Beware the Registered Investment Adviser

RIAs must put clients’ interests first, but don’t always do so

Arnold and Cheryl Levy were a year away from retiring in the summer of 2009 when their investment adviser bought into a fund betting on a drop in emerging markets with almost $200,000 of Arnold’s retirement money. The Levys were coping with a family illness and didn’t notice the trade until that December, when the adviser, Jeffrey Liskov, alerted them to losses on the fund, the Levys say. According to court filings, they lost about $85,000 on the ProShares UltraShort MSCI Emerging Markets exchange-traded fund. “We were just beside ourselves,” says Cheryl, 67.

Liskov’s firm was a registered investment adviser, a category of company that has been billed as an alternative to traditional brokers. In theory, RIAs, which employ 285,000 advisers, are legally bound to put their clients’ interests first and typically charge fees instead of commissions. By contrast, most broker-dealers charge a commission, and the standards they must adhere to are less stringent; brokers are required to ensure that investments are “suitable” for customers, but they’re not under any obligation to put a client’s financial interests ahead of their own.

In practice, the RIA industry offers few protections for investors. More than 10 percent of the 11,700 RIAs registered with the Securities and Exchange Commission report they have been the subject of disciplinary actions ranging from lying on registration forms to felony convictions, according to SEC data and the Sunlight Foundation, a nonprofit research group. 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,” says Sheryl Garrett, founder of a group of RIAs called the Garrett Planning Network.

From 2007 through 2010, independent RIAs gathered an additional 2 percent share of the $13.5 trillion wealth-management market, according to Aite Group, a research firm. That brought their total to about 11 percent, or $1.6 trillion, while the largest full-service brokerages lost about 3 percent. The industry gained new attention in January, when the SEC 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,” says Andrew Stoltmann, a Chicago securities lawyer.

RIAs are not required to disclose their performance history to prospective clients, and many decline to volunteer it. “Most advisers are going to say, ‘We customize the portfolio to you, so we don’t have a composite of returns to show you,’” says Kristi Kuechler, former president of the Institute for Private Investors, a group of high-net-worth investors.

Many advisers include clauses in their contracts that require disagreements to be settled through arbitration. Filing an arbitration claim can cost anywhere from $775 to $8,200 on claims up to $5 million, and subsequent fees can top $70,000, according to C. Thomas Mason, a securities lawyer in Tucson. The costs are “an enormous deterrent” to pursuing claims against RIAs, Mason says.

The Levys sued Liskov in August 2010. They claim in legal filings that they lost a total of $149,000 on investments made by Liskov, to whom they had granted the authority to buy and sell securities on their behalf. Arnold, who works for a car dealership, has delayed retirement in part because of the losses. Cheryl lost her job as an administrative assistant in April and is unemployed.

Liskov filed for bankruptcy in February, which halted the progress of the lawsuit. Arnold Levy says he decided not to pursue the case in part because the IRS placed a tax lien on Liskov’s home. Levy’s attorney warned him that paying off the IRS could deplete Liskov’s assets, potentially leaving nothing to satisfy other claims.

In court filings, Liskov has said he left the Levys a voice mail in July 2009 telling them about the purchase of the emerging markets fund. That means they should have been aware of the risks, says Albert Zabin, one of his attorneys. Liskov is no longer registered with the SEC. The agency filed a civil complaint against him on Sept. 8 alleging that he engaged in fraudulent or deceptive conduct such as making unauthorized foreign-exchange investments that led to millions of dollars in losses for clients.

Ordinary brokers must meet capital requirements that vary based on the size of their business and the type of trading they do. “If a large brokerage firm defrauds you, at least they have the money to pay you back,” says Brian N. Smiley, an Atlanta securities lawyer. RIAs overseen by the SEC, by contrast, have no net capital requirements, the agency says. Brokers who don’t pay arbitration awards “get their registration suspended,” says Jane L. Stafford, a securities lawyer in Kansas City, Mo. If advisers don’t pay, they “may have to disclose that they have an unsatisfied judgment against them, but it’s not an automatic shutdown.”


    The bottom line: The 11,000-plus U.S. RIAs now manage $1.6 trillion, but there’s little evidence they are safer than brokers.

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