Throwing 404(c) Participants (And Sponsors) Under the Bus: ERISA Section 404(c) False Promise of “Sufficient Information”

The Supreme Court’s decision in LaRue v. DeWolff, Boberg & Associates(1) in 2008 started a trend recognizing the need for greater protection of participants in defined contribution pension plans. The LaRue decision signaled the long overdue recognition by the judicial branch that, unlike defined benefit pension plans, defined contribution plans shift investment risk to the plan’s participants and beneficiaries.

Recent cases such as Braden(2), Tibble(3) and Tussey(4) have continued the trend in protecting plan participants. Recent participant-centric cases have focused on the issue of unnecessary costs associated with a plan’s investment options. While this is an important issue, this paper focuses on yet another issue which should be pursued, that being the fact that key promises provided by ERISA, namely the promises of a “broad range” of investment options and “sufficient information to make informed investment decisions,” are not being kept.

ERISA’s Promise of Disclosure
In discussing the importance of disclosing investment information to 401(k) participants, the preamble to the final 404(c) regulations (“Preamble”) stressed the need

to ensure that participants and beneficiaries in ERISA section 404(c) plans have sufficient information to make informed investment decisions….[as] the investment decisions made by participants and beneficiaries in ERISA 404(c) plans will directly affect the funds available to such individuals at retirement. For this reason, participants and beneficiaries should be assured of having access to that information necessary to make meaningful investment decisions.(5)

However, ERISA has totally failed to ensure that participants and beneficiaries actually receive such meaningful investment information. As a result, participants and beneficiaries in 401(k) and 404(c) suffered significant losses in the 2000 and 2008 bear markets, losses which could have been reduced had plan participants actually had the information necessary to implement strategies to reduce or avoid such losses.

Modern Portfolio Theory and 401(k)/404(c) Plans
Defined contribution pension plans have emerged as the primary form of private pension plans. The popularity of 401(k) plans lies in the fact that defined contribution plans allow employers to shift the burden and risk of investment loss to the plan participants by electing so-called 404(c) status. If a plan meets all of the requirements for 404(c) status, then a plan is not responsible for any losses incurred as a result of a participant’s investment choices.(6)

In reviewing both the statute and relevant regulations governing 401(k) plans, the language clearly references the applicable principles of modern portfolio theory, especially the importance of effectively diversifying one’s investment portfolio. The ERISA fiduciary is required to give

appropriate consideration to those facts and circumstances, given the scope of such fiduciary’s investment duties, the fiduciary knows or should know, are relevant to the particular investment or investment course of action, including the role that the investment plays in the plan’s investment portfolio, and has acted accordingly.(emphasis added)(7)

Appropriate consideration by a fiduciary requires him to determine that an investment is reasonably designed, as part of the plan’s portfolio, to further the purposes of the plan, taking into consideration the risk of loss, the opportunity for gain, the extent of the portfolio’s diversification, the portfolio’s liquidity and the investment’s projected return.(8)

Modern Portfolio Theory (MPT) was introduced in 1952 by Dr. Harry Markowitz.(9) The cornerstone of MPT was the introduction of the correlation of returns among investments as a factor in creating investment portfolios. Prior to the introduction of MPT, portfolios were constructed largely using only an investment’s returns and standard deviation. The theory behind including MPT in the portfolio process was to combine investments that behaved differently in various economic conditions in order to avoid large losses.

While Markowitz’s concept of MPT has been fairly criticized due to the questionable assumptions behind the theory and its calculation process, the validity in factoring in correlation of returns among investments remains a valid and valuable approach to portfolio construction and risk management. Both the Department of Labor (DOL) and the courts have adopted modern portfolio theory, and the value of effective diversification, as the standard in evaluating the prudence of ERISA fiduciaries’ actions.(10)

The cornerstone of modern portfolio theory is diversification based on the correlation of returns among the investments being considered. Therefore, it can be argued that plan sponsors must factor in correlations of returns of the investments chosen for their plan in order to ensure ERISA’s promise of a “broad range” of investment options. Likewise, it can be argued that plan participants should be given the same information in order to exercise the same prudence with their own plan accounts.

Diversification and Risk Management
Proper risk management through the use of effective diversification depends on using the correlation of returns of investment. As Markowitz stated in his seminal book, “Portfolio Selection: Efficient Diversification of Investments,”

To reduce risk it is necessary to avoid a portfolio whose securities are all highly correlated with each other. One hundred securities whose returns rise and fall in unison afford little protection than the uncertain return of a single security(11)

Markowitz’s position on effective diversification has been adopted by the Restatement (Third) Trusts.(12) And yet, courts and various commentators, while admitting the values of effective diversification, often continue to analyze diversification solely on the basis of the number of investment options offered by a pension plan.

There is a popular investment saying that says that “amateurs chase returns, while professionals manage risk.” That sentiment is seconded by two legends in investment management, Ben Graham and Charles Ellis, to wit:

The essence of investment management is the management of risk, not the management of returns.(13)

Managing market risk is the primary objective of investment management.(14)

Factoring in the correlation of returns of various investments allows investors, including plan sponsors and plan participants, to manage risk by avoiding a portfolio made up entirely or largely of highly correlated investments. It also allows investors to avoid being confused by the “diversification by asset category” scam often perpetrated by dishonest and unethical plan service providers and other financial advisers, a scam which leaves unsuspecting investors without the benefits of effective diversification, particularly downside risk protection.

ERISA’s “Broad Range” and “Sufficient Information” Promises
ERISA section 404(c) sets out various requirements that must be met in order for a plan to effectively shift the risk of investment losses to the plan’s participants. One of the sections main requirements  is that a plan provide its participants with a “broad range” of investment options.(15) Section 404(c) requires that a plan offer at least three types of diversified investment options-a broad equity-based investment option, a broad fixed income-based investment option, and a cash/money market based investment option.(16) Each category of investment option offered by a plan must have materially different risk and return characteristics.(17)

The other main 404(c) requirement is that the plan must provide participants with “sufficient information in order to make informed investment decisions” in order to allow participants to minimize the risk of large investment losses.(18) The courts have recognized the importance of ERISA’s promise of “sufficient information.” As one court noted

courts must look to the evidence and determine whether the plan provided the participants ample information, including adequate information to understand and evaluate the risks and consequences of alternative investment options.(19)

Building on the importance of the provision of “sufficient information,” at least two courts have suggested that if participants are not provided with the material information necessary to protect their interests, then the participants cannot be said to have exercised the control over their 404(c) account as required by ERISA for 404(c) status.(20)

Section 404(c) incorporates the information disclosure requirements of 401(k) plans. Sadly, neither requires the disclosure of correlation of returns data for the investment options offered by the plan.

The DOL has released a bulletin outlining various types of investment information that may be provided to plan participants without incurring any additional fiduciary liability. Interestingly enough, the bulletin states that plan sponsors can provide generic information on general investment topics such as historical investment returns, historical investment risk and correlation of returns.(21)

So the DOL says plans can educate plan participants on the importance and benefits of correlation of returns information, but they do not allow plans to provide plan participants with the correlation of returns data for the plan’s actual investment options, thereby denying participants the opportunity to effectively diversify their retirement accounts and minimize the risk of large losses. This would seem to be totally inconsistent with ERISA’s stated purpose, to help protect pension plan participants and their beneficiaries.(22)

It can, and should, be argued that correlation of return data is analogous to the historic return and risk data allowed under the DOL’s release, as such data does not advise plan participants as to which investments to choose. Correlation of returns data simply gives investors material information on which investments not to choose in order to minimize their investment risk. This would seem to be totally consistent with both ERISA’s promise of “sufficient information” to allow “meaningful control over the assets in their account, as well as ERISA’s stated purpose to help protect pension plan participants and their beneficiaries.

Time For Change

404(c) is not working. It does not provide participants with the information they need to make informed and reasoned investment decisions.(23)

That was the testimony of Fred Reish, one of the nation’s leading ERISA attorney, before the Department of Labor’s Advisory Council. Mr. Reish was simply stating what many ERISA experts already know, especially with regard to information needed by plan participants to implement effective risk management strategies.

Fiduciary law is derived from the common law of trusts and agency. Both trust law and agency law emphasize the importance of a fiduciary’s duty of loyalty, which includes a duty to disclose material information to a fiduciary’s beneficiaries and principals, especially when silence may result in harm to such beneficiaries and principals.(24) Under ERISA, a plan sponsor is a fiduciary.

Given the obvious significance of correlation or returns data in the risk management process and ERISA’s admitted goal of providing plan participants with “sufficient information to make informed decisions” to effectively manage their retirement accounts and avoid large losses, one would wonder why the DOL does not seek a change to require the disclosure of such data to plan participants. When this issue is brought up, opponents often claim that plan participants would not understand the data and/or would not know how to properly use such data.

That objection is an education issue and has nothing to do with the value of such information protecting plan participants and in furthering ERISA’s goals. Sadly, ERISA does not require plans to provide education to plan participants. The ability of 404(c) plans to transfer investment risk to plan participants, without requiring both the disclosure with such material information and education program on how to properly use such information, effectively allows plans and plan sponsors to throw 404(c) plan participants “under the bus.”

It has been suggested that the failure to provide investment education to plan participants could be deemed to be a breach of the plan sponsor’s fiduciary duty of loyalty to the plan participants.(25) This argument is even more persuasive given the Securities and Exchange Commission’s recent study which concluded that most Americans are functionally illiterate with regard to investing.(26)

The real resistance to providing correlation of return information to plan participants, and for that matter plan sponsors, could be that disclosure of such information would reveal a conflict of interest between plan service providers and pension plans. Forensic analyses of pension plans often show that the majority of investments recommended by plan service providers, especially with regard to equity-based investments, are highly correlated and, therefore, are not compliant with ERISA’s “broad range” requirement. This can result in unwanted potential liability for plan sponsors and improper risk exposure for plan participants, as they cannot effectively diversify their plan accounts.

The denial of such material information is both unnecessary and inequitable given a 404(c) plan’s ability to shift the risk of investing onto the plan’s participants. Both Congress and the DOL need to amend ERISA by requiring that plan participants and their beneficiaries be provided with correlation of returns data on the investments offered by their 401(k) and 404(c) plans, as well as educated on the proper usage of said data so they can properly manage their plan accounts to minimize the risk of large losses.


1. LaRue v. DeWolff, Boberg & Associates, 128 S.Ct. 1020 (2008)
2. Braden v. Wal-Mart Stores, Inc , 588 F.3d 585 (8th Cir. 2009)
3. Tibble v. Edison International, 711 F.3d 1061 (9th Cir. 2013)
4. Tussey v. ABB, Inc., 54 WL 1113921 (W.D. Mo., March 31, 2012)
5. Preamble to 404(c) Final Regulations, 57 Fed. Reg. 46906, 46909-46910
6. 29 C.F.R. § 2550.404c-1(d)(2)(i)
7. 29 C.F.R. § 2550.404a-1(b)(1)
8. 29 C.F.R. § 2550.404a-1(b)(2)
9. Harry M. Markowitz, Portfolio Selection: Efficient Diversification of Investments”, 2d ed., (Malden, MA: Basil Blackwell Publishers, Inc., 1991)
10. DiFelice v. U.S. Airways, Inc., 497 F.3d 410, 423 (4th Cir. 2007); Laborer’s Nat’l Pension Fund v. N. Trust Quantitative Advisors, Inc., 173 F.3d 313, 317 (5th Cir. 1999)
11. Markowitz, 5
12. Restatement Third, Trusts, § 90 (Prudent Investor Rule), cmt f. Copyright © 2007 by The American Law Institute. Reprinted with permission. All rights reserved. (“Effective diversification, then, depends not only on the number of investments but also on the ways and degrees in which their responses to economic events tend to cancel or neutralize one another through negative or slight ‘covariance’.”)
13. Ben Graham quote
14. Charles D. Ellis, “Winning the Loser’s Game: Timeless Strategies for Successful Investing,” 6th ed. (New York, NY: McGraw/Hill 2010), 103-104
15. 29 C.F.R. §2550.404c-1(b)(1)(ii)
16 .29 C.F.R. §2550.404c-1(b)(3)(i)(B)
17. 29 C.F.R. §2550.404c-1(b)(3)(i)(B)(2)
18. 29 §2550.404c-1(b)(2)(i)(B)
20. In re Regions Morgan Keegan ERISA Litigation, 692 F.Supp.2d 944, 957 (W.D. Tenn. 2010); In re Sprint Corp. ERISA Litigation, 388 F. Supp. 2d 1207 (D. Kansas 2004)
21. Department of Labor Interpretive Bulletin 96-1
22. 29 U.S.C. § 1001(b); In re Unisys Sav. Plan Litigation, 74 F.3d 420, 434 (3d Cir. 1996)
23. Available online at Detail.aspx?pub=2592
24. Restatement Third, Trusts, § 78. Copyright © 2007 by The American Law Institute. Reprinted with permission. All rights reserved. (“Whether acting in a fiduciary capacity or personal capacity, a trustee has a duty in dealing with a beneficiary to deal fairly and to communicate to the beneficiary all material facts the trustee knows or should know in connection with the matter.” (emphasis added)
26. Ary Rosenbaum, “Why 404(k) Plan Sponsors Should Make Sure Education and Advice is Offered to Their Participants,”
27. “Study Regarding Financial Illiteracy Among Investors,” available online at news/studies/2012/917-financial-literacy-study-part1.pdf


Posted in ERISA, Investment Advice, Investment Portfolios, Investor Protection, pension plans, Portfolio Construction, portfolio planning, Retirement, Retirement Plan Participants, Retirement Planning, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , ,

Put Up or Shut Up!

The Securities and Exchange Commission (SEC) continues to delay action on a proposed universal fiduciary standard that would require anyone providing investment advice to always put a customer’s best interests first. While investment advisers are currently required to put a customer’s interests first, stockbrokers and other financial advisers are allowed to put their own financial interests first.

This disparity obviously makes no sense. Yet, the SEC continues to say that it is studying the issue. This issue could be resolved simply if the SEC would simply let the public decide. The SEC would probably rejects such an idea, saying the potential costs involved must be considered.

My response – What additional costs? Most broker-dealers already have their own in-house investment adviser division, which supposedly would be reviewing traded according to the fiduciary standard applicable to investment advisers. FINRA, the primary regulator for the financial services industry, has clearly stated that brokers and broker-dealers are required to always put a customer’s best interests first. Adopting a universal fiduciary standard would simply be in accordance with FINRA’s position.

The SEC recently reported that they received a poor response from the financial services industry from their request for information regarding the additional costs that would result from a universal fiduciary standard. The SEC should not be surprised. As mentioned above, there is no legitimate evidence to support such a claim.

The financial services industry also claims that a universal fiduciary standard would result in people being unable to receive adequate investment advice. Legally speaking, evidence which is based on pure speculation is admissible. The financial services industry has no substantive evidence to support their claim because they cannot do so.

As a former compliance officer who worked with brokers, I find it hard to believe that a good, honest broker is going to refuse to provide advice to anyone and walk away from potential compensation, whether a fee or commission. Why would they? If they are providing advice that is in the best interests of the customer, they are entitled to make a living. As for those who might refuse to provide advice unless they can put their own financial interests first, I say good riddance.

Its time for the SEC and the Department of Labor to tell the financial services industry to “put up or shut up.” Enough of the empty, unsubstantiated rhetoric. Its time for the various agencies whose expressed missions are to protect the public to actually do so or come clean and tell the public the real reason they refuse to do so. As former Supreme Court Justice Louis Brandeis once said, “sunlight is the best disinfectant.” Continue reading

Posted in Fiduciary, Investment Advice, Investment Fraud, Investor Protection, pension plans, Portfolio Construction, Retirement Planning, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , ,

Wealth Preservation and Those Pesky 401(k)/403(b)/IRA Beneficiary Forms

Everybody hates paperwork. So when employees and investors are asked to fill out all the paperwork associated with 401(k) plans and individual retirement plans (IRAs), most people just enter something without giving it  much thought.

When I was a compliance officer, I would always cringe when I saw that the designated beneficiary was “estate.” Unless there is absolutely no other choice, choosing as the designated beneficiary on a 401(k), 403(b) or IRA is absolutely the worst choice anyone can make, as it effectively prevents the account owner’s heirs from using various options that can be used to maximize the account’s value through the use of “stretch” options and individual inherited accounts. Fortunately, the owner of the 401(k), 403(b) or IRA can always go back and execute a new beneficiary form to address such issues.

Beneficiary forms present other issues for retirement account owners. One often overlooked issue is the question of whether the custodian of the retirement account still has the account owner’s beneficiary form on file. Clients are often surprised when I suggest that they confirm that their custodian can produce their beneficiary and provide the client with a certified copy of the beneficiary form. They are even more surprised when the custodian cannot comply with the request.

With all the mergers and consolidation that has occurred in the financial services industry over the past few years, it is not unusual for a custodian to be unable to produce the retirement account’s beneficiary form. Unfortunately, it is not uncommon for custodian’s to have a policy dictating that in the absence of a beneficiary form, the default beneficiary is the account owner’s estate, regardless of who is at fault for the inability to produce the beneficiary. First year law school – the large print giveth, and the small print taketh away.

I usually handle one or two cases a year involving a custodian’s inability to produce the beneficiary form for an account. The potential implications for the owner’s heirs, both in terms of taxes and honoring the owner’s wishes, can be significant.

By requesting a certified copy of the account’s beneficiary form, the account owner can verify that the custodian has a copy of the account’s beneficiary form and obtain a certified copy of same, ensuring avoidance of the “estate as beneficiary” problem. In the event that the custodian is unable to produce the original beneficiary form, the account owner can execute a new beneficiary form and have the custodian provide them with a certified copy of same.

Owners of retirement accounts often name their spouse as the primary beneficiary of the retirement accounts. Owners should always name a contingent beneficiary or beneficiaries, if possible, so as to avoid the “estate as beneficiary” problem. Owners often name their children as contingent beneficiaries. I strongly recommend that owners wishing to name multiple beneficiaries and/or non-human beneficiaries, e.g., trusts or foundations, consult with counsel experienced in retirement account law, as there are various issues which, if not properly addressed, can prevent the owner’s original wishes from being accomplished.

Banks and other retirement account custodians often refuse to use anything other than their standardized, “cookie cutter” forms. Unfortunately, such standardized form often do not properly address the potential tax and inheritance issues involved with multiple beneficiaries and non-human beneficiaries.

Proper counsel can draft the beneficiary forms needed to protect the account owner and ensure that his wishes are accomplished. Some custodians will work with an owner’s counsel on such issues, others will not. By addressing such issues and identifying difficult custodians who do respect the account owner’s wished, the account owner can find a better custodian for the account.

Account owners should never accept a custodian’s representations regarding retirement account law as the final word on the subject. From experience, both as an attorney and a former compliance director for several broker-dealers, I can tell you that the consistency and accuracy of a custodian’s internal operations staff can vary widely, even day-to-day. Sad, but true.

Retirement accounts are often a major asset in one’s estate. Consequently, retirement account owners need to either take the time to carefully read retirement account documents to retain counsel to read and interpret such documents in order to prevent unwanted tax issues and to ensure that the account owner’s wishes are accomplished.

Retirement account owners should also review the beneficiary forms for such accounts on a regular basis to ensure that they still reflect the owner’s wishes. There are several cases where ex-wives have received the proceeds of their ex-husband’s retirement account because the ex-husband forgot to execute a new beneficiary account form for the account. In the leading case on this issue, Kennedy v. Kennedy, the U.S. Supreme Court ruled that although the ex-husband’s will left the retirement account to his new wife, the beneficiary form on retirement related accounts controls the disposition of the retirement account, not the terms of any will left by the retirement account’s owner.

This article is not designed or intended to provide legal, investment, or other professional advice since such advice always requires consideration of individual circumstances. If legal, investment, or other professional assistance is needed, the services of an attorney or other professional advisor should be sought.

© Copyright 2014 InvestSense, LLC. All rights reserved.

Posted in Asset Protection, Common Sense, ERISA, Investment Advice, Investment Portfolios, Investor Protection, IRA, Life Advice, pension plans, Retirement, Retirement Distribution Planning, Retirement Plan Participants, Retirement Planning, Wealth Distribution, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , ,

Avoiding Costly “Closet” Index Funds

I am a member of the Paladin Registry, a select group of attorneys and investment advisers dedicated to educate investors so that they can better protect themselves against investment fraud and other questionable activity by the investment industry. You can review some of my articles at

I just posted a new article discussing the unnecessary costs associated with so-called “closet” index funds, funds that charge fees that are often 3-4x higher than true index funds while providing similar, in some cases lower, returns. You can review the article at

Posted in Asset Protection, Investment Advice, Investment Advisors, Investment Fraud, Investment Portfolios, Investor Protection, Portfolio Construction, portfolio planning, Portfolio Planning, Retirement, Retirement Plan Participants, Retirement Planning, Uncategorized, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , , , , ,

1 + 1 = 34: The True Impact of Mutual Fund Fees

One of the most common mistakes I see investors make is failing to understand the true cost of investment fees. Many investors dismiss an annual management fee of 1 percent as “just” 1 percent.

Just as investment returns compound over time, so does the impact of investment fees. Over a twenty year period, a fee of “just” 1 percent reduces an investor’s end return by approximately 17 percent. Throw in an advisor’s usual annual advisory fee of 1 percent and an investor has reduced their end return by 34 percent. If an advisor persuaded an investor to purchase a variable annuity, with annual fees of 2 percent or more being the norm, the cumulative fees of 4 percent would reduce an investor’s end return by 68 percent!

Fees for actively managed mutual funds are typically much higher than the stated annual management fee. This is especially true for so-called “closet index” funds. Closet index mutual funds are actively managed mutual funds that closely track a relevant market index.

Closet index funds are actively managed mutual funds that have a high R-squared rating. A fund’s R-squared rating indicates the percentage of an actively managed mutual fund’s performance that can be explained by a relevant market index. An R-squared rating of 90% would indicate that 90% of the fund’s performance could be attributed to the performance of the market index rather than the fund’s active management.

Professor Russ Miller has developed a metric, the Active Expense Ratio, that uses a fund’s R-squared rating to help investors determine the effective fees that investors pay on actively managed mutual funds. His findings are that investors investing in actively managed mutual funds are usually paying effective annual management fees that are four or more times the fund’s stated annual fee.

A final approach to evaluating the true cost of actively managed mutual funds is based on the incremental cost and incremental return of an actively managed mutual funds. This concept was first introduced by Charles Ellis in “Winning the Loser’s Game,” which I consider to be one of the most helpful book for investors. My proprietary metric, the Active Management Value Ratio, used incremental cost and return, as it more accurately reflects the added cost and added benefit, if any, resulting from active management.

Let’s assume that an actively managed mutual fund has an annual return of 22 percent and an annual expense fee of 1 percent. A comparable index mutual fund has an annual return of 20 percent and an annual expense fee of 0.22 percent. The incremental return of the actively managed mutual fund would be 2 percent, or 200 basis points, and the incremental fee would be 0.78 basis, or 78 basis points. (A basis points equals 0.01 percent, so 100 basis points equals.)

Since the public may have trouble understanding the concept of basis points, I like to present an analogy using dollars instead of basis points. One of the keys to successful investing is to avoid unnecessary fees, as fees effectively reduce an investor’s end return. So which option is better for investors, paying $22 for 20 percent return or paying $78 for 2 percent return? Yet another cost efficiency way of looking at the options would be which option an investor considers more prudent – paying $22 dollars for 20 percent annual return , or $100 dollars for 22 percent annual return.

The answer seems obvious, and yet the Investment Company Institute reports that over 80 percent of money invested in mutual funds is invested in actively managed funds, with a large percentage of the investment coming from pension plans.

Costs do matter.

Posted in ERISA, Fiduciary, Investment Advice, Investment Advisors, Investment Portfolios, Investor Protection, pension plans, Portfolio Construction, portfolio planning, Retirement, Wealth Accumulation, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , , , , , , , , , , ,


While I normally write about investing and strategies that investors can use to improve their chances for success, every now and then I come across a non-investing piece that I think is worth sharing. Over the years I have seen far too many friends dealing with divorce, depression and other personal issues. In some cases, such issues have been the result of a failure to properly align one’s priorities. As I read this piece, I myself decided to take a break and offer this excellent article as a form of lagniappe, a familiar term here in the South which means “a little extra thrown in.”

“A professor stood before his philosophy class and had some items in front of him. When the class began, he wordlessly picked up a very large and empty mayonnaise jar and proceeded to fill it with golf balls. He the asked the students if the jar was full. They agreed that it was. The professor then picked up a box of pebbles and poured them into the jar. He shook the jar lightly. The pebbles rolled in the open areas between the golf balls. He then asked the students again if the jar was full.  They agreed that it was. The professor next picked up a box of sand and poured it into the jar. Of course, the sand filled everything else. He asked once more if the jar was filled. The students responded with a unanimous “yes.” The professor then produced two beers from under the table and poured the entire contents into the jar effectively filling the empty space between the sand. The students laughed. “Now,” said the professor as the laughter subsided, “I want you to recognize that this jar represents your life. The golf balls are the important things – your family, your children, your health, your friends, and your favorite passions – and if everything else was lost and only they remained, your life would still be full. The pebbles are the other things that matter like your job, your house and your car. The sand is everything else – the small stuff. If you put the sand into the jar first, there is no room for the pebbles or the golf balls. The same goes for life. If you spend all of your time and energy on the small stuff you will never have room for the things that are important to you. Pay attention to the things that are critical to your happiness. Spend time with your children. Spend time with your parents. Visit with grandparents. Take your spouse out to dinner. Play another 18. There will always be time to clean the house and mow the lawn. Take care of the golf balls first – The things that really matter. Set your priorities. The rest is just sand.” One of the students raised her hand and asked what the beer represented. The professor smiled and said “I’m glad you asked. The beers just shows you that no matter how full your life may seem, there’s always room for a couple of beers with a friend.”


Posted in Common Sense, Life Advice | Tagged ,

The Power of the Informed Investor

“Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you under-stand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits and our salesperson’s compensation, may vary by product and over time.”

The referenced disclosure was part of a rule proposed by the Securities and Exchange Commission (“SEC”) in an attempt to resolve a dispute with the Financial Planning Association over the SEC’s refusal to require stockbrokers providing investment advice for a fee to register as investment advisers under the Investment Advisers Act of 1940. The Financial Planning Association eventually sued the SEC and won the case.

The court struck the proposed rule down, effectively removing the requirement for the disclosure. Lost was a meaningful disclosure that alerted investors to the inherent conflict of interests problem regarding stockbrokers, their ability to legally put their own financial interests, e.g., commissions, ahead of their customers’ best interests. The SEC could have revived the required disclosure in order to help protect investors, in accordance with their stated mission, but they did not do so.

The SEC subsequently commissioned a study by the Rand Corporation that included a study of investors’ understanding of the difference of the legal duties that stockbrokers and investment advisers owe to the public. The study found that a majority of investors mistakenly believed that stockbrokers owe a fiduciary duty to act in their customers’ best interests. Investment advisers are held to a fiduciary standard, which means that they must always act in their clients’ best interests. Stockbrokers are held to a duty to only recommend “suitable” investments, a nebulous term that allows stockbrokers to recommend products that are “suitable,” yet provide higher commissions for the stockbroker than other equally “suitable” investment options.

A study by TD Ameritrade, another broker-dealer, resulted in similar findings. Some of the interesting findings of the studies:

  • Only 29 percent of those polled understood that the primary responsibility of stockbrokers is to sell investment products.
  • 90 percent of the investors polled believe that a stockbroker and an investment adviser who provide the same services should be held to the same standard in dealing with the public.
  • 97 percent of investors agreed that financial professionals should be held to a fiduciary standard requiring that they always put clients’ interests first , including a requirement that anyone providing investment advice must disclose all fees and conflicts.

Both studies demonstrated both the public’s confusion on the fiduciary duty issue and the need for some sort of disclosure statement advising the public of the conflict of interests issues regarding stockbrokers. And yet, to date,  the SEC does not require stockbrokers to disclose the conflict of interests issue

There is a familiar saying – “knowledge is power.” Nowhere is that truer than with  regard to investing. The more knowledge an investor has, the greater his or her ability to detect investment fraud and avoid unnecessary financial losses. Thus, the byline on our blog, “the power of the informed investor.”

I started this blog in order to provide the public with information that they could use to manage their financial affairs proactively to better protect their financial security. (See and Based on the feedback and emails that I have received, people have found the information on the blog useful and informative.

A recent study found that only 22 percent of the public trust the financial services industry The SEC should take strides toward improving trust in the investment industry by requiring greater transparency on fees and more investor-friendly information that helps investors protect their self-interests.

The SEC needs to act in accordance with its mission statement and enact a regulation that alerts investors to the conflict of interests issue regarding stockbrokers and the potential financial harm that can result to investors as a result of the stockbroker’s ability to put the stockbroker’s financial interests ahead of their customer’s best interests. The studies mentioned herein clearly reflect both the need for such disclosure and the benefits that such transparency would provide in leveling the playing field.

How could someone in good faith argue against the benefits of a disclosure that would inform the public of important information that serves to promote honesty and basic, fundamental fairness, a disclosure that would allow investors to better protect their financial security?

I do not expect the SEC to enact a rule requiring broker-dealers and stockbrokers to disclose their conflict of interests. That is why I have written this post, to make the public aware that stockbrokers can legally put their own financial self-interests ahead of a customer’s best interests. Now help your friends and family and pass the information on.

Happy Holidays!

Posted in Fiduciary, Investment Advice, Investment Advisors, Investment Fraud, Investment Portfolios, Investor Protection, Variable Annuities, Variable Annuity Abuse, Wealth Management, Wealth Preservation | Tagged , , , , , , , , , , , , , , ,