Thursday, August 30, 2018

Fiduciary Standards and Investment Advice

The New York Times recently published a compelling article about a dispute a woman had with J.P. Morgan Securities after she discovered odd activity in her mother's account.  The account, which was to help provide for her mother through retirement, had losses at times when the market otherwise rallied:

Around the time of her mother’s move, Ms. Dewart noticed what looked like unusual activity in the account, which she and her older sister had overseen for about four years. A closer look revealed that it was down $100,000 in a month.

“My own accounts were rallying, so I thought this was strange,” she said.

She notified the firm that something seemed awry. As someone who does research and policy analysis for a living, she also put her own skills to work.

She pored over piles of statements and trade confirmations, built spreadsheets and traded phone calls and emails with the broker who handled the account, Trevor Rahn, his manager and the manager’s manager. She hired a lawyer and worked with a forensic consultant.

After about six months, she learned that the account, worth roughly $1.3 million at the start of 2017, had been charged $128,000 in commissions that year — nearly 10 percent of its value, and about 10 times what many financial planners would charge to manage accounts that size.

Much financial misconduct may go undetected when sophisticated Wall Street firms manage money for ordinary people.  Here, Ms. Dewart appears unusually sophisticated and determined.  It still took her about six months to figure out exactly how much money had gone out the account in commissions in a single year.  For the average, financially-illiterate American, odds of truly understanding account activity may be even lower.

Law must play a role here.  Legal standards should provide adequate assurances to make sure that financial advisers remain faithful to their clients and do not opportunistically mismanage their accounts.  This has been a hot issue for some time. The Department of Labor's fiduciary rule attempted to do this for retirement money. The SEC is now considering how to craft an appropriate "Best Interests" regulation to better govern broker behavior.  As it works to craft the right regulation, it should keep in mind how much misconduct may go undetected because people don't know much about the area and often struggle to connect the dots.

Speaking of connecting the dots, there are a few dots relevant to the New York Times Story that didn't make it into the article.  Publicly available sources provide additional context if you know where to look.  Let's start with the settlement amount.  The article reports that J.P. Morgan eventually credited some of the commissions back and later settled as sum Ms. Dewart is "prohibited from discussing" because of the confidentiality agreement. The existence of the confidentiality agreement does not mean that amount is not actually public information.  According to the BrokerCheck report for Mr. Rahn, J.P. Morgan paid a settlment of $64,590 in connection with a complaint that came in on November 13, 2017.  In the Times article, J.P. Morgan cagily stated that Ms. Dewart "agreed to an appropriate resolution of this matter in June."  The BrokerCheck form reveals that matter's status was "settled" with a status date of June 13, 2018.  This probably means that after all that, Ms. Dewart recovered $64,590.  

But there is no reason to wonder whether that settlement involved Ms. Dewart.  The information, although not on BrokerCheck, is already public record.  Florida has excellent sunshine laws and will produce reports from the CRD Database on request--and quickly too.  It took me less than 24 hours to pull the report.  It confirms that the settlement involved Ms. Dewart.

Is this settlement amount fair and reasonable given the allegations and what happened?  This is probably unknowable.  All the documents are not publicly available.  But there is good reason to believe that Ms. Dewart didn't manage to recover the opportunity costs for the period of time the account was allegedly mismanaged.  In many instances, these cases settle on a net-out-of-pocket basis.  That means that the investor may be able to get back some of what they "lost" relative to their initial investment.  For example, if you invest $100 and end up with $70 after a year, then the out-of-pocket loss may be $30.  But if the market went up 20% during the same time period, the actual losses (taking into account the lost opportunity to get market gains) are probably closer to $50.  In practice, this means that a bull market allows a stunning amount of exploitation.  Many customers will never alert to opportunity cost losses if their accounts are going up.

There is another dot worth connecting here.  Mr. Rahn has another disclosure on his BrokerCheck report.  It reveals that another firm has an outstanding judgment/lien against Mr. Rhan for $763,424.76.  If the lien hasn't been paid, Mr. Rahn owes Deutsche Bank Securities about three quarters of a million dollars.  The Lein appears to be based on an arbitration award against Mr. Rhan from a claim that was filed in 2011.  That award can be found by searching for Mr. Rahn in the FINRA Awards Database.  Apparently, Deutsche Bank sued Mr. Rahn for not paying a promissory note.  The award is notably because Mr. Rahn was also assessed $205,654.59 to cover Deutsche Bank's attorney's fees.  The CRD report reveals that he received a withholding notice on August 9, 2014.  This means that Mr. Rahn probably loses a portion of his pay each pay period to pay off the outstanding lien.  Although there is always an incentive for commission-compensated brokers like Mr. Rahn to do more transactions than necessary to make more money, investors may want to be careful about working with brokers that have financial problems or substantial outstanding debts.

 

 

http://lawprofessors.typepad.com/business_law/2018/08/fiduciary-standards-and-investment-advice.html

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