Financial Advisor Malfeasance: Does It Take Two to Tango?

If a consumer is immersed in an investment fraud is she guilty too? Some people think so.

Interacting with a financial professional can be a bit of a tango. One foot forward and one foot backward. Hopefully, the overall momentum is in the right direction. Sometimes, though, it goes the wrong way. A client loses money due to manager maleficence. Is it only the professional who is responsible or can the consumer be complicit as well, thereby making financial misconduct easier?

When there is a conviction having to do with a Ponzi scheme or a broker misrepresentation is the victim culpable too? Certainly, we would all like to think not. But, consider the opinion of others about specific unfortunate circumstances when investors lost money.

Greed Overcoming Common Sense

A high profile case in Indiana a few years ago was Timothy Durham who was convicted of fraud and conspiracy. His crime was a $200 million Ponzi scheme. Durham is now serving 50 years in federal prison which will turn out to be a life sentence unless he is paroled. Scott Cohn, an “American Greed” special correspondent, wrote this about Durham’s victims, whom he doesn’t see as completely innocent.

But it wasn’t just his own greed that allowed him (Durham) to pull off the fraud for so long. Durham had plenty of help from his own victims...

Donna Immel, whose father Herman Nussbaum lost $170,000 in the scam and has since passed away, recalls the time she suggested to her dad that he might want to be a little more cautious about putting all his savings into Durham’s firm, Fair Finance… ‘No.’ He said, ‘Fair Finance has treated me well, and I don’t have any problems with it.’

Like many clients, Nussbaum had begun investing with the company when it was operating legitimately under a previous owner. Most customers either didn’t notice or failed to ask questions when Durham took over in 2002 and began turning Fair into his personal piggy bank. Perhaps lulled by the seemingly dependable returns, they just kept pouring their money in.

It’s a tragically common theme in scam after scam: perfectly intelligent people willing to set aside their own common sense—and some basic principles of investing—in the quest for a little extra return or steadier results. Nussbaum paid dearly, losing his entire life’s savings. He is hardly alone.”

Lack of Customer Sophistication

According to Mark Egan from the University of Minnesota and Gregor Matvos and Amit Seru from the Chicago Booth School of Business, roughly 7% of active advisors were disciplined for misbehavior or deceit between 2005 and 2015. Broker infringements included customer complaints and arbitrations, regulatory actions, employment terminations, bankruptcy filings, and criminal or judicial proceedings.

This means clients could have lost money dealing with one of these brokers. This is no surprise. What is a surprise, however, is that the authors suggest that it is not just moral laxity on the part of brokers that leads to transgression. It is also a deficiency of customer sophistication because counties where the most misconduct occurred tended to have a low education level in conjunction with higher incomes.

Closing Thoughts

Though it seems harsh, at least in specific cases, the authors quoted indicate greed and a paucity of financial smarts contribute to victimization. For me, I would add possible brain alterations in older individuals which leads to poor judgement and the tendency to more easily engage in investments scams.

How to rectify these contributing factors to financial disaster is difficult. The second issue (financial smarts) can be curbed through education if the consumer sees the need and is willing. The first, greed, is ingrained in the very fiber of human nature and not easy to reverse. This is especially true in a specific set of the older population who are the most vulnerable who, interestingly enough, the investment industry is beginning to try to identify and help—bravo here.

It is always well to remember, “If the promise of return is too good to be true, it is too good to be true.”

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