When it comes to money, you want the most competent financial advisor to help you grow your assets and provide you with income, especially closer to retirement. However, hundreds of millions have been lost in recent years due to bad investment advice from greedy financial advisors who know full well that the products they promote are too risky for average investors. The best product for you may or may not be the one that earns you the most commission, I have seen many investors blindly trust their advisors and buy many low quality investment products that end up costing them a lot of money. It’s important to understand that just because something is unethical doesn’t mean it’s illegal, and current regulations don’t provide enough protection for you as an investor. Therefore, it is very important that you know the common tricks.
Some private bankers even broke the law to profit. Take the case of Kevin Wallace, a former Merrill Lynch private banker who provided financial advice to many Asian tycoons and their families in the late 1990s. Mr. Wallace is a Harvard Business School graduate, a high-profile banker. accused of unauthorized transactions and later sentenced to prison. The Singapore High Court found Mr. Wallace guilty of forging signatures and trading shares without the client’s permission. The incident was discovered by suspicious customers who complained to Merill Lynch that Mr. Wallace had told them there was no need to look at official bank documents because they were incorrect. Interestingly, none of the bank’s support functions, such as risk management, operations, compliance, and audit, were able to detect the fun business before customers filed a formal complaint that triggered a high-level investigation.
Wallace was asked to resign shortly after. Merrill Lynch later brought a case against him, and the judge ordered Mr. Wallace to make a US$25 million payment to the bank.
There are several common tricks financial advisors play:
Trick 1: Offer “free” financial advice
Good, experienced private bankers charge a service fee for careful research and analysis. They would carefully review the client’s financial goal, investment timing, risk tolerance, and family’s special needs before deciding if certain portfolio strategies are appropriate. They would also disclose any conflict of interest in the asset allocation process. However, most advisors you know are just salespeople who are paid by the number of financial products sold. I would say that around 60-70% of advisers fall into this category. Because they are not paid unless they are successful in selling certain types of products (often complex and risky derivatives), advisors would often recommend products that are not consistent with their overall investment objective. The “free” advice you received often turns out to be very expensive as your portfolio loses tens of thousands of dollars.
Trick 2: The Performance Bonus Trap
You should pay attention when your hedge fund managers tell you that you should feel comfortable letting them manage your money, since they “only get paid for performance.” For legitimate portfolio and hedge fund managers, your total compensation package consists of a fixed management fee and a performance bonus at the end of the year. While it may seem fair for managers to be paid solely based on the financial performance of the portfolios they manage, most investors don’t see the problem with the “pay only for performance” arrangement. After all, if a manager can’t meet a certain benchmark in terms of performance, they won’t get paid, that’s fair, right?
Wrong. Most investors do not understand that under this agreement, a very strong incentive is created for advisors and portfolio managers to invest in risky assets in the hope of higher returns. In order to fully maximize potential earnings, fund managers are likely to include many highly leveraged products, such as low-quality bonds and futures with high coupons and significant credit risk. In the end, investors take on much more unnecessary investment risk.
Trick 3: Misrepresent overall portfolio performance by ignoring funds that closed (survival bias)
Another common trick played by dodgy financial advisors is to misrepresent the overall performance of the portfolio. While it may be illegal in certain parts of the country to outright lie about performance, many advisers choose to present only hedge funds that are still surviving today, simply ignoring the ones that went out of business over the years.
Trick 4: Drop the name
It’s not uncommon for financial advisors to leave people’s names highly visible during a presentation, hoping to impress potential clients. However, it is extremely unethical for an advisor to do so. This is because confidentiality clauses in 99% of service agreements would have prohibited such disclosure. The name drop shows a lack of integrity.
