The Real Cost(s) of Suitability

Is it possible to accurately measure the impact on clients’ financial lives when they receive ‘suitable’ vs. ‘fiduciary’ recommendations?

Diahann Lassus, of Lassus Wherley (offices in New Providence, NJ and Bonita Springs, FL) recalls a client case where her expertise was challenged, not by the client circumstances, but by the mismanagement of her client’s previous advisor.  “He was over 80 years old, and he had specifically said, what I want to do is grow these assets for my kids as an inheritance,” says Lassus.  “We looked at his portfolio, and he had about $1.7 million in assets,” she says.  “Her former advisor, who was affiliated with LPL Financial Services, had invested his retirement money in four annuities and three non-traded REITs.”

One of the annuities was charging 3% a year for various loads and expenses, and during the raging bull market since 2009 had been growing at a rather pedestrian rate of 1.5% a year after expenses.

The REITs, meanwhile, were under water.  In one of them, the client had paid $10 a share, but the shares were worth an estimated $6 a share when Lassus came on the scene.  “I say ‘estimated’ because there is actually no market for them,” she explains.  “They sell these non-traded REITs as high-yielding investments, but they don’t explain that the yield they are getting out of it is their own money coming back to them.  They don’t understand that and nobody is telling them.”

What to do?  The non-traded REITs had a buy-back provision, where small increments could be sold back to the general partner at a steep discount, locking in worse losses than had already occurred.  Lassus is in that process now, hoping to unload the last shares before the children have to inherit them.

Getting a real market return on the annuity money was the next objective, but there were obstacles.  “All four of the annuities had a five-year surrender period that started at 9%,” says Lassus—implying a 9% commission that the annuity company has to recover before it will allow the client to liquidate or transfer to a lower-cost no-load annuity.  “For three of them, we had to wait until the surrender charges had gone away.  The smallest of the annuities, about $150,000 in value, we were able to surrender, take the tax hit and put it in a taxable account so he at least had access to some of his funds.”

Lassus was eventually able to execute a 1035 exchange of the other contracts into Vanguard annuities, where the total fees will be closer to 0.45% a year.  But even this creates a problem.

“Remember that his goal was to grow the assets to pass on to his heirs,” says Lassus.  “Because all that money is tied up in the annuities, they’re not even going to get the step-up in basis on the assets.”

Her bottom line: “When you see this kind of stuff come in the door, you think: the rep obviously paid no attention to what the client wanted, had zero concern for the individual, and just focused on the commissions.  There is no other explanation for these recommendations.  It’s like everything the client wanted to have happen is not going to happen.  It’s beyond frustrating.”

Real-world data

At industry conferences, in the press, in regulatory discussions and in dialogue around the DOL Rule, we hear the same debate.  Over and over again, the differences between a ‘suitability’ standard held by brokerage firms, reps and sales agents, and a ‘fiduciary’ standard are described as: ‘suitability’ means the advice can be conflicted, while ‘fiduciary’ means it will be impartial. 

Or sometimes: ‘suitability’ means the representative can make a big commission, while ‘fiduciary’ guarantees that the advice will be in the consumer’s best interest.

But so far I haven’t seen anybody define this distinction in terms of actual advice, in actual client circumstances.  In the absence of this data, it’s fair to ask: So what if a client paid commissions for an annuity instead of a recommendation to invest in ETFs, so long as the commissions were fully disclosed in the sales materials? 

So what if the broker recommended in-house managed accounts that are investing in many of the same stocks that a low-cost index fund would be buying? 

Is there any evidence that there is actual harm happening in the real world when we hold brokers and sales reps to a suitability standard—even though their advertising and marketing clearly implies that they provide objective advice tailored to their customers under a fiduciary standard?

To see if I could obtain better data on this increasingly hoary debate, and perhaps inject more perspective as well, I turned to the readers of the Inside Information newsletter—most of whom pledge to act as fiduciaries even where it is not strictly required under our current regulatory system.  Many of them have told me, anecdotally at industry conferences, that the brokerage firms and broker-dealer reps in their markets imply that they’re trusted advisors, holding themselves out as advisors, financial planners, and investment consultants, even as they sell high-commission solutions that damage the financial lives of their customers. 

Interestingly, a high number of clients of fiduciary financial planning firms have worked with a broker at some point in the past.  This may be because brokerage firms have substantially larger marketing budgets than fiduciary advisors.  (Have you ever seen a financial planning firm’s 60-second national television advertisement?)

I asked this collection of fiduciaries whether they had occasion to see, up close and personal, the difference between advice provided under a ‘suitability’ standard and a ‘fiduciary’ standard, and to help quantify what the difference can be, in actual dollars where possible, in client financial circumstances.

Many had.  “I consistently see clients whose portfolios were set up by someone who was not following a fiduciary standard,” says William Carrington, of Carrington Financial Planning in Washington, D.C.  “Portfolios that are constructed from no load, low-expense-ratio funds and ETFs are so rare that they stand out—that’s how unusual it is.”

Kathleen Campbell, of Campbell Financial Partners in Fort Myers, FL estimates that about 98% of her clients have previously worked with a ‘suitability standard’ broker.  “Suitable means plenty suitable for the broker and not so suitable for the client,” she adds, saying that ‘suitable’ is, in her opinion, one of the biggest farces in the financial advisory world. 

Steve Thorpe, of Pragmatic Portfolios in Durham, NC, estimates that somewhere between 50% and 60% of his clients have received self-serving brokerage firm advice before they walk into his office.

Lassus says that her firm runs into many situations where clients were sold non-traded REITs, annuities with long surrender periods and separately-managed accounts laden with undisclosed fees.  “Brokers still do a lot of wrap-fee accounts,” she says, “and so you’re trying to evaluate three different accounts, and you discover that there are sub-accounts with their own fees, and assets inside those which might be separately-managed accounts, and as we’re trying to unravel what the client is paying, the brokerage firm won’t help us move it.  Your only option is to liquidate all the accounts, even though the tax issues can be brutal.”

Fixing the Damage

Many fiduciary advisors found that they had to fix ‘suitable’ portfolios that brokers had recommended to clients.  Carrington cites one example among many, clients whose Merrill Lynch broker had sold him a mutual fund with a 5.75% sales charge and an expense ratio of 2.35%.  “They wanted to know why they weren’t making money,” says Carrington.  “When the clients informed the broker that they were leaving, the broker traded the entire account into about 30 different funds in order to generate dozens of transaction fees.

“Much of the abuse I see is undisclosed—not hidden, just not mentioned—fees from load funds,” Carrington adds.  But he also says that there is a hidden cost (seldom factored into the ‘suitable’ vs. ‘fiduciary’ calculus) that can be measured by services not rendered, where a broker will collect as much or more in commissions as an advisor would in fees, but not receive any ongoing service for the money paid. 

“A lot of time, the performance statements have the name of an advisor the client met with once, and has not heard from since,” Carrington explains.  “Brokers collect the Class A load, then move on to the next client as quickly as possible.  By the time they come to me, the clients suspect something is not right.  And it’s only after I explain the system that they realize they’ve been had.”

Brooke Salvini, of Salvini Financial Planning in Avila Beach, CA, shared a statement from a broker-managed portfolio that was almost completely invested in short-term or Treasury bond funds, with some gold and money market funds mixed in.  Average expense ratio: 1.31% a year—compared with 0.05% for comparable Vanguard funds.  The load funds were paying 12(b)-1 fees.

The fees weren’t Salvini’s biggest problem with the recommendations.  “Over the past year, those funds had returned -6.08% vs. 3.64% for a very conservative 20/80 index portfolio,” she says.  Her message to the client: “Even if you’re in complete agreement with your advisor that a financial crash is imminent, he could be preparing you for that event in a way that is significantly less costly for you and gives you the potential for returns should the predictions not come to fruition in the near or distant future.  He is making a strong bet on one scenario and executing it in a very expensive manner.”  Her report was accompanied by Morningstar pages on the various expensive ‘suitable’ funds in the portfolio, and alternatives that a fiduciary would recommend.

Gary Vawter, of Vawter Financial in Columbus, OH, tells of a widowed client whose husband died in 2009, leaving her with the proceeds of a $1 million life insurance policy.  By the time Vawter came on the scene, her Merrill Lynch broker had traded the account to the point where it had lost 40% of its value during a period when the market was up over 100%.  “We never did determine exactly what was going on, although her last Schedule D showed in excess of 200 sell transactions in one year,” says Vawter.  “The account looked churned and burned.”

The solution?  “There was a $300,000 loss carryforward, which allowed us to make some adjustments without tax consequences,” says Vawter.  “She was very fortunate to be the beneficiary of her husband’s pension plan; that and Social Security will pay most of her financial needs.  She recently moved to a retirement community, so there will be a bigger draw on the portfolio going forward,” Vawter adds.  “It’s bittersweet for her to tell me, when she comes in for our appointments, ‘I wish we could have met you sooner.’

In another example of the damage that can be caused by ‘suitable’ advice, Vawter worked with a 55-year-old single school teacher, with no kids, whose prior ‘financial planner’ had advised her to take a 72(t) withdrawal plan from her IRA, which would be used to pay $50,000 annual premiums on a cash value life insurance policy.  “Due to her substandard health, the underwriting probably increased the premiums by 100%,” says Vawter.  “And she didn’t need a death benefit in the first place.”

By the time Vawter came into the picture, this person had paid $150,000 in premiums, and the cash surrender value was $75,000.  The policy carried a 20-year surrender period.  She eventually cashed out and received $25,000, and of course she had to continue taking the 72(t) withdrawals, losing the benefit of long-term tax deferral to take income which she didn’t need. 

The financial impact of this ‘suitable’ advice?  “This,” says Vawter, “was a conservative investor who lost 85% of her principal in three years of a bull market.”

Collateral damage

The biggest misnomer in the ‘suitability’ vs. ‘fiduciary’ debate is that the only real difference is the amount of commissions pocketed in a ‘suitable’ recommendation.  The stories I received from fiduciary advisors makes it clear that the damage people suffered when they thought they were receiving impartial advice from a broker or agent often went far beyond the amount of the commissions. 

“We received an introduction to the 82-year-old father of one of our clients, who is worth an estimated $10 million today,” says Bret Kaye, of AEPG Wealth Strategies in Warren, NJ.  “In doing our initial due diligence, we found out that he had been sold a $12 million (face amount) variable universal life insurance policy back in 2004, when he was 70, and his wife was 69.” 

That’s pretty awful, right?  It gets worse.  In 2008, the registered representative who sold him the original policy, an IAR with LPL Financial Services, came back and recommended that he exchange that policy for a variable universal life product with John Hancock that would cost a similar premium.  Ka-ching!  New commissions!  “Part of the recommendation led him to make a $900,000 additional contribution to the cash value of the new policy,” Kaye adds.

The biggest problem with the recommendation didn’t become evident until later.  The new policy was constructed with a $4.9 million base VUL policy with a rider for $7.5 million in annual renewable term insurance, where the rider’s premium would be guaranteed for ten years.  After that, the client would be 84 years old, and the term policy would reset to a much, much higher premium.

“The reason the client came to see us,” says Kaye, “is that the ‘advisor’ had come back to him and said, oh, by the way, your term premiums are about to increase considerably cost-wise, so we’re going to have to get rid of the $7.5 million term rider, your contract is only going to be worth $4.9 million, and we’re going to have to increase your annual premiums from $40,000 to $250,000.

The client eventually decided to cash out of the policy altogether, rather than throw a lot of good money after bad.  The damage?  After paying $40,000 a year for 14 years, and dumping an additional $900,000 into the new policy when the switch was made, the client received a check for the cash value worth $240,000.  The ‘fiduciary’ recommendation would have had that money going into a thrifty, well-diversified portfolio during a strong bull market.  The financial damage went far, far beyond the commissions the representative had pocketed.

Kaye offers a second story, which exemplifies the ‘IRA rescue strategy’ he has been seeing recently in client portfolios after they’ve taken the advice of brokers and reps operating under a suitability standard. 

“We recently met with a woman who is 60 years old, an executive earning $250,000 a year, with about $1.5 million worth of 401(k) assets to her name,” says Kaye.  “Before coming to see us, she sat down with a broker who touts herself as a specialist in retirement readiness and income planning, who has written several books and appeared on talk shows.  She recommended that the client—who doesn’t have a life insurance need at all—buy an equity-indexed universal life policy.” 

Kaye recommended against it, but the client listened to the other person’s advice and went through with the deal.

The client purchased a (face amount) $1.5 million Minnesota Life policy, whose premiums were to have been paid with $100,000 yearly distributions from the client’s 401(k) plan—for the first three years.  The plan was that the client would take out policy loans starting in year four to use as retirement income.

As it happened, the client did not get a top rating by the insurance company’s underwriters, so the premium jumped from $100,000 to $133,000.  “She’s in the top tax bracket,” Kaye explains.  “And these distributions are fully taxable.  This woman told the client, we’ll just withdraw $200,000 a year for the first three years so you have the extra $66,000 to pay taxes on the $200,000 distribution.” 

Kaye notes that the client lives in New Jersey and is subject to relatively high state taxes, so the actual tax liability on each of the distributions will be closer to $80,000.

Against Kaye’s advice, the woman went along with this ‘suitable’ recommendation.  We won’t know the ending of this story until the client borrows from the policy to pay her retirement expenses.  But we can guess.  The arrangement was predicated on the cash account in the policy earning at least 7.1% a year—an assumed return which sounds extremely aggressive considering that the life policy is taking money out of the account to pay for the cost of insurance coverage.  The financial impact can be measured as losing years of deferral and the tax consequences—plus, of course, the commissions.  But the real impact is a high probability that the woman, who was nicely set up for retirement before running into the representative posing as an advisor, will run out of income in her declining years.

From tax-exempt to commissions

Taking withdrawals from a qualified plan in order to pay premiums on an annuity was a frequent theme of the responses I received.  A client working with an agent affiliated with NYLife Securities was talked into taking distributions to pay the premiums on a $1.5 million New York Life variable annuity, most of it invested in bond funds. 

“It performed horribly, provided no additional tax benefit, no flexibility, just a huge commission,” says Eric Brotman, of Brotman Financial Group in Timonium, MD.  “We had the client file a complaint, but New York Life came back to us and said that they saw no wrongdoing.  The recommendation, they said, was ‘suitable.’”

The surrender charge locked the client into the annuity for seven years—although, at Brotman’s recommendation, the client is taking out 10% a year penalty-free.  “We talked about taking it further to the regulators,” says Brotman.  “But he decided to just let it be.”  End of story.

Brotman recalls another story where a friend asked if he would look at her mother-in-law’s financials.  “She came in with a giant stack of statements,” he says.  “She’d been taking advice from an LPL Financial advisor, and all of the advice looked pretty good.  He had recommended reasonable funds, there were reasonable costs, she had a Prudential annuity as a part of her plan but it made sense in the overall context of her investment portfolio.  I’m thinking: she’s in decent shape.  This is okay.”

Then Brotman dug down to the 6-month mark prior to his meeting, and discovered that the woman had changed advisors.  “At his recommendation, she had taken everything in the portfolio and moved it to an equity-index annuity,” he says.  Estimated commission: between $25,000 and $30,000.

The Maryland Insurance Administration has recently suspended the insurance license of this firm, which had become locally famous for its “Money Guys” infomercials.  In this case, the woman had paid a surrender charge on the Prudential annuity so she could move the money into a contract with a 20-year surrender period.  “She had no idea what she had done,” says Brotman.  “And there was nothing we could do for her.”

An advisor who has asked to remain nameless reports a situation where a son inherited a very substantial inherited IRA.  “We advised him to keep those resources in that particular vehicle, so that he could slowly draw it down and defer the bulk of the tax consequences into the future,” says the advisor.  “He began to take large disbursements at the outset.  We thought he was using the disbursements to start a new business or feed his lifestyle, but later discovered that he was investing them in non-traded REITs through an out-of-town broker affiliated with FSC Securities.”

The client reached out to the advisor, asking if it would be possible to roll the non-traded REIT shares back into the inherited IRA. 

Of course, that wasn’t possible, so the tax deferral had been lost irrevocably.  When the advisor checked the underlying value of the shares of the non-traded REIT, it had lost half its value—in two years.  “I don’t even know if the REIT can be liquidated without a penalty,” she says.  “It’s a mess.”  The broker, she says, has since surrendered his securities license.

Line of defense

In the course of collecting these stories, I was surprised to see how many times the financial planner served as the last line of defense against predatory sales agents, in what is theoretically a highly-regulated marketplace.  It is often up to the advisor to contact the brokerage firm or insurance company to rescind abusive transactions from overzealous sales agents in the field.  Neither the SEC, FINRA or the arbitration system appears to be catching these damaging recommendations. 

Consider the case of an advisor who wants to remain nameless, due to the litigious nature of the person he’s reporting about.

“One of my clients, a nurse, came across an advertisement for a ‘free’ dinner, and she and some colleagues decided to go to learn more about ‘protecting their assets in retirement,’” the advisor says.  The client was married; the family consisted of two adults and no children.  They owned two rental properties that brought in $50,000 of income a year.  “They’re both eligible for Social Security and both have strong retirement savings,” including a 403(b) plan with $400,000 with the client’s current employer.

The seminar was conducted by a ‘financial planner’ and ‘Retired Income Certified Professional,’ who also happens to be on the radio, and whose website doesn’t mention that the firm is actually an insurance agency.  After the seminar, the individual with the RICP credential aggressively solicited the client family, and claimed they had discussed the annuity he was recommending with their CPA, and that the CPA thought it was a good idea. 

“It was later identified that the CPA was never shown the contract,” says the advisor telling the story.  “But he managed to convince our client to move $400,000 out of her current employer’s 403(b) into an annuity with a 7% commission and an 8-year surrender period.  “The fees were so high that she would be lucky if the underlying investments in the annuity would make 2% a year.  The client claims he never mentioned his commissions.”

The advisor was, of course, horrified to discover what his clients had done.  “The product was not appropriate for clients who had plenty of income on their own,” he says.  “There was no need for an additional ‘guaranteed’ income stream.”  He adds that he, himself, has not recommended a rollover out of her 403(b) plan into his own asset management accounts.  “It has good investment options,” he says.  “We helped create an asset allocation within the 403(b) that balanced well with the portion of their assets that we manage.”

This story, unlike most you’ll read here, has a happy ending.  “We wrote a letter to the annuity company, explaining the situation, and that the client did not feel this was an appropriate product for them,” says the advisor.  “The annuity company was able to return the entire contributed amount, no surrender charges incurred, back to the client’s 403(b).” 

He adds that the ‘Retired Income Certified Professional’ became enraged when he discovered that the transaction had been rescinded.  “The client said he called, texted and emailed throughout the day,” he says.  “It got to the point where my client was crying to me.  The producer even wrote them an email claiming that ‘clearly they were being misled by someone else.’  We’re happy,” he adds, “that everything worked out in the end.”

Why don’t clients take these cases to the regulators or to the courts on their own?  Many do; FINRA’s dockets have been clogged with between 4,500 and 4,650 cases each of the past three years, but just 579, 662 and 611 cases were closed during that period, according to the FINRA website.  Average turnaround time: an intimidating 14.5 months.

In many cases, where the fiduciary advisor will recommend that the client seek restitution, the client will demur, not wanting to go through the complex hassle of litigation against a formidable multinational brokerage organization with its high-powered legal team.

And if they do, they run into the ‘suitability’ standard all over again.  “I was an expert witness in an NASD arbitration,” says Scott Leonard, of Navigoe in Redondo Beach, CA.  “I was brought in to talk about fiduciary responsibility and liability.  The plaintiff’s attorneys were introducing all the advertising, marketing and letters where the broker was promoting his CFP, his codes of ethics, his fiduciary responsibility.  But the problem,” says Leonard, “is that the NASD does not have a fiduciary rule, so the arbitration panel refused to hold the broker’s recommendations to that standard.”

Leonard says that any broker, even if he or she has the CFP designation, is currently free to market him/herself as a fiduciary, knowing that any conflicted recommendations will only be held to a suitability standard in the FINRA arbitration system.  Wronged clients who thought they were taking advice from an advisor they could trust are defeated before they even get started.

Against clients’ best interests

What often seems to be lost in the debate over ‘suitability’ and ‘fiduciary’ is that agents and brokers operating under a ‘suitability’ standard have a direct financial motivation to act against the best interests of their clients.  When Amy Pender, of Natural Investments, LLC in New York City, began working with a senior woman in her late 80s, she found previous account statements where an Oppenheimer & Co. broker had been buying and selling the same stocks over and over again, racking up more than $6,000 in commissions each year.

“She was very concerned about outliving her assets, and I saw that she only had about $120,000 left in her portfolio,” says Pender.  At a time when the markets were going up, her portfolio was going down.”

A second client, in her late 60s, has experienced some serious health challenges.  “She had told her former advisor, a Wells Fargo broker, that she couldn’t qualify for life insurance,” says Pender.  “She didn’t need guaranteed income, as she had very little risk of outliving her assets.  The broker talked her into putting 40% of her assets into a variable annuity, which earned him a tidy five-figure commission and saddled her with fees on the portfolio amounting to more than 4% a year.

“Of course, any growth has now become taxable to her beneficiary, and she’s been roped into at least seven years of paying sky-high fees for riders that she doesn’t need.  She thought the annuity was protecting her assets and giving her a guaranteed 7% return every year.”

Pender talked with both clients about malpractice issues.  “Neither client wanted to get the regulators involved,” she says.  “They just wanted to get away from their brokers and get on with things.  I think they both felt intimidated and overwhelmed by the prospect of arbitration.”

Brian Lahr, of One Life Financial Group in White Bear Lake, MN, ran into a former client who cleared through a broker-dealer called Intercarolina Financial Services and who lists on his website that he is included in something called the “Guide to America’s Top Financial Planners.”  According to the Better Business Bureau, this ‘award’ is handed out by contacting all professionals in a particular location, and offering to sell them a plaque or certificate indicating that they are prominent in their field.    

“The client had lost her husband maybe five years before she came into my office,” says Lahr.  “Her broker moved about $600,000 of her assets into four annuities.  The all-in costs for those four annuities all exceeded 4% a year, two were over 5% and the most expensive came in at 5.96%.” 

Two of the annuities had expensive death benefit features, despite the fact that the woman’s husband had passed some years before, and her sole concern was not running out of money in retirement.

There’s more.  The broker had earned a commission on the sales, and was charging a 1.75% annual advisory fee on top of everything else, to manage the funds inside the annuities.  And what was he managing?

“All of the holdings in the account were invested in the PIMCO Total Return Fund, so there was really nothing to manage,” says Lahr. 

Despite the bull market, the woman’s total portfolio was down to about $400,000 in cash values.  “When you take that 5-6 percent cost out every year, it makes it pretty hard to break even,” says Lahr. 

The solution?  Lahr cancelled the unnecessary riders and death benefit features, and rolled out one of the annuities into an account that is invested in DFA funds with a Vanguard fund added in.

This was the first time Lahr has contacted an attorney to see if there were legal remedies for this bad advice, and he received a quick lesson in the realities of the brokerage marketplace. 

“The attorney said that the broker would only be held to a suitability standards, so good luck,” says Lahr.  “He said: I don’t know if you’ll be able to find anybody who would take your case.”

Weapon of silence

Many advisors did not want their name used, because they feared the litigious nature of the large brokerage firms—and as I got deeper into this story, I realized that this fear of reprisals and tangling with the legal teams on retainer at brokerage firms has had a huge impact on suppressing these ‘suitability’ horror stories and preventing them from being resolved.  The litigation system, which is supposed to protect people who have been wronged, has effectively been turned around 180 degrees into a weapon to silence advisors and clients who see wrongdoing.

One advisor tells the story of a client who had a taxable account and two IRAs.  In all three accounts, his Edward Jones broker had sold him variable annuities, and the client believed that he had been promised a guaranteed 7% growth of his principal.  The advisor pointed out that there was no such guarantee, and the client became angry and defensive—a not-uncommon reaction to having been misled.

After a close review of the annuity contract, the advisor concluded that the variable annuities, plus the insurance rider, cost between 2.5% and 3% a year—and, to make matters worse—every time the client contributed new money to the VAs, he was hit with a 5% sales commission.  There was no guaranteed return; just a standard 60/40 mix of expensive funds in the cash account.

The advisor helped the client cash out one of the VA contracts and put the money in a low-cost ETF portfolio, eliminating the excess fees, and executed a 1035 exchange on one of the other ones, into a lower-cost product that probably saved 2.5% a year in fees. 

The third contract, he says, will have to wait until the surrender charge runs out.

Another advisor, who prefers not to use his name, met with the mother of one of his clients who was 82 years old at the time, a widow who owns her own home, has a pension and her husband left her income from his pension, for total benefits of $2,700 a month.  “Given her standard of living, she felt she needed more income,” says the advisor.  “She had been taking distributions from an annuity of around $3,300 a month, and when she came to me, the balance was about $620,000.” 

In addition, there were several non-traded REIT investments with an original investment amount of $112,690, that were now worth $50,634, and an IRA worth $133,000.

The client originally wanted to explore the possibility of a reverse mortgage on her home.  But she also wanted to continue the relationship with the broker who had sold her the annuity and the non-traded REITs, who happened to be her son-in-law—a registered representative affiliated with a broker-dealer called Independent Financial Group.  “He was charging a fee of $7,500 a year on her assets, in addition to the commissions,” says the advisor. 

“We got some quotes from lenders and she ended up using a person I found locally, and completed the reverse mortgage,” the advisor continues.  “And basically our engagement was over.  It was frustrating,” he admits.  “The double-dipping was a big problem for me.  She had no business being in those REITs and annuities and things that she clearly did not understand, that were not addressing her income goals.  It’s one of those situations where you just want the person to be able to get out of the relationship.”

Brandon Grundy, of Ridgeview Financial Planning in Santa Rosa, CA has four clients who have worked with the same LPL registered representative.  “They had been referred to me over the years and each client said the same things,” he says.  “After being there for years they didn’t understand what the advisor was doing.  They didn’t understand what they owned.  They didn’t know what their investments cost.  They had been losing money even though the market was up, and their advisor had been making changes.

“It got to the point,” he adds, “that when a prospect called in I could tell before they even stopped talking who their current advisor was.”

After reviewing statements for each prospect, Grundy discovered that they all had the same portfolio structure: multiple high-cost variable annuity contracts plus a managed  portfolio of SMA accounts, along with master limited partnerships (MLPs).  “The clients were paying management fees of approximately 1.5% on top of relatively high mutual fund expense ratios and the average cost of their VA contracts was almost 4%,” says Grundy.  “These VAs seemed to be sold to them every few years, and often multiple qualified and non-qualified contracts from the same two or three companies.  A few of the prospects mentioned paying extra fees for planning via check, but that wasn’t on the statements.”

The clients all complained of losing money while the market was running higher.  “They were not just underperforming, but were net-negative after years with the advisor,” says Grundy.   “And I could see it on their statements.  Their VAs were underperforming and their managed account/SMA structures were lagging as well.  A couple of the folks even went so far as to comment that their advisor drove a Tesla and had a small plane, and they could maybe understand where that money was coming from.”

A more complicated case involves a female client whose LPL-affiliated representative sold her an equity-indexed annuity linked to a balanced index in mid-2016.  By the time Rick Brooks, of Blankenship & Foster in Solana Beach, CA, talked with her in early 2018, the annuity had generated a total return (not annualized) of 5%. 

“She still has 10 years to go on the surrender period, and the next three carry a 10% penalty, so you know the commission was obscene,” says Brooks.

Brooks deems that to be garden-variety collateral damage from ‘suitable’ advice.  Worse was the broker’s next recommendation: to sell a rental property that had been generating about $5,000 a month of income that the woman was using to pay her bills. 

“When she came to me, she didn’t know what the tax impact of that sale was going to be,” says Brooks.  “The broker wanted her to put the money she had received—roughly $850,000—into another annuity.”

After talking with Brooks, the client decided to purchase two rental condominiums with the funds.  “She’s much more comfortable owning real estate than investing in the capital markets,” Brooks says.  “But she lost the opportunity to do a tax-free exchange.  I’ve also convinced her to start taking her minimum penalty-free withdrawals from the annuity,” he adds.

Fixing the problem

It’s not easy to calculate the exact costs of ‘suitable’ advice on client financial situations, in part because each situation is different, in part because some costs are never fully disclosed, and it’s hard to know what a portfolio would have been worth if it had been invested, instead, in low-cost investments.  But any fair assessment would have to include not only the impact of commissions (which are usually the ONLY costs factored into these equations) but also the significant impact of negative investment returns during a bull market, plus lost opportunities for long-term deferral when the recommendation is to take money out of a 401(k) or IRA to buy a ‘suitable’ annuity or non-traded REIT.  Plus the ongoing costs incurred by those expensive annuities, non-traded REITs and mutual funds—products that have to pay reps and brokers to recommend them because their annual expenses are far too high and their investment performance far too low for them to compete fairly on their own merits.  Plus the cost of lost services, where the ‘suitable’ recommendation was a one-time transaction, while fiduciary advisors provide ongoing advice for their fees.

Add to that the very real impact of not being able to survive, financially, in retirement, due to the additive impact of various ‘suitable’ recommendations that destroyed a person’s long-term financial viability.

I asked advisors who believe in the value of fiduciary advice what they think should be done to fix the ‘suitability’ vs. ‘fiduciary’ system we have now, and was surprised that nobody—not one of the more than 100 individuals who responded to my initial request—thought brokers and dually-registered reps should be held to a fiduciary standard.  Instead, they would like to give consumers a clearer distinction between those who are held to ‘suitability’ and ‘fiduciary’ standards, so that unsophisticated investors can be appropriately skeptical of ‘advisors’ touting products that have to pay people to recommend them.

“There is a major problem for the consumer of financial advice when the life insurance ads during March Madness has, as its call for action: “talk to one of our advisors,” says Chis Cooper, who practices in San Diego.   “If the SEC can do nothing more than regulate the titles of those who are fiduciaries from those who are not, then there would not be as much a need for fiduciary standards being imposed on the financial services industry.  Perhaps,” he adds, “we can make the title of ‘advisor,’ mean something again.”

How confident are fiduciary advisors that something will actually be done about the harm that ‘advisors’ held to a ‘suitability’ standard are wreaking on the public?  Interestingly, the confidence level is very low.

“The brokers have the big pockets,” says William Jerome, of Capital Financial Services in Glenville, NY.  “The SEC will succumb to pressure from the lobbyists and pre-purchased Congresspeople.”  Adds Brandon Grundy, of Ridgeview Financial Planning in Santa Rosa, CA: “Those writing the regulations seem to be greatly influenced by the industries they regulate.  I don’t expect the SEC to buck that trend.”

“I talk with the regulators, and they’re convinced that these bad recommendations are all on a case-by-case basis,” says Lassus.  “But incentives and the culture absolutely matter.  Look at what happened at Wells Fargo, in terms of everybody setting up those accounts.  It was all about the incentives.

“Of course,” she adds, “I do believe you have to have a little bit of evil in your soul to follow these incentives.  I don’t understand how you can act this way, no matter what incentives are offered you.”

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