NEW YORK — Susan Bernardo trusted her stockbroker. She wound up losing a fortune.
Her broker advised her to sell $400,000 worth of relatively safe municipal bonds, she says, and sink the proceeds into real estate and energy partnerships in hopes of earning more income. She needed the money to raise her small son. More than six years later, those investments are in trouble. The stream of interest payments she used for living expenses has mostly dried up and the value of her portfolio is half of what it was, according to a financial planner who helped her file a claim against the broker.
Bernardo says the broker never told her how risky the new investments were, or about the fat 5 percent commission that brokers typically get selling them. The broker did not return calls seeking comment.
That her broker might not have acted in her best interest never occurred to her. “I thought, ‘OK, someone is watching over me,’ ” says Bernardo, now 57, of Wantagh, N.Y.
The Obama administration thinks too many brokers aren’t looking out for clients, and instead pushing risky and costly investments for big commissions. The White House is backing a proposed rule it hopes will help end the practice. The new rule would require brokers handling retirement accounts to put the interest of their clients ahead of their own, a so-called fiduciary standard required of lawyers, doctors and some financial professionals like registered investment advisers.
Under the current rule, brokers must limit recommendations to what is “suitable” for clients based on their financial situation and appetite for risk. That’s too weak, critics say. Brokers don’t have to offer cheaper alternatives or keep an eye on the investments. Critics say this current rule has allowed brokers to invest too much client money in high-fee mutual funds that erode returns over years, or put it in risky products.
In announcing its support for stricter standards, the White House cited a report from its Council of Economic Advisers that estimates brokers with conflicts of interest are cutting returns in individual retirement accounts by 1 percent a year, or about $17 billion.
And if brokers were held to the same standard as doctors or lawyers, critics say, fewer would be cleared of wrongdoing by the Financial Industry Regulatory Authority, or FINRA, an indus- try-funded group that oversees arbitrations and can impose fines and penalties. More than six of 10 FINRA arbitrations last year resulted in no award for investors, though many were withdrawn/settled before a ruling.
“When they give bad, conflicted advice, they should be held liable, and they’re not,” says Mercer Bullard, a law professor at the University of Mississippi. “Unless they’re a fiduciary, it’s very difficult to win that case.”
Details of the proposed rule haven’t been hammered out, but lobbying for and against it is already intense.
A lobby group for the securities industry, the Securities Industry and Financial Markets Association, or SIFMA, is trying to kill the rule, which was proposed by the Labor Department. It fears officials there lack expertise about the brokerage industry and will write the rule to make it too costly for brokers to help clients with small accounts, and force them to stop advising them. It would rather the Securities and Exchange Commission take the lead.
The head of the SEC, Mary Jo White, has said the agency is exploring the idea of a rule of its own. She wants all brokers giving advice to be held to the higher standard, not just those handling retirement money.
William Percy wishes he’d been more careful with his broker. He says the broker persuaded him to hand over $330,000 from 34 years of laying and repairing telephone lines at Pacific Bell. The broker put that money into a variable annuity. It’s a complicated product, and has drawn fire from regulators for high costs and hidden risks. Percy says his annuity is now worth $100,000.
“She was getting paid to get us into this,” says Percy, 66, of Broomfield, Colo. “She wasn’t looking out for my benefit.”
Percy is suing the broker and her firm in California state court, as are four other former clients. Her lawyer and the firm note that Percy lost in arbitration before FINRA.
Critics of the current “suitability” rule, written in 1975, consider it dated and ineffective. Many brokers then filled their days taking orders to buy and sell stocks and bonds, not giving investment advice to ordinary workers. Workers generally didn’t need advice because many had pension plans that guaranteed income after they retired. Back then, 401(k) accounts didn’t exist.
Now, most companies don’t offer guaranteed pensions and, with 65 percent of retirement savings in 401(k) plans and IRAs, brokers have taken on the role of adviser.
Brokers dispense advice when people change jobs or retire and have the option of rolling over 401(k) accounts into IRAs. Switching allows them to choose among more funds and investment products than is typically available in a 401(k). But a 2013 study found that such moves were often a mistake as they can trigger high fees and commissions, and many in- vestors are confused on costs.
SIFMA, the securities lobby, disputes that $17 billion is lost each year in IRAs due to bad advice and warns against seeing a pattern in horror stories of individual cases.
“Can investors be better protected? Sure. There’s always a way to get better advice and disclosure, and we support that,” says Kevin Carroll of the group. “But are customers in brokerage accounts being systematically harmed? The answer is no.”
The problem is many people don’t even know investing basics, says Barbara Roper of the Consumer Federation of America.
By the time Stephen Meadows realized his mistake, the retired architect had lost more than $100,000, a fifth of his original investment, says his lawyer, who is trying to get his money back in arbitration. His broker put him into nontraded REITs that pay large commissions to those selling them, but are difficult to unload in a pinch and, as Meadows found out, can sock you with losses.
Meadows says his broker never told him about the commissions, typically 7 percent of what’s invested, or the numerous risks. But he rejects the notion he should have known better. “If people want me to design a building for them, I don’t expect them to know how to do that,” says Meadows, 63.
The good news is that investors appear to be wising up. They put $183 billion into low-cost U.S. stock index funds in the past year while pulling $125 billion from higher-fee actively managed funds, says Morningstar, a research firm. They are also shifting more to so-called fee-only advisers who get a fixed cut of money they oversee.