Wall Street V. Main Street Podcast – Episode 2 with James P. Galvin Esq.

The following is a transcription of a recent episode of Wall Street vs. Main Street,  a radio show hosted by the firm’s managing partner D. Daxton White.

In this episode, Mr. White discusses variable annuities, the troubling situation brewing in Puerto Rico as well as what has been going on in the oil industry. Special guest and former financial advisor, James P. Galvin,  visits the show to share his perspective on the broker client relationship.

Episode 2 Transcript:

Producer: Welcome to Wall Street versus Main Street; A different take on the investment show. With our host, Dax White. Dax White is the managing partner of the White Law Group, a national securities, fraud securities, arbitration, and investor protection law firm. With offices in Chicago Illinois, and Vero Beach Florida. The White Law group has represented hundreds of investors in the FINRA arbitration claims against their brokerage firms, and through this show, Mr. White will shine a light on some of the tricks of the brokerage industry, and provide valuable information to investors on how to successfully navigate the investor financial advisor relationship.

Dax: Welcome to Wall Street versus Main Street. I’m your host Dax White and we’re here doing a different take on an investment show. I am not going to give advice. I’m not a licensed professional. I am a securities attorney and I do deal with the issues of the brokerage industry every day. The objective of the show is not to now say, hey buy XYZ stock, instead my goal is to provide information that I think would be important to investors so that you can protect yourself and sort of even the playing field between Wall Street and Main Street because unfortunately we see it all the time where unsophisticated investors are taken advantage of by a sophisticated financial professional and there’s just information that I wish that investors had had before they got involved with that person.

So without any further delay I will jump into some questions. These are questions that I’ve put together because we’re new show. But feel free to send us questions to our website and we’ll try to answer those in a future show. What’s our first question?

Producer: My broker recommended I invest in a variable annuity but I don’t know what that is or whether it’s a good idea?

Dax: Okay, variable annuities are an insurance product but unlike a term life or whole life or anything like that there’s an investment component that goes into it. Obviously I can’t speak on whether or not a variable annuity in the abstract is a good or bad idea but there certainly are some questions that would come to my mind in terms of a recommendation to buy a variable annuity. The basic functions of a variable annuity are again you’ve got this insurance component, you’re going to get a death benefit at some point once you pass away. So that’s your first logical question, do we need a death benefit? Do we need insurance? Because a lot of times what I see with a variable annuity is a financial advisor who, when the client wanted to invest in stocks and wanted some growth, and they say “hey buy an annuity because we can do that in the subaccounts,” and while that’s true, the reality is that if that’s your sole objective is to have a growth portfolio you can accomplish that much cheaper than with a variable annuity. A variable annuity, not unlike a lot of insurance products, is very expensive. There’s a lot of charges that go into it. There is usually a 4% commission to the broker, which in my experience may be the motivation why they’re saying hey let’s do a variable annuity as opposed to an ETF, which has the basis points of about 0.1%. We’re talking 400% versus 0.1%. So again it has to do with your goals. If insurance is an important thing to you then a variable annuity can certainly have its time or place. But that’s the big question, do we need insurance? From there the other things would be, do we need liquidity? You know that there’s a time and place for virtually every investment, certainly there’s a time and place for variable annuities, but where we see problems is when it’s a huge percentage of somebody’s portfolio. If you’re somebody who’s worth $1 million and you’re retired and are needing $40-$50,000 a year in income and a broker recommends that you put all of your money in a variable annuity that’s probably going to become a problem. Because at some point, maybe a year, maybe five years maybe even 10 years down the road maybe you got a health issue, maybe you got to help out a family member, maybe… whatever it is that you suddenly need access to your money and you can’t get to it because there are huge surrender charges on annuities. They taper over time, it’s usually between seven and nine years, but if there’s some health event in the first three years for example, of your owning a variable annuity and it’s all of your money you’re gonna have to pay huge penalties to get at your money and that could be a problem. Again, if it’s a huge chunk of your money and that’s the recommendation and you’re concerned about liquidity than an annuity might not be the right place for you. But if it’s a small percentage of your portfolio and your desire is to have that death benefit, whether it’s to pay for funeral expenses or to leave some money to an heir than maybe there’s a place for the annuity. But again the questions you need to be asking are, how is this appropriate given my objectives? Talk to them about the costs because with annuities there’s definitely a high expense ratio there. Talk to them about liquidity, talk to them about alternatives. Broker’s obligation is to make a suitable investment, and that doesn’t mean that the investment has to be in your best interest necessarily, it just has to be suitable for you. And lots of things can be suitable for you but they don’t necessarily all have to be in your best interest, so keep that in mind when you’re dealing with your advisor. Keep in mind that they are in sales. Their job is to sell products and annuities are a very popular product in the brokerage industry, frankly because they make a lot of money on annuities. So again those are the things that I would ask if somebody was recommending that you buy a variable annuity.

Producer: I’ve read a lot of bad things about annuities so are there situations when they can be good?

Dax: Absolutely, every investment has pros and cons and certainly annuities have pros and they primarily have to do with that death benefit, the insurance component. There’s also some guaranteed riders that you can purchase that can get you an income stream for life. Those are usually very expensive features of an annuity so be very careful there because…Here’s the big problem with annuities they’re complex, even for me, and I deal with these things all the time. I’ll read through these contracts and it takes me a while to really figure out the features are and so what ends up happening is that you have financial advisors, they run into the same problems and they might read the contract and tell you features that don’t actually exist. We’ve had a number of cases where the financial advisor said that this annuity I’m selling you is going to pay you income for life and that wasn’t true. He didn’t buy that rider. It provided an increase in their death benefit for life so the death benefit in year one was $100,000 and it had a 7% increase and in year two the death benefit was $107,000. But for a lot of people when they’re buying annuities for income the death benefit is the least important feature they wanted that income component. And again I’ve seen where brokers just drop the ball and then they tell the client that’s what they’re getting when they’re not. but if that’s what you really want that is another probe for annuities. You’ve just got to make sure you get the right features, read that contract, and go through it with the financial advisor. They are making plenty of money by selling you that annuity, they’ve got the time and if they’re not willing to walk you through, it answer your questions than you’re with the wrong person anyway.

Producer: So the difference between a fixed annuity and a variable annuity is?

Dax: A huge difference and they all have to do with risk. A fixed annuity literally guarantees you a return. It’s going to be a smaller return than a variable annuity. The sales job on a variable annuity is that you’ve got this upside growth potential that comes from the subaccounts but that also comes with risk just like any other investment. The subaccounts are generally in mutual funds or stocks or bonds and so what you are doing with the variable annuities you are giving yourself the opportunity for some growth but you’re of course taking on the same risks that you would in anything else. Fixed annuities are different. They are not investing the subaccount. That’s literally insurance company saying we are going to give you the following income for life and then you just have to look at the features of the product and figure out what you’re actually getting. They’re all different but in terms of how they operate it’s incredibly different. We don’t see fixed annuity the cases because we don’t have clients losing money in them. We do see variable annuity cases because again you have financial advisors who misstate the features. They get people trapped in an investment where they can’t get their money out. You have subaccounts that are aggressively invested, they lose money and now here we are stuck with an annuity, and all we really needed was some income that we can’t get.

Producer: Would you give instructions on how people can send in questions?

Dax: Sure. You can visit our website and there’s a contact button on their. Just fill out the contact form and send in a question and hopefully we will add that in future weeks.

The next thing I want to touch on is a news topic. Sort of what’s going on in the world right now and something I wish investors were paying more attention to. A lot of people heard about what’s going on in Greece and certainly the market was impacted over the last month or so because of what’s happening there and weather they will default on the debt, will they not. But there’s actually something that’s happening even closer to home and much scarier, at least to me, and that’s the situation in Puerto Rico. Puerto Rico is having the same problems with insurmountable debt and an inability to pay it. I think American investors at least are far more exposed to that risk than they are to Greece. But you don’t you hear a lot of people talking about it. We’ve got cases involving it already. It sort of started to unravel about a year ago involving some UBS products. But there’s more exposure there. That has to do with some of the things that are going on now, some of the municipal bonds and part a problem, although I don’t know that it is a problem, but this is sort of what is going to create outcome, is that Puerto Rico can’t, unlike Detroit, that declared bankruptcy, Puerto Rico can’t declare bankruptcy. So they can’t discharge debt, they can’t restructure debt they got to pay it and they can’t. So you’re either going to end up in a situation where the rules change or it’s going to be litigated in courts for years. But the debtholders are going to be the ones left holding the bag as is often the case. The debtholders in this case are a lot of huge bond funds. Bond funds that were trying to maximize return for investors and so now they’ve got portfolios that are a little over concentrated in Puerto Rico because Puerto Rico as the situation got worse there, they had to increase their yield. So instead of paying 4- 5% maybe Puerto Rican debts paying 6-7% and so you got bond fund advisors saying “okay, how can we increase our return so we look more attractive than the other hundred bond funds out there” and that’s what a lot of them have done is over concentrated their debt in their ownership of Puerto Rican debt. Frankly, if you’re owning one of those funds you’re at risk that that debt will pay off poorly. The ones that we’ve seen have to do with… there’s a lot of Oppenheimer funds that are in this situation, the Oppenheimer Rochester fund, there’s various state issues of them. They’ve got high concentrations of Puerto Rican debt and it’s not 50%, it’s more like probably 5 to 10%. But if you’re owning a bond fund your objective is to make a nice little return without losing any money, so you can be real shocked when there’s a correction there of any kind. Even if the exposure is 5 to 10% that’s probably more risk than you are willing to take on when you bought that investment. Some other ones that we’ve seen that have that concentration problem: Main Street high-yield, excuse me, Main Stay High-Yield Municipal Fund, Alpine High-Yield Municipal Duration Fund and the Franklin Double Tax Free Income Fund. Those are some bond funds that we’ve seen through our research that may have more Puerto Rican debt than they need. That’s something that I would caution investors on in terms of what’s happening in the world right now. You know generally speaking I would tell people, don’t chase yield. There is always a correlation between risk and return. You know, if you’ve got a bond fund that’s paying 1 to 2% more than most, there’s a reason. In this case that’s what we’re seeing again, we don’t have clients that are calling as yet because they haven’t lost the money yet. But I’m concerned because I see the writing on the wall and I think in the future that may become a problem. That’s the news of the week, something to keep in mind.

Dax: Welcome back. The next topic I want to talk about, again the goal here is to arm the public with information to help them in something that we see a lot in our practice is some confusion on what is the financial advisor’s obligation to clients. Because most clients that we speak with believe that the financial advisor has a fiduciary duty to them. And while that can be the case in some situations generally it’s certainly not. I can tell you the brokerage firms fight that tooth and nail in arbitration hearings and argue that they have no fiduciary duty to clients. There’s this disconnect between the advertisements you see on TV, where they say trust us and we got this huge track record and give us all your life savings and the obligation that they actually believe they have to clients and the standard they believe they have is what’s called a suitability standard. Essentially what they would argue is that their obligation is to make an investment that is suitable for you based on your investment objectives, your income, your net worth, your assets and your investment experience and as long as whatever they are recommending is suitable and falls in-line with those objectives they would argue that that’s where their obligations to you end. That can be very different than recommending something that is in your best interest because that’s what a fiduciary duty is. Fiduciary duty is literally to put the interest of your client ahead of your own. Unfortunately that can be a huge difference between suitability because they might say oh I found this mutual fund that I believe is suitable based on what they’re looking for and that mutual fund might pay them 1% more than another investment that’s actually better for them and more in their interests—that would be a fiduciary duty standard . That’s a huge problem that we see and it’s certainly information that investors need. Ask your financial advisor what’s your obligation to me? Do you have a fiduciary duty to me? Put it in writing. I want to make sure that if you’re recommending a product to me that it’s in my best interest and not in yours. Too often we see that the suitability standard can let people down. And it’s actually up for discussion in legislation right now, so perhaps the standard will change. I will tell you that I I’m doubtful. Unfortunately that has everything to do with big-money lobbyist. The brokerage firms are spending a lot of money to make sure that the new fiduciary duty rules don’t pass but if you’re concerned about it and you want to reach out to your congressman or congressperson I would absolutely suggest that you do that because I think they need to hear from people. Because if we could get a uniform fiduciary duty standard that’s more in line with clients’ expectations I think that can go a long way towards cleaning up the brokerage industry. Because again, too often we have clients who believed, my broker had fiduciary duty to me, I trusted them, they were looking out for me, and the standard is not necessarily that. What’s interesting to me from a practical standpoint, is again, brokerage industries will argue to the death that they have no fiduciary duty to you, but it’s actually one of the easier things at hearings for us to prove. I picked this up from a defense lawyer years ago, I really like this practice step, at the hearings we literally will ask the financial advisor, do you put your interests ahead of your clients? if they say yes, I mean that just makes them look terrible, because of course you’ve got arbitrators sitting there going “oh man, I can’t believe that they would do that,” and if they say no, which is typically how they testify, and they say they always put my clients interest ahead of their own. I literally slap the black law dictionary in front of them and asked them to read the definition of a fiduciary duty. Because that’s what it says, fiduciary is somebody who puts the interests of their clients ahead of their own. So if you just ask them it’s hard for them to testify otherwise. Their lawyer will get mad and say you’re asking them to make a legal conclusion. I say no, he’s simply testifying as to what he thought, whether or not he actually put their interest ahead of his own. So that’s sort of our practice tip or topic of the week, something I wish investors knew. Next, I’m going to bring on a guest to give their perspective on the brokerage industry. This is actually somebody from my office so he’s basically required to be here but his name’s James Galvin he’s a securities attorney, his background is that he worked at the University of Miami investors’ rights clinic which is funded by FINRA and they handled small and arbitration claims on behalf of investors. Claims that lawyers would not take on because of the size of the case. He also worked at the SEC but more importantly and more relevant to our discussion today, is that before he went to law school he was a financial advisor. So I thought it would be important or at least interesting to people to bring him on and get his perspective on working in the brokerage industry. Welcome James
James: Hey, how are you today?

Dax: Doing great. Tell me a little bit about your first year as a financial advisor, and let’s not talk about the firm because I don’t think that’s relevant. I certainly, having talked about this in the past think your experience is pretty consistent so I don’t think this is a firm problem, I think this is an industry problem. Tell me a little bit about that first year, how’d they have you find clients, what did they tell you to sell, etc.

James: First year is a pretty insane. It’s all about trying, are you going to make or are you not going to make it, so most of a club mentality. In order to make it, and basically by that I mean continue being employed there, you have to generate enough commissions to meet your quota. Really that involves getting in front of as many people as possible and you know selling products to them that are going to generate enough commission for you to stay employed. Typically your first year you’re not, you know, going to be picking your own product mix, it’s getting picked for you. That may or may not be a good thing because all your time is really spent trying to get clients and so they’re not really teaching you necessarily what the different products are, which ones are more appropriate for somebody versus another.

As far as getting clients it can be anything from, obviously they’re going to tell you to get all of your friends and family to come in, referrals from them, all the way to doing lunches where you just bring lunch to the offices and basically give a short spiel to everyone at the office and tell them what you do and get them to come in. Whenever they come to the meeting, you’re not the only one in there, your managers can go in there with you and he’s going to sell the products to them because again most people don’t know what they’re doing.

Dax: So tell me about that. Before they sent you out to these seminars what training did you have?

James: Really the majority of it is sales training. They’re going to teach you different ways to, you know, get in front of people. You’re going to memorize scripts, lots of scrips. There’s going to be the script that you’re going to use on the phone when you call someone for the first time. There’s going to be the script that you use when you go to do one of the lunches, or a script that you’ll use for the first meeting. There’s going to be a script for every single one of the products that you are going to be selling to them and it’s basically something that is written with the sole purpose of hitting on all the reasons why they would buy it from you. And you’re going to rehearse it over and over again.

Dax: You mentioned that you didn’t really make a lot of selection on the products that you would sell. What stuff did your firm have you selling?

James: Well everybody had to have some type of insurance. So basically everybody has a need for life insurance and disability insurance so whether or not that was the case or not that was what you were told to sell everybody. Variable annuities, real estate investment trusts, class A mutual fund shares, all the products that basically pay an upfront commission versus doing something like a fee-based account that takes a percentage of the assets over every year.

Dax: This is all to me that quota, cause again if you don’t sell enough you’re out.

James: Right, if you want to be one of the people to make it and have this life that they paint for you then you got to hit that quota

Dax: Okay, thanks James. Appreciate you coming on. Again, you’ve been listening to Wall Street versus Main Street where each week we try to shine light on some of the tricks of the brokerage industry and arm you with information that you need so you can have a better relationship with your financial advisor. For more information visit our website WallStreetversusMainStreet.com. We’ve got lots of resources there, information to help you. Thank you for listening.

Producer: The views expressed by the participants of this program are their own and do not represent the views of and not endorsed by the White Law Group, its officers, directors, employees, agents, representatives, shareholders, none of its subsidiaries, none of the content should be considered legal advice and as always consult a lawyer.

This transcription has been created by Dragon Software. There may be grammatical or translation errors.