What Were They Thinking?

The title for this week's column was inspired by John Edwards.

Let's forget whether the "love child" really is his. Let's ignore the denials of any knowledge about payments made to his mistress by his finance chairman. Let's also acknowledge that private conduct should remain private.

After the affair, Mr. Edwards decided to run for president. When he made that decision, his private conduct became fair game.

What was he thinking? That the rabid press corps would not find out? That it would not affect his candidacy?

In the heady world of finance, there are powerful players. Some of them believe the rules do not apply to them. Or maybe they just weren't thinking. Here are some current examples:

1. David Aufhauser: Before his resignation, Mr. Aufhauser was a Managing Director of UBS, which describes itself as "one of the world's leading financial firms." He was also General Counsel of UBS' Investment Bank and a member of the Group Managing Board of the company.

Mr. Aufhauser has a very distinguished background. He earned an MBA from Harvard and a law degree from the University of Pennsylvania. Prior to joining UBS, he was the General Counsel of the U.S. Department of Treasury. Among other duties, he supervised the Enforcement Division.

According to a complaint filed by the New York Attorney General, "Executive "A" at UBS unloaded his personal holdings in auction rate securities shortly after learning that the market was in trouble--at a time when UBS continued to aggressively market these securities to its retail customers. The Wall Street Journal reported that sources familiar with the matter identified Mr. Aufhauser as "Executive A."

Mr. Aufhauser was not charged with any wrongdoing and he was not alone in his conduct. Other executives of UBS dumped $21 million of these securities.

But I have to single out Mr. Aufhauser because he was a highly trained lawyer and the General Counsel of the Investment Bank. Where was his moral compass?

He knew there was a problem with auction bonds. He thought the problem was severe enough that he should rid himself of his entire holdings of $250,000. Yet, apparently, he did nothing to alert actual or prospective retail customers of UBS.

I have to ask: Mr. Aufhauser, What were you thinking?

2. Thomas DiNapoli: Mr. DiNapoli is the Comptroller of the State of New York. He has a great idea. He would like to make up for current losses in public pension funds by taking bigger risks in hedge funds and real estate. His goal is to have the authority to invest more than 25% of fund assets in "alternative investments."

Mr. DiNapoli has obviously not considered the data on hedge funds.

One study of the performance of 1917 funds found that only 17.7% beat a simple S&P 500 index fund.

Another study co-authored by Burton Malkiel (the author of A Random Walk Down Wall Street) concluded that investors in hedge funds "... take on a substantial risk of selecting a very poorly performing fund or worse, a failing one."

While Mr. DiNapoli risks compounding losses by investing in highly volatile funds, the Commonwealth of Massachusetts is moving in the opposite direction.

Its pension fund fired the "legendary" Bill Miller of Legg Mason, and other active managers who managed $1.8 billion of its domestic stock portfolio. It is putting $1.4 billion into an index fund. While the Massachusetts pension plan also invests in hedge funds, it is moving away from retaining active managers for its U.S. stock portfolios.

I understand what the Massachusetts pension plan fiduciaries were thinking. They were responding to overwhelming data and their own experience.

But Mr. DiNapoli, what were you thinking?

3. Unnamed major brokerage firm (you know who you are!): A reader of The Smartest 401(k) Book You'll Ever Read changed jobs. She called you to discuss rolling over her 401(k) which you manage for her former employer. She wanted to open an account with Vanguard and invest in a globally diversified portfolio of low cost index funds recommended in my book, consistent with her asset allocation.

Here is what you told her: "Low fees mean low returns."

Surely you know that the opposite is true: Lower expense ratios are strongly related to higher returns. This is not a subject of serious debate. Many studies demonstrate this fact.

I think I know what you were thinking.

4. Readers of this column: Wachovia, Citigroup Inc., UBS AG, JP Morgan Chase & Co. and Morgan Stanley have all settled claims that they misled investors in connection with the purchase of auction rate securities. Most observers believe this is the tip of the iceberg.

It seems clear that the culture of greed and disdain for the welfare of retail clients pervades Wall Street.

If you have an account with a brokerage firm, let me ask you this:

What are you thinking?

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.

Comments

[dadw5boys]

OK ,WHERE DO WE SIGN UP FOR THEM TO INVEST OUR SOCIAL SECURITY ???????

Great job there Brownie !!!!!!!!!!

[WIpatriot]

Relax, Congress will take care of that for you....

[BigGuy]

"It seems clear that the culture of greed and disdain for the welfare of retail clients pervades Wall Street."

I was a full service broker for a dozen years. THAT'S FALSE. There may be greed from the top and greed from brokers beginning, but brokers don't stay in business without providing a high level of service and acting with integrity.

But brokers who do best for their clients may do not do best for themselves. Educating people who do not have much money and helping them to build wealth does not pay as well as helping wealthy folks move their money around. I helped my clients build wealth through buying and holding and through trading, but they never had much money invested with me, so that work would not now be compensated.

At most of the large firms, if the account size is less than $25,000 (50 or 100), the broker does not get paid at all for trading -- only for sale of a product that ties the client to the firm (not to the broker), like a mutual fund or an annuity.

Even paying full-service commissions, most investors can get much higher returns with a portfolio of five to ten blue chip stocks and writing some covered calls than they can get with most mutual funds, even no-load funds. Most full service brokers will only get paid for servicing such an account if the account begins with a deposit of cash and securities exceeding $100,000.

[dadw5boys]

You forgot the owner, CEO, and BIG CHRISTIAN of Country Wide who worked in Collusion with Property Appraiser to OVERVALUE property and make the loans look great on paper so they could put people into over priced homes with little down payment and reap 3 to 10 times the going rates as profit when they sold the mortages!!!!!!!!!

All the FBI has to do is show the Property Appraiser received a BONUS after a large sale of bundled mortages. But they won't go after Bush's buddy now will they !!!!!!!

[SisterAnn]

Dan, I have my money in a brokerage.

I don't have a clue how to move to a discount brokerage.

I don't know how to buy index funds without being with a brokerage.

I don't trust funds because they put so many bad stocks in with the good ones, but I haven't had any luck buying individual stocks either.

The market seems to be taking turns running up one sector, then dumping it, causing losses to many, then running up another sector. Even bonds are over priced some say.

I read today that some brokerages are buying back bad loans. Insanity reigns.

[dansolin]

You might find this blog helpful:

http://www.huffingtonpost.com/dan-solin/its-so-easy-your-broker_b_56296.html

Dan

[WIpatriot]

Well, Dan, I don't have an account with a brokerage firm, but I'm sure you can guess what I'm thinking anyway.

[archerlane]

We condone their actions by letting finacial world denizens buy their way out. Fraud on this level should be met with public trial, prison time, restitution and penalties for the victims pain and suffering. The fines should be distributed to the victims and not the agencies who cave in with a settlement. The actions of the attorneys general are commendable, but where were they when this stuff was actually going on?
Pension funds who use hedge funds to boost returns should be ashamed of their involvement in perpetrating the lack of transparency veil that covers the finacial denizens.

These white collar thieves do believe that the rules do not apply to them.

[WIpatriot]

I'd have to agree with every word, archer, except "ashamed." These people know no shame.

[cylindar]

A broker is a tool. A broker is not someone you should ever take advice from.

[Halsey]

Dan dan dan,

My gosh..you lump all "brokers" into a greedy lot. I have ONE client with auction rates..she bought them at Morgan Stanley...then..she moved to me. I NEVER EVER sold an ARS...but...input, twice a week, every week..the sell order...and..I do believe that withing the next 2 weeks..she will be OUT..(thank God)..

I should make more money that I do considering the asset base I'm dealing with...but I actually TRY to get my clieints to plan ahead..doing the computations for Future Value..what they absolutely NEED to put away to not outlive their assets.... so many won't listen..they want the overnight 50%...cause that happened 3 years ago... who knew Georgia would attack Ossetia (and the Russians would over-react)..who KNEW oil would hit 180..then fall back to 118...then go up again... I TRY to get clients to properly diversify...yes...Index funds (but ETF's..with even lower expenses than open ended funds).

Give at least me a break..I am not getting rich of my clients' money...I am trying to teach them how old money...gets old...NEVER put the principle at risk..and if we have gains (and yes..we do)..we raise the value of the principle... the greed of the average investor is their undoing...

(btw..I truly believe brokers like those you cited...should go to JAIL AND pay HUGE fines..huge)

[robinhood2]

Brokerage firms have always put their retail customers last. It was true when the book "Where are the Customers' Yachts?" was first published in 1940, it was true in the late 1980's when the limited partnership fiasco blew up, it was true in 2000 when the Internet stocks crashed after being hyped by Wall St. analysts and it is true today. I deal with a discount broker, make my own decisions and pay very little in commissions.

[demockracy]

This is deja vu all over again. Consider this description of the Reagan era S&L scandal:

"The theft from the taxpayer by the community that fattened on the growth of the savings and loan (S&L) industry in the 1980's is the worst public scandal in American history. Teapot Dome in the Harding administration and the Credit Mobilier in the times of Ulysses S. Grant have been taken as the ultimate horror stories of capitalist democracy gone to seed. Measuring by money, [or] by the misallocation of national resources...the S&L outrage makes Teapot Dome and Credit Mobilier seem minor episodes.....

"The S&L story is desperately important not for the reasons usually given but because its development, maturity and crisis raise profound questions about American society. In the light of this bonfire, we must ask whether our great professions are still capable of self-regulation, of giving honest service, and of accepting fiduciary duties in an age when all costs and benefits are reduced to monetary measurements and all conduct that is not specifically prohibited has become permissible. Watching the obedient dance of our officials and politicians when their patrons pipe a tune, unrebuked by a public that attends this show as it might any other, we must ask whether this generation of Americans remains capable of self- government."

--from Martin Mayer's THE GREATEST-EVER BANK ROBBERY The Collapse of the Savings and Loan Industry (Scribner's)

[sher2x4]

I've been trying to finish that book forever,
but everytime i pick it up and start reading
i get so mad it becomes a hazard to my health.

It's unbelievable what those people did.

What i can't figure out is why that book is not required reading in our school system.
in fact every one should at least make an attempt at reading it.

[montemalone]

In order for a book to be required reading in our school system , students would have to be able to read.