Avoiding Financial Fraud

Ron Lieber’s New York Times column Even Vigilant Investors May Fall Victim to Fraud was quite disturbing and not a little worrying. It recounts how Matthew Weitzman, a founder and principal at AFW Wealth Advisors, a Registered Investment Advisor, and a fee-only firm, is no longer with AFW. The firm informed its clients of “certain irregularities in a limited number of client accounts.”

You can read Lieber’s article for the details. What is not clear, though, is how much money was involved nor how quickly the irregularities were discovered. Though, from my point of view, they are not the most worrying aspects. What concerns me most is that Mr. Weitzman was a member of the National Association of Personal Financial Advisors (NAPFA).

When a member of the advisory community violates the trust that clients place in him, all clients and advisors suffer. What this country does not need right now is any further deterioration in what little confidence we have left in the banking system, the federal government or our financial advisors.

I have been a fee-only planner since 2003, and whenever possible, I recommend that investors seek out financial planners who are compensated directly by their clients, rather than by commissions. In this way, you will avoid obvious conflicts of interest.

Members of NAPFA all practice a fee-only method of compensation and sign a Fiduciary Oath, which means that they swear to act only in their clients’ best interest. So it is with great discomfort that I heard that not one, but two, former members of NAPFA have been accused of bilking their clients.

What to do? As Ronald Reagan once said, “Trust but verify.” And of course, you should never write checks directly to your advisor, but only to an independent custodian. It is the independent custodian who should be providing you with confirmations of all transactions and trades, and a monthly statement. These are sensible precautions in the age of Madoff.

As Lieber says, “Open your mail. Confirm the accuracy of your trades and fund transfers. Read your account statements. Every month. Every number. Every single word.” I am not sure about reading every number, every word, but I get his drift.

Lieber further recommends that you handle all of your stock transactions yourself. I believe most investors will find this “solution” impracticable, inconvenient and unnecessary. I believe a better solution is for you to sign a limited power of attorney, allowing your advisor to enter transactions on your behalf, but which does not allow him to withdraw your funds. Only you should have the ability to withdraw funds from your account. I am not an attorney, but I believe that this provides adequate protection. (Attorneys, please weigh in.)

My mother always said “A promise is a promise.” Unfortunately, there are always people who will promise one thing and do another. It’s disappointing to have your expectations dashed.

I don’t know about you, but I expect firefighters to be brave, judges to be moral and rabbis and priests to comfort the troubled. Yet, there have been judges who, instead of upholding the law, bend it out of shape for personal gain. And there have been priests and rabbis who have preyed upon our young and betrayed our trust.

Lieber says, “I’ve always believed that advisers in the (NAPFA) association were plenty smart and morally upright, but it’s hard to recommend them now without at least including an asterisk.”

In my experience, NAPFA members have the highest standards in the profession. But like every profession, there may be individuals who choose to violate the trust of clients they serve.

It’s not easy to protect yourself against out and out theft, but you can take some small comfort from the fact that if financial advisors break the law, they are subject to prosecution by the regulatory authorities.

In my opinion, a great majority of investors will lose countless dollars because of the continuance of “Standard Operating Procedures” at Wall Street investment firms. Every day these firms peddle ill-conceived, hard-to-understand, expensive investments, because it is profitable for them to do so. Investors will lose more money in the ordinary course of business than they will ever lose due to outright fraud.

Unfortunately, what is legal on Wall Street is bad enough.

And so, I will continue to heartily recommend NAPFA members, because the fiduciary standard is the right way to do business.

And yes, monitor your accounts. Remember, “Trust but verify.”

Understanding the Financial Crisis, Part 3

In a previous post, I highlighted Barry Ritholz’s article on how the financial crisis was caused by an “enormous change in lending standards … that took place during the 2002-2007 period. It was more than a subtle shift — it was an abdication of the traditional lending standards that had existed for decades, if not centuries.”

In the November 1st New York Times, Gretchen Morgenson gives details on just how badly one bank behaved during the housing boom. Was There a Loan It Didn’t Like? goes behind the scenes of mortgage lender Washington Mutual.

Briefly, senior mortgage underwriter, Keysha Cooper says she was pressured by bank managers and mortgage brokers “to approve loans, no matter what.”

“At WaMu it wasn’t about the quality of the loans; it was about the numbers,” Ms. Cooper says. “They didn’t care if we were giving loans to people that didn’t qualify. Instead, it was how many loans did you guys close and fund?

When underwriters refused to approve dubious loans, they were punished, she says.

Ms. Cooper started at WaMu in 2003 and lasted three and a half years. At first, she was allowed to do her job, she says. In February 2007, though, the pressure became intense. WaMu executives told employees they were not making enough loans and had to get their numbers up, she says.

“They started giving loan officers free trips if they closed so many loans, fly them to Hawaii for a month,” Ms. Cooper recalls. “One of my account reps went to Jamaica for a month because he closed $3.5 million in loans that month.”

One loan file was filled with so many discrepancies that she felt certain it involved mortgage fraud. She turned the loan down, she says, only to be scolded by her supervisor.

Brokers often tried to bribe Ms. Cooper to approve loans, she says. One offered to pay $900 to send her son to football summer boot camp if she would approve a loan that had been declined by a host of other lenders. “I told him no and not to disrespect me like that again,” Ms. Cooper says.

Hidden fees meant brokers could easily make between $20,000 and $40,000 on a $500,000 loan, Ms. Cooper says.

Ms. Cooper says that loans she turned down were often approved by her superiors. One in particular came back to haunt WaMu.

Vetting a loan one day, Ms. Cooper says she became suspicious when a photograph of the house being bought showed one street address while documents deeper in the file showed a different address. She contacted the appraiser, and recalls that he said that he must have erred and that he would send her the correct documents.

“I was so for sure that it was fraud I wanted to get on an airplane,” Ms. Cooper says.

The $800,000 loan was approved, but not by Ms. Cooper. Six months later, it defaulted, she says. “When they went to foreclose on the house, they found it was an empty lot,” she recalls.

Conclusion

• Ms. Cooper says she was pressured by her managers to approve mortgage loans “no matter what” including  loans that turned out to be fraudulent.
• Kerry K. Killinger, the WaMu chief executive was paid “tens of millions of dollars.”
• “WaMu was seized by federal regulators in late September, the biggest bank failure in the nation’s history.”

photo credit: Jimmy2000