Advisor Blog

We've been discussing the dangers of investing in life settlements for years, as have many other sources - including the SEC, GAO, Wall Street Journal and the Texas State Securities Board.

Life Partners, based in Waco, Texas and one of the largest brokers of life settlements has been charged by the SEC with fraud.  The SEC alleges that the company was systematically and materially underestimating the life expectancy estimates it used to price transactions. Life expectancy estimates are a critical factor impacting the company's revenues and profit margins as well as the company's ability to generate profits for its shareholders.

According to the SEC's complaint filed in federal district court in Waco, Texas, Life Partners misrepresented and failed to disclose in public filings with the SEC that the company's systematic use of materially underestimated life expectancy estimates constituted a material risk to the company's revenues. Beginning in 1999, the company used life expectancy estimates provided by Dr. Donald T. Cassidy, a Reno, Nevada-based doctor with no actuarial training or prior experience rendering life expectancy estimates. The SEC alleges that Life Partners failed to conduct any meaningful due diligence on Cassidy's qualification to act as a life expectancy underwriter and instructed the doctor to use a life expectancy methodology that was created by the company's former underwriter, a part-owner of Life Partners and that the company's executives were aware that the Cassidy-rendered life expectancy estimates were systematically and materially short.

Don't say we didn't warn you.

Now, listen to this, and I'll tell you 'bout the Texas...
I'll tell you 'bout the Texas Radio.
I'll tell you 'bout the hopeless night
Wandering the Western dream.

    - Jim Morrison, 1971

It seems that every time I turn on the radio over the weekend, I'm assaulted by a slew of what amounts to financial "infomercials".  They are actually very similar to the late-night TV commercials hawking everything from weight-loss pills to miracle hair growth remedies.  And, they are just about as credible.

These shows always have a disclaimer that's run at the beginning and the end of the show stating that the show is "for entertainment value only and should not be construed as investment advice".  At least, the last part of that statement is certainly true.  Unfortunately, we all know that they really are investment advice regardless of the disclaimer.

Some of the most incredible claims come from insurance salesmen trying to sell insurance products as investments.  The claims are often outrageous and frequently just plain wrong.  Last year, we heard one such show making claims that we knew were false.  So, we contacted the Texas Department of Insurance and made them aware of it.  They didn't seem to care much and actually said that there wasn't much that they could do until someone who bought the product complained about it.  In their own words, "we have to wait until the fraud actually occurs."  They suggested that we talk to the Attorney General about deceptive advertising.  That got us just about as far.  Don't count on the State of Texas to protect you from these lies.

As usual, the securities regulators are a little more vigilant.  One of the biggest spenders on "infomercials" in the D/FW marketplace is a guy that tries to convince people that they can hire his firm to time the market.  The host of the show uses a lot of silly sound effects and promises the "world's best" cookies to people that will attend his seminars.  FINRA and the SEC finally cracked down on his advertising practices, but he's still on the radio constantly - just being a bit more careful.

Then, there are the real bottom feeders - the guys pushing life settlements.  Despite all of the recent investigative reporting, many are still out there making unrealistic claims.  We've written about one particular group before - and they still have a website where they claim that "Our clients have never lost a penny of principle!"  Really?  Would you trust an advisor that doesn't know the difference between principle and principal?

It seems obvious that you shouldn't trust this type of "advisor".  But, how do you know who you should trust?  We've talked about this issue in previous posts.  Scott Maxwell has written about it in his essay series.  There are several good books that have been published recently that explain it well.  One of those is The Investment Answer.  We've recommended it before.  Another good one is The Little Book of Bulletproof Investing by Ben Stein and Phil DeMuth. 

The United States Securities and Exchange Commission (SEC) requires each investment advisor that is currently registered to file a revised Form ADV Part 2 that meets the new requirements adopted under the Dodd-Frank Wall Street Reform and Consumer Protection Act within 90 days after the end of the investment advisor's fiscal year.  For the vast majority of advisors, that means that the new version of this form has to be filed by March 31, 2011.

We are already hearing that a number of advisors
 will not meet the deadline.  This is not really surprising, considering the amount of time that is required to produce this filing (just the SEC document explaining how it should be written in "plain English" is 75 pages long).  According to the SEC's estimate, it takes a small advisory firm about 60 hours to complete this filing and it could take well over a thousand hours for a very large firm.  We have also received correspondence from some of the major compliance consulting firms indicating that they have been unable to accept any additional engagements for the past couple of months as advisors have rushed to seek assistance in preparing the required filing.  The consequences of missing the filing deadline are potentially severe, ranging from a warning or a fine up to revocation of the firm's registration.

We have always maintained an internal compliance program and do not rely on outsourcing our compliance duties.  We believe that it is important to demonstrate that we maintain strong compliance controls and prefer not to incur additional costs in outsourcing the work that would have to be passed along to our clients in the form of higher advisory fees.  Our Form ADV Part 2A is posted on our website's home page and is also accessible from the SEC's public disclosure website.  It contains a lot of new information about our firm and we hope that you take the time to read it.  If you're one of our clients, you'll be receiving a "Summary of Material Changes" next month, which is also a new SEC requirement.  If you have any questions about the content, please contact your advisor to discuss it.  If you have questions about Chris Dodd or Barney Frank, we can't help you with that.  We do, too.

Most potential clients are completely unaware of the bifurcated standard of care that exists between broker-dealers and Registered Investment Advisors.  Most of the so called "advisors" that work for major financial services firms are registered representatives of a broker-dealer.  Broker-dealers and their representatives are regulated by FINRA, the Financial INdustry Regulatory Authority.  FINRA is a self-regulatory organization of broker-dealers.  The standard to which FINRA regulated firms are held is called suitability.  In other words, if a product meets the FINRA definition of "suitable", it can be sold to a client.  This does not mean that it is the best product for the client.  In fact, it frequently is the product that pays the salesman (his card won't say that - he or she will be a "financial advisor" or "wealth manager" or an "asset preservation specialist", etc) the highest commission.  And, that's OK under the FINRA suitability standard.

On the other hand, Registered Investment Advisors (RIAs) are regulated by either the Securities and Exchange Commission (SEC, for larger advisors) or by the state regulatory authorities (for smaller advisors).  RIAs are held to a fiduciary standard.  The fiduciary standard is the highest standard of care under the law and requires that the RIA put the client's best interest first at all times, including putting it ahead of its own interest.

There is a vast difference between the two standards.  Knowing this, you may ask yourself why anyone would ever choose the lesser of the two.  It comes down to ignorance and obfuscation.  Most clients have no idea that the two standards exist.  Most broker-dealer representatives (aka salesmen) don't exactly go out of their way to explain it.  And, since more than 90% of the "advisors" out there are really FINRA regulated salesmen, the voice of the RIAs is often unheard through all the noise.  Nevertheless, this is extremely important and we can't imagine why anyone would choose to do business with an advisor that provides a lower standard of care.