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Link to Article #1When Smaller Advisers Deceive, Investors Have Little Chance of Recovering Losses
Investors who rely on stockbrokers and investment advisers to manage money got new protections from regulators last month. One issue the rules didn’t address: Smaller advisers usually don’t have enough capital or insurance to compensate customers for losses the advisers caused.
Smaller advisers—often working through independent offices without much oversight—are about 1.5 times more likely to declare bankruptcy in the year following a customer dispute that results in a legal settlement. And they are 3 times more likely to have an unpaid judgment or lien show up on their record, according to Mark Egan, a finance professor at Harvard Business School.
“If there is no money, it’s hard to get people their money back,” Securities and Exchange Commission Chairman Jay Clayton said in an interview. “There are a host of ways this has been dealt with in the regulated space, and we should be thinking about it.”
Many individual investors are using advisers instead of brokers these days, drawn by regulatory and structural changes that favor the advisory-business model of charging steady fees instead of trading commissions. The number of people working as investment advisers has grown 33% since 2008, according to the Financial Industry Regulatory Authority.
Smaller investment advisers often are thinly capitalized and, in many cases, don’t carry enough insurance to cover a significant legal judgment against them. Yet they usually have discretion over how to invest customers’ money. Compared with brokers, the average adviser works in a smaller firm with fewer colleagues. State regulators say most firms under their oversight are one- or two-person shops with little supervision.
That problem befell Jean Whitley, 91 years old, whose adviser told her there was a windfall to be had in cryptocurrencies. In 2018 the advisor convinced her to hand over $150,000 for a cryptocurrency fund, but never started such a fund and instead used the money for personal and business use, according to an indictment in a Colorado state court. He also took $250,000 from a Denver-area couple and $20,000 from another senior citizen, the indictment says.
Ms. Whitley hasn’t recovered any money, and the advisor couldn’t be reached for comment, directly or through his lawyers.
David Fleming, 76 years old, came to regret the trust he put in his former adviser, Chris Young Yoo, who now sits in federal prison in Sheridan, Ore. The couple invested about $2 million with him. Mr. Yoo said he would put their money in hedge-fund strategies and claimed to have insurance. For a decade or so, he sent the Flemings about $784,000 in interest payments.
But Mr. Yoo stopped communicating in late 2015. It turned out Mr. Yoo had been running a Ponzi scheme, according to prosecutors. The Flemings say they lost about $1.25 million of the money originally invested with Mr. Yoo and haven’t been repaid any of it.
Investors who want to sue an adviser for fraud or malpractice often find the firm is too small to justify a lawyer’s involvement, according to Bob Banks, an attorney in Portland, Ore., who pushed his state to require a $1 million “errors and omissions” insurance policy for advisers and brokers. That became law in January 2018. No other state requires such insurance, which protects against risks other than theft, such as negligent advice causing losses, according to the North American Securities Administrators Association.
Industry groups told the SEC last year that regulators haven’t shown problems are extensive enough to justify a new insurance or capital requirement.
The cost of a $1 million errors-and-omissions policy for a smaller adviser is about $8,500 a year. About 40% of advisers who manage under $1 billion and focus on high net-worth clients don’t have such coverage.
Most advisers have authority over how to invest customer money, according to the SEC, which says 91% of federally regulated advisers have discretion over client portfolios.
© 2015 Mutual Fund Observer. All rights reserved.
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