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So Many Investors to Fleece, But So Little Time

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It was a busy week for those in the securities industry. I can only touch upon the highlights of their activities in "helping" investors achieve their financial and retirement goals.

The big news was the civil complaint filed against Goldman Sachs by the SEC. Don't get confused by the complex language concerning "synthetic collateralized debt obligations (CDO)". These charges involve garden variety fraud.

Here's the essence of the allegations, as described by Robert Khuzami, Director of the Division of Enforcement:

"The product was new and complex but the deception and conflicts are old and simple,... Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party."

If I sold you a mutual fund, and disclosed to you the stocks in the fund were picked by a hedge fund manager who had a short position on the fund shares, would you buy the fund?

The complaint alleges this slick move cost investors more than $1 billion.

While these allegations remain to be proven, we need not speculate about the outcome of a case involving the Quadrangle Group LLC and Quadrangle GP Investors II, LP.

According to the SEC, the Quadrangle defendants were accused of securing a $100 million investment from the New York State Common Retirement Fund using a "pay-to-play" scheme in exchange for enriching a political operative and the Deputy Comptroller's brother.

Who were the victims of the scheme? According to Mr. Khuzami: "The victims were New York State's hard-working retirees, who were entitled to have honest advisers manage their hard-earned dollars."

The Quadrangle defendants settled these charges by paying a $5 million penalty, "without admitting or denying the allegations". You can draw your own conclusions about their conduct.

Those cases captured the headlines, but it was business as usual for the rest of the industry.

Last week, I discussed how high expense ratio index funds can clobber your returns. As an example, I used the Dreyfus S&P 500 Index Fund (PEOPX) which has total expenses of 0.50%. I noted that you can purchase comparable funds, tracking the same index, with an expense ratio as low as 0.10%.

It turns out that the Dreyfus fund is one of many examples. The Nationwide S&P 500 index fund (GRMAX) has a maximum front end sales load of 5.75% and a total expense ratio of 0.52%.

The State Farm S&P 500 Index Fund (SNPBX) makes the Dreyfus and Nationwide funds look like Vanguard or Fidelity by comparison. It boasts a total expense ratio of 1.50% and a maximum deferred sales load of 5.00%.

The five year average return of the Nationwide fund and the State Farm Fund is 1.07% and 0.55% respectively. The five year average return for the Fidelity Spartan 500 Index Fund (FUSEX), which has an expense ratio of only 0.10%, and no front end or deferred sales load, is 1.88%.

Nationwide's fund has net assets of a whopping $2.31 billion. I suspect a good slug of those assets are accounted for by 401(k) plans, where this fund is the designated S&P 500 index fund.

State Farm's fund has $515 million in assets. I have the same suspicion about the source of some of those assets.

Investors in these funds are losing tens of millions of dollars over time by either being forced to use these fund options in their 401(k) plans or by being ignorant of the effect of costs on returns. If these funds are in 401(k) plans, it is difficult to understand how the fund sponsors are fulfilling their fiduciary obligations to plan participants by imposing these funds on them, when far less expensive, and better performing, index funds are readily available.

It is all just grist for the mill for the securities industry -- a mega-skimming operation -- which is in business to transfer wealth from their clients into their own pockets. They do so smoothly, and with such great expertise, that the most skilled pickpocket must blush with envy.

While Congress debates the merits of financial reform, the nest eggs of Americans continue to descend into the abyss. I agree with those who question the need for reform, but for a very different reason. To borrow a line from those who opposed health care reform, I think we need to discard the present system and start all over again.

Count me in if you want my help in this effort.

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