No Crystal Balls: Recognizing Broker Misconduct
Robert Port is an Atlanta-based lawyer specializing in commercial litigation and fiduciary disputes. He recently wrote an article entitled “Courtside Seat: Everything I Know About Investing I Learned in Court” which summarizes lessons learned from decades of representing individuals who’ve lost money thanks to the misconduct of their investment advisors, insurance agents, and stock brokers.
The first lesson that Port and Steve discuss hinges on the unpredictable nature of markets. The simple truth is that no one has a crystal ball when it comes to forecasting markets or stock prices. For one thing, these prices rise and fall based on news, which is itself unpredictable by definition. Statements and insinuations by people pitching their skills and insights—claiming, for example, that stock XYZ or the S&P 500 will be 20% higher or lower by some date—ought to raise a major red flag. Port argues that because of this randomness to asset price movements, it is impossible for brokers, fund managers, or financial newsletters to consistently time and beat the market. They might outperform for a year or two, but, eventually, their returns will “revert to the mean average,” which will likely be lower than overall market trends, especially after fund and trading fees are extracted. There is more luck than skill in beating the market, Port asserts, citing academic research that backs him up on this point.
Why are so many investors susceptible to the duplicitous claims of those who present themselves as financial wizards who know when and what direction stocks are headed? Naivete or an uncritical willingness to believe, greed, and lack of due diligence may all play into it, but one shouldn’t ignore the major advantages that Wall Street and other operatives have when it comes to dazzling people with technical charts and analysis. The arsenal of tactics and sophisticated language used by industry to draw individual investors into making bad decisions often rises to the level of misconduct and can be litigated as such. The investments being peddled may be mutual or hedge funds or stock picks, among others. As Port writes, the lesson here is to “Avoid actively managed investments. Stock picking and market timing are losers’ games.”
Avoid Investment Products And Financial Fraud
Out of the seven lessons Port writes about in “Courtside Seat”, Steve asks Robert to elaborate on the fifth: “Be Leery of Investment Products”. Port admits that “his antenna goes way up” when he hears the phrase “investment product” or “investment vehicle” because of his extensive experience working with investors who have gotten entangled in these to disastrous results. Some examples of investment products that can be abused are limited partnerships, real estate investments, investment trusts, annuities, and mortgage-backed securities. For starters, the firms which engineer these products don’t always have their clients’ best interests at heart. Developed as they often are by MBAs and financial “quants” (who make mathematic models), they tend to be highly technical, wrapped in legalese, and opaque to just about anyone trying to understand how they work. Worse, they are often laden with fees and expenses that are not obvious to investors and not properly explained by the brokers that sell them. Professional brokers themselves often don’t understand what they’re selling either. This kind of complexity should be a warning sign that you are getting in over your head. Port offers a simple rule of thumb: If you can’t explain what and why you’re investing in to a middle schooler, you probably shouldn’t be buying it.
How To Tell Good Advisors From Bad Ones
On the topic of investment advisors, Steve alludes to the dilemma that many people face in trying to figure out the quality and truthfulness of the information they’re getting from their advisors. He asks Robert about his opinion of financial advisors and whether they perform a valuable role for their clients. While admitting that he’s been skeptical of the industry in the past and remains alert to the damage that advisor fees can do over time, Port says he’s come to believe that advisors who work based on a simple upfront fee—as opposed to commissions—do provide a legitimate and needed service. Advisors with integrity are sensitive to the possibility that fees and expenses will, compounded over time, have a large impact on their client’s wealth. He mentions that he has an advisor himself because he believes in the advisor’s ability to do a better job than he could in managing his investment portfolio.
Don’t Chase Brokers Touting Past Performance
Steve wraps up the conversation by asking Robert to unpack the fourth lesson in “Court Side”: “Don’t chase winners.” Robert’s answer in part loops back to and extends the first lesson about crystal balls and the danger of brokers selling predictions. In this case, the trap is laid by an attempt to establish a reputation based on past performance. Mutual funds and financial newsletters are notorious for bragging about above average returns from their recent past. Even though they are required to add a disclaimer that “past performance is no guarantee of future results”, the sales and marketing pitch is nevertheless designed to foster trust in their investing acumen. The persuasive language used and the intrinsic promise of stellar returns is too much for many investors to resist. Port believes that these claims of exceptional management talent made by appealing to a solid track record—however qualified by the small print—are fundamentally dishonest because no money managers are able to maintain consistently above average returns. In fact, past performance is a poor predictor of future success, and the chances of someone beating benchmark averages or peers over a multi-year time span is, as Port puts it, “essentially zero”. While Warren Buffet may be the exception to the rule, there is every reason to believe that “your guy” is not going to resemble Buffet a decade from now. The lesson is to not lurch after funds or managers with a hot hand because you’re guaranteed to be late to that hand’s run of good luck.
Steve Pomeranz: My next guest spends much of his time litigating on behalf of investors who have been harmed by the misconduct of stockbrokers, investment advisors, insurance agents, and others in the financial services industry, so when I read a piece written by him entitled, “Everything I Know About Investing I Learned in Court”, it got me thinking. What is the investment view from a person who specializes in prosecuting fraud in this industry? To that effect, I want to welcome Robert Port. He is partnered with the Atlanta law firm of Gaslowitz Frankel LLC, and he’s written this article about a number of the lessons that he’s learned by watching all of these individuals go through the court system or the arbitration system. Welcome to the show, Robert.
Robert Port: Thank you very much for having me, Steve.
Steve Pomeranz: Number one. Lesson number one, and I was surprised that this would be the first one, but Wall Street does not have a crystal ball. What do you see when you’re out there litigating?
Robert Port: Well, what I see often is that folks are very attracted to people who claim to have the expertise to say” this is going up, this is going down, buy this, sell this”, and I think, for me, understanding that no one can predict the future was, in an odd way, something that’s very obvious, but at the same time it was essentially an epiphany when it came to investing. The probability of predicting the future is very slight. I guess in pure statistic terms you maybe have a 50/50 chance of getting it right, and probably even less, so if you spin at out further when you talk about investing, what that leads me to conclude is that it is a bit of a fool’s errand to rely on any one person who claims they know what the future’s going to hold. Sometimes they get it right, and it’s more by accident and luck than skill.
Steve Pomeranz: Simply, if you know that the future is unpredictable, and therefore predicting the future of the stock market is unpredictable…You know, there’s this old…It’s kind of a terrible story, but I remember it being passed around the brokerage industry when I was in it, and that was, let’s say, if you tell your clients, “Hey, this thing is going up.” And you tell the other 50% that, “This is going down.” It’s going to go one of those two directions, and whatever direction it goes in, those people are going to think you’re pretty smart, and the 50% of people are going to go away, so then you got the remaining 50%. You tell 50% of those things are going up, something’s going down, and half of those people are going to get it right, and the other half are going to go away, so now you’ve got this subset of people who think you’re really, really smart. You do it one more time, and then those people that are left think you are a genius, and then I guess those are the people where they end up in court being sued because nobody knows anything about the future. Crazy, isn’t it?
Robert Port: Well, it’s funny you should mention that example because I have actually heard of scams that are perpetrated exactly that way. They will start with 500 people, and they’ll send them a mailer that we predict this is going to happen, and as you say 50% of the time they may be right, and then they’ll send it to the next 250 people and say, “Well, we got it right this last time. Let’s try this.” And so on and so forth, and they convince the last remaining subset to send them money, and surprise surprise—it disappears.
Steve Pomeranz: Right, right, right. Yeah. Again, that’s such an interesting point. Scammers come up with all these kinds of strategies, and we tend to be believing people, and when information is put before our eyes, we don’t really look beneath the surface very often. Here’s another one, lesson number five—I have to skip around for time purposes—is be leery of investment products. Wall Street loves to sell limited partnerships and real estate investments, and annuities and things like that. What have you seen in your travels there?
Robert Port: Well, most of the time … Again, given what I do, when I hear the word investment product, my antenna goes way up because generally what these are, are fairly complicated investment strategies or sometimes called vehicles, that Wall Street firms with their MBAs and analysts have put together that are often—just because of the number of people and experts who need to put this together—are loaded up with fees, and, candidly, many of the folks who sell this stuff on the brokerage side when it eventually gets down to the retail broker offering it to his retail customer, a broker often doesn’t understand it. All they’ve got is a page or two of the sales points they should make, and, rest assured, very few of the actual customers understand it, and it’s a fairly simple … I might be accused of simplistic approach, but my view is that if it takes 40, 50 pages of dense legalese to explain what you’re investing in, it’s probably not a good idea to invest in it. And, more simplistically, if you can’t explain to a child who’s maybe in junior high why it is you made that investment you probably ought not to. You ought to be able to explain your investment very quickly and succinctly to somebody.
Steve Pomeranz: Many people listening to this show don’t have advisors, or they may use someone, and they really can’t tell what the quality is or the truth telling is of these advisors. From your experience, first of all do you think that people need advisors? Do you think advisors serve an important role in people’s financial well-being?
Robert Port: I very much do. I originally came to this suspicious of, sort of, all advisors not necessarily because everyone’s illegitimate or a crook or doing not only crooked things but inappropriate things, but I’m very sensitive to the drag that fees over long periods of time can do to wreak havoc on investments. But I’ve come to conclude that an advisor who charges an appropriate fee—I’m very partial to folks like you who do a fee only type of structure, not commission based—I’ve concluded that I view that fee as almost an insurance premium. I use an advisor myself. I think I can do it myself, but I know I shouldn’t, and I view the fee I pay my advisor as my insurance premium to keep me away from my money because I have concluded, or maybe just rationalized, that I can, trying to do it on myself, suffer, not necessarily losses, but lack of return that would likely far exceed what I’m going to pay an advisor. So, I think for people with any meaningful amount of money—and that’s a relative term—it is well worth it to consider using an advisor, again, who is sensitive to the fees and costs incurred in providing their services, but I almost always think it is a good idea.
Steve Pomeranz: You know, I took a chance asking that question.
Robert Port: I know. I know.
Steve Pomeranz: I didn’t know how you were going to answer that, but there have been many studies that—I was looking at one the other day—that from 1996 to 2015, the S&P 500 is up over 8% compounded annually, but the average investor has only made about 2%. I think that that really goes to what you’re saying is that if you’re doing it yourself you’re subject to emotion. You’re not really a professional at it. You’re not doing it every day. You get caught up in other things. Maybe you forgot to sell something, or you really didn’t research it properly when you bought it, etcetera, etcetera, so then the question comes to, so you got the good guys, I guess, to be oversimplifying, and the bad guys here, and we’re trying to figure out how to not get a bad guy. And so we talked about people who predict the future and sell something based on that. We’ve talked about people who sell investment products, and you know they make commissions. A lot of times those commissions are hidden. You don’t even know what they’re making. It’s kind of built into it, and it’s buried in it.
Lesson number four, and I’m not sure that this has to do with advisors themselves, but this idea of don’t chase winners. What does that mean?
Robert Port: Well, as anyone who looks at anything involving investing— even things such as Money magazine or lots of other publications—you will see ads that will say “top mutual fund for the last number of years”, or people touting, “Last year I returned to my clients X% on their investments.” It’s very attractive and appealing to think, “Well, this person must know what they’re doing. This firm must know what they’re doing. I will go there.” I think what I have learned looking at, I guess some of the more academic literature here, is that investment returns over the long term revert to the mean. I guess they revert to the average, so, yes, sometimes some folks will get far above average. But the probability that any one person or firm will stay above average for long periods of time is very, very slim.
Steve Pomeranz: Yeah.
Robert Port: What I often hear when I say that is, well, people say, “Well, you know, Warren Buffett has done it great all these years.”
Steve Pomeranz: Warren Buffett. Exactly.
Robert Port: That’s true. He’s like, you know, I could be a Warren Buffett groupie, but the reality is, statistically, he’s an expected result, but he’s a very, very rare result. What I often say in response to that is, “Fine. What’s the probability that you or me or anyone can choose who is going to be viewed as Warren Buffett 20 years from now?”
Steve Pomeranz: Right.
Robert Port: Of the tens of thousands, hundreds of thousands, of advisors out there what is your assurance that you will find the man or woman who is going to get it right consistently year after year after year after year? The probability is essentially zero, so what I have concluded is that you should hit, as they say in baseball, hit for the average. Swing for the averages. Don’t swing for the fences all the time.
Steve Pomeranz: Yeah.
Robert Port: Don’t be enamored by what so ever is hot at the moment because just like someone who’s always swinging for the fences, you’re going to strike out a lot, and that’s fine in baseball, but not fine with your hard- earned investment money.
Steve Pomeranz: My guest is Robert Port. He’s a partner with the Atlanta law firm Gaslowitz and Frankel, and he’s written this article about “Everything I Know About Investing I Learned in Court”, and, you’ve heard a few of the items listed. To find out more about this, and actually to see the article, go to StevePomerantz.com. We’ll put a link up there for you, and we’ll put it out on all the other social media as well. Robert, thank you so much for joining me today.
Robert Port: I enjoyed it, Steve, Thank you for having me.