Fiduciary Fallout from Risky Investments Picks Up Steam

According to Canada.com, NatBank Brokerage will pay $750,000 (assume this is Canadian dollars) to medical doctor, Gilles Dussault. Representing lost income and interest on such, the court-determined fine follows a rough and tumble relationship between the physician and his brokers, a father and daughter team. Advised to short $2 million of savings bonds and then left to make his own decisions when prices rose, Dussault's losses grew until, two and a half years later, his holdings were liquidated to "cover what he owed in 1996." As a result, Dr. Dussault sued, alleging that the "original short sale was contrary to his investment objectives and financial interests." The bank countered, asserting that he knew the risks all along and that his losses would have been smaller had he closed his position sooner than occurred. In a 29-page opinion, Judge Mark Peacock described the plaintiff as "a man alone in a rowboat in a storm in the mid-Atlantic," adding that "The firm had always been his guiding light in the past and now that the waves were towering over him, the beacon was gone." He further characterized the transaction as conflicting with the investor's objectives and lambasted the brokers for not providing adequate information about the riskiness of the short sale. (See "Bitter pill for NatBank brokerage, Canada.com, January 16, 2008 for the full text of the article.)

Thanks to Mr. Carlos Panksep, General Manager of the Centre for Fiduciary Excellence, for pointing out this item. When asked what caught his attention about this news story, Carlos responded as follows. "In reading about this case, I could sense the lack of fiduciary accountability on the part of the advisor, possibly due to her inexperience. However, a firm which promotes a high priority to fiduciary education and sensitivity would have possibly avoided this outcome. I hope this firm will improve its practices as a result rather than bury this incident as unimportant or rare."

On the institutional front, Massachusetts Secretary of State William F. Galvin is asking Merrill Lynch (MER) about a $12+ million loss incurred by the City of Springfield. According to The Republican, the Springfield Control Board accuses the brokerage firm of "investing funds in an unsafe manner not permitted by state law." Focus on a collateralized debt obligation ("CDO") known as "Centre Square" ("a fund based in the Cayman Islands and Delaware") will logically examine why a $12.6 million spring 2007 outlay fell to $1.2 million by November. Reporters Peter Goonan and Dan Ring write that Merrill Lynch has declared the city responsible for making "its own investment decisions." (See "State subpoenas Merrill Lynch officials in Springfield investment loss," January 14, 2008).

Expect more articles along these lines of "he said, she said." Inevitably losses (especially big ones) are going to result in lawsuits. Determining who bears ultimate responsibility is far from trivial and opens the door to other inquiries. Disclosure is a factor. Education is another consideration.

• Suppose a broker (advisor) provides significant information about risk drivers but the investor is unable to digest it properly. Should the broker (advisor) turn down the business even if it means that he (she) might lose his (her) job for not bringing in enough clients? How will he (she) know that a client is ill-equipped to invest in a particular instrument or strategy?
• In the absence of mandatory education and experiential requirements to sit on a city board (or state or company equivalent), what controls should be in place to preclude individuals from being able to inappropriately commit funds? How should the institution better vet the broker (advisor) at the outset and during the investment period?
• What constitutes fraud on the part of the broker (advisor) for not "properly" disclosing risk factors?
• Will the typical broker (advisor) be able to adequately explain the risk trouble spots associated with a complex investment instrument or strategy? If not, why are they promoting such to investors?
• For individuals or institutions, what safeguards (action steps) should kick in as an investment is heading south, if at all? (Value may plummet only to rise again as long as the position is not liquidated before recovery.)
• How should regulators better define and enforce suitability?
• What role should the market play in terms of "lessons learned" by various players?
• Will attorneys have a different take on suitability than that of brokers (advisors)?

A recent article about UK trustees suggests that fiduciaries may acknowledge a problem but not feel comfortable moving towards a solution. In "Trustees ask for help," Global Pensions reporter Heather Dale (January 21, 2008) cites grim statistics from Hewitt Associates. Requests from British plan decision-makers "have doubled over the past 18 months" at the same time that more work, due to increased regulatory scrutiny, adds pressure. Do the math. More work, more complexity, more pressure, more scrutiny = big challenges. Does this mean that trustees must forge an even closer relationship with the fund's broker (advisor)? If so, how will questions of responsibility be impacted?

Caveat emptor will surely be the watchword for months to come. At what point are individuals (institutions) considered "duped" into investing in "excessively risky" assets and on what basis? How should suitability vary by type of institution? How can plan participants, shareholders and taxpayers better inform themselves about the risks being taken by a particular city, state or company pension?

The questions are endless. The answers are important.