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Striking Out

Allan Roth

ROUGHLY 20 YEARS AGO, I left the world of corporate finance. I saw some of the ugly, high-fee undiversified products many of my friends owned—and how those differed from the ultra-low cost, disciplined investing at the companies where I had been a financial officer. I wanted to change things.

But after two decades, I’d say I’ve struck out. Still, there are lessons to be learned from my failures, as well as some encouraging changes occurring within the financial industry.

I started strong out of the gate. I met with Vanguard Group’s founder, the late John Bogle, and he encouraged and inspired me to become a financial advisor. I eschewed collecting commissions or levying a percent of clients’ assets, and instead charged by the hour. Soon, I was corresponding with some financial writers I admired, including William Bernstein, Jason Zweig and Jonathan Clements.

Months later, I was writing for what was then the big-time Money magazine. In an anonymous column called “The Mole,” I warned readers of the tricks of my trade and how to avoid being victims. I was committed to doing my part to ensure consumers got a fair shake. Here’s where I struck out—and the lessons for all of us.

Strike 1: Hold independent fund directors to their fiduciary duty.

I bought my first index funds in the late 1980s. Unfortunately, I hadn’t yet heard of Vanguard or John Bogle. Instead, I began with two giants, Dreyfus and Fidelity Investments. Over time, Fidelity did the right thing and lowered its index-fund fees. Dreyfus did the opposite and raised fees, trapping me and thousands of others between two bad choices—keep paying the higher fees or pay a large capital-gains tax bill to get out.

The Investment Company Act of 1940 dictates that the fiduciary duty of independent directors is to the fund shareholders, not the fund management company. The fund directors have the ability to negotiate fees or to change fund managers. Bogle introduced me to a senior officer at Vanguard who gave me permission to communicate Vanguard’s willingness to explore a tax-free merger of Dreyfus’s S&P 500 fund with Vanguard’s far lower-cost fund.

I sent a certified letter to Joseph DiMartino, the fund’s independent chair (and also the former Dreyfus CEO), in which I stated that a high-cost index fund had no chance of beating a low-cost index fund investing in the same S&P 500 index. I wrote that he would be violating his fiduciary duty if he didn’t explore this or use it as leverage to get Dreyfus to lower its fee. The Dreyfus legal department suggested we discuss a settlement that would require me to sign a confidentiality agreement. I declined.

I was sure the law was on the fundholders’ side. I was wrong. I later managed to get discussions going at high levels at the Securities and Exchange Commission, including a senior attorney reporting to the SEC chairwoman. In the end, nothing happened. I wrote about the SEC being too cozy with Wall Street. I sold all but a token amount of my Dreyfus shares. I wanted to hang on to a small amount, so it would remind me of one of my biggest financial blunders.

Lesson: Laws aren’t what they seem. Financial regulators may want to catch the Bernie Madoffs of the world, but that’s about it when it comes to consumer protection. Be your own regulator.

Strike 2: Stop advisors and brokerage firms from blatantly falsifying muni bond income.

In my practice, I saw client statements that showed the income on their individual municipal bonds was twice that of the interest rate of muni bond funds with roughly the same maturity and credit quality. The big muni bond funds got to buy in bulk—and yet the industry claimed that brokers could purchase smaller amounts earning much more. Baloney.

I discovered the muni industry’s simple but brilliant trick: Buy a muni bond at a premium that will mature or be called at par a few years later, and count that amortization of premium as income. Muni bond funds aren’t allowed to do this. On many occasions, I had to tell clients that the 3.5% tax-free income on their statement was really 0.5%, with the rest simply a return of their own principal. A typical response: “How is this legal?”

The muni bond industry is regulated by the Municipal Securities Rulemaking Board (MSRB), a self-regulatory organization that’s subject to oversight by the SEC. I sent a certified letter to the chair of the board, asking why this practice was legal and noting it’s the economic equivalent of an advisor saying they’re charging 1% when actually they’re withdrawing 3%.

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The letter resulted in an invitation to come to Washington, D.C., to speak to Lynnette Kelly, the executive director of the MSRB at the time. She and her senior staff laid out a lovely breakfast just to meet with me—the nicest people you’d ever want to meet. Though no one argued with the point I was making, they noted that other parts of the bond market did this, though to a lesser extent.

In the end, all they did was invite me to write an educational paper that they would then put on their website. I did so. But when the edited version came back, it did more to continue to trick the public than to help, so I asked them to remove my name from the paper.

Lesson: The MSRB is a self-regulatory organization and, when a part of the financial industry regulates itself, bad things happen to the consumer. Really nice people are driven by financial incentives and, most of the time, that’s also bad news for consumers.

Strike 3: Help the CFP Board enforce the higher standard it touted.

I became a Certified Financial Planner because I wanted to be held to the higher standard the CFP Board claimed to enforce. Early on in my practice, I came upon a client who had a troubling portfolio designed by his previous CFP. The portfolio included a variable annuity where the CFP apparently couldn’t decide between charging a commission or an ongoing asset management fee, so he did both. This double dipping resulted in the client paying an estimated 5.29% annually.

When I confirmed the facts with the insurance company that managed the annuity, even it must have thought this crossed the line. The insurer offered the client a generous settlement, which the client took under the condition that he got to file complaints against the CFP in question. The client filed the complaints in 2008. Though I wasn’t surprised regulators took no action, I was confident the CFP Board would act. Wrong again.

The CFP Board said this was old news and, after that incident, that it takes enforcement of standards very seriously. But I pointed out that, for years, virtually every certificant that the CFB Board publicly sanctioned came after a regulator or a court took action. It was just a matter of time before the CFP Board would be exposed for falsely advertising that it enforced a higher standard.

That time came in 2019 when The Wall Street Journal revealed that more than 6,300 certificants—out of approximately 72,000—were shown as having clean records on the CFP Board’s search website but, in fact, had regulatory disclosures. Those disclosures included more than 5,000 who had received customer complaints, and 499 who had past or current criminal charges.

The CFP Board has its own board of directors, who are charged with holding senior management accountable. What did they do that year? According to the required filing, which I had to wait two years to see, they gave the two top officers hefty pay raises. Last year, the board’s chairman wrote me saying much has changed and claiming that the CFP Board now takes the establishment and enforcement of high ethical standards very seriously. Déjà vu all over again. The obvious conclusion: The CFP Board has given up on its mission to help the public.

Lessons learned: Talk is cheap. Those touting fiduciary duty and higher standards are perhaps more likely to be abusing clients than those who don’t. It’s easy to get fooled, as I was when I became licensed.

But where I may have failed in trying to get industry watch dogs to give consumers a fair shake, countless others succeeded in alerting consumers to some of these practices. Fund fees are plunging as much of the traditional media, as well as sites like HumbleDollar and Bogleheads.org, educate people on what they need to do to put their own financial independence ahead of Wall Street’s profits. These days, the mighty Dreyfus lion has become almost extinct and even the CFP Board is at least using advertising that’s less misleading. While I struck out with those that were supposedly protecting people, team consumer is scoring more and more hits—and may still win the game.

Allan Roth is a financial planner and writer. His investment columns can be found in publications such as AARP, Barron’s, ETF.com and Advisor Perspectives. He’s the founder of Wealth Logic, LLC, an hourly based financial planning and investment advisory firm with the goal of providing a one-time plan. Allan is proud to have the lowest client retention rate in the business. He’s a licensed CPA and CFP, and has an MBA from Northwestern University’s Kellogg School of Management, but still claims he can keep investing simple—at least as simple as possible given the very complex tax issues in developing a plan. 

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Jeff McComas
Jeff McComas
7 months ago

Allan: The mole! I loved reading and always looked forward to two sections of Money magazine back in the day. The page of “best performing / recommended mutual funds (ETFs) by sector” which always had mostly Vanguard funds listed, and then the Mole article. I loved reading how it actually was in the financial advisor / broker space. Always a great read, and always taught me something. Thanks.

You did (and continue to do) a tremendous service to individual investors. If there was a Mount Rushmore for financial heroes, Jack Bogle would be the 500 foot tall statue centerpiece, surrounded by 100 foot visages of you, Allan Roth, and probably Jonathan Clements, Warren Buffett, and Bill Bernstein. Rick Ferri and Andew Tobias are waiting in the wings to get the call to the monument.

Thanks, Allan, for doing what you’re doing, and keep it up! We need you now, more than ever.

Allan Roth
Allan Roth
7 months ago
Reply to  Jeff McComas

Jeff. Thank you for protecting the mole’s identity back when I was writing that column once some smart people on Bogleheads.org discovered it was me!

Donny Hrubes
Donny Hrubes
7 months ago

I’ve come to realize there are many ‘laws’ in existence in our world. “If clouds are full of water, they pour rain upon the earth. Whether a tree falls to the south or to the north, in the place where it falls, there will it lie.”
Nature has it’s laws, and it is a fact there are many economic laws put in place long ago by and in the best interests of a certain few.

Like knowing laws of Nature and following them, the economic laws in place are better followed than disregarded. Trying to buck these laws is like going against the laws of Nature, won’t be really successful.

Now, if the investment advisor industry has it’s rules set up in their best interests and not the investor’s, why even mess with it? I’ve never had an advisor that was worth much. I quit giving money to the kind people managing my IRA’s and instead long ago increased putting it in another investment better suited for my own gain.

I’ve dabbled in rental houses many years and in the last couple decades stepped that up. The rules of the rental home industry are good to know. I am profiting from following them, even in a small way. The Covid problem was decimating to business and the rules are set up to help the landlords to not be as decimated. The big institutional folks are protected with governmental legislation and so will be the little man such as myself.

The stimulus checks sent by Congress kept most of my renters current in rent. Thank you taxpayers.
Also, only one tenant was irresponsible and miss allotted the money away from the rent. Their lease was not renewed and they left owing several months rent. Their deposit wasn’t returned, a law that helps landlords approved this.
Then, two months after, there was a big ol check given to my manager which was over the amount owed. So, the renters were made whole and got some money paid to them and my business bank account increased. This because of a ‘renters assistance’ program established by local government with the help of lobbyists, thank you again taxpayers.

My question is, how many other situations such as mentioned are there that are in place to benefit the few?
How can you utilize these situations for your own benefit?

UofODuck
UofODuck
7 months ago

As your article illustrates, little has changed in the financial services industry that should give investors much comfort. I spent 42 years in the financial services biz and, when trying to help friends and family make sense of their investments, I am continually astounded by the naivete of investors as to what constitutes income and what they are paying in fees. In part, this is the result of a deliberate effort on the part of too many investment providers to make their disclosure materials as unreadable as possible, but is also a result of too little effort being placed on the need for at least a modest amount of financial education. As you note, successful investing need not be over complicated, but it does require some basic understanding of the time/value of money, risk v. return, investment time horizon and how fees can affect long term returns. Unfortunately, until advisor salaries are decoupled from sales and AUM, its hard to see much change occurring.

Ted Meek
Ted Meek
7 months ago

Consider me a victim of the variable annuity “arrangement” and high fees in our small fledgling 401K about 20 years ago that we set up in our small business. I trusted my advisor and he was taking my employees and myself to the cleaners with fees 5+%. I began following Jonathon Clements in the WSJ and when I raised my concerns the advisor’s response was feeble. Fortunately, my investable assets at the time were not significant enough to change my retirement income, but I was a bit ashamed of myself for not reading the small print.

Mel Turner
Mel Turner
7 months ago

Allan, Thanks for being a soldier of the truth. We need more people who are willing to join the battle.

evan rayers
evan rayers
7 months ago

Allen states: The Dreyfus legal department suggested we discuss a settlement that would require me to sign a confidentiality agreement. I declined.

There is/are/were a small % of individuals of your fiduciary caliber Allen, particularly before the www.

As Upton Sinclair Quotes:
It is difficult to get a man to understand something when his salary depends upon his not understanding it.

Good luck & Best wishes sir!

Andrew Forsythe
Andrew Forsythe
7 months ago

Allan, thanks so much for this. Eye opening to say the least.

Last edited 7 months ago by Andrew Forsythe
wtfwjtd
wtfwjtd
7 months ago

Thanks for writing this Allen, and for efforts on behalf of the investing public. I appreciate all the work that you do, and I say that as a consumer who was bamboozled for a few years by a large bond fund company in the late ’90’s, utilizing deceptive tactics similar to the ones you describe.

SanLouisKid
SanLouisKid
7 months ago

I started to work for Ameriprise (American Express Financial Advisor) and then discovered that Variable Annuities were their solution for almost every client’s portfolio. I left. Thank goodness for Vanguard. Not only do they directly benefit their customers, but they also put pressure on the rest of the investment companies to reduce costs. As an individual I have very little impact on the big financial companies. As part of the collective Vanguard community, I think we’re having an impact (and getting a good deal in the process).

Roboticus Aquarius
Roboticus Aquarius
7 months ago
Reply to  SanLouisKid

Ameriprise used to hide the fact that they stuck most of their clients in a type of wrap account as well. Falling for that was my big mistake, but at least I declined the variable annuity trap. I read a book by one of the first people to sell them in bulk, and it frightened me.

It took me years to completely unwind the Ameriprise accounts, but it was a good lesson. It prompted me to teach myself enough to manage our accounts and investments effectively.

B Carr
B Carr
7 months ago

Hear! Hear! Mr Roth, I see you standing should-to-shoulder with Mr Bogle!

RCP
RCP
7 months ago

As an attorney who does securities litigation and arbitration on behalf of investors, I regularly see the vast gulf between the industry’s aggressive marketing and client communications portraying themselves as trusted advisors, and the full repudiation and denial of any fiduciary obligation when called to task in court or arbitration.

Jim Mahaney
Jim Mahaney
7 months ago
Reply to  RCP

Shouldn’t that change though given PTE 2020-02 if there is a rollover from a 401(k) to an IRA? The DOL is indicating that every financial advisor is acting in a fiduciary capacity when the rollover is recommended… and it must be in the client’s best interest.

Jim Mahaney
Jim Mahaney
7 months ago

Allan – Thank you for your article where you have humbly pointed out where you feel you may have come up short. In my view, your points pale in comparison to all the great work you have done to turn a spotlight on AUM fees and high commission products. While the industry has been slow to change to flat fees or hourly fees (for obvious reasons), your contributions have likely helped thousands make better decisions if they didn’t need to sign up for “wealth management” but rather just needed some help along the way.

I’ve submitted a working paper to the Journal of Retirement (where I sit on the Editorial Board) showing how even 1% in fees reduces annual safe withdrawal rates by 15% and generates a median cost in legacy values of 23%. Of course, average “all-in” costs are much higher when all the TAMP fees, separate account fees, wrap fees, active management fees, custodial fees, etc. are considered. The long-term cost in terms of income, late life wealth to pay for healthcare, and future inheritances is staggering unless financial advisors can somehow make up for these drawdowns with superior advisory contributions.

You, Rick Ferri, and a couple of others have spearheaded this attention to fees and it’s vitally important in my opinion to brighten the spotlight even more as we’ve now moved primarily to a 401(k) world.

Edwin Belen
Edwin Belen
7 months ago

You didn’t fail. You ran across big challenges that most individuals would struggle to beat on their own. I think the end of your article shows that with people like you looking out for those that don’t know or can’t, we live in a much better world. Keep fighting the good fight!

William Ehart
William Ehart
7 months ago

What a wonderful column Allan. I know all smaller investors like myself will be grateful to learn about all your efforts.

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