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Phil Trupp

Phil Trupp

Posted: January 25, 2011 07:05 PM

CFO's are preoccupied with administrative duties and have little time to play stock analyst. Yet they are often forced by circumstance to clean up behind their brokers. And if it's messy for CFOs, the problem is much more dicey for the ordinary "retail" (non-professional) investor who is saving for retirement.

Since becoming a day-trader in 1979, I have dealt with countless stock and bond brokers. I can count on one hand those who actually cared about anything other their own bottom line when it came to making recommendations for their retail clients. Most investors desperately want to trust their brokers, to believe they are acting in their clients' best interests. Unfortunately, this is a sad and ultimately heartbreaking act of magical thinking.

So I again ask, respectfully: Do you know what's in your 401(K)? Most likely you don't.

If you're like millions of other savers who don't have time to do your own analysis, you probably assume the manager of your account is a guru or rare collection of financial wizards who know exactly what they're doing, and that they are doing it in your best interests.

Think again. Mostly likely those 401(K) managers have only one goal in mind: the fees that pad their bottom line. After all, no one does you a favor by selling you risk, and that's exactly what some brokers are all about.

Don't get me wrong. There are good brokers in the mix. I have seen them in action. But they are rare creatures, indeed. Most brokers are there for one thing only: making commissions.

This is a situation now under examination by the Securities and Exchange Commission. Under Section 913(g) Title 10 of the Dodd-Frank Reform and Consumer Protection Act of 2010, the SEC is required to conduct a study to evaluate the effectiveness of standards for brokers who service retail investors. The study is decades overdue.

At this writing, the Commission is essentially leaning toward making brokers into virtual analysts of the financial products they sell. You expect your plumber to know what he or she is doing, and stand behind their work; why not the same standard for those in the financial services industry.

The SEC is writing a code for a universal "fiduciary standard," demanding that the client's interest -- and not the broker's bottom line -- must be the guiding ethical responsibility of broker-dealers who invest your 401(K) and other equity retail portfolios made up of stocks, bonds and derivatives. I'm all for it!

At present, most broker-dealers are held to a much lower standard: it's called a "suitability requirement." This "suitability" phrase of art is so wishy-washy that it is next to impossible to find any two regulators who can agree on what it really means. I define it this way: Your broker calls with a "hot" new financial product; if you buy it, it's considered "suitable"; it fits your idea of what's basically just okay. In my opinion, it sets the bar disastrously low.

But if the brokers and regulators can't agree on a solid definition of suitability, what's an ordinary investor to do? It forces most of them to rely on their brokers and defer to their judgment, and that is not exactly a prudent move.

Broker-dealers regulated by the industry-backed Financial Industry Regulatory Authority now stick to the suitability standard. Those regulated by the SEC are required to operate under the fiduciary standard, according to the Dodd-Frank regulations. The Dodd-Frank regulations want to bring all brokers under the fiduciary umbrella.

The SEC is leaning toward the Dodd-Frank position, which favors the investor, because it calls for all brokers to take on a hard and fast ethical and professional responsibility. The logic put forth by Dodd-Frank assumes that a uniform fiduciary standard will accommodate most existing business models and fee structures.

The proposed universal fiduciary requirement has generated much controversy, especially among those who subscribe to Wall Street's take-the-money-and-run ethic -- a position which has driven millions of retail investors out of the market. The 2008 financial meltdown revealed cowboy economics at its worst, and caused the most spectacular collapse of the economy since the Great Depression.

In my own financial dealings, I have learned the hard way to rely on myself, to be my own analyst. With microscopic intensity I find it prudent to thoroughly vet even the recommendations made by brokers I trust. This is an unavoidable chore, but it is one I whole heartedly recommend to any investor, at any level of sophistication. If we learned nothing else after 2008, it is that when Wall Street gurus say "trust me," it holds no more weight than a pick up line in a singles bar.

An industry-wide fiduciary standard, with brokers being held accountable legally and ethically to their clients, is a good first step in rebuilding shattered investor confidence. It isn't the perfect solution. In a world of greed and cunning, nothing is perfect and never will be.

Bottom line: you, the investor, must do your own homework and stay on top of your broker -- and that includes those unseen "experts" managing your 401(K) retirement accounts. Never forget it's your money the broker takes to the casino. You had better be looking over his or her shoulder when the cards are dealt.

Full disclosure: On one occasion I failed to fact-check a broker; as a result, I found myself embroiled in the $330 billion auction-rate securities scandal. I wrote a book about that mistake. Thankfully there was a happy ending. I did get my money back. But it did reinforce the bitter truth of how one instant of innocent trust on Wall Street can turn your life upside-down.

Please check out on my book on the subject at my website: www.beruthless.net. It's so much about money as it is about the human toll of broken and misplaced trust, and what can happen if you let your guard down.