Misrepresentation, sloppy work dominate complaints against advisers

Bitter letters, caustic e-mails and desperate phone calls alleging misdeeds by registered investment advisers are up 37% in the wake of the dot-com crash, and one securities attorney says that’s just the “tip of the iceberg.”

The most frequent complaint accused advisers of misrepresenting an investment or its risk, followed by alleged foul-ups related mostly to sloppy paperwork, according to confidential SEC records that were made available to InvestmentNews under the Freedom of Information Act.

“Toward the end of this last bull market, the rats came out of the woodwork,” says Sacramento, Calif., securities lawyer Vincent DiCarlo, who runs the website InvestorRecovery.com. “You had all kinds of people setting up as financial planners, investment advisers and stockbrokers who didn’t know anything about investing.”

Poor communication

The Freedom of Information Act compels government agencies such as the Securities and Exchange Commission to release otherwise confidential data if it can be demonstrated that the public has an overriding interest in the information. The records in question cover a period from 1996 through the first quarter of 2001, spanning the tech boom and bust (See chart).

They contain both good news and bad news for RIAs.

Only a few hundred complaints per year, out of tens of thousands, were aimed at advisers. But the nature of the complaints suggests that advisers are performing poorly on something at the core of their profession – communicating with clients.

Most of the top 10 gripes were sales-practice related – investors accusing advisers of making unsuitable recommendations or false or misleading advertising.

For their part, SEC-regulated registered investment advisers – those with at least $25 million in assets under management – believe complaints are relatively few because their business is less prone to abuse.

“Compared certainly to the broker-dealer industry, the investment advisory profession has been relatively clean,” says David Tittsworth, executive director of the Investment Counsel Association of America, an RIA trade group in Washington.

“Even in hard times like the last 12 months, where the market has tanked pretty good, that still remains so,” he says.

The records bear that out, at least on the surface. Of 27,920 complaints filed with the SEC in 2000, 425 targeted RIAs, compared with 17,529 complaints in 1996, of which 310 were against RIAs. Complaints in 2000 were up by 59% over those filed five years earlier, while complaints against RIAs rose only 37%.

RIA complaints as a percentage of total complaints declined slightly over that time, to 1.5%, from 1.7%.

Nearly half of the complaints in 2000, about 13,000, were filed against broker-dealers, according to the SEC.

With more brokers and registered representatives doubling as investment advisers, however, the SEC believes that many more RIA complaints are being lumped into the broker-dealer category.

Not surprisingly, large companies received the most complaints. From 1996 to 2000, American Express Financial Advisors had 90, Fidelity Investments 49 and the Principal Financial Group 28.

But considering that their customers number in the millions, the RIA complaints, at least, seemed insignificant.

Heartland Advisors Inc. in Milwaukee, reeling from a municipal bond re-pricing fiasco last year, was the smallest firm to rank high on the list, placing fourth with 21 investor complaints.

Avoiding surprise

Most complaints aren’t rooted in intentional wrongdoing. Rather, they can be traced to a breakdown in communication between advisers and investors.

“People and their broker and their financial adviser and investor adviser … probably need to communicate better,” says Susan Wyderko, head of the SEC’s office of investor education and assistance, which handles the complaints.

“They [advisers] need to communicate better the time it takes to transfer accounts, because in many cases it seems to take longer than investors think it should,” says Ms. Wyderko. “They need to communicate about the investments themselves so that clients aren’t surprised or unhappy about things that happen in their account.”

Investment advisers who have received complaints agree that communication is the main problem.

“I think often it’s a communication breakdown of some sort,” says Bob Colby, vice president and general counsel of Diversified Investment Advisors, a Purchase, N.Y., firm with $35 billion under management, 12% of it discretionary.

“Some people are easier to communicate with than other people. It’s two ways. It just isn’t the big investor adviser or the pension records keeper that isn’t listening. Sometimes it’s the customer,” he says.

A couple filed an unsuitable-recommendation complaint in December against Peninsula Asset Management Inc. of Bradenton, Fla., claiming that they lost $150,000 in six months after the original adviser managing the discretionary account – a personal friend – left the firm.

“Some of the stocks we are now in are very poor choices, which [Peninsula] bought or sold without my knowledge,” reads the complaint.

“These are professionals, who assured me that their strategy protects us from such drastic losses,” say the investors, whose identities were concealed by the SEC.

Supplementary documents show the couple categorized themselves as “aggressive investors.” And Peninsula managed to increase their principal to $340,665, from $287,992, when they closed the account late last year.

“The account actually outperformed the market,” says Brian Miller, Peninsula’s vice president and compliance officer. “It’s just one of those situations where when the market starts to run down, no one likes to lose money.” The letter was the firm’s only SEC-filed complaint and, to date, it has heard nothing more from the investors.

However, to improve client communication, Peninsula started sending out general letters about major portfolio changes. “I wouldn’t say it was a direct reaction to this complaint. It was just that we said, `What can we do to better communicate with our clients?” says Mr. Miller.

Not collectable

Philip M. Aidikoff, president-elect of the Public Investors Arbitration Bar Association in Norman, Okla., thinks the RIA complaints that the SEC sees are just “the tip of the iceberg.” Most people don’t bother complaining, because the SEC has no authority to adjudicate disputes, he says.

Investors are unlikely to pursue serious wrongdoing by RIAs in court, because independent advisers typically run small, thinly capitalized operations without insurance.

Lawyers such as Mr. Aidikoff won’t touch them. Last week, Mr. Aidikoff says, a Northern California woman came to him about her experience after she switched a $1.8 million account from UBS PaineWebber to a two-man RIA firm.

The advisers promptly liquidated her portfolio of bonds and blue-chip stocks near the top of the technology bubble and put 75% of the proceeds into tech stocks.

“They wanted to show her that they’d do better for her, and when the tech market collapsed, she collapsed. She lost half of her life savings,” says Mr. Aidikoff, a securities attorney in Beverly Hills, Calif.

“Am I going to take the case? Probably not, because I work on a contingency, and my responsible party, this RIA who ran this woman’s portfolio into the ground, is probably not going to be a collectible defendant.

“Just logically, I’d agree with the trade association that there is probably less of a difficulty, less of a problem ratio with RIAs,” says Mr. Aidikoff, citing their asset-based fee structures and freedom from in-house products.

“On the other hand, if a broker at PaineWebber screws up, PaineWebber is there to make it right, to at least pay the arbitration. Ask the trade association what percentage of RIAs carry insurance. If it’s 25%, that’s probably twice as many than are actually insured.”

The SEC, for its part, tries to resolve investor complaints by forwarding them to the investment advisory firm for a response.

Sometimes the process exposes misunderstanding, but beyond that, the SEC can’t do much more. The SEC doesn’t track how many complaints go to arbitration or court.

When it spots trends or sees egregious violations, those are passed on to the SEC’s enforcement division, which handles a fairly constant 40 or so cases against RIAs each year.

Many cases involve claims of misleading performance data in advertising materials, or in rare cases, performance data that are fabricated altogether, says Wayne Carlin, director of the SEC’s Northeast regional office

Other common RIA enforcement actions involve conflict-of-interest cases regarding soft-dollar abuses and breach of fiduciary duties in which certain accounts are given preferential treatment over others because of the fee arrangement.

“Our cases are not based on a lack of communication,” says Mr. Carlin. “Our cases are based either on the adviser having committed fraud or having committed a serious breach of fiduciary duty, so we are dealing with situations where there is some level of intent involved in the wrongdoing.”

To minimize complaints of misrepresentation and to protect themselves from federal or civil actions, advisers need to go beyond the legal requirements of disclosure, says Jeanne Robinson, chairwoman of the board of professional review for the Certified Financial Planner Board of Standards in Denver.

“It goes to the spirit of disclosure,” says Ms. Robinson, an RIA with Marshall Financial Group in Doylestown, Pa. “That willingness to go beyond the legal requirements of disclosure and go to the spirit of disclosure is critical.”