The recent story about the Port Washington stockbroker banned from the industry for stock churning reminded me how important it is for investors to protect themselves.
Every time I hear about someone in the investment industry violating trust, I read about the details of the fraud, and can only say these tragedies are preventable. Worse, the wronged investors are almost never made whole.
First, I would avoid commission-based compensation. Not because all commissioned brokers are intrinsically evil, but the model itself forces investment decisions that would not ordinarily be made.
I know this because I used to be commission-based myself, and I am now fee-based.
The other reason is that these firms live on three priorities: production, production and more production. So if you want to be the top dog in your firm and have your name put up on the leader board with your commission tally (yes, they have them) start trading. A lot.
But even an honest broker can be misled with honest intentions. To give a personal example, I had placed a client in shares of Amazon after the 2008 crash. The stock doubled.
I called the client advising them to lock in a profit (which seemed prudent in the aftershock of the financial crisis) and sell the shares. And so we did. To this day, I cannot tell you honestly if I was motivated by the stock price advance and selling out of prudence or taking what I told myself was a well-earned commission for doubling the client’s money.
What I do know now is that holding on to Amazon afterward would have made the client far richer. But the seed was already planted: sell now, and you have nothing to apologize for. If there was an incentive for holding it, things might have turned out differently.
One of the things I dedicated myself to when I entered the profession was to learn as much about the role of incentives in economics and tax policy. And I can tell you even the most well-meaning, altruistic people in the world can be affected. Like it or not, incentives determine outcomes as much as investor psychology.
Other ways to protect yourself include avoiding investments that are not publicly traded. Private placements have a notorious record for many reasons, one being underperformance, second, the lack of liquidity if you need to sell, and last, valuations for these fee-laden vehicles are often opaque. The selling broker often receives a 7% commission with the sale.
That’s 7% you must overcome in performance before the money is even invested, and the syndicators reward themselves even more. Do yourself a favor and buy wholesale. It says it right there in the Mishneh.
A case from Syosset took place some years ago about a broker who stole $5 million from his clients, using the money to fund a lavish lifestyle.
The investors will never see that money again. Remarkably, the investment vehicle being promoted wasn’t the stuff of instant riches. All the broker promised clients was a 4.00% per annum return for two years, after which, they got their money back, which is not only a modest proposition, it could have easily been matched or exceeded with conventional investments like GinnieMaes.
The last thing to know is that the enforcement agencies are slow to respond and the fines they levy are seen as merely a nuisance by the offending broker/dealer. I cannot tell you how many times I’ve seen the Financial Industry Regulatory Authority (FINRA) boast openly about banning a broker from the industry, only to check his record on-line and find a career spanning decades, filled with dozens of fines, forced arbitration proceedings that take years to adjudicate, and multiple warnings.
Take into account that most investors don’t file formal complaints to the regulator. The trail of ruin these bad actors leave have cost investors billions, but FINRA is more corrupt than the industry it regulates, and its executives are slathered with exorbitant salaries and benefits.
FINRA should be disbanded and the SEC should take over all market enforcement operations. They have utterly failed to protect retail investors, and so, you’re on your own.
Your best bet to finding someone worthy of stewardship of your hard-earned funds is by referral.