Stan Morrill was confident his nestegg would provide for him and his wife for the rest of their lives. After all, the Eastman Kodak (EK) veteran, a factory worker for 31 years, had attended the free financial seminar recommended to him by co-workers. Morrill says the host, Michael J. Kazacos, one of Morgan Stanley's (MS) top brokers, dazzled him with a plan that would let him retire at 49. Morrill just had to roll over his pension and 401(k) into a tax-deferred account managed by Kazacos. After that, he could safely withdraw $36,000 a year—plenty to cover his bills—without ever touching the $320,745 principal. "I saw no reason why I should stay and work," says Morrill, who signed on in 1998.
But he says the strategy, which assumed unusually high investment returns of up to 14%, didn't pan out. Morrill's balance now stands at just $57,559, and with little other savings, he's scrambling. At 59, Morrill doesn't yet qualify for Social Security benefits, so he has taken a job as a janitor at a local school paying $9.50 an hour. In April 2007 he and his wife, Cathy, sold the five-bedroom Victorian house in a suburb of Rochester, N.Y., where they had raised their two kids, and unloaded some inherited land in Florida. Now they own a modest ranch house on the outskirts of town. "It's all gone," says Morrill. "I've had thoughts of suicide."
Cases like Morrill's are becoming more common among America's 77 million baby boomers. If the Me Generation isn't careful, it could become the Poor-Me Generation. Over the next 20 years, a record $17 trillion will move from pension funds and 401(k) accounts into the hands of freshly minted retirees, says trade group Investment Company Institute. Not surprisingly, that money pot—and the fat asset management fees it will generate—has financial-services firms salivating.
The problem is that, like Morrill, many retirees and pre-retirees are woefully unprepared for the shift from "wealth accumulation," or saving and investing, to "wealth distribution," or drawing down those assets throughout their golden years. On June 24, MetLife (MET) research arm Mature Market Institute released a study showing that 69% of pre-retirees overestimate the amount of money they can safely withdraw from their accounts each year during retirement—many, dramatically so—while 49% underestimate their expenses. Likewise, a May study by the research group National Institute on Retirement Security found that about one in three households approaching retirement is at risk of running out of money.
Aggressive investment brokers are focusing on that yawning gap between perception and reality. Promising early retirement, fat investment returns, and big annual cash withdrawals, they're increasingly succeeding at seducing investors to turn over their retirement accounts—and then putting them in high-fee and often inappropriate investments. "This is emerging as a big problem," says Mary L. Schapiro, CEO of the Financial Industry Regulatory Authority (FINRA), the securities industry's private oversight group, which recently launched a program to train corporate benefits managers to vet financial advisers who run in-house seminars. "The issue has intensified for the next generation of retirees—the largest we've ever seen."
A Pitch for Products
Despite the increased scrutiny, in some ways it's getting easier for rogue advisers to operate. More are tapping into pools of workers from inside employers' offices. According to benefits consultant Hewitt Associates (HEW), 40% of companies with 401(k) plans now offer investment advisory services in which outside firms educate employees on financial issues—up from 28% in 2003. And those numbers don't include the many on-site seminars taking place without management's explicit consent. "The biggest challenge is the implied credibility of these meetings taking place at the workplace," says Karen Tyler, president of the North American Securities Administrators Assn., a group of state securities regulators.
The seminars can be breeding grounds for fraud. Last year federal and state regulators examined 110 securities firms and branch offices that offer so-called free-lunch sessions. They found most to be little more than thinly veiled sales presentations, with some suggesting unrealistic scenarios such as "how to receive a 13.3% return" and "how $100K can pay $1 million to your heirs." Under FINRA rules, brokers can't guarantee specific rates of return or promise investors they'll outlive their money.
"Investors should never lose sight that the goal of the seminar is to sell them products," says Mark Story, manager of investor communications for the Securities & Exchange Commission's Office of Investor Education & Advocacy. The regulators' study also found that 10% of the seminars appeared to be downright fraudulent, prompting investigations now under way.
In many fraud cases, brokers seek to take advantage of a little-known tax loophole that allows investors to tap into their 401(k) or other retirement accounts without penalty before they reach 59½. Under IRS rule 72(t), enacted in 1974, investors can withdraw money from their tax-free accounts if they commit to take out the same amount each month for at least five years. "Clients get lulled into the belief that because this is a government exemption, these [moves] are blessed by the IRS," says Frederick Rosenberg, an attorney in East Hanover, N.J., who specializes in such cases. "Nobody ever shows you that there's more than a 50% chance you'll be destitute."
Preying on Vulnerability
Stan and Cathy Morrill have plenty of company in Rochester, the birthplace of Kodak and Xerox (XRX). In January a group of Kodak and Xerox retirees, including Morrill, filed a lawsuit seeking class action status in New York State court against Kazacos and another against Morgan Stanley broker David M. Isabella, with both suits also naming Rochester branch manager Ira S. Miller. The suits allege the brokers routinely targeted "unsophisticated" employees, often attracting prospects with "free advice" sessions held on company premises.
There, according to the suits, they told clients they could take out 10% from their portfolios each year and still have a "comfortable income for life." (Previous arbitration claims against the brokers made similar allegations.) Many advisers recommend withdrawal rates of between 4% and 6% a yearand less for early retirees. At 10%, most retirees will empty their nestegg long before they die. "They were vulnerable to a pitch that said they'd live happily ever after," says one of the plaintiffs' lawyers, Joseph C. Peiffer of Fishman Haygood Phelps Walmsley Willis & Swanson in New Orleans.
FINRA, meanwhile, has been investigating Morgan Stanley's Rochester branch. The watchdog has made a preliminary decision to recommend disciplinary actions against the three brokers for using deceptive tactics to sell securities, as well as other breaches of their fiduciary responsibility. In similar cases, FINRA also has made the parent companies pay tens of millions of dollars in fines and restitutions to clients.
Morgan Stanley says its policy is to cooperate fully with such investigations. As for the class action, the firm says the majority of the account losses came as a result of the market downturn of 2000-02, coupled with client withdrawals for personal expenditures beyond living expenses. "We believe the allegations are legally defective and have moved to dismiss them," says spokeswoman Christine Pollak.
Kazacos retired from Morgan Stanley last year. His lawyer, David Gourevitch, denies allegations that Kazacos encouraged clients to retire early and says the broker's investment strategy was sound: "They are trying to shift the blame for their decision to Kazacos in the hopes of obtaining a litigation windfall." Isabella was let go in April, says his attorney, Andrew W. Sidman of Bressler, Amery & Ross in New York. Sidman adds that most of Isabella's clients had no complaints: "The [clients] with whom we have spoken say that [Isabella] was attentive and caring and their investments did well, considering the performance of the market." Miller is no longer a branch manager. Through an attorney, he declined to comment on the suit.
Not Isolated Cases
Conflicts like these are playing out with alarming frequency around the country. In Shreveport, La., two brokers from InterSecurities, a St. Petersburg (Fla.) financial firm, allegedly promised employees of railroad Kansas City Southern (KSU) that they would earn a 13% return on their investments while at the same time withdrawing amounts equal to their salaries. According to a FINRA resolution, the pair made an unusually high commission of 7.25% for each investment they sold to clients. A spokeswoman for InterSecurities says the firm "goes to great lengths to educate its customers about the potential risks associated with various forms of investments. We regret that the value of those customers' accounts declined, but we believe it was due to the significant downturn in the market in 2001 and 2002, and it was not due to any misconduct." Kansas City Southern declined to comment.
In a similar case, regulators say a top broker at Securities America, an affiliate of Ameriprise Financial (AMP), told employees at an ExxonMobil (XOM) refinery in Baton Rouge, La., that they could retire as early as 55. The pitch, according to an arbitration decision, included a PowerPoint presentation with projections of returns as high as 18% and scenarios in which retirees could withdraw sums in line with their salaries. More than 100 employees signed up for the broker's services between 1997 and 2003, transferring over $300 million to the financial firm, according to the complaint.
FINRA in 2006 awarded 32 of the former ExxonMobil workers $13.8 million, one of its largest arbitration awards ever. It also banned the broker from the securities industry for life. Says a Securities America spokesman: "This matter occurred several years ago, and Securities America has significantly enhanced its compliance, policies, procedures, and oversight." Exxon�Mobil declined to comment.
Rochester, a company town situated between Buffalo and Syracuse on the southern shore of Lake Ontario, was fertile territory for Kazacos and colleagues. Xerox and Kodak, once members of the "nifty fifty" group of hot tech stocks in the 1960s and early 1970s, have fallen on hard times. Kodak has cut its workforce in Rochester by two-thirds, to 23,000, since 1982. Xerox has eliminated 7,000 jobs since 2000.
With the companies losing their edge, Rochester had plenty of boomers wondering if they would be casualties in the looming rounds of layoffs—and eager to get out on their own terms. Says Alabama Securities Commissioner Joseph P. Borg, who has been probing brokers whose clients include former General Motors (GM), Ford Motor (F), Uniroyal, and Sears (SHLD) employees: "When a company announces that they're going to buy out folks, it's like shooting off fireworks to aggressive brokers."
Kazacos used word-of-mouth recommendations to penetrate the Kodak community. Along with sessions at a local hotel, he held several after-hours seminars at the company's headquarters—events facilitated not by Kodak but by employees on their own, with flyers posted in glass cases in employee break rooms. Clients say Kazacos showed them a 1990 letter from Kodak benefits manager Michael D. Pribanich to Dean Witter Reynolds Chairman Philip J. Purcell. (At the time, Kazacos worked for Dean Witter, which merged with Morgan Stanley in 1997.) The letter praised Kazacos for the "outstanding job" he did "presenting investment and pre-retirement information to the Eastman Kodak counseling staff" and called him "a credit to your organization." Pribanich, now an investment adviser in Rochester, says he never intended for the letter to be used as an endorsement: "I heard about it after the fact. He was using it without my knowledge." Kodak declined to comment.
Kazacos' colleague, Isabella, had an edge. He had worked in the Xerox finance and accounting group for 22 years before joining Morgan Stanley in 1994. Isabella was familiar with Xerox's retirement plan and used his connections to build up his client list, according to the class action and customers involved in the suit. His pitch, they say, was similar to Kazacos': Retirees could safely take out 10% a year without cracking their nesteggs. "He told us we'd be millionaires," says 70-year-old Bob Yates, a machine operator at Xerox who retired 10 years ago with $420,000 and now has $56,000. Isabella's attorney, Sidman, says the broker never encouraged anybody to retire early. Says a Xerox spokesman: "There is no way to provide quality assurance of what others say to our employees. Therefore we only refer our employees to our benefits center, where they can get information on our benefits, but no advice."
Kazacos, a divorced father of three sons, was the brightest star at Morgan Stanley's Rochester branch. Born in Syracuse in 1941, he received an undergraduate degree in business administration and political science at the University of Findlay in Ohio in 1964 and spent some of the next 16 years working at and owning a car dealership. In 1980 he joined E.F. Hutton as a broker; five years later he moved to Dean Witter. Kazacos lives in a $1 million house with an elevator on nearby Lake Conesus, where he has hosted lavish July 4 fireworks displays. He also owns investment properties, including two on Sanibel Island, Fla., worth a combined $1.69 million, and an $877,800 condo in Hilton Head Island, S.C.
Losing Clients to Kazacos
Morgan Stanley's Rochester branch impressed clients. Kazacos' corner office on the 10th floor of the all-glass First Federal Plaza building had a panoramic view of downtown Rochester and the Genesee River. Kazacos' credentials, including a framed award for being a top broker, were displayed prominently, clients say. In an arbitration hearing, Kazacos said he was the firm's top producer in the U.S. for mutual funds and annuities in 1999. "You'd look at this guy, and you'd think he must be really good at what he does," says ex-Kodak employee John Romano, a plaintiff in the suit.
Kazacos' sales pitch was difficult for other advisers to match. Mark Congdon of the advisory firm Horizon Group remembers losing prospective clients to Kazacos for years. For most people in retirement, Congdon would put 10 years' of living expenses into safe investments and allow them to take out no more than 4% a year from their accounts. "It was amazing how many people ended up telling me they're going with Mike Kazacos," says Congdon. "One of the reasons was that I wasn't allowing them to withdraw enough."
According to the lawsuit and interviews with former colleagues and customers, Kazacos' financial maneuvering was more aggressive. These people say his strategy seems to have boiled down to one goal: moving money into and out of various accounts to generate maximum fees. Kazacos would start by putting their money into Morgan Stanley mutual funds, which were among the industry's most expensive. After this, say clients, Kazacos would move assets out of the Morgan Stanley funds and into a variable annuity that owned Morgan funds, which had a 5% or greater commission. According to former colleagues, Kazacos was chummy with the salesman of that product, inviting him to his lake house.
Next, say clients, Kazacos would typically shift assets out of the annuity and into Morgan Stanley's Portfolio Architect, a managed-account program that charges clients 1.5% on top of the standard mutual fund fees. At each step Kazacos collected commissions and fees. Gourevitch, his lawyer, says the strategy was solid, allocating money in a balanced way through diversified stock and bond funds. The attorney denies that Kazacos moved assets into the managed account program.
A former employee at the Rochester branch says Kazacos may have made investment moves without clients' permission. Toni Liversage, Kazacos' sales assistant from 1993-96, was in charge of supplying brokers with investment order forms. Liversage claims she saw Kazacos sign clients' names on documents, which is against FINRA rules. Liversage says that when she raised concerns with the branch manager, Miller, she was told to "mind your own business." Morgan Stanley declined to comment on the allegations. Kazacos' attorney calls them "utterly false." Miller's attorney, Howard R. Elisofon at Herrick Feinstein, says: "Not only is it untrue, but to my knowledge no customer has ever made such an allegation."
A few years ago, some of Kazacos' clients began to notice that their account balances were falling quickly. Bob Geter, an ex-Kodak sales manager, had been lured by Kazacos' promise of double-digit returns. The father of two retired at 58 in 1996 with a $315,489 nestegg. Geter says he called Kazacos in 2005 after his balance plunged. "He told me to have confidence and said he didn't get where he was by not knowing what he was doing," says Geter.
Geter decided to do the calculations himself, and his numbers showed the account would run dry within two years. He says he then started calling Kazacos more frequently but was passed off to one of the broker's sons, who also worked in the office and who told him to get a job. In an arbitration case in which similar allegations were made, Kazacos said in a 2002 hearing: "I tried to respond the best that I could to remedy their concerns, to ease their concerns; and every time they called, I was there."
One Sunday morning, Rochester attorney Robert J. Pearl was on the radio talking about investors' rights. After the show, he received a call from a client of Kazacos who had grown worried about his diminishing account balance. Word spread that Pearl had taken the case of the former Kodak employee, and soon the attorney was deluged with calls. By February, Pearl had filed four arbitration claims with regulators on behalf of roughly 40 clients from Kodak and Xerox. According to public records, Morgan Stanley has paid out more than $2.5 million on those claims against Kazacos and Isabella.
Disgruntled customers continued to come forth, forming the basis for the lawsuits in January. At Kazacos' urging, Romano, an industrial hygienist, had retired in 1995, handing the broker $169,218 to manage; nine years later the balance had dropped to $57,787. It was much the same for Stephen Skuza, a former Sears repairman who has taken a part-time delivery job at Auto�Zone (AZO) now that he has only $35,000 in his account, down from $189,684. "Kazacos put us in a big hole," he says.
Now some clients from the Rochester branch are turning to other local financial firms for help. But building trust with these customers has been difficult. Congdon, who lost business to Kazacos, says he can offer little solace now: "Once I looked at the devastation, I said 'I can't help you. But a resume writer can, because you're going back to work.'"
Business Exchange related topics:Baby Boomer RetirementRetirement StrategiesFinancial Advisers
"Ruined by 401(k) Predators" (Special Report, July 14 & 21) misstated the amount of money expected to shift from pension funds and 401(k) accounts into the hands of new retirees. Roughly $5.1 trillion will change hands by 2011, according to Financial Research Corp. Some $20 trillion will roll over by 2046, according to Morgan Stanley (MS).