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Bad Boy Brokers


It's more likely that people will end up dealing with brokers who are eroding accounts in small but accumulative ways that get overlooked than obviously bad ones like who make the newspapers.

Some “Bad Boy Brokers” manipulate the market (LIBOR scandal). Others practice insider trading (Rajat Gupta). A few may just be in over their heads and try to cover up by “borrowing” clients’ money (Russell Wasendorf). Then, there are the scam artists (Bernie Madoff).

These are the less-than-honorable financial professionals who we see on television and read about in the newspaper: the “Bad Boy Brokers,” which I will abbreviate to BBB. They are the few brokers/advisors who go to extremes in their successful attempts to defraud the investing public.

Then, there are other financial professionals; the ones that aren’t publicly recognized, but are affecting more investors, because they erode accounts subtly in small but significant and accumulative ways. This group is greater in number than the BBB. But until clients are aware of the harm that they can do, these perpetrators will continue doing it until caught just like the BBB.

The techniques of these menaces are different than the “Bad Boys.” They are more subtle. In fact, they are so elusive that most of the time the broker is able to rationalize to himself that he is acting in his client’s interest. I will refer to this group as bBB rather than BBB.

As an illustration, a bBB doesn’t give enough information to the client. Without crucial facts (such as unexplained opaque costs

), the client unknowingly selects a choice less in his own best interest than the broker’s or his company’s. A load fund is one example. A load is an extra charge to the client, often when buying the fund (front-end load) or when selling (back-end load). A front-end load paid by the client will mean he has less to invest and thereby the return to him will be less than it would have been, all other things being equal.

Or, the bBB is double dipping and the client is unaware. This practice refers to an advisor or broker who sells a client managed funds and the investor pays the former a fee for finding the funds, plus reimburses the internal management fees of the funds that are suggested. In other words, the client compensates twice. It is one thing if he knows he is doing it, but it’s another if he doesn’t.

Occasionally, the advisor or stockbroker may be overtrading a client’s account costing the client money that is not offset by performance. It is well known that high turnover costs are rarely recovered by sufficient gains to make the excessive trades advantageous.

Furthermore, the bBB may also be charging for services not received, i.e., giving the perception he is beating the market when it is not true. Though unethical according to practice standards, there are ways to compare a client’s results to inappropriate benchmarks to make the client’s outcomes look more favorable than they really are.

Or the advisor is not protecting his client’s money as well as he could simply through lack of attention. For example, the financial professional may not direct high-paying dividend stocks to the client’s tax advantaged account so that the dividends can accrue tax free.

Finally, and amazingly, there often is complicity between the bBB and the client. The former rationalizes his acts. At the same time, the client can’t recognize what is happening because he abdicates control to the professional and stops taking any responsibility for

his own money. This cycle can only be broken through awareness, reading pertinent material and asking questions plus more questions.

As GI Joe says, “Knowing the enemy is half the battle.” The enemy here may be ourselves as much as a bBB.


Read more

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Victor J. Dzau, MD, gives expert advice
Victor J. Dzau, MD, gives expert advice