From the December 2007 issue of Wealth Manager Web • Subscribe!

December 1, 2007

Financial Crusaders

There's a lot of money being made in the money business. Alas, not all of it is necessarily being made on the up and up. Say hello to four self-styled "Ralph Naders" of finance, each one seeking to make the money business more fair and square, each one relentless in his or her mission to see that the common investor gets an even break. Whether you see them as thorns-in-the-side, or selfless saviors, their messages cannot be ignored.

Name: Kevin Olson

Home: San Francisco, Calif.

Main Beef: Mark-ups on munis are too high.

Bond markets have become more transparent, and double-digit markups, once as common as flies circling a garbage dump, are becoming harder--but not impossible--to find. High single-digit markups, on the other hand, are still fairly commonplace, especially in the municipal bond market, and that makes Kevin Olson angry. "Is a 6.678 percent markup on a bond sale fair and reasonable?" he asks, citing a recent transaction that earned a red flag on his Web site, www.municipalbonds.com. "No, I don't think so."

A former municipal bond trader himself---with Bank of America, Paine Webber and others--Olson, 46, turned independent investor advocate in 2000. That's when he launched his Web site and began pumping out regular reports and press releases blasting the muni-bond industry for its mountainous mark-ups and lack of transparency. "That year," he says, "I reported spreads of 20...30...40...50 percent! There were cases where a bond that sold at par for $100 in the morning was bid for sale at $50 that afternoon!"

Olson's regular missives decrying such spreads prompted authorities at the Securities and Exchange Commission and the National Association of Securities Dealers (now part of the Financial Industry Regulatory Authority) to take action. In 2004 they opened investigations into the improper pricing of muni bonds. Those investigations led to the enactment of greater oversight and tighter regulations designed to give the individual bond investor a fighting chance.

Olson's actions may also have helped push for the implementation of the TRACE system, where today. virtually every corporate and municipal bond trade in the nation is reported online, open for all the world to see. The combination of greater oversight and increased transparency, Olson estimates, has saved investors at least $8 billion.

But according to his calculations, there are billions more that could stand to be saved. "Trade reporting and price transparency have gone just about as far as they can go," he says. "What we need now is real market reform. We need a place where everyone can go to put up and accept bids, where bonds can be traded openly with little friction and without the high mark-ups--much more similar to how stocks are traded."

In the meantime? Olson suggests that you don't even consider buying or selling a municipal bond without first checking its trading history on www.municipalbonds.com. (The trading history of individual bonds is also available on www.investinginbonds.com and on the Web sites of certain brokerage houses, such as Fidelity.)

Olson also suggests that you work with several brokers--not just one--and don't assume that discount brokerages are always the cheapest, for that isn't always the case. He also says that new issues on municipal bonds (which are similar to IPOs on equities) can often be had for the thinnest mark-ups and therefore offer the highest yields--but you often have to ask for them.

Name: Yolanda Holtzee

Home: Seattle, Wash.

Main Beef: Corporate governance is an oxymoron.

She spends hours a day (generally two to three), starting in the wee hours of the morning, at her computer or on the phone, sniffing out cases of suspected securities fraud. When she spots anything un-kosher, she emails or calls the regulatory authorities. "If you see something you think is a violation of securities law, why not snitch?" asks Yolanda Holtzee, 51. "After all, if your neighbor's house was being broken into, you'd call 911, wouldn't you?"

Holtzee works part-time running a private investment group and also serves as an expert witness in securities cases--always testifying for the plaintiff. She says the motivation for her gadfly activities is partially in the public interest, partially self-motivated. "I want a level playing field for myself and for all others," she says. "The stock market should be a place to earn an honest buck, and that isn't always the case."

Twenty years ago, Holtzee says she was working as an engineer in a large manufacturing concern and discovered that bribes and kickbacks were part of the way business was done. "I didn't want to work for a company like that, so I quit, and I wrote a letter to the co-chairs of the company explaining why." The letter started a company-wide investigation, but shortly thereafter, the company was sold. Unsure whether the bribes and kickbacks continued under new management, or whether old management continued their antics elsewhere, Holtzee regrets not having blown the whistle to authorities.

But she is making up for lost time, lately in the area of microcaps.

"Microcap issues are where you find the most blatant and egregious fraud today," says Holtzee. "I'd say 80 percent of the issuers, the companies themselves, are somewhat culpable. Maybe they don't go out and intentionally commit fraud, but they aren't innocent bystanders, either. They aren't completely unaware that when you hire a stock promoter (PR firms that function as investor relations departments for small companies), they play games and often do whatever to fluff up share prices."

One example of those "whatevers": Sending out spam to thousands of unwitting potential investors with headlines such as "Ready to Explode!" "Ride the Bull!" and "Money Machine!"

Holtzee is careful not to take credit for the recent SEC initiative called "Operation Spamalot," but she does note that a good number of the 35 companies sanctioned were companies that she had complained about.

Operation Spamalot resulted in a bevy of criminal indictments for both issuers and stock promoters. "I'm happy about that," says Holtzee. "It's good to know that my incessant whining to the commissioners has seen results. It shows that squeaky wheels do, in fact, get oiled."

Advice to fellow wealth managers? "Spend time to familiarize yourself with securities laws so that you personally won't get caught up as a person of interest, perpetrating fraud," says Holtzee. "If you do spot something that you think is a violation of securities laws, snitch. It's your duty." And, finally, "If you're going to invest in microcaps, diversify well; possibly consider an index fund," she says.

Name: Martin Weiss

Home: Palm Beach Gardens, Fla.

Main Beef: Investment banking firms' ratings are a joke.

With the recent subprime-mortgage-backed securities fiasco, lots of people are asking why the major ratings firms weren't quicker to alert investors that many of those securities were dogs.

Martin Weiss says he knows the answer.

"Millions of investors build their retirement portfolios (both the fixed-income and equity sides) based on the 'buy', 'sell,' or 'hold' recommendations of the major banking firms. What they don't realize is these ratings are far from objective. They are, in fact, pure payola--literally bought and paid for by the companies being rated," Weiss fumes.

Best known as the founder of the Weiss Ratings (which he has since sold to TheStreet.com), Weiss has testified before Congress and the SEC that there's something terribly amiss with the major ratings firms such as Standard & Poor's, Moody's, Fitch Ratings, and A. M. Best--sometimes referred to as the "nationally recognized statistical rating organizations" or NRSROs. Their recognition comes from the SEC, which dictates whose ratings other financial firms may use for various regulatory purposes. There are currently only seven organizations so sanctified.

"Consumer Reports would never, ever take money from a company whose products they are reviewing. A restaurant or movie critic would never take money from a restaurant or movie producer. But the NRSROs take significant money from companies they rate," says Weiss.

The "payola," as he calls it, occurs in a number of ways.

First, the NRSROs are paid outright fees by the companies being rated, and if those companies don't like the ratings they get, they can end their contracts. Second, if a company doesn't like a rating it gets, it can opt to have the rating remain unpublished. Third, additional revenues are derived from other business lines of the rating firms, such as consulting. If a company is given a bad rating, it has the option of finding a new consultant on which to lavish lucrative contracts.

Weiss, 61, says he personally knows Ralph Nader. "I don't presume to fill Ralph's shoes in the financial world," he says. "I spend more of my time running a for-profit business; I'm only a part-time Ralph Nader." The business of which he speaks is Weiss Group, Inc., a diversified financial consulting and publishing corporation.

But his for-profit venture doesn't keep Weiss from commenting regularly on the sorry state of the ratings business. Weiss has spoken not only to Congress and the SEC, but has also appeared frequently on major TV news shows and is often quoted in the national press.

What can wealth managers do to protect themselves from getting sucked into making foolish investment decisions by paid-for ratings?

Weiss suggests turning to his namesake company, even though it isn't his company anymore. "Weiss ratings have always had the same policy not to accept compensation from any companies being rated. That clearly makes Weiss ratings superior," he says. "I can say that now--now that it isn't my company anymore--without being accused of bias."

Indeed. One study by the U.S. General Accounting Office (GAO) found Weiss Ratings three times as likely to spot a dog as its ratings competitors.

Name: Rick Ferri

Home: Troy, Mich.

Main Beef: Wealth managers charge too much.

Charles Schwab introduced discounts to the brokerage business. John Bogle and Vanguard hit the market with super low-cost mutual funds. In both cases, industry standards would never again be the same. Rick Ferri, 49, hopes to shake up yet another industry standard--the traditional 1 percent charged by many, if not most of today's fee-only wealth managers.

Ferri started his fee-only practice, Portfolio Solutions, in 1999. He began with low fees, and his fees are still low. Ferri charges 0.25 percent per year on assets up to $5 million; 0.15 percent per year on additional assets from $5 million to $10 million; and 0.10 percent per year on assets over $10 million. The minimum is $500 per quarter.

His investment style makes use of low-cost, broad-based index funds (mostly Vanguard and Dimensional) and exchange traded funds (usually Vanguard and Barclays). Total fund expense ratio is approximately 0.20 percent.

"The typical advisor uses a lot of active strategies, often employs expensive investment products, overcharges the client, and rather consistently underperforms the indexes," says Ferri. "By keeping my fees low and using low-cost index funds, quantitative performance goes up. I call it cost alpha. It works for clients. It works for me." Indeed. Portfolio Solutions has grown rapidly in the past several years, and the firm is quickly closing in on its first $1 billion under management--with approximately 500 separate clients serviced by a total staff of six, including Ferri himself.

And profit margin? Healthy. "We charge much less than other advisors, but our expenses are also considerably less," says Ferri. "We manage money. Period. We don't maintain a fancy office. We don't meet with clients on a regular basis and take them to dinner, or buy them baseball tickets. We don't send fruit baskets and flowers. There's no nicey, nicey stuff. Not even birthday cards. We manage money. That's it."

Ferri knows darned well that he is a thorn in the side of many portfolio managers who, he reckons, feel guilty for taking more client money than they know they deserve. "I see them at conferences, and they don't want to look at me, don't want to talk to me," he says. "Then I get those who say, `You aren't doing clients any great favors, because you're only investing in index funds.'"

"Show me how you're doing any better with your active strategies and high fees," Ferri responds to those who challenge him. "Most portfolio managers out there either under-perform the market, or they claim to outperform the market, but they can only do so because they are using all the wrong benchmarks."

Of course, a lot of fee-only wealth managers who charge the traditional 1 percent also do general financial planning for their clients, advising on matters of cash flow, insurance, estate planning and such. And that really gets Ferri ticked. "Financial planning is an entirely separate business from portfolio management--or at least it should be," says Ferri.

"In my mind, a financial planner should do financial plans. If he or she then does asset management, that should be broken out and charged for separately," he says. "I also feel that the financial planner has a fiduciary duty to recommend other potential asset managers, and not offer himself as the only game in town. I don't know many financial planners who also do portfolio management who do that.

"I know I'm making waves in the industry. But I'm not going to stop. In fact," he says, "the waves are only going to get bigger!"

Russell Wild, MBA (Russell@russellwild.com), a financial journalist and a NAPFA-certified financial advisor, is the author of The Unofficial Guide to Getting a Divorce, Bond Investing for Dummies, and Exchange-traded Funds for Dummies.

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