Last week, WSJ reporter Jason Zweig broke the story of Powerball winners who were exploited for millions of dollars in commissions and fees. For those without the time to read the full article, succinctly, a couple won a $180.1 million dollar lottery in 2008 and walked away with $59.6 million after taxes. Shortly thereafter, they started a charitable foundation to research a disease that had taken their daughter years prior with a $26.4 million dollar gift. They then took a large portion of that gift to a local stockbroker who was only licensed to broker the sale of investment products or trade securities on commission and were sold $18.9 million in annuities. By 2011, he had sold them an estimated additional $5.6 million in annuities, netting commissions of over one and a half million dollars and generating hundreds of thousands of dollars in fees annually to the product companies. In addition, the broker continued to “twist” or “churn” the existing annuities, redeeming the cash to purchase new annuities and consequently generating hundreds of thousands in additional commissions. Finally, the broker even went so far as to tell the foundation’s donors to cancel life insurance policies with the same companies holding the annuities despite one of the donors having a terminal cancer diagnosis. The family and foundation later sued the broker’s company and were awarded $7.3 million dollars in compensatory damages by an arbitration panel.
How does this happen?
It’s a fair question. How does a family with tens of millions of dollars and a charitable foundation place so much trust in someone who deserved so little? How does a single client end up not only generating millions in commissions but also being taken advantage of overtly for a decade before someone does something about it? One of the prominent thought leaders of the financial planning world, Richard Wagner, put it this way in the last book he published before his death: “They are not us, we are not them.”
What Mr. Wagner meant, in the context of the book, is that financial advice professionals (financial planners, financial advisors, etc.) should not be from the same company or beholden to the same company that creates the products they use as solutions for their clients. This means that any advisor working for a company that produces investment, insurance, debt and leverage, or any other financial product is not a financial advice professional, but a financial product salesperson. Conversely, anyone claiming to be a financial advice professional must be beholden to no third party in their line of work. The sole relationships influencing the advice given to the client should be that between the client and the professional or firm they are working with.
Yet, in the case of the Powerball winners, there were multiple elements of conflict in play:
- The broker was not licensed to give advice or manage money, only to sell investment products and transact business on commission.
- The broker worked for a financial products company that sold mutual funds and insurance products such as annuities and life insurance.
- The broker was paid commissions for recommending the company’s products to the Powerball winners, and in turn, the company made millions in fees on the products that were sold.
- When the commissions ran out on one product, the broker simply redeemed that product and sold another to generate new commissions.
- When asked outright for “a statement disclosing all fees, commissions, charges, transfer fees, etc. of any kind that will be charged for the purchase of any investment device you are planning on using,” the broker replied, “There is* no fees on this Product.”
*Poor grammar included in the original. Albeit, that might have been a hint that they weren’t working with a brilliant financial professional.
So, not only did the family and the foundation take this broker at his word, but they were outright lied to in the course of doing business with the broker. Should that have happened? No. Should the broker’s firm’s compliance team caught that email sent to the clients and vehemently corrected the misrepresentation by the broker? Certainly. But did they take any action to protect the client? No. After over a decade of malfeasance, they decided to protect themselves from liability by firing the broker but did not proactively do anything to make their client whole. They simply lawyered up and remained silent, as they have remained silent to this day, other than the $7.3 million they now owe the family and foundation for abusing their trust.
What protections are there today?
Shockingly little, it turns out. While at the time of the Powerball story and the family winning the original prize, the standard for a broker’s conduct was “suitability,” that standard is rather bare. It left open an enormous amount of leeway for the family to be taken advantage of, and thus it was. A few years ago, the standard for such transactions would have been “elevated” to a “best interest” standard, but ironically. At the same time, it might have made a regulatory enforcement action against the broker and his company easier, it would have done nothing more for their victims. The “best interest” standard merely requires that the brokers in question recommend options that are in their client’s best interest from the options available to the broker.
This means that at no point would the broker have been prohibited from selling the products he sold, nor would the firm have been any more liable than they already were under the suitability standard for how grossly inappropriate the sale of the annuities was in the first place. The broker could have simply claimed the products were the best available to him at the time, and the firm’s liability for not making better options or more appropriate options available would have simply been equal as they were before.
One might ask why this is permitted, and the simple answer is that lobbyists in Wall Street do a damn good job of talking out of both sides of their mouths. In marketing, advertising, and daily client conversations, the salesmen of firms such as the one in discussion here tell their clients, “we do comprehensive financial planning, and from that, we must make recommendations in your best interest,” while simultaneously they state under penalty of perjury to state and federal government regulators and legislators that their advice is “solely incidental to the sale of a product,” for which a fiduciary financial planning regulatory requirement and legal liability would simply be “too burdensome.”
What would a Fiduciary Financial Planning obligation have done?
Replay the story of the Powerball winner, and replace the product-slinging broker with a fee-only, fiduciary, CFP® Professional financial planner who is ethically bound to make recommendations with a duty of loyalty and a duty of care for their clients. For one, they’re not going to be selling any proprietary financial products manufactured by their parent company; in fact, they wouldn’t have any to sell. Instead, they’d be conducting a holistic assessment of the family and foundation’s needs, creating a comprehensive financial plan that detailed the best way to make such charitable donations to the foundation in the first place, and then providing direction on how best to invest the money. This would quite likely be a collection of low-cost passive index funds or ETFs, perhaps a handful of US treasuries or guaranteed instruments such as certificates of deposit. They’d likely help the foundation spread its assets out across more than a single financial institution to help maximize its FDIC and SIPC insurance protections.
In the course of selecting investment options for the foundation and the family, they’d be disclosing all of the costs and risks associated with the investments. They would monitor the portfolio on an ongoing basis and make trades only necessary to ensure alignment with its risk-reward profile or for the occasional cash distribution need. They would have regular meetings with the investment committee for the foundation and the Powerball winning family to discuss the state of their portfolio and the marketplace at large to ensure that the portfolio was performing adequately in line with market conditions but also to ensure it was still aligned with the objectives and values of the family and foundation respectively.
When the wife of the Powerball winning family was diagnosed with terminal cancer, they certainly wouldn’t recommend canceling a life insurance policy worth millions of dollars. They’d have already established a robust estate plan for the family not only to ensure that the life insurance was in force throughout the diagnosis and treatment but would have helped to ensure that there were no exposures to estate taxes or other potential pitfalls should their assets not have been allocated and titled appropriately.
Further, when the family first became clients and since that time, there would have been a constant tempo of tax planning around every element of the family’s lives, not simply the sale of investment products to the foundation. The goal would have been not only to maximize the foundation’s impact as the family would have intended, but also have allowed them to retain as much of their wealth after tax as possible.
Oh, and if that hypothetical financial planner strayed? If they got greedy and made recommendations in their own interest rather than the family or foundation’s best interest? They’d not only be liable to make their client whole, they would owe them treble damages (3x) the harm they’d caused whether by error or greed.
But instead, the family found a broker, the broker worked for a product company, and they were sold a literal bill of goods.
The Necessity of Fiduciary Financial Planning
Today marks the fifth year that MY Wealth Planners has stood as Longmont’s sole fee-only financial planning firm. Despite my expectations when taking the practice independent and fee-only that the privilege of filling that role would be a short-lived and temporary blue ocean, it has persisted for half a decade at this point. We work with one hundred and eighty families and small businesses; we’ve advised twice as many over the years. Yet, to this day, we know as a matter of regulatory fact that we are the sole practice in Longmont legally and ethically obligated to act in our client’s best interests at all times.
Despite the common sense in that standard and how attractive it surely must be, remember the lobbyists mentioned earlier. Over 95% of those professionals claiming to be financial advice professionals are, as described earlier, financial product salesmen. Some sell their own company’s products, others sell other company’s products. Sometimes the products are high quality and necessary for those buying, other times they are not. Let us never forget the wisdom of Maslow’s hammer: “For a carpenter whose only tool is a hammer, all problems look like nails.”
As a fee-only, fiduciary-at-all-times financial planning firm, we’re pleased with the shape of our hammer. The hammer is comprehensive financial planning, agnostic to whether we manage money or not, agnostic to whether you buy insurance or not, and agnostic to whether you take our advice or not. Our role is to provide our clients with the advice and guidance to live their best financial lives, whatever that means to them. That is a nail we will happily hammer away at for many years to come.
For the rest of the figurative financial advice carpenters out there who live in a double standards world where they claim to financially plan for their clients while telling regulators all they do is sell products? Well, a world in which fiduciary financial planning is mandatory and not simply a “caveat emptor” necessity remains a dream of a time yet to be. May that time draw ever closer. Until then, it’s only your life savings, hopes, and dreams that you’re hoping are in the hands of a professional and not a salesman.