Investor Beware: Why Falling Wall Street Pay Could Hurt You

 |  Includes: IYF, XLF
by: Jake Zamansky

Investment bankers and stock brokers are hurting. Bonuses for bankers have been slashed across Wall Street. As James Stewart noted over the weekend in The New York Times, the bankers and traders at Morgan Stanley were particularly stunned as the firm announced it was capping cash bonuses for 2011 at $125,000! That’s huge money for the 99%, but a pittance by today’s standards on the Street.

Stock brokers, meanwhile, the retail guys who sell stocks in offices across the country, are also hurting because the commissions they live on are down, way down, by most industry accounts. Last year’s volatility scared the bejesus out of the Mom-and-Pop investor, and they are staying away from the stock market in droves, hurting brokers’ pay.

In fact, the lack of business for brokers is so bad, that many small and middle-tier firms have begun to wither on the vine and even shut their doors.

These developments lead us to ponder the mindset of the financially hurting banker and broker. We are led to one conclusion.

To make up for declining bonuses and commissions, bankers will be more inclined than ever to pump out dubious derivative products. We’re talking about products like those high-risk and inscrutable reverse convertibles, leveraged and inverse ETFs, reverse Chinese stock mergers and the like. The very ones that wiped out so many investors in 2008 and its aftermath.

Meanwhile, retail stock brokers, struggling to make the payments on the second or third home and kids’ private-school tuition, will be tempted to recommend unsuitable and expensive investment strategies for their clients. That means more calls by brokers on clients to trade on margin, to buy high-fee variable annuities, to make costly “switches” of the products and to load up on illiquid, dubiously priced and secretly dangerous non-traded REITs.

Over the next few years, investors will be particularly vulnerable to brokers touting complex, whiz-bang investments that promise high returns but often deliver heartache and sleepless nights.

Why? Well, historically low interest rates make it nearly impossible for investors, particularly retirees, to keep up with the ever-increasing cost of living.

With the announcement on Wednesday that the Federal Reserve will keep interest rates near zero at least until late 2014, the door opened wider to the unscrupulous of Wall Street.

The regulators, so slow to catch up to the crooks during the financial crisis, may now have been jolted out of their slumber to the dangers brewing in Wall Street’s toxic financial-engineering laboratories.

The Financial Industry Regulatory Authority is attempting to turn up the heat on complicated investment products, as industry paper InvestmentNews noted last week.

In a recent regulatory notice, FINRA outlined characteristics of what it calls “complex products,” which could include structure notes, inverse or leverage ETFs, hedge funds and securitized products such as asset-backed securities.

FINRA identified duties that fall to individual brokers in understanding complicated products and explaining them to customers, according to InvestmentNews. The notice also said that stock brokers should consider whether less complex and cheaper products might achieve the same objectives.

Will such sound thinking enter the minds of Wall Street in the coming months, in light of dwindling bonuses and commissions?

Unlikely. For one thing is certain: Many Wall Street bankers and brokers fiercely resist cutting back on their consumption. So rest easy, yacht and Ferrari dealers. But as the banks try to push more complex and expensive products on to their customers, investors may be the ones losing sleep.

Disclosure: Zamansky & Associates are securities attorneys representing investors in arbitration and federal and state litigation against financial institutions, including Morgan Stanley, in cases involving complex financial products including structured products, ETFs, mortgage-backed securities, variable annuities and hedge funds.