TSBJ’s investment philosophy but hired them with no restrictions.  No one at TSBJ read plan documents, knew the plan history, their cash needs or the demographics of the participants.  When Trevor was terminated, they had lost over $700,000 and collected fees of $17,031.54.  The court said TSBJ subjected GIW to too much market risk and liquidity risk and failed to diversify the investments.  They were fined $537,000 and had to rebate their fees.  The Court, then, turned around and found the Trustees jointly responsible for “Allowing” TSBJ to violate the investment objectives.  Guess who paid.  (No, TSBJ paid—deeper pockets.)

Whitfield v. Cohen

In the still landmark case Miller Druck president Malcolm Cohen was personally liable for $637,412 for not monitoring the investments of the company money manager (who later turned out to be unregistered, and went belly-up), and for continuing the investment when it was clearly inappropriate for Miller Druck.  Ante up, Malcolm

 

Other important cases

• 401(k)/ ESOP (See corporate abuses, above).
• Zangrelli had a two person 401(k) and he picked the investments.  His assistant when she retired was dismayed to learn her fund was up 2.8% during a time when cash averaged 4.5%.  Zangrilli had to pay $150,000 out of his pocket in “Lost Opportunities”.
• Landegraff v. Columbia Healthcare:  In Landegraff, the employees sued management for failure to diversify the company stock purchase plan because they bought only company stock and it was a loser (the employees lost, but later…)
• Weyerhouser was ordered to pay $20 Million back into their fund because they failed to diversify their ESOP.
• “Lets build a museum.”  Another Doctor (no trend intended) bought art for his partnership 401(k) (not in itself, illegal).  Then, on his property, he built a building to house and display the art.  No word on whether he charged friends an entry fee.  Still, his personal interests were served with employee benefit money.

Corporate Interests:

• Yale University:  For instance, in a case suit against Yale University, a donor made restrictions on a charitable gift, but Yale invested it along with other funds.  The restriction did not have to be followed said the court “as long as the college’s purposes were lawful.”  If it were an ERISA plan, the holding would likely have been different.
• Leigh v. Engle:  (An associated party) bought stocks the company had an interest in to prevent a corporate raider takeover.  The manager made a lot of money, but the court said that was irrelevant, both are fiduciaries and there is a fiduciary breach because the investments served personal not beneficiary needs (“selling for profits attributable to the use of trust assets”).  Listen to the defendant, “But we made a lot of money, how can that be wrong?”
• “Good Old Charlie’s Bank”:  The common scenario of a client or prospect saying that they can’t move any money because they keep it down at good old Charlies Bank.  “After all, Charlie was there for us when we were starting out, and he even gives us preferential loan rates because of the compensating balances we keep in our pension fund”.   A transaction like this has an interesting descriptive moniker:  IT’S ILLEGAL.  Look up “Prohibited Transactions” in some of our other books.

  

Boondoggles:

• Pebble Beach. Imagine this improbable scenario.  A Money Manager invites the top Consultant salespeople who have placed the most money with the firm to a “Due Dilligence trip to Pebble Beach.  Spouses are invited, all expenses paid,.  There is tennis, golf, and great dinners.  Everybody gets a $500 Pebble Beach  Somewhere along the way a ½ hour visit to tour the Manager’s offices (less than an hour away).  Can you spell “Party in interest conflict”  Look up due diligence.
• In a case called Carelli, where the trustees and spouses were sent to Hawaii all expenses paid by the money manager, the money manager did not even show up. How objective do you think the Trustees can be?
• Finally, in the best example of a party in interest conflict, but still a great story of greed and power abuses, we have:  USA v. Rosenthal.  Check the names:  David Solomon, Solomon Asset Management, Drexel Burnham Lambert, High Yield Bond Department, Michael somebody.  This is a great case.  Solomon called Michael Millkin (something he said he did about 30-50 times daily) and said he needed a tax write off.  Millkin said he had no tax shelters available, but, “I’ll tell you what I’ll do.  Drexel will sell you some securities and then buy them the next day for a lower price.  Then next year, we’ll give you some profitable trades to make it up.  Call Alan Rosenthal (he was the head of Drexel’s convertible bond department) and tell him what you need, and he’ll take care of you.”  Well—-guess who got nailed (Drexel, Solomon, Millkin?)  Rosenthal got a year in prison, 3 years probation, a $250,000 fine, had to do 300 hours of community service.

How Does This Impact You (The Client)?  And More Importantly, What Do You Do About It?  (or “Give me another pitchfork, Martha, I’m a’havin trouble paddling this here canoe uphill”)

Advisors who guide their clients to investments based on fees earned instead of independent advice are dead.  (Pause for solitary coronet playing taps.)  NO!  No!  That’s wrong—Good Riddance.

Financial Advisors, Investment Advisors, and fund managers who, in their quest for new assets at the expense of their investment expertise integrity will suffer the fate of Don Quixote, tilting at windmills, or more likely Monty Python searching for the Holy Grail.

Gone will be:  B-shares, 12-b-1 fees, product sales, 1% consulting fees and investment recommendations without fiduciary responsibility.

Advisors will be expected to evaluate investment options solely according to client’s investment objectives, document  recommendations, fully explain market risks, provide full disclosure including all fees and cost comparisons, explain that past performance is an unreliable predictor of future performance, keep the investment process an ongoing one and be a fiduciary.  If they can’t accept that, the NSA is taking applications.

At the end of all of this, we will have the age of corporate and investment transparency.  The end result of these developments will be a more open, more shareholder-oriented investing world.  Those who play by the rules will be winners, and will benefit.

Above all, Advisors WILL remember, you’re dealing with Somebody Else’s Money©

John Lohr with Ian Lohr © 2004

Howling Wolf Enterprises

www.islepress.com

NOW AVAILABLE FROM ISLE PRESS

Order at www.islepress.com

The Fiduciary Sale, The Director’s Cut

By John Lohr and Ian Lohr, © 2003

240 Pages.

The complete discussion of Fiduciary Responsibility focused at the Financial Advisor community comes complete with marketing suggestions on using fiduciary responsibility to present managed money to clients.

$49

Investing as a Fiduciary, The Director’s Cut

By John Lohr and Ian Lohr © 2003

140 pages

Intended for trustees, company officers and other fiduciaries in the corporate, foundation, endowment and government communities, this book comprehensively explains fiduciary responsibility and what fiduciaries must do and not do.

$29

See all our publications, and look for the new investor book, Somebody Else’s Money, due Fall, 2004  at www. Islepress.com

 

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