THE BLOG
07/24/2013 11:35 am ET

The Intelligent Investor Series 2: Airing Wall Street's Dirty Laundry, Investors Deserve Better

Labaton Sucharow recently issued its second annual report about the financial services industry, "Wall Street in Crisis: A Perfect Storm Looming." Their findings, while not surprising, are disturbing nonetheless. Here is what they highlighted:

  • 52 percent of respondents felt their competitors engaged in unethical or illegal activity to gain an edge in the market;
  • 24 percent felt employees at their own company are likely have engaged in misconduct to get ahead;
  • 29 percent believed that financial services professionals may need to engage in unethical or illegal activity in order to be successful; and, 23 percent of respondents indicated that they had observed or had firsthand knowledge of wrongdoing in the workplace;
  • 26 percent believed the compensation plans or bonus structures in place at their companies incentivize employees to compromise ethical standards or violate the law;
  • 24 percent would likely engage in insider trading to make10 million if they could get away with it;
  • 28 percent felt the financial services industry does not put the interests of clients first.

Where are people incentivized to change the status quo? The relatively new office of the SEC Whistleblower is a healthy start. If fraud is suspected, there is a reward to report it. Yet, the survey also found 17 percent who felt their leaders were likely to look the other way if they suspected a top performer engaged in insider trading. And, 15 percent doubted that leadership, upon learning of a top performer's crime, would report it.

These findings don't do much to boost investor confidence given the participants in this recent Labaton Sucharow sampling were 250 respondents from the financial services industry employed as traders, portfolio managers, investment bankers, hedge fund professionals, financial analysts, investment advisers, asset managers and stock brokers.

We agree with what David Loeper recently wrote:

"The problem is that consumers cannot tell the difference between a true fiduciary working solely for the client's best interest and a conflicted one that serves two masters-the client and the product vendors that pay them... If Congress really wants to protect consumers, the only course of action would be to eliminate dual registration completely. There are too many stakeholders with strong lobbying groups to make such a system a reality, so once again the obligation to act ethically falls in no one's lap but your own... "

Investors should not be sold a bill of goods. If a financial professional is simultaneously able to be both a fiduciary and a salesman, there is no true fiduciary responsibility.

After massive government bailouts, scandals, and no existing uniform code of ethics, it remains unclear how consistent consumer protections could be enacted and enforced, however, their absence comes at a severe price -- and it's investors who ultimately pay.

Here are three questions investors can ask a financial adviser to determine if s/he is working for them, or, on them:

Will you sign a fiduciary oath?
This one is from the National Association of Personal Financial Advisors (NAPFA). While many investors have never seen this, (never mind brought one into every meeting with every financial professional hired) it's an integral step on paving an ethical road with financial relationships. As Mr. Loeper wrote, at present under the law, this responsibility ultimately sits in the hands of investors. (We've always thought fiduciary responsibility is not something which should exist only "in the eye of the beholder" -- rather, it is meant to underscore an ethical, good-faith relationship between the investor and the financial adviser.)

How do you earn money? If the response involves the word "commission" or "load" or "incentive", there's likely to be a financial motivation to sell financial products. Salespeople who are paid in this manner may or may not hold dual registration, so, it's important to determine not only who or what pays them, but how they're paid. Fee-only advisers should work on their advisory fee and not be accepting any other monies from your portfolio's activity. Ask if you can have a comprehensive breakdown of all fees -- and make sure none are hidden in products.

Who/what pays you? While this may seem similar to the advice above, determining if a financial professional is working independently, or, is affiliated with a particular financial institution or product group can be enlightening.

If you have questions you would like answered, or, if you're not sure what to ask your financial team, let us know.

The information contained in this blog is provided solely for convenience purposes only and all users thereof should be guided accordingly. The Abernathy Group II does not hold itself out as a legal or tax adviser. If you wish to receive a legal opinion or tax advice on the matter(s) in this report please contact our offices and we will refer you to an appropriate legal practitioner.