The Florida Bar

A New Perspective to the Investment World from an Investor’s Rights Attorney

January 27, 2021

By Chris Vernon

The self-proclaimed “philosopher” (and pretty good actor) Matthew McConaughey, who is now in his 50s, says “Process of elimination is the first step to our identity (a.k.a. where you are NOT is as important as where you are).”  I submit that your philosophy of investing should include the process of elimination of what you don’t want in deciding how to invest. This concept also applies equally to any assistance with financial issues that you provide to your more senior clients.

When you look at investing through the lens described above, you will likely notice that a typical Google search on investing, a typical investment seminar that includes a steak dinner, or even a cocktail party discussion with someone in the financial industry pushes one of two extremes: (1) Great opportunities with little discussion of risk; or (2) Risk avoidance investing.  Although some of these search results, seminars, and cocktail party discussions are very good, much of it is some combination of conflict-driven, incompetent, unethical, and designed to get you to buy whatever they are selling (whether it be a commission-based product or a management fee).  It is hard to find objective investment advice that is both holistic and equally focused on risk and return.

Keep in mind that there are more than 3,000 broker dealer firms in the United States that are members of FINRA (Financial Industry Regulatory Authority).  Given this context, consider the following two facts: (1) Investors file more than 3,000 formal claims against brokerage firms yearly, which is the equivalent of each member firm getting a client so upset every year that they file a formal legal action against the firm (this would be the equivalent of every law firm in the country getting a malpractice claim lodged against every year); and (2) FINRA, who purportedly regulates the broker dealer industry, lodges fines and restitution orders of less than $100 million a year against all its collective members combined, which is only a fraction of the net income of one of the largest of the 3,000 plus broker dealers regulated by FINRA (i.e., LPL Financial makes about five times the amount that FINRA fines the entire industry). The takeaway from this is that customer complaints are simply a cost of doing business and the regulators are unable or unwilling to stop practices that lead to customer complaints.

And, keep in mind that this does not include thousands of investment professionals in the U.S. that are not regulated by FINRA, such as trust companies, investment advisors, financial planners and insurance salespeople. This means that there are a whole lot of “financial advisors” out there trying to convince you and your clients to let them manage your money.

Given these numbers, there are clearly many “good” financial professionals in the marketplace who are both competent and ethical who represent a viable option to help invest the portfolios of you and your client.  However, there are also a great many of these “investment professionals” who are “bad” because they are either not competent or not ethical enough (or both) to adequately address risk or to maximize the true return potential for the level of risk being taken by you and your clients. Among other things, this article helps you with the difficult task of distinguishing between and “good” and “bad” financial professional.

My perspective on investing is based primarily on the representation of individual investors in court and arbitration all over the United States for the past three decades. In essence, I have seen many products and strategies in which the risks are downplayed (or even deceptively hidden) as well as products in which potential returns are deceptively muted for the investor to increase the potential benefit for the issuer and the salesperson.  When these products and strategies either crater due to the risks or underperform in terms of returns due to the sharing of those returns with the issuer and salesperson, the investment professionals and investment firms lamely claim that the results were not foreseeable, which often contradicts the sales pitch that got you into the strategy or products in the first place.

Despite the foregoing, I am not suggesting that you and all your clients forego an investment professional and manage your own money.  There are a number of situations where an investment professional is beneficial and appropriate.  Rather, I posit there is a different approach. That approach is to objectively identify what you and your clients don’t want or need and, based on that determination, seek out professionals, advice, strategies, and products that avoid those situations.  This approach will help you define how you should invest to meet your needs rather than the needs of the investment professional and the financial industry.  This approach is designed to be an objective, step-by-step decision tree methodology that will help you and your clients create a map to control your own financial destiny.  The initial steps of this approach are set forth below and the remaining steps will be featured in coming months.

Step One

DETERMINE WHETHER YOU SHOULD AVOID WORKING WITH AN INVESTMENT PROFESSIONAL

If you look at macrotrends in the securities industry, you will see that what we used to refer to as discount brokers (e.g., Schwab, Fidelity, etc.) are acquiring a much larger share of the retail investor market. However, the most profitable firms still seem to be full-service brokerage firms.  This is evidence that investors still pay more for a full-service brokerage firm even though you may be told otherwise by these full-service brokerage firms and their advisors.  The issue becomes whether it is a good idea for you to pay someone to help you (other than the support you can now get from the discount firms).  Given the low interest rate environment over the past decade, these extra fees (which may not be easily recognizable) can be a significant drag on the returns of conservative investors.

Separate from the cost issue, many studies show that passive investing works as well as hiring someone to outperform the market. Thus, there is an argument to be made that no one needs an investment professional. However, I would argue that some people need the right investment professional to advise them and work with them for a number of reasons (e.g., knowledge, experience, time, stress tolerance, etc.).

Using our approach when you or your clients are making decisions regarding the bulk of your net worth, the important first step is the objective determination of whether you need an investment professional at all. This self-analysis may sound daunting if you don’t have a financial background, but it’s easier than it might sound, and it will help you in objectively deciding whether you need an investment professional.

Here is a suggested simple self-analysis example. Write down the following:

  • Your primary source of income and approximate income (e.g., if you are in the real estate business, then write down real estate; if a retiree, then write down bonds if you own a lot of bonds) and for how much longer you anticipate receiving that income);
  • Your major assets and approximate value (e.g., home, 401k, cash value in insurance, businesses you own, insurance, IRA) and whether they are available to use or move to a different asset;
  • Your major liabilities (e.g., mortgage, credit line, car payments); and
  • Your generally anticipated annual financial needs both until retirement and post retirement.

Once you have completed this, look at the overall picture and see if you notice any patterns, such as whether you are paying high interest rates on debt, whether most of your assets and income are dependent on the real estate market, etc.

You might say this analysis is a simplified version of what many investment professionals will do when you meet with them. However, the value of doing this before you reach out to an investment professional is to help you avoid going to someone who sells insurance if you don’t need insurance, or someone who sells real estate investments if you are already overconcentrated in real estate.

This analysis also avoids the bias that most in the securities industry bring to the table in working with you to create this analysis. In fact, it is common knowledge around our law office that many investment firms actually design these analyses so that the result is almost always that the perfect investments for the client are the investments that that investment firm can sell and make a lot of money selling.

As discussed below, this self-analysis not only helps you decide whether you need to work with an investment professional, but also represents a big stride towards determining what type of investment professional you need if you determine that you should work with an investment professional.

Step Two

HOW TO AVOID THE WRONG INVESTMENT PROFESSIONAL AND THE WRONG INVESTMENT FIRM

To set the stage for the first step of this approach, ask yourself the following question: If you (or your client) had a lot of money to invest and wanted help investing, what would you (or your client) do first? Almost anyone over 50 would ask someone they know and trust the following question: “Can you recommend a good investment professional?”

From my perspective, this is the first mistake. Asking this question is like asking for a recommendation for a good doctor without any reference to what kind of doctor you might need. For example, if you know the world’s best heart surgeon and someone with an ankle injury asks if you know of a good doctor, the referral to the great heart surgeon could be a bad one even though you recommended a “good” doctor.

And, sadly, the question is much more dangerous in the investment world because, unlike doctors, investment professionals and investment firms typically do not acknowledge the focus (or the limits) of what they do and their expertise. For instance, the heart surgeon would let you know right away that they cannot help you with your ankle and would recommend an ankle doctor. On the other hand, the investment professional typically does not replicate this behavior. If you want to test this theory, ask a trust officer, an insurance salesperson, a stockbroker, and an investment advisor whether they are a good fit for you and your clients and they will all likely say “yes.” The only exception might be that some of them don’t want to deal with you unless you and/or your client have a lot of money to invest.

The second problem with the approach of simply asking someone if they can recommend a “good investment professional” is that most friends, family, and even tax and law professionals have little understanding of what constitutes a good investment professional. This is such a problem that we actually started a company called Investor Lifeguard with the primary objective of grading (A-F) investment professionals as well as vetting investment products and strategies recommended by those investment professionals.

There is a reason why it is harder to pick the right investment professional than to pick the right doctor.  This is because the investment professional world was originally built on a platform of sales (think real estate agent) rather than a platform in which a professional is paid for rendering a service (i.e., doctor, lawyer and CPA approach).  In fact, the term “stockbroker” has largely been replaced by the term “financial advisor” over the last few decades. And, although the investment professional world has evolved more in the “professional” direction (and continues to evolve in that direction), much of it remains driven by commissions or asset-gathering as opposed to payment for true, objective, conflict-free, competent advice. For this point to hit home, think about the qualities of a salesperson and then think about whether your friends who are investment professionals fit that profile more than the doctors, lawyers, and CPAs that you know.

Based on the foregoing, many investment professionals are more salesperson than professional. Consequently, you are quite likely to end up with a good salesperson if you ask most folks to recommend a good investment professional for you.  And, to state the obvious, do you want your money to managed or directed by a salesperson or a professional?

So, now that I have outlined the wrong question to ask, what is the right question(s) to ask? Based on helping investors as both an attorney and an investment advisor, and having started a company designed to protect investors (Investor Lifeguard), set out below is an analysis for you and your clients to minimize the chances of making an investment decision that causes irreparable damage to you or your clients’ retirement and financial futures.

Using Step One above as a segue to Step Two of avoiding the wrong investment professional, you already have the basic ingredients to determine what skill set and expertise you need based on your objective analysis of what you want and need versus what you don’t want or need in your investment portfolio.  Once you determine the skill set and expertise that you or your clients need from an investment professional/investment firm, you and/or your clients can go about the difficult process of finding a competent, ethical, and financially sound investment professional with the skill set and expertise that matches your needs.

After you decide what type of investment professional you need, the next step is to find one that is competent and ethical with your desired skill set. The sad reality is that there is a massive amount of those “bad” investment professionals described above. Although most of the “bad” investment professionals are more on the incompetent side than the unethical side, the damage to your portfolio can be just as devastating regardless of the specific reasons for your losses.

Our law firm gets calls almost daily from retirees around the country who discover the traps of their investments after it is too late. For instance, investors buy high commission product that didn’t perform as they were led to believe, they no longer want, and they can’t sell because there is no buyer’s market or there is a penalty to sell. Or, worse yet, they may have invested in something that is now starting to look like a scam or a Ponzi scheme.

Based on the foregoing, how do you and your clients find an investment professional who is not only the right type of investment professional (see Step One), but is also ethical and an actual an expert in his or her field?

First, you need to understand that it is easy to become an insurance salesman or financial advisor in comparison to the training, experience, education and testing required of lawyers, doctors, and CPAs. Unless your financial advisor is a Certified Financial Planner (CFP), a Chartered Financial Analyst (CFA), or holds an equivalent designation, it is unlikely he or she has the type of education and testing required of other professionals on whom you rely. Consequently, it is crucial for you to take the time to confirm the investment professional’s licenses and designations.

To elaborate on this point and give you a sense of how easy it is to become an investment professional, I will give you a slice of my own journey.  As a fellow lawyer, you know that to become a lawyer, I had four years of undergraduate studies, three years of law school, a rigorous background check, and a challenging multi-day licensing exam.  In stark contrast, I took a two-day crash course on how to become a Registered Investment Advisor, took a morning test on the third day, and passed it with flying colors.

Admittedly, becoming a CFA or CFP (as well as some other designations) are serious undertakings, but few investors know the difference between my Series 7 license, a CLU, a CFA or a CFP.  To be clear, do not base your decision of what investment professional to work with based on any of the following factors: TV or radio show; advertising in newspaper; book writing (often ghostwritten); personality; golf handicap; friend recommendation; or free steak dinner.

Second, based on the foregoing, you need to investigate and verify the following: that the investment professional does not have customer complaints in the last 10 years (or a history of other problems such as criminal, bankruptcy, or regulatory issues); and that the investment professional can sell you legitimate products and strategies other than illiquid products with big commissions. This information is available for free through the FINRA Broker Check system, most state regulators, and our aforementioned firm, Investor Lifeguard.

By focusing on the right criteria for selecting a qualified investment professional, you will significantly reduce the chances that your net worth takes a substantial hit from bad investment products or strategies in your portfolio.

Even if you can parse out and stay away from the incompetent and unethical advisors, you still have work to do before you select an investment professional. As I said above, just because and investment advisor is “good” (i.e., both competent and ethical), he or she may not be the type of advisor you need. Much like hiring a lawyer, going to a doctor, or even buying a car, you should be dealing with someone who understands and offers what you need versus an individual who simply recommends what they’re selling.

CONCLUSION

Once you and/or your clients determine if you want or need the assistance of an investment professional and, if so, determine the “type” of investment professional to work with as well as identify some “good” investment professionals to choose from, the next steps in the objective, step-by-step decision tree methodology involve avoiding “bad” financial products and strategies, avoiding scams, and crisis investing. These remaining topics will be featured in later installments. It is my hope and plan that these articles will collectively give you and your clients a road map to investing that will help you avoid much of what I have seen derail more senior investors throughout my legal career.

“Remember, whatever it is, let’s make sure our money is working for us and not for somebody else.”

About the Author

Chris Vernon is a Naples-based financial litigator who represents investors in financial disputes throughout the United States. He holds an AV rating by Martindale-Hubbell, has been recognized by Florida Super Lawyers and The Best Lawyers in America every year for the past decade. He is also licensed as a Registered Investment Advisor and has testified as an expert on investment matters and FINRA arbitration matters.