Wall Street V. Main Street Podcast – Episode 8 – Client Questions

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 answers questions he’s received from clients. Should I go to cash? Why is China’s slowdown hurting our economy? What investment recommendations made by my financial advisor should I be on the lookout for?

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 FINRA arbitration claims against their brokerage firms and throughout this show Mr. White will shine a light on some of the tricks of the brokerage industry while also providing valuable information for investors on how to successfully navigate the investor/ financial advisor relationship.

Dax: Welcome everyone you’re listening to Wall Street versus Main Street. I’m your host Dax White. As we indicated in our lead in, this is a different take on the investment show, I’m not a licensed professional to sell securities, instead I’m a securities attorney who represents investors and claims against brokerage firms. The objective here is not to provide investment advice but rather to arm investors with information that I think based on my years of doing this, would be important for investors to have, to even the playing field and make them more aware of some the tricks the brokerage industry uses to get you into products that maybe don’t make sense for you. So each week will try to dive into some various different topics, to pass along that information and go through some of the things that maybe are happening in the market and how that might impact recommendations that you will see from your financial advisor, things to be on the lookout for and hopefully we’ll be able to pass along some of that information. If you have questions, please visit our website. It’s at WallStreetVMainstreet.com, send us a question and maybe we’ll try to answer it in a future episode. We’ve got some questions this week which were about to dive into. These are questions that I’ve actually heard from existing clients who we’re helping in cases against their brokerage firm and they’ve just come up and I’ve jotted them down. But we would love to hear from you, we would love to get some questions to the websites, so that we can tackle those in future episodes. What’s our first question?

Producer: I’ve been watching all the wild swings in the market recently and I’m scared that it’s going to be like 2008 again. I called my broker and asked him to go to cash but he convinced me to stay the course, and that everything would be fine. Should I listen to him?

Dax: It depends and maybe that’s the best lawyer answer that you’ll ever get. It always depends, but part of that’s an investment question. I don’t know if the markets will go up or down, if I did I probably would just be playing the market, not helping investors. What I think is significant about that is to let investors know that financial advisors always say this. I’ve been through two market corrections thus far in my career, 2001 which is the.com crash, and then 2008 which is obviously the great recession. And in virtually every instance you’ve got clients who said, “Hey I told him I want to get out of the market, and he said, or she said, “No, you gotta stay in, everything will be fine” and the reality is, depending on your time horizon, maybe that’s the right advice. We’ve certainly had corrections through the course of time but generally speaking, the stock market does go up. So if your time horizon, I’m in my 30s, I don’t plan to retire for 30 years, I probably should stay in the market, because the difficulty is timing the bottom. Timing the market is virtually impossible, so, when do you go out, and when do you go back in, if you’d gone to cash in 2008 and waited until 2011 to go back in, you missed it. The market recovered, and you wouldn’t have captured that, and you would have sold at the bottom. And that’s the kind of thing you are going to hear from a financial advisor and again and the answer really depends on your objectives and where you’re at. If you’re 75 years old and can’t really afford any risk than maybe number one, maybe you shouldn’t be in the market in the first place. But if your broker’s got you in the market you’re scared that you’re going to drop down to a point were now you can’t really live on your investments then maybe cash does make some sense.

But more importantly maybe it’s time to reevaluate the portfolio in general because maybe you shouldn’t be exposed to that kind of risk. But in terms of the broker saying, “Hey, stay the course, everything is going to be fine.” That is going to be their stock response and frankly they’re trained to do that, and there’s a reason behind it. Number one is what we just talked about which is generally speaking, that may not be the worst advice. It depends on what your objectives are, but the larger part is they don’t make any money if you’re in cash. And so you have to have that in the back of your mind when you’re deciding when your broker saying “No, stay the course, stay the course,” you gotta parse through it and figure out is that the right advice for me or the right advice for them. Because if you go to cash and you just sit there and you’re not trading, you’re not investing and you’re not doing anything. They’re not making any money off of you. So that’s part of why they might be saying “No, stay the course, stay the course,” but the other part, and in fairness to them, it that really depends on what your time horizon is, because again, if your time horizon is 30 years, if you go out of the market and it bounces back and you don’t capture that, you’re going to be way behind. There’s analysis of that, that talk about how that can negatively impact the performance of your portfolio over a 30 year period of time and so going back to my original response, it depends. It really depends on your investment objectives, but what I want investors to know is sort of you have to keep in mind is, what’s the financial advisor’s motivation. Why are they saying that and the motivation is they need you in the market. That’s how they make money. But in terms of whether that’s right advice for you that depends on your particular situation. So what’s our second question?

Producer: I keep hearing in the news that China’s economy is slowing down but why would that affect my investments since I only invest in US-based companies?

Dax: This was particularly timely just because of the dip that we’ve seen over the last couple weeks. We did have the markets enter into a correction territory. A correction is anytime the markets dip down 10% from their peak and so the market peaked earlier in the year and we’ve seen sort of this range it’s been trading in. But more recently it did dip 10% from the peak, both in the Dow and in the S&P. And so it did enter into a correction zone and part of that is because of the craziness that is going on in the China market where they’ve had an enormous explosion in their index, and then over the last couple months, an enormous correction, and that has finally filtered over to the US market. But it not only has to do with what’s going on with their stock market so much as what’s going on with their economy.

I think the reason that you saw that affect US-based companies here is because China is a huge driver of the global economy right now and certainly is one of the few growth countries. So if their economy slows below expectations you are going to see that predominate throughout the entire global market. The reality is it’s a shrinking world and very few companies don’t have some China exposure. The largest of our Dow companies or S&P companies are all trying to capture that growth market in China. Look at Apple, Apple has a huge market share in the United States where are they going to grow, they want to grow by capturing the middle class that’s coming out in China right now and selling them iPhones. If the China economy slows down significantly you’re going to have fewer people who are in a position to buy iPhones and that’s going to hurt their bottom line. And you’ve seen that in their price. I think it was around $126 a share in mid August and now today it’s trading substantially below that. And that’s part of the reason, you got these companies, the world more interconnected, and it’s more difficult to say, “Hey, I’m a US-based company, and the US economy is doing great, there’s no signals of slowdown here, why is my stock price down?” The reality is most companies are trying to sell stuff in China or maybe they get goods from China or maybe collaterally there’s going to be some impact and so that’s why you’ve seen it impact our economy. But at the end of the day it seems like the US economy is doing well and relatively speaking China markets down 30-40%, so for us to enter into correction mode which is just 10%, is still better than how they’re doing. What’s our third question?

Producer: What product should I be concerned about if my broker is recommending it?

Dax: Generally every investment has a time and place. So I can’t just say, “Hey, its variable annuities.” If your guy is selling you variable annuities then that’s wrong. Or non-traded REIT or private placements or some of the types of investments that we see. Because there is a time and a place for every investment so let’s say variable annuity being an example, a broker wants to sell you a variable annuity you’ve got a $2 million portfolio and they want you to do a hundred thousand dollars investment in variable annuity because it’ll provide a death benefit that will be able to pay for funeral costs. That might be a great idea. That might be exactly what you need. Because you don’t want to have to worry about your spouse dealing with that or coming up with the money or maybe there be some tax implications of drawing it out of a different account. So that can make complete sense. Whereas if the same situation, same investor, $2 million portfolio, now you got a financial advisor that says, “Hey let’s put your entire $2 million in a variable annuity,” that may not make any sense. That might be a huge over concentration maybe they’re doing it because variable annuities do pay a higher commission than some products. That would be a situation where there are some red flags there and I’d want to peel the onion further to figure out what that recommendation makes sense.

So again, generally it depends on what your situation is and how much of the portfolio it is, but in terms of take away, what are the red flags, what should you be looking for? What I would say is anything that sounds too good to be true. If you’ve got advisor in this climate where there is very little yield who’s trying to sell you a bond that pays 9% and he’s telling you it’s conservative, he’s wrong. Treasuries are paying 2%; corporate bonds are paying like three. The reality is, if you’re somebody who’s trying to sell debt to raise money you want to pay the lowest rate possible. And if you’re paying 9% it’s because no one would buy it at eight or 7or at 6. You have to keep raising the rate until someone is willing to buy it. And usually the reason for that is because you’re seen as more of a default risk. Which is why treasuries are at two. That’s like the gold standard, we’ve never defaulted on our debt and that’s why people are willing to take a lower yield to hold that investment. So if you’ve got advisor is saying, “hey I got this great product, it’s paying 9%, no risk, it’s just like treasuries, it’s just like CDs,” whatever the representation might be – That’s too good to be true. And that’s not a specific investment per se but that’s something that you should be worried about. If they’ve got something where it’s a promissory note backed by this and it pays 10% whatever, again, if it sounds too good to be true, then generally speaking is. That’s what you should be worried about if your advisors recommending something. The other thing to watch out for or any of the investments that are high commission because you just get into the inherent conflict of interest where a financial advisor might be recommending it because it’s in their best interest as opposed to yours. While there is a time and place for virtually every product, that to me is a red flag and that’s usually what we’re seeing are cases where the broker over-concentrated a portfolio and a product that paid them between five and 7% when there were other alternatives that would’ve been equally as suitable or even more suitable for them, that would’ve paid the advisor a much lower commission. Some of those products are private placements, non-traded REITs, oil and gas limited partnerships, tenant in common, which are real estate deals, variable annuities which I mentioned, or variable universal life policies, those are usually in the 3 to 4% range, that’s a little bit lower, but we definitely see advisors who recommend those inappropriately. So you have to be careful with those, but mostly you just have to keep in mind that there is a direct correlation between risk and return in investments.

If your advisor is telling you, we’re going to make 15% and they’re saying there is no risk, that’s a disconnect. That’s impossible. If you’ve got a huge rate of return than you’re probably accepting more risk and maybe that’s okay with you and that’s different. But if you’re a conservative investor and your advisor saying, “Hey, this is super conservative and also pays 15%,” that doesn’t make any sense. That’s something that you should be on the lookout. I mentioned earlier and in terms of an example, what we’re seeing a lot of right now with debt for oil companies, we’ve got the fracking companies in North Dakota and Colorado and Texas and a lot of them funded their operations through bond offerings and they’re paying 8 ½, 9, 9 and a half percent, and obviously with oil prices where they are right now they’re at a great risk of default. Which is part of the reason they had to pay that huge percentage. But certainly if there is an investor out there who was looking for some yield and yield’s hard to find right now. If you’re a retired investor you know it. Maybe you’re retired and you wanted 4% on your money, that’s very difficult to find without some risk right now. But if your advisor calls and says “hey, I have these great bonds, you know it’s this oil gas company and they’ve got great drilling rights and it pays nine a half percent, very conservative.” It’s not. A lot of those companies are going to end up defaulting, you’re going to see a lot of mergers and acquisitions I think in the oil and gas base coming up here because not a lot of these companies can make it. The banks are getting ready to reevaluate their loans I think October 1 is the deadline for that. A lot of them are going to get squeezed and in my experience when you see companies declare bankruptcy the ones who usually take it on the chin are the bondholders and pensions. So that’s something that would be of concern but again it all harkens back to the main point which is, if it sounds too good to be true it is. If you’ve got a bond that’s paying five times treasuries, in an environment where there is little to no yield, it’s not conservative. So just keep those things in mind. I think that’s all the time we have for questions. We’re going to cut to a break with some commercials here. When we come back we’re going to dive into some more war stories, types of cases that we’ve seen in our practice, to give you some idea of red flags, things to be on lookout for.

Welcome back to Wall Street versus Main Street, a different take on the investment show, I’m your host Dax White. I’m a securities attorney, we represent investors and claims against brokerage firms so the objective of the show is not to give investment advice but rather to provide my background, things that I’ve seen in the industry that I wish investors knew before they embarked in a relationship with a financial advisor. Before the break we did some questions, and in this segment we’re going to talk about some war stories, things that I’ve seen, just to provide some color on the type of stuff that’s out there. Yet again, the brokerage industry is not unlike any other industry where you got good ones and bad ones. And unfortunately we see the bad ones, but certainly if all investors had the information that we had, I think that you’d have situations where as soon as you realize that your broker is making recommendations inappropriate you could shut it down, fire him, and hire somebody else. So the types of cases that we generally deal with, we talked a little bit with that last question before the break, generally has to do with this nexus between commissions and greed where you’ve got a financial advisor with a very short-term model, where they try to make a huge upfront commission that is in their best interest but not necessarily in the best interest of the client. And usually that is sort of the motivation and then from there you get into various types of products and different goals of what they’re trying to accomplish, but that’s usually the nexus of it. And whether it’s negligence in terms of the portfolio that’s set up or outright fraud depends on the particular case and that particular broker, but usually commissions is at the heart. There’s a huge range in terms of the types of products that a financial advisor can sell. All the way from bonds where they can make a couple hundred bucks to private placements where they can make thousands and thousands of dollars. If you’ve got a financial advisor whose a bad financial advisor, whose looking out for himself first and foremost that’s usually where they are going to steer you to, they are going to steer you to the highest commission product out there, and tell you that “all this is great, suitable for you and is going to do wonderful.” And maybe they hope it will. But the underlying problem is that conflict of interest that they have in making a recommendation that pays them more.

In terms of war stories, one that I think about a lot because we had a number of clients involved in the situation was a financial advisor up in Michigan a couple of years ago. He went into a large Fortune 500 company and convinced, we had about 20 – 30 investors that fell into this category, but he convinced all of them to take their lump sum pension benefits rather than a pension for life that would’ve paid them monthly. Convinced them to take the lump sum. I think the pension benefits were to pay them between 5 and 6% of what the lump was for life. So they would’ve gotten, depends on how long they had been with the company, etc. But let’s say it was $1,500 a month for as long as they would live. Rather than do that he convinced them to take a lump sum and “I’ll put you in a variable annuity that’ll pay a 6%.” So slightly more, a little bit more bang for your buck, so you have a better quality of life in retirement. He got a ton of investors, we represented between 20 and 30, I don’t remember the exact number, but there are undoubtedly more of them out there, but he convinced all these people to do that by this variable annuity that unfortunately did not do what he said it did.

His representation to the investors was that it would pay a guaranteed income stream and while some variable annuities do have that feature, it’s a specific rider that you have to purchase and it’s very expensive because from the insurance company standpoint if they’re required to pay this out every month, the markets not always going up, so in a downward market they have to factor that in, in terms of costs, but for this particular individual, none of the investors purchased that rider. Instead the feature that he sold them on, he told them it was a guaranteed income feature but the reality is what it was is a guaranteed growth on a death benefit. Which is entirely different, so if you invest $500,000 into a variable annuity and it had a guaranteed death benefit increase of 6% that means that in year two, if you passed away, you’d have $530,000 guaranteed. But that is not what these people needed. They were retiring and planning on living on this lump sum. The reason the feature didn’t work is because that only paid on a death benefit but if you were withdrawing from the annuity that eroded the death benefit feature, they are never going to see that, which didn’t really matter to these people because what they needed was income to live on.

And so basically they eroded their policies and by year four or five they were worthless. And they thought throughout this time period that what they were spending was the growth that he promised them. Again if you got a $500,000 annuity and you think that you’re getting guaranteed 6% then you can comfortably spend $30,000 year and think you’ve still got the 500, when in reality what they had was 470 minus, in a time period in the market when the market was actually going down. The underlying investments in the annuity were going down and so it was substantially less, and they’d call him and he’d say, “Let me talk to the annuity company, get that worked out, there’s a problem,” but he led these people to believe this for a long time. And unfortunately you had a lot of people who were losing their homes, unable to pay bills, living on Social Security only. It was a very sad situation. But that’s the kind of stuff we see. We’re running out of time, so I’m going to wrap it up there. If you’ve got questions or you just want to touch base, check us out at Wall Street V MainStreet.com.

Producer: You’ve been listening to Wall Street versus Main Street and the views expressed by the participants of the program are their own and do not represent the views of nor are they endorsed by the White Law Group, its officers, directors, employees, agents, representatives, shareholders, nor any of its subsidiaries. None of the content should be considered legal advice. As always consult a lawyer.

This transcription has been created by Dragon Software. There may be grammatical or translation errors. For clarification, listen to Episode 8.