When Investor Trust Is Shaken

Retaining client confidence in a time of investment scandals.

his article, a companion article to “ The Mutual Fund Trading Scandals ,” discusses the techniques that five investment advisers used in dealing with client concerns over the mutual fund trading scandals. These techniques can be used by CPA/investment advisers.

The criminal and unethical practices by U.S. financial institutions that have come to light over the past few years have seriously victimized the small investor and rocked the public’s confidence in most investment vehicles. While shareholders watched their appreciations nose-dive, front-page headlines exposed the lavish, excessive lifestyles of CEOs. Brokerage research departments at the best-known investment firms were exposed for writing glowing stock analyses that had more to do with the investment goals of the banking side of the firm than with any in-depth research.

But the more recent scandals involving late-trading, market-timing and trading ahead of clients have arguably hit harder at the comparatively naive clients of CPAs offering financial advice than at professional investors. “The mutual fund scandal has cast a dark cloud over the (investment) industry in a way that no other financial scandal has over the past several years,” says Richard Vitale, CPA/PFS, MST and chairman of the Boston-based firm, Vitale, Caturano & Co. PC.

All the CPA advisers we spoke with realized the emotional hit the charges evoked in their clients. Most of them told us they took a proactive stance in broadcasting their positions on the scandals before clients even called them. Advisers, perhaps seasoned by the corporate governance scandals that preceded the recent charges against mutual funds, know clients often are slow to react to the news. But delayed or not, the questions will come. Here’s how some of your CPA colleagues are handling the issues.

The first step is for CPAs to appreciate these events from the perspective of the unsophisticated investor. “Mutual funds always have been touted as an investment vehicle that allowed the average investor to benefit from cost-effective, professional management,” Vitale says. “Unfortunately, the actions of a handful of companies were criminal.” While the activities did not have a major impact on his clients, “since we largely did not focus on putting client assets into the fund families in question,” Vitale made sure his firm was well-versed on the unfolding investigation and ready to answer client questions as they arose. This reaction is one we found common to many CPA advisers.

“We maintain an open dialogue that distinguishes between firms where employees behaved criminally vs. those that were said to have weak internal policies, but not criminal activity,” says Vitale. He calculated the damage to the average investor’s mutual fund account to be “a small fraction of 1%.” Still, he says, the breakdown of trust by the criminally charged companies was intolerable. “In the end our clients were comforted knowing we managed their accounts with only their best interests in mind, and we were more than willing to openly discuss, explain and differentiate the issues and status of the various investigations.”

Many firms contacted clients by mail or phone. Evensky Brown & Katz, a financial planning firm in Coral Gables, Florida, knocked out a 12-page letter almost immediately, says Deena Katz, CFP. Although none of the $500 million the firm invests for its clients was with any of the named mutual funds, the firm still felt it important to anticipate client concerns. It did receive calls from clients who were still holding positions in some of the funds in portfolios created before they did business with Evensky.

In some cases advisers told clients who came to them with older portfolios invested in these mutual funds to continue holding them because tax consequences made liquidating them impractical, says Randi Grant, CPA/PFS, a partner with CPA firm Berkowitz Dick Pollack & Brant in Florida. Grant’s firm had two clients caught in the situation, one invested in Strong and the other in Putnam. When the scandals broke, “we called them up and advised them to liquidate,” she says.

Grant’s standard approach is to recommend a small group of funds that she can monitor closely. “Most firms have their own pools of funds because you just can’t watch them all,” she says. “You limit yourself to a small group of funds and managers.” She is hopeful that the diligence of the SEC in pursuing these abuses will help clean up the problems.

At Evensky Brown & Katz, the staff of 17 also prides itself on maintaining close contact with fund managers and sources close to funds, so that if any are being mismanaged they’ll pick up on it early enough to exit. However, Katz also feels that the firm’s 19-page, 81-question fund screen, which she jokingly calls the “Evensky Sieve,” helps the firm avoid getting into bad funds to begin with. At least five questions on the form relate to trading costs and fund fees. The firm requests details on basic procedures, including how internal trading procedures are conducted, to avoid conflicts of interest. And most questions go right to the heart of the matter: Are any of your professionals allowed to invest in individual securities for their own account? What is your policy on front-running? (Front-running refers to the practice of alerting favored customers or partners when a fund plans to buy or sell a large stock position.)

Pillar Financial Advisors in Waltham, Massachusetts, queries its fund managers monthly as follows: “Do you or have you in the past ever provided special privileges, including preferential pricing arrangements, to hedge funds or any other investor? If so, please explain in detail the arrangement, including how this may have affected other investors.” In the scandal alerts it sends to its clients, Pillar cites this paragraph as an example of the firm’s ongoing diligence.

What have firms done in cases where their clients did hold shares of funds tainted by investigations—even distantly? Pillar Financial Advisors penned a letter to its clients to alert them that the New Jersey Attorney General had launched an investigation into Pimco Funds, a mutual fund that Pillar recommends to its clients. Pimco was caught under the umbrella of an investigation of its parent Allianz AG’s other fund company, PEA Capital, which subsequently agreed to pay $18 million to settle improper trading charges in its funds. Authorities accused Pimco of allowing a hedge fund to rapidly trade in violation of prospectus rules.

According to Pillar vice-president Beth C. Gamel, CPA/PFS, the letter dated February 25, 2004, said, in part: “We immediately called Pimco and spoke with senior vice-president Andre Mallegol, who said that an ‘exhaustive review by an outside law firm’ found no violations of prospectus rules. We also reviewed a statement on Pimco’s Web site by Chief Investment Officer Bill Gross, who asserted that all trades were consistent with prospectus rules.” Mallegol said he believed Pimco’s Newport Beach, California, office was unfairly lumped into the complaint with PEA Capital.

Pillar stayed with the investigation until its conclusion, writing a subsequent letter to tie up any loose ends for its clients. It said: “In February we informed you that the New Jersey Attorney General had filed a civil fraud complaint against Pimco Funds. We use Pimco Total Return and Pimco High Yield Bond in many of our client portfolios. We’re writing to let you know that after Pacific Investment Management, which runs the Pimco bond funds, provided additional information to the New Jersey Attorney General, all improper trading charges against Pacific Investment Management were dropped.”

Vitale, Caturano also was careful to keep clients in the loop when a management firm with which it places assets was targeted in an investigation. When Massachusetts Financial Services Co. (MFS), a subsidiary of Canada’s Sun Life Financial, the oldest mutual fund company in America, came under charges of market timing, Vitale, Caturano rode it through, while keeping its clients up to date about developments in the case.

However, Vitale says that in retrospect it’s doubtful that his in-depth analysis of the complaints was even appreciated by all of the firm’s clients. “Over time,” Vitale says, “our clients tended to lose interest in the specifics—particularly when the investigations were largely administrative issues, not criminal behavior.”

In some cases advisers avoided the offending funds because they’d already rejected them on a cost basis. That was the case with Francis C. Thomas, CPA/PFS, a full-time faculty member at Richard Stockton College of New Jersey, in Pomona, New Jersey, who, in addition to teaching, specializes in taxation and investment advisory services for a small number of clients in Port Republic. “I educate my clients that costs do matter.” But the scandals have reinforced the fact that advisers have a twofold job, says Thomas. “Advisers must educate clients so they can make better decisions and be more cognizant of their risk tolerance.”

“Encourage clients to take a college course or read some of the excellent books available,” he advises. Authors such as Greenwich Associates founder Charles Ellis and Burton Malkiel of Princeton University in New Jersey can empower investment advisers and their clients. Ellis wrote Winning the Loser’s Game: Timeless Strategies for Successful Investing and Capital: The Story of Long-Term Investment Excellence; Malkiel wrote A Random Walk Down Wall St. and 10 Rules for Financial Success. Other good sources for improving your financial literacy are any of the books by John C. Bogle, outspoken founder of the Vanguard funds, especially his Common Sense on Mutual Funds: New Imperatives for the Intelligent Investor.

“If reading doesn’t calm client fears, remind them that modest returns over inflation (such as those from insured savings accounts) may not bring financial security,” says Thomas. “Running out of money also is a risk—and investing wisely is a much better solution.”

As have the five investment advisers we spoke with, smart CPAs have responded to the mutual fund scandals by taking a proactive stance. Keeping close to their clients and a close watch on the funds they recommend has strengthened the CPA-client relationship and has shown clients once again the value of a professional adviser.

Maureen Nevin Duffy is a freelance business journalist and writer in Asbury Park, New Jersey, and host of a weekly talk radio show ( www.restoreradio.com ). Her e-mail address is mnd23cpa@aol.com .


Year-end tax planning and what’s new for 2016

Practitioners need to consider several tax planning opportunities to review with their clients before the end of the year. This report offers strategies for individuals and businesses, as well as recent federal tax law changes affecting this year’s tax returns.


News quiz: Retirement planning, tax practice, and fraud risk

Recent reports focused on a survey that gauges the worries about retirement among CPA financial planners’ clients, a suit that affects tax practitioners, and a guide that offers advice on fraud risk. See how much you know with this short quiz.


Bolster your data defenses

As you weather the dog days of summer, it’s a good time to make sure your cybersecurity structure can stand up to the heat of external and internal threats. Here are six steps to help shore up your systems.