Why Only 1 in 4 Investors Trusts Their Financial Advisor

It was only a question of time.

The sharp decline in the markets has increased the number of formal arbitration complaints filed by investors against their financial advisers, notes an article in the Washington Post .

The latest numbers show that investor arbitration complaints against their financial reps "soared 86 percent in the first three months of this year after climbing nearly 54 percent in 2008. New cases during the period totaled 1,715. Adding in April's figures, FINRA (the industry regulatory agency) projects that filings are on track to hit 7,000 this year, up from 4,982 in 2008." according to the article.

The main reason for the increase: "breach of fiduciary duty, which requires a representative to act in the best interests of a client, with 946 cases filed through March. That's followed by 758 cases of alleged misrepresentation and 631 cases claiming negligence."

This blog has numerous articles on the lack of fiduciary standards, especially in the mutual fund industry.

The basic reason for this is that load fund companies sell mutual funds. Selling is the focus, which then makes salesmen the focus. The focus of salesmen is their commission, or better yet, trail of commissions. Commissions are easier to earn when they are not disclosed to investors, which gets us into the hot areas of transparency and the almost unknown world (to shareholders, anyway) of 12b-1 and secret revenue sharing deals fees.

Weak Fiduciary Rules In the Mutual Fund Industry
Fiduciary ruler are very weak in the mutual fund industry. By contrast, the definition and enforcement of a financial rep's fiduciary role is very clear and more strictly enforced under ERISA and in the pension fund world. Those same ERISA rules and strict penalties have no rule of force in the mutual fund world.

That explains why the number of arbitration cases is up sharply. It's also important to remember that for every case filed, there are easily 10 more people who have been ripped off who don't want the hassle of gong to arbitration or just do not even know they were ripped off.

The Failure of Active Management
If mutual fund investors were more aware, they would understand that many of them were paying for active management. If they would have received the benefits of active management from a full-time portfolio manager and their staff, why should their fund be down the same as an index fund?

What's the point of being active if the manager cannot act defensively, or as the performance numbers show, they did not act at all?

I spent the last seven years at two mutual fund companies and in recent memory we had a Treasury Inflation Protection (TIPs) Fund which did not even own any TIPS. Instead, the portfolio manager put the money into derivatives which were supposed to get a higher return. They did not. The shareholders got deceived (they bought a fund which did not own what it was supposed to own), plus they got a lower return. Even worse, the vast majority of these fund shareholders never even knew about the problem since the fund company never told them.

So it's no wonder the number of arbitration complaints are up. If more shareholders knew about the failures of active management, the number would be significantly higher.

The Financial Planner Problem
This article also notes the looming problem with financial planners who still seem to be coming to grips with the investing world in 2009.

The problem is that the financial planner industry is fragmented and has varied membership standards and no enforcement abilities. This means that individual investors who need advice the most due to the poor investment environment have to triple-check the qualifications of any potential adviser before they use them. All this only adds to the anxiety of being an investor or mutual fund shareholder in 2009.

While many independent financial planners are former wire house brokers, many have no mentoring or real Wall Street experience which would make them hardened, critical and objective investment professionals. As a result, too many independent financial planners can get cowed by mutual fund wholesalers and other salesmen who sell exotic derivatives or other expensive, fee-laden non-traditional funds.

While the independent financial planners wrestle with the problem of who should earn the title of "financial planner," investors should take the initiative. They should grill potential advisers to see if they would accept under-the-table commissions or what specific experience they have, and what research is at their immediate disposal. Then, remember that all fees are negotiable.

The New Rules of Investing in 2009
From the shareholder's perspective, remember the new rules of investing in 2009: One strike and you're out.

If you think your financial rep acted against your interest in any way, find a new rep.

It will take years, maybe up to a decade, for the average investor to recoup their housing and portfolio losses. Keep your life simple. If your rep is not on you side, get a new one.



Food For Thought
Only 22% of American consumers trust investment advisers to protect their assets.
--Boston Consulting Group, March 2009