Fiduciary Magazine

Archive for the ‘Fiduciary Info’ Category

Fiduciary duty is determined by facts and circumstances and it is not uncommon for fiduciaries to be unaware of their status. One of the first issues that will arise in breach of fiduciary duty litigation is determination of whether the defendent, in fact, owed a fiduciary duty.

The issuance of Bearer Bonds has been discouraged for almost 3 decades with the passage of the TEFRA in 1982.

“The interest on any such bonds issued after 1982 would be taxable to the issuer in the case of corporate bonds, and taxable to the holder in the case of municipal bonds.”

I guess that did not smack in the face of the Italian authorities when they intercepted 2 Japanese men who held $134.5 billion in fake US Government Bearer Bonds.

“Italian law does not call for the criminal arrest of persons found to be taking funds without permission to another country. It might have been another matter if the police had determined immediately that the bonds were false.”

Which raises the question: If you have a client who has bonds in bearer form, or is dealing with Bearer Bonds, how can you vouch for their authenticity?

Madoff turned the table on the client: he had it set up so that he basically interviewed them for admittance. That made the potential client want it more. I can’t imagine how those people feel right now.

When your money manager is the:

broker/dealer
custodian
investment advisor

you have to have a lot of trust for that person or entity. To me, that type of trust would rank with God or a higher power.

I hold the SEC responsible because they were alerted and they were too afraid to ask for what they needed. Politics has no place in fiduciary care.

So far, nothing has changed since Madoff. There are proposals, but nothing has changed.

By JANE J. KIM and AARON LUCCHETTI

Buried in President Obama’s proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher “fiduciary” standard that would compel them to place their client’s interests ahead of their own.

Currently, brokers are only required to offer investments that are “suitable,” which means they can’t put clients in inappropriate investments, such as a highly risky stock for an 80-year-old grandmother. The move could change the way products are sold and marketed and even how brokers are compensated.

The first step should be to do away with the Series 7 Registered Representative’s license. I don’t think they all need to sit for the CFA, but they need to be better able to manage risk. There is not a single question on the test about how to minimize losses nor how to maximize profits.

“This is a smart and overdue move” for the large brokerage firms owned by investment banks, says Sallie Krawcheck, who formerly ran the wealth-management business at Citigroup Inc. “It’s certainly a victory for clients.”

Many investors don’t even know the difference between the two standards, believing their brokers already are acting in their best interests.

But requiring brokers to operate under a fiduciary standard could force them to offer products that are less costly and more tax-efficient. They will have to disclose any potential conflicts of interest, such as any fees they may get for favoring one product over another. That could mean clients will be offered fewer proprietary products if the broker can find a lower-cost option elsewhere.

For example, a broker couldn’t put you in a mutual fund with higher fees — or one he gets a bigger commission for selling — if he could get a comparable fund with lower fees elsewhere, says Tamar Frankel, an expert on fiduciary law at Boston University School of Law.

The proposal addresses a long-simmering debate over how brokers and investment advisers, who have traditionally offered more financial-planning advice, are regulated.

For years, investment advisers — regulated by the Securities and Exchange Commission as part of the Investment Advisers Act of 1940 — have been held to a fiduciary standard, meaning that in serving the clients, they have to put their clients’ interests first. Brokers were excluded from that definition of investment advisers as long as they didn’t get paid special compensation for that advice, and gave it as “solely incidental” to their brokerage services.

But over the years, that distinction became more blurred as brokers held themselves out as financial planners, even as they continued to operate under the more lenient standards. Making matters more confusing is the fact that some brokers became dually registered, operating under a suitability standard when they are selling products, but under a fiduciary standard when doling out investment advice.

Richard Ketchum, chairman of the Financial Industry Regulatory Authority, says “a fiduciary standard should be established for broker-dealers when they are offering investment advice.” He said the SEC should lead a discussion of how to define those situations and adds that features of both broker and adviser regulation should be kept.
The Intelligent Investor

* The Fight Over Who Will Guard Your Nest Egg

The change also will give investors more power if they take their broker to court. “If a fiduciary violates his duty — that is, gives advice which is contaminated by self-interest — he could be sued not only for damages that have been caused for this advice but could also be sued for punitive damages,” says Boston University’s Ms. Frankel.

The tougher fiduciary standard would discourage brokers from charging trading commissions instead of fees based on a client’s assets, says Alois Pirker, a senior analyst at Aite Group LLC. That is because brokers could be accused of recommending trades simply to drive up their commissions. Some firms have already been encouraging brokers to register as investment advisers.

The Securities Industry and Financial Markets Association, a Wall Street lobbying group, has pushed for updating standards so brokers and financial advisers are held to the same rules when they provide the same service to clients. But the group stops short of saying the standard should be the more expansive and potentially more costly fiduciary standard.

Changing to a tougher standard won’t be easy. “They’re going to have to rejigger the whole bloody thing…and rethink what services they offer and by whom,” said William Spiropoulos, chief executive of CoreStates Capital Advisors LLC, a Newtown, Pa., money manager. Mr. Spiropoulos, who worked as a broker for many years, now operates under the tougher standard.

Allen Stanford was arrested shortly after being indicted.

Had anyone done a full-on fiduciary review, they could have gone a long way to side-stepping the Madoff and Stanford crimes. In Madoff’s case, there was no transparency: Madoff was the Investment Advisor, the Broker/Dealer, and the custodian of the client funds.

You couldn’t have stopped the crime from happening, but you could have avoided being a victim.

It should be written in your Investment Policy Statement (IPS) that you have frequent portfolio reviews. Morningstar has a good article on a few things that you can include in that review.

Click for the article

Are financial advisers legally required to put your interests ahead of their own?

It depends on whether they are brokers or registered investment advisers. Different sets of laws apply to these two types of professionals, even though brokers and advisers sometimes do the same thing. Unfortunately, it’s not always clear which one you’re dealing with.

The duty to put clients’ interests first, known as a fiduciary obligation, applies to advisers and is a fairly strict requirement in the eyes of the law. The law regards the job of adviser as a position of trust and requires those with a fiduciary obligation to disclose all conflicts of interest and to act with a heightened sense of duty toward clients. The job of a broker, however, is considered transactional — to make a trade on your behalf — and comes with a more limited set of legal obligations.

The difference between the two used to be apparent in the way each got paid. Advisers charged a fee for managing your investments, usually based on the value of the assets in your portfolio. Brokers charged commissions on trades they made on behalf of clients. But many brokers have traded commissions for fee-based compensation, muddying the waters. Must fee-based brokers adhere to the stricter standard that applies to advisers? Yes, in some cases, but the line isn’t clearly drawn.

Mary Schapiro, head of the Securities and Exchange Commission, is aware of the confusion and says that the SEC might recommend creating a single standard that applies to advisers and brokers. In the meantime, the only sure way to know whom you’re dealing with is to closely question the person handling your money. Those who must meet the higher standard consider it a selling point and will probably be happy to say so.

By David Landis
Kiplinger’s Personal Finance

Bernard Madoff’s $65 billion investment scheme has made the term “Ponzi scheme” the water cooler topic of 2009. These types of fraudulent schemes are run under the pretense of a legitimate profit-making business where funds are solicited, often by broker-dealers, from new investors. The new funds are used to pay earlier investors, thereby inducing further investments. The Ponzi-scheme operator all the while siphons off funds for his or her own use, engaging in a scheme that is destined to fail and land in some sort of formal dissolution proceeding. Most, if not all, such Ponzi schemes ultimately end up in a bankruptcy proceeding or receivership.

As a Ponzi scheme progresses, the earlier investors often withdraw more money than they invested, thereby receiving fictitious profits. Broker-dealers are often paid handsome commissions for soliciting the investments. When the Ponzi scheme has failed and it is time to unwind the tangled financial web, questions then arise on the part of bankruptcy trustees and receivers as to how or whether they can recover funds transferred. Claims for recovery of funds are made against: (1) the investors (for both principal repayments and fictitious profits); and (2) the broker-dealers for return of commissions paid for soliciting the investments on behalf of the Ponzi debtor. Use of the fraudulent transfer laws in both the Bankruptcy Code and state statutes is the most common mechanism to seek to “claw back” the transfers made by the Ponzi debtor.

Claw back claims can be based on either an actual fraud theory (where the actual fraudulent intent of the Ponzi debtor is sufficient to establish the claim to recover the funds transferred), or a constructive fraud theory (where it must be established that the Ponzi debtor did not receive reasonably equivalent value in exchange for the transfers made at a time when the Ponzi debtor was insolvent). Under either theory, the good faith of the transferee is relevant, establishing a partial or complete defense depending on the circumstances.

The United States Court of Appeals for the Ninth Circuit has generated three significant opinions in the last year providing further guidance for bankruptcy trustees and receivers in their pursuit of these “claw back” claims. These cases distinguish between transfers that constituted a return of the principal amount originally invested versus profits or “interest” which might have been paid to an investor. In re AFI Holding, Inc., 525 F. 3d 700 (9th Cir. 2008)(repayment to investor as return of principal was not recoverable since the payment partially or fully extinguished the investor’s restitution claim, but “profits” paid to investor are recoverable); In re Slatkin, 525 F.3d 805 (9th Cir. 2008)(prejudgment interest may be awarded on recovery of profits from investors); and Donell v. Kowell, 533 F.3d 762 (9th Cir. 2008)(investors’ good faith may be relevant as a defense regarding a return of principal, but will not protect them from claims to recover profits).

A particular category of transfers subject to avoidance claims in Ponzi scheme cases are the transfers made by the Ponzi debtor to its broker-dealers as commissions in order to solicit new investments. Some courts have found that, because a Ponzi enterprise has no legitimate purpose, there can be no value provided by a broker in furthering or assisting the debtor in perpetrating the fraud. Therefore, the commissions paid to them are recoverable by a trustee or receiver. See, e.g., Warfield v. Byron, 436 F.3d 551, 560 (5th Cir. 2006)(“It takes cheek to contend that in exchange for the payments he received, the [debtor’s] Ponzi scheme benefited from his efforts to extend the fraud by securing new investments”).

Other courts have looked more narrowly at the relationship between the debtor and the broker. They measure “what was given and received” by the debtor and the broker, looking at the market commission rates versus what was paid, finding that, “Money is valuable even when used for illegal purposes.” In re Churchhill Mortgage Inv. Corp., 256 B.R. 664 (Bankr.S.D.N.Y. 2000)(court should focus not the consequence of the debtor-broker transaction in the context of the entire Ponzi scheme, but “on a comparison of the values of the mutual consideration actually exchanged in the transaction between the Broker and the Debtor. . .”).

The bottom line is that both investors and broker-dealers may be subject to claw back claims in bankruptcy and receivership proceedings of Ponzi debtors. Their good faith status may or may not rescue them from litigation, depending on the type of claim brought and the precedent or opinion of the presiding court.

Kathy Phelps is a Partner at Danning, Gill, Diamond & Kollitz LLP in Los Angeles