Safeguards Are Scant as Registered Advisers Increase 39%

Arnold and Cheryl Levy were a year away from retiring when Jeffrey Liskov, acting as their registered investment adviser, took a large position during July 2009 in a speculative fund with Arnold’s retirement money.

The Levys were dealing with an ill family member at the time and the trade escaped their notice until December of that year when Liskov alerted them to losses on the fund, the Levys said in a telephone interview. According to court filings they lost about $85,000 on the ProShares UltraShort MSCI Emerging Markets exchange-traded fund, which placed bets that foreign stocks would drop.

“We were just beside ourselves,” said Cheryl, 67. She and Arnold, 69, of Stoughton, Massachusetts, felt they could trust Liskov’s judgment, she said. Actually, Liskov was sliding toward bankruptcy, and they had to absorb a 44 percent loss on the fund.

Registered investment advisers -- firms that employ about 280,000 individual representatives nationwide -- are billed as an alternative to traditional brokers because they are legally bound to a fiduciary duty to put their clients’ interests first, and typically charge fees instead of commissions. Brokers, who number about 632,000, are held to a suitability standard that their advice meet clients’ needs at the time a product is sold.

In practice, the lightly regulated RIA industry -- where low barriers to entry helped swell membership by 39 percent in six years -- may offer few protections for investors who wind up with incompetent advisers.

No Guarantee

Registering as an RIA “is just notifying regulators that you are holding yourself out as a professional investment adviser, and that doesn’t necessarily mean that you’re good, or ethical, or competent,” said Sheryl Garrett, founder of Shawnee Mission, Kansas-based Garrett Planning Network Inc., a network of fee-only financial planners.

Inappropriate investments, high fees and an inability to collect on legal awards are some of the problems investors may face with registered investment advisers, according to attorneys such as Angela Magary, a Boston-based securities lawyer, who have represented clients in arbitration or court actions against their advisers.

There are more than 14,000 independent RIA firms, which typically manage investments for individuals and may also provide related financial-planning services, controlling about $1.5 trillion of assets, according to Aite Group, the Boston-based research firm.

Attracting Attention

The industry gained new attention in January, when the U.S. Securities and Exchange Commission recommended that traditional brokers should be held to the same fiduciary standard that applies to RIAs.

“The RIA business has gotten a big reputational boost in the last year,” because of a heightened focus on its fiduciary status, said Andrew Stoltmann, a Chicago-based securities lawyer, who has represented more than 700 investors against brokerage firms.

There are no industrywide figures available for customer complaints against their RIAs. More than one in 10 RIAs report they have been the subject of a disciplinary action, according to a study by the Washington-based Sunlight Foundation, a nonprofit firm that advocates for open government. Such actions may include being convicted of a felony or making false statements to regulators.

Tally of Trouble

Customers filed 3,208 complaints against their brokers in 2010, according to the Financial Industry Regulatory Authority, the self-funded regulator for the securities industry. Customer complaints for the RIA industry don’t go through one centralized entity and may be resolved informally between an investor and a firm, through arbitration, or through court action.

The SEC, which generally investigates possible violations of securities law, took 113 enforcement actions against investment advisers or investment companies in 2010. The commission doesn’t track aggregate fines against the industry.

Most investment advisers serve their clients well, said David Tittsworth, executive director of the Washington-based Investment Adviser Association, a lobbying group for SEC-registered advisers.

“I don’t think there’s a silver bullet, but I think the model of fiduciary duty and disclosure of conflicts of interest is a very good model,” he said.

Registered advisers have gained ground with investors, according to Alois Pirker, research director at Aite. Since 2007 independent RIAs have gathered an additional 2 percent of the $13.4 trillion wealth-management market, bringing their share to about 11 percent, while brokers from the largest full-service firms have lost about 3 percent. That shift may be driven in part by traditional brokers fleeing large financial firms whose reputations were damaged by the 2008-2009 financial crisis.

Independent View

Alan Harter, 41, left Morgan Stanley Smith Barney in January to start his own advisory firm in part because his clients expressed concern about potential conflicts of interest at his former employer.

“It’s very hard for a large broker-dealer organization to treat 18,000 brokers as fiduciaries,” because the range of experience of its brokers may vary widely, said Harter, managing director of McLean, Virginia-based Pactolus Private Wealth Management, which he founded in January and which provides investment-management and financial-planning services to families with $25 million or more in assets. Harter and his firm, which serves 32 families, have no complaints or related events listed with regulators.

Performance Record

Advisers are not required to disclose their performance history to prospective clients, said Ted Laurenson, a New York-based partner at McDermott Will & Emery.

“Most advisers are going to say, ‘We customize the portfolio to you, so we don’t have a composite of returns to show you,’” said Kristi Kuechler, former president of the Institute for Private Investors, a membership group of high-net-worth investors. Some use that line to evade a request for performance history, she said.

When investors do run into problems with an RIA, they often decide to accept losses rather than face expensive, protracted legal action, said Laura Corsell, a partner with Montgomery, McCracken, Walker & Rhoads in Philadelphia.

Many advisers include arbitration clauses in their agreements with clients that require customers to bring any complaints through either the American Arbitration Association or JAMS private arbitration, according to C. Thomas Mason, a securities and employee benefits lawyer in Tucson, Arizona. The costs are “an enormous deterrent,” Mason said. Standard initial filing fees for AAA range from $775 to $8,200 on claims of up to $5 million, and subsequent fees can top $70,000, depending upon complexity, length and the arbitrator’s hourly rate, Mason said.

Ease of Complaints

“More than 90 percent of the complaints we see are against brokers and broker-dealers,” rather than against advisers, said Brian Hamburger, an Englewood, New Jersey-based attorney and the founder of MarketCounsel, which advises RIAs and brokers on compliance. That’s in part because Finra makes it easier to bring complaints against a broker, “not because the brokerage model or the RIA model attracts a different caliber or class of people,” he said.

The Levys went to court against Liskov in August 2010. They claim in legal filings they lost about $149,000 on positions taken by their adviser, including the exchange-traded fund. Liskov had invested them conservatively through the worst of the stock market’s fall during 2008 and 2009, the Levys said in a telephone interview. Arnold, who works for a car dealership, has delayed retirement in part because of the investment losses, he said. Cheryl lost her job as an administrative assistant in 2010 and is currently unemployed.

Nothing Left

Liskov filed for bankruptcy in February of this year, which halted the progress of the lawsuit. Arnold Levy said he and his wife decided not to pursue the case in part because the U.S. Internal Revenue Service filed a tax lien on Liskov’s home, which happened in 2010, according to the Plymouth County Registry of Deeds. Magary, their attorney, told the Levys the lien potentially would leave nothing for them.

Liskov had alerted the Levys to the initial purchase of the fund in a voicemail in July 2009, he said in court filings, and they were aware of the fund’s risks, said Albert Zabin, an attorney for Liskov, who lives in Plymouth, Massachusetts. He’s no longer registered as an investment adviser representative, according to the SEC website.

Capital Standard

Ordinary brokers must meet certain capital requirements that vary based on the size of their business and on the amount and type of trading they conduct, according to the SEC.

“If a large brokerage firm defrauds you, at least they have the money to pay you back,” said Brian Smiley, an Atlanta-based securities lawyer.

There are no net capital requirements for SEC-registered advisers, said Robert Plaze, associate director for regulation of the division of investment management for the SEC.

“If a broker doesn’t pay a Finra arbitration award, they get their registration suspended,” said Jane Stafford, a Kansas City, Missouri-based securities lawyer. If advisers don’t pay, they “may have to disclose that they have an unsatisfied judgment against them, but no one’s going to shut them down.”

Advisers must generally register with the SEC if they manage $25 million or more and register with the states in which they do business if they manage less. That threshold will rise to $100 million by June 28, 2012, shifting about 3,200 advisers from SEC to state oversight.

Fees and Commissions

Advisers may have fewer conflicts of interest than brokers because most don’t accept commissions, said Barbara Roper, director of investor protection at the Washington-based Consumer Federation of America. More than 95 percent of federally registered investment advisers charge clients a fee based on a percent of assets under management, and about 9 percent receive commissions, according to a January SEC report on the investment-advice industry. Most broker-dealers receive commissions, the report said.

“We’re still seeing people charging fees that are way too high,” in spite of the industry’s move away from commissions, said Liz Weston, author of “The 10 Commandments of Money.” “We have a problem of an industry that’s geared toward making money more than geared toward serving clients.”

Adviser fees generally range from less than 1 percent to 2 percent of assets under management and may vary based on the size of a client’s account. Those may not include separate hourly fees or charges for underlying investments.

Stocks and Bonds

Charging fees based on assets under management may also create a conflict of interest if it encourages the adviser to concentrate clients in higher-fee or higher-risk investments, said Michael Engdahl, an attorney and associate professor of financial services and business law at Edinboro University in Edinboro, Pennsylvania.

Engdahl is representing investors in arbitration against an RIA firm that directed clients into stock portfolios rather than bond portfolios, which had lower fees. The firm had invested Engdahl’s retiree clients 100 percent in stocks, he said. This year advisers have had to include a plain-English brochure detailing their fee schedules in regulatory filings with the SEC. The brochures are available on the SEC website.

Many investors choose an adviser through referrals, said Mark Matson, an adviser based in Mason, Ohio. They should check an adviser’s disciplinary record with the SEC and state regulators, and should interview multiple candidates before investing, said the CFA’s Roper. There are no “surefire” steps to guarantee an adviser is competent, she said.

What’s Disclosed

Arbitration awards or legal settlements must be disclosed on an adviser’s ADV form, which RIAs file to register with the SEC or with states, if they reflect on the integrity of the adviser, said the SEC’s Plaze.

“The ADV questions don’t pretend to ask every single thing that may be disclosable to clients,” said MarketCounsel’s Hamburger.

Reports that include customer disputes with investment adviser representatives are available on the SEC website.

Investors should also ask about the number of clients who have left the firm in the past year, and ask for referrals to former clients, Kuechler said.

“At the end of the day, whether a person is a broker or whether they’re an RIA, I think that 99 percent of us really want to do the right thing by our clients,” said Susan John, an adviser based in Wolfeboro, New Hampshire, and chair of the National Association of Personal Financial Advisors.

“Of course, there’s always that 1 percent.”

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