In the crowded financial services marketplace, the TV ads sound like a baby boomer’s dream come true. The music is classic ’60’s and ’70’s, memorable and upbeat. Smiling, attractive, carefree people play with their grandchildren, walk on the beach and generally frolic. The announcer talks about financial planning as the key to meeting your goals in life, and they show the questions they’ll ask just to illustrate the point. The handwritten example of a life goal is a classic: “move to Napa, buy a vineyard”. The clever tagline both captures the problem and encourages you to use their services: Get To What’s Next.

The question of what may be next could easily be asked of the company itself. This particular company originated over 100 years ago and over the years created its own mutual funds and life insurance operations. In 1984 it was acquired by a financial conglomerate, which added property and casualty insurance, and in 1994 its operations were “rebranded” in the conglomerate’s name. In 2005 the financial planning operations were spun off into an independent company with a strategy to reach the “mass affluent”, or individuals with $250,000 or more to invest. Along the way various ancillary operations were added or sold, such as the sale of its defined contribution retirement plans business in 2006.

Change is inevitable, nowhere more so than in the corporate world, and the company has consistently pursued financial planning for individuals, so what’s the big deal? The potential problem is that with each of these corporate changes, and with each interim set of corporate goals and tactics, longtime clients can find themselves out of synch with the “new” services. Of course, while the company may communicate their new emphasis (but sometimes not), they are certainly not going to point out that this emphasis may not be a fit with current clients’ needs. Combined with turnover among planners and the ongoing need to attract new clients to feed corporate revenues, clients may find themselves receiving very little attention after their initial honeymoon period. As markets and client goals and circumstances change, this inattention can create unanticipated risk.

Despite the job title of “financial planner”, all the company’s planners are registered securities representatives, or brokers, which means that they get paid based on the investment products they sell. While this is not inherently bad, the drive for profits repeatedly leads to problems. Consider the company’s recent regulatory history.

• $215 million to settle a class action suit in 2001. The plaintiffs alleged that the firm and its brokers churned insurance policies and annuities, overstated product performance, misrepresented insurance as an investment product and wrongly sold annuities to qualified retirement plans and senior citizens.
• $7.4 million in fines and settlements with the SEC and NASD in 2004. The regulators cracked down on mutual fund breakpoints, or the sales charge discounts mandated for large purchases, and the company was among several that were required to pay restitution and penalties for not honoring those discounts.
• $1.25 million to settle an enforcement action with the NASD in 2005. The company offered the 529 college savings plan of only one state, and this plan was sold to customers in other states who could have gotten tax benefits by investing in their own state’s plan.
• $57 million in settlements with the SEC, NASD and the state of Minnesota in 2005. The company permitted market timing, which benefited some investors at the expense of others, within its mutual funds and variable annuities, and ran “shelf-space” programs in which certain providers of investment vehicles paid fees to receive preferential treatment in client sales. None of these arrangements were disclosed to clients.
• $9.3 million as a result of an NASD arbitration ruling in 2006. Three retired pilots claimed that one of the firm’s brokers squandered their retirement savings through frequent trading of high-fee mutual funds.
• $16.3 million as a result of an NASD arbitration ruling in 2006. One of the firm’s brokers coaxed Exxon employees into retiring early, cashing out their company-sponsored investment plans and investing in high-fee mutual funds. Despite investment losses the broker suggested he could gain returns of between 11.5% and 18%.
• $7.4 million to the state of New Hampshire in 2006. The state regulators alleged that the firm steered clients into the company’s own lackluster mutual funds instead of better-performing products from others and did not adequately disclose the conflict of interest to customers.

In all these cases, the company did not admit wrongdoing, and some of the problems were attributable to individual brokers. But the common thread is that sales took precedence over the interests of the clients, and the company did not have adequate controls or leadership to properly value those client interests over their own.

While this is the corporate and regulatory history of a specific company, its name is not important; indeed, a similar history is shared by many large, diversified financial services firms. The vast majority of the planners and brokers in these firms are honest and well-intentioned. Unfortunately, they often find themselves caught between the client and the corporate goals and mandates. Sadly, many of these employees who have spent their careers in such business structures may not even recognize that these practices can cause problems; it is simply the way they have been trained and is all they know.

This and other large, traditional firms can serve clients’ needs, but there are also fee-only planners who do not receive compensation for investment products. This sales-driven environment places even a greater burden on investors to educate themselves, ask questions and consider a number of investing arrangements before committing. As Ronald Reagan so wisely said, trust but verify.

February 2007