A Sept. 18 Business article about how to choose a financial adviser quoted Jeffrey R. Sonn, a securities lawyer in Fort Lauderdale, Fla., as saying, "After he makes the sale, he has no legal duty to call you." The article should have noted that Sonn was expressing the securities industry's position, not his own. (Published 9/29/2005)
Gotten a good tip on a financial adviser lately?
Consumers who decide they need help in choosing investments may find that choosing an adviser is the first step -- and that winding up with the wrong adviser is a costly misstep.
A few years ago, Michael Kostoff, a retired teacher in St. Augustine, Fla., turned for advice on how to invest her retirement nest egg to Vincent Cervone, a financial adviser recommended by Kostoff's brother-in-law, a doctor.
But instead of safer and more-suitable bonds and large-company stocks, Cervone put the bulk of her $114,000 into highly speculative micro-cap stocks, including NeoMagic Corp. and Cypress Bioscience Inc., according to allegations recounted in an arbitrator's award in June against a firm that helped handle the transactions.
Net loss: her entire investment.
Her brokerage, meanwhile, pocketed $19,000 in trading commissions on the account, according to Kostoff's lawyer, Theodore M. Davis of Brooklyn.
"The motive for making the trades was to generate commissions that were in the brokerage's interest but not my client's interest," Davis alleged.
With more baby boomers worrying about their finances and finding an exploding number of confusing financial products on the market -- variable annuities, wrap accounts, private real estate investment trusts, unit trusts -- the financial-advice business is booming. NASD, the private-sector regulator of the securities industry, says its more than 660,000 registered representatives, also known as stockbrokers, were licensed last year, up more than 58 percent from 1990. Also up: scams. NASD filed 1,396 disciplinary actions last year, up 53 percent from 1992, the earliest figures available.
Mary L. Schapiro, NASD's vice chairwoman, says the need for investors to check out who's giving them financial advice is more acute than ever. "There are firms out there you definitely do not want to do business with," she says.
As it happens, Kostoff was fortunate. Though Cervone has left the industry and his main former employer, Glenn Michael Financial Inc. of Melville, N.Y., had closed its doors, an NASD arbitration panel ruled against the firm that did back-office work for the brokerage. In a rare decision against a so-called clearing firm, the panel ordered Fleet Securities Inc., now part of Automatic Data Processing Inc. of Roseland, N.J., to pay $460,000, including $343,000 in punitive damages, finding that the firm should have known about the "fleecing" of the Kostoff account. A spokeswoman for ADP declined to comment.
Timothy Feil, a lawyer for Cervone, said his client settled a related arbitration case "for a nominal amount" without admitting wrongdoing, and wasn't a party to the arbitration case, which involved a separate firm. Therefore, Feil said, Cervone did not have a chance to present his side of the story.
"We adamantly deny any inference of wrongdoing that may have been made in the award," Feil said.
Most victimized investors aren't as lucky as Kostoff, but investors can protect themselves by doing their homework before they entrust others with their financial futures.
Regulators, financial planning experts and consumer advocates say the first step is to understand who is in the market and who regulates them. If you are confused, you are not alone. NASD lists dozens of professional designations for investment advisers, from AAMS (Accredited Asset Management Specialist) to WMS (Wealth Management Specialist). There are Qualified Financial Planners, Personal Financial Specialists, Chartered Retirement Planning Counselors, Certified Retirement Financial Advisers and many more.
Some consumer advocates recommend simply skipping the alphabet soup and turning to one of the low-cost industry giants, Vanguard Group, which provides retirement planning advice on its Web site and low-cost advice for a fee, or Fidelity Investments, which offers a conflict-free sales staff, though its funds charge somewhat higher expense fees than Vanguard's.
But for those who insist on paying upfront fees, sometimes substantial, for financial advice, at least 800,000 people registered with the federal and state governments as some type of financial adviser are waiting for your call -- as are agents who sell insurance-related financial products, lawyers, accountants and an uncounted number of legal-but-unlicensed financial advisers.
The umbrella terms "financial planner" and "financial adviser" have no legal meaning and are roughly synonymous. In looking for one, whatever the name, experts advise finding someone registered with the government or NASD.
Almost every financial adviser falls into one of two main categories: brokers, who are regulated by NASD; and registered investment advisers, overseen by the Securities and Exchange Commission or state securities departments.
The nation's 660,000 brokers, also known as registered representatives, buy and sell securities, usually in return for a commission. And while they may -- and often do -- offer financial advice, it must be "incidental" to their main job of executing the transaction, Schapiro says.
On the spectrum of advisers, brokers are the least accountable to investors, said Jill Gross, an associate law professor and a co-director of the Securities Arbitration Clinic at Pace Law School in White Plains, N.Y., who noted that brokers are required only to have "reasonable grounds" for believing that the recommendation is "suitable" for the customer based on income tax status and other criteria, according to NASD rules.
But suitability is a "touchy-feely" concept, says Andrew Stoltmann, a Chicago securities lawyer, and only claims of extreme wrongdoing have a chance at full recovery.
For instance, in 1999, Steven Carico, a longtime manager of a dry-cleaning operation in Williamsburg, Ohio, received a $400,000 lump sum from his employer when the owner sold the business and retired. He turned for advice to William G. Nelson, a broker with Stifel, Nicolaus & Co., a St. Louis-based brokerage, who in less than a month put $317,000 in one stock, a "micro-capitalized, remote and localized" bank, Southwest Bancorp Inc., based in Stillwater, Okla., according to a 2002 arbitrator's ruling. The results were predictable.
Three years ago, Carico was awarded his entire loss plus legal fees, about $151,000, on a claim that the investment was unsuitable for his age, income and risk profile. A spokesman for Stifel, Nicolaus declined to comment; efforts to reach Nelson were unsuccessful.
That said, Stoltmann says he turns down four of five cases brought to him, many of them valid but tougher to win.
To check whether a broker has gotten into trouble with regulators or customers, investors should go to www.nasd.com and click on the BrokerCheck tab. Investors need to know either the broker's Central Registration Depository, or CRD, number or the name of the broker's employer. To find out, ask the broker.
All brokers are supervised by one of about 5,200 broker-dealers. Some -- Merrill Lynch & Co. and American Express Co., for instance -- are famous. Others aren't. Both types can run into trouble. Last month, a Michigan-based firm, Hantz Financial Services Inc., agreed to fines of $675,000 to settle allegations of fraud and misrepresentations, after NASD said the firm characterized itself as "independent" and offering a range of products from a variety of mutual fund companies. Instead, NASD alleged, the firm steered customers to "preferred suppliers" in exchange for millions of dollars in fees that weren't disclosed.
According to NASD, Hantz brokers followed a script with potential clients.
"I am an independent financial consultant. Do you know what that means?" the script said. "To be an independent financial consultant means a lot more freedom and flexibility to offer a number of different products and services without being captive to one or a few product companies."
Bradley Schram, a Bloomfield Hills, Mich., lawyer for Hantz, which agreed to the penalty without admitting or denying wrongdoing, noted that the settlement contains no specific finding that the firm intentionally engaged in inappropriate conduct, only that its actions "may have had the effect of causing customers to be misled. . . . It's a nuance that's sometimes lost," he said.
But brand names certainly don't offer a guarantee of avoiding problems, either. Last month NASD regulators found that Morgan Stanley & Co. kept "buy and hold" customers with less than $50,000 in expensive and "inappropriate" accounts that automatically deducted thousands of dollars in fees. The New York firm agreed to pay $1.5 million in fines and $4.6 million in restitution without admitting or denying wrongdoing.
A Morgan Stanley spokesman said the company was happy to have the matter settled. He said the accounts remain "a good vehicle for many investors; it's a question of making sure they're used properly."
Many neophyte investors turn to an investment adviser, defined by the SEC as anyone paid to provide advice about specific securities.
Unlike brokers, investment advisers are fiduciaries, who must exercise a standard of care imposed by law and, in effect, put clients' interests before their own. Brokers, for instance, are not usually required to call when, say, a portfolio suffers big losses. Investment advisers are.
"The broker talks to you in good times," says Jeffrey R. Sonn, a securities lawyer in Fort Lauderdale, Fla., who handles many elderly clients' cases against brokerages. "After he makes the sale, he has no legal duty to call you."
Of course, the higher legal standard helps only when a client is suing and hopes to recover investment losses, an outcome most would like to avoid. A rule of thumb, however, is that investors needing more advice and a full financial plan that looks at their real estate, income, debt, retirement goals and major expenses should find an investment adviser.
Picking one is daunting. There are more than 11,000 registered advisory firms and 173,000 registered advisers. Most people calling themselves financial planners are actually registered investment advisers and licensed by a government: Firms and individuals managing $25 million or more are registered with the SEC, smaller ones with the states.
To check the background of a larger firm, go to www.sec.gov and click on "Check Out Brokers & Advisers" under Investor Information to be directed to a firm's "Form ADV." The two-part form contains information about whether the firm has had trouble with regulators or clients, among other things. That form is available now only for advisory firms. To get individuals' forms, investors must ask the investment adviser.
To check smaller firms, investors should go to the Web site of the North American Securities Administrators Association, at www.nasaa.org, to find their state's securities regulator.
On all background checks, be sure to look for a broker or adviser's employment history. Several job changes in a short time is not a good sign.
Many regulators say a good place to begin is to ask a relative for a recommendation or attend one of the free seminars offered at many community colleges.
An unavoidable part of the process is a face-to-face interview in which investors ask questions that make some people uncomfortable. The big one: How do you get paid?
"As a culture, we don't often talk about how people are paid," says Susan Wyderko, director of the SEC's office of investor education. "You have to."
The reason is that many, if not most, financial advisers are paid commissions by mutual fund and financial services companies. Often, investors aren't told of cheaper, sometimes better, alternatives. To find a planner who is paid only by a flat fee and can offer conflict-free advice, go to the Web site of the National Association of Personal Financial Advisors, www.napfa.org.
For extra comfort, some investors look for advisers accredited by one of a number of companies that test planners and make them follow stricter ethical rules. A major group is the Certified Financial Planning Board of Standards Inc., a Denver-based company that has issued a CFP designation to 48,000 planners.
Of course, investors face risks even if they think they're being careful.
When she was thinking of retiring a few years ago, Donna Widmer, a 59-year-old computer programmer for Hallmark Cards Inc., handed her retirement savings of $400,000 to Randall Hallier, a financial adviser she had heard give an investment seminar at the local library in Roeland Park, Kan.
Hallier is the owner of Retirement Plus Inc., of Overland Park, Kan., a registered investment advisory firm that has had no problems with regulators, according to its Form ADV.
According to a complaint filed in federal court in Kansas City, Hallier put the money in an expensive annuity that Widmer didn't need: Its main feature was a death benefit, and Widmer has no beneficiaries. The complaint also alleged the annuity was made up of "aggressive" mutual funds concentrated in telecom and tech sectors, despite the fact that Widmer was an unsophisticated investor seeking "a conservative return in order to meet her living needs."
The suit alleged damages of $150,000.
Hallier's attorney, Michael E. Waldeck, argued that the investments were suitable.
After deliberating about eight hours, a jury came back with a verdict: Widmer lost.
Waldeck said many lawsuits are brought by disappointed investors who simply don't "fully understand the risks of the marketplace."
Jeffrey S. Kruske, a lawyer for Widmer, said the verdict was "shocking to us." He added: "They didn't recommend any alternatives, just annuities. There's no reason why she needed all that stuff."
He said they had not decided on an appeal.