Don’t Get Burned and Frozen


Variable Annuities:  Are they for you?

Mary got burned and frozen, all in in the same day. How could this happen? Here is Mary’s story:

Mary’s husband Jim had a high-paying job at a Fortune 500 Company. When he retired, his pension options were Lump Sum or Lifetime Annuity. He chose Lump Sum, and so they had a few million dollars in retirement funds to invest. He chose a financial adviser in Orange County without doing much research. This adviser was not a CFP®, not a fiduciary, not a fee-only adviser, and not even a college graduate. He was not registered with the Securities and Exchange Commission (SEC). The SEC requires companies to disclose important financial information through the registration of securities it sells. This adviser got an exemption and only had to register with the State.

You may be wondering “How do I find out things like these?” The answers are right in front of you when you sign the investment agreement with your adviser. It’s called an ADV form, which all Registered Investment Advisers are required to give you prior to a financial agreement. You can also look up an adviser on www.brokercheck.finra.org to find pertinent information, such as licenses, work history and a negative information like fines and suspensions.

If Jim had looked at the ADV, he would have discovered some additional “red flags”. For example:

  • This adviser was fined and suspended in 2012 for engaging in an unauthorized sale of securities.

  • This adviser charges a management fee of 2% of Assets managed, whereas the average fee is 1%.

  • This adviser puts his client’s money into Private Placement Offerings (PPOs), where the adviser himself is listed as the fund manager and receives a 2.5% management expense fee plus a share of fund profits. PPOs allow companies to raise money without regulatory oversight by the SEC. There is no prospectus to review, and investors can’t easily sell their stake in the company because there is no public exchange (e.g. NYSE). A PPO is often someone’s pipe dream. Don’t let it be your nightmare.

  • Clients’ accounts are held at an unknown custodial firm (unlike a Schwab or Fidelity), and if they did due diligence on the custodian, they would have found numerous complaints at the SEC and unjustified fees.

Suddenly, Jim died. Jim had handled most of the financial chores for the couple, and because the statements he was receiving from his adviser and from the custodian had shown his investments growing, he had stayed the course. Mary is a novice when it comes to investing, so she also stayed the course, trusting that her husband had the wisdom to protect and grow their retirement nest egg. Mary is a very sweet lady, and would periodically call the adviser to ask if she had enough in her accounts to give away money to her family and charities. She bought a brand-new luxury car. She took her extended family on a cruise. Life was good, until she got burned and frozen.

Mary’s world came crashing down when she was told that her adviser was being investigated for fraud, her accounts had significantly declined in value, and what was left in the accounts was frozen by the courts because her adviser filed for Chapter 11 bankruptcy. The lawyers told her she is unlikely to ever see any of her money, leaving her to survive on a Social Security paycheck.

What can you do to preclude getting burned and frozen?

  1. Perform due diligence when selecting an investment advisor.

  2. Read the ADV completely before signing an investment agreement.

  3. Understand your investments. Does it align with your goals and risk tolerance?

  4. Be comfortable where your money is being held. Custodians such as Schwab, Fidelity, Vanguard, and TD Ameritrade are all reputable custodians. If you’ve never heard of the custodian, it should be a red flag that your money may be at risk.

  5. Understand all the fees that will adversely affect your investment returns.

Mary’s story is truly sad. There are unscrupulous people in the world who will prey on others. With a healthy dose of skepticism, and a little due diligence, you can find that trusted adviser who will help you achieve your financial goals.

As President Reagan said, “trust but verify”.

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