Ethics

ETHICS

Before anything, let me state my position:

ETHICS COUNT. CHARACTER MAKES A DIFFERENCE. KNOWLEDGE IS MANDATORY TO DETERMINING THE SUITABILITY OF AN INVESTMENT. UNFORTUNATELY KNOWLEDGE IS ALMOST NON EXISTENT VIA THE BULK OF REPRESENTATIVES IN THE INVESTMENT, INSURANCE AND PLANNING FIELDS AND THEREFORE ETHICS IS HIGHLY SUSPECT. AN AGENT AND/OR THE FIRM CANNOT BE ETHICAL WHEN THEY ARE FULLY AWARE THAT THEIR TRAINING AND KNOWLEDGE IS DEFICIENT.

"Integrity means avoiding any communication that is deceptive, full of guile or beneath the dignity of people. "A lie is any communication with intent to deceive." Whether we communicate with words or behavior, if we have integrity, our intent cannot be to deceive."

Stephen R. Covey

There are several issues that will be discussed that will be undoubtedly reviewed as caustic and cynical- some in the business will say it is unfounded. However, I submit, my statements have evolved from years of teaching all investment subjects (securities, financial planning, insurance and real estate) as well as being taught to by leaders in the securities, insurance and investment fields through the various courses and degree work I pursued. Further I have acted/act as an arbitrator, expert witness and financial planner and have interviewed and talked with thousands of securities brokers, insurance and real estate agents and their supervisors, attorneys, financial planners, NASD personnel, consumers, arbitrators, investment organizations, students, Certified Planners, ChFC's,- the entire gamut of the investing public, its salesmen and related parties. I therefore submit that few pundits have covered as wide a range and as an in depth analysis of the various topics.

Most of the critical comments- and the crux to any such overview for ethics- will address the inherent lack of of knowledge and training provided in any of the licensing courses. Further, particularly as it addresses securities, that few of the participants at any level have acquired the basic education in risk and reward- the absolute fundamental requirements for the sale of an investment and the key element to determining suitability.

In context with the attainment of this knowledge is a focus on the duty and obligation of what a prudent man would have been required to do- or WHAT HE KNEW OR SHOULD HAVE KNOWN about the investments he was offering. According to just about any definition, a prudent man (and within that context I also include securities attorneys, arbitrators, NASD personnel and others) has a duty and obligation to obtain fundamental knowledge that is mandatory to an understanding of investment (insurance/planning) application- the real world exercise of applying risk and reward basics to the products being utilized. Additionally, such (prudent men) agents must adequately and accurately portray such elements to the consumer so they can understand what it is that they are or will be doing. These knowledge/ethical requirements are necessary irrespective of a discretionary or non discretionary account since the consumer is most almost solely relying on the agent to provide the insight needed to address any investment offering. However, it is my clear contention that the industry(ies) are so bereft of adequate training through licensing that the majority of advisors, absent separate and additional training, are so woefully unprepared in such fundamentals that they cannot properly advise clients on anything but the most rudimentary of investments concerns.

SECURITIES: Let's address the first controversial topic- knowledge, experience and ethics in the securities business. As stated in many other areas on these pages, I have taught the securities licensing training courses of the Series 6, 7, 8, 24, 26, 27, 52, 52, 63 and so on for a period of 15+ years. Such training was more than adequate to pass any of the exams (I had a 90%+ pass rate for the Series 6) but woefully inadequate to address anything but the most rudimentary of concerns for almost all consumers. Spending 20+ minutes explaining the types of mutual funds over a period of 2 ½ days is not offering literally any insight on risk and reward (alpha, beta, correlation, asset allocation)- hence nothing toward suitability. And since I knew that, I felt ethically bound to acknowledge such facts to the students and caution them about their liability exposure and the need for further training. I have also done so to the NASD, SEC, consumer organizations, etc. since the clear absence of fundamental knowledge of risk and reward is obvious at each level.

Now before you dismiss this and further commentary, recognize that the criteria for risk, reward and suitability are not subjective elements that I have selected for my own identification. Pick up any major text (Investments by Bodie, Kane and Marcus is used for CFA training and is must reading for those actively involved in investments selection. Farbozzi has a book on Fixed Income Investments, etc.) and you will see the same basic criteria mentioned extensively and consistently. All of the (good) courses I have taken focus on these same basics. And because this was how I was taught (and currently doing all the time), I have therefore used this same criteria in the extensive teaching I have done for the last 18 years. To reiterate, such basic elements include beta, alpha, correlation, diversification, asset allocation, standard deviation, Sharpe Ratio and a few others. Outside of a relatively sophomoric commentary on beta, the licensing classes do NOT discuss these topics. And, most succinctly, if one does not know what unsystematic risk is in regards to diversification or who Bill Sharpe is (to my knowledge, he is never discussed in investment classes though his ratio is now used more extensively), then the agent is extremely limited in almost all areas of securities application and suitability, without this understanding, the agent doesn't know what he/she is doing.

Recognize as well, that once the exam is passed, securities licensees are able to sell almost immediately.

But clearly, since at least the firm knows that the agent is limited in knowledge, there is a lack of ethics at a minimum at the firm level for allowing a sale by an unknowledgeable and unsophisticated broker to the unknowledgeable and unsophisticated investor- literally the bulk of securities investors.

The point being this- from my own experience, from interviewing numerous agents and reviewing securities cases: for the first two years after licensing, many reps know they don't know anything and look to the firm to provide the guidance and knowledge they need to protect both themselves and their clients. Invariably it is not there or is so simplistic as to primarily induce a sale. Even when I got my license(s), and even though I had been teaching miscellaneous courses for years, I knew something was wrong during my licensing training because the basics of investing were never addressed. I was lost for some time in determining what I should do. But the problem I faced and that is faced by many licensees today is the fact that the supervisors themselves HAVE NO ADDITIONAL TRAINING OR KNOWLEDGE EITHER. IT IS NOT OFFERED IN THE SUPERVISORY SECURITIES LICENSES. So, while a firm is responsible for these agents for at least two years after licensing until such time as the agents can get additional training in the basics of risk and rewards, if a firm is not, cannot or does not want to offer the necessary knowledge to supervisors, then the firm is acting unethically. It is the law- though rarely enforced- that a firm is responsible for the suitable sale of almost all products to consumers. Such a sale is as simple as the sale of single issue securities since diversification of a portfolio must be addressed. If diversification is not addressed, neither is risk (one and the same). By law therefore, such a sale is not only illegal but unethical.

SUITABILITY IS NOT TAUGHT IN ANY SECURITIES COURSE. THE WORD IS USED BUT THERE ARE EFFECTIVELY NO EXAMPLES IN LICENSING, NO TESTING, NO NOTHING. SUITABILITY IS ALSO NOT TAUGHT TO SECURITIES ATTORNEYS OR IN ARBITRATION CLASSES.

AFTER TWO YEARS OF "EXPERIENCE": Once the "apprenticeship" period has ended- and absent other background and education such as a MBA, etc.- the onus for recommending suitable investments and having the requisite understanding of risk and reward falls more directly on the broker/planner/agent. Literally any individual who has worked for two years must have become aware of their severely limited knowledge and sought additional education through recognized designations or degrees in order to increase those skills to- at least what I term- minimum levels that a prudent man would demand. Those that do not partake of such activity are either severely lacking in cognitive skills or are unethical. I DO recognize the real world. Basically, many agents do NOT find it "necessary" to increase skills since it would only be an impediment for sales. That is unquestionably true and that has been submitted to me as a rationale for years. But the point that I am addressing here is ETHICS.

INSURANCE: The same comments are addressed for insurance agents and the required requisite knowledge- save for the consumer to recognize that insurance is unquestionably the most difficult area to properly address in planning due to the lack of product information available. Further, an agent's length of experience provides no definitive criteria for knowledge or ethics. Far more issues need to be reviewed (see Who Can You Trust for further information). The main controversy in the industry is the use of highly commissionable products that are sold to the the unsuspecting consumer. It is not necessary here to reignite those comments. The issue of commissions can- and does- cause a major conflict of interest problem. But there are many agents who utilize these products ethically and therefore the issue of commissions cannot be the sole focus. Where much of the problem lies is with the insurance companies themselves who have, first, maintained an industry lacking in the presentation of statistical evidence to validate the use of a particular product. My point is that a premium is made up of mortality costs, expenses and return on the extra cash in a policy. Since there are no industry mandated standards, each company has effectively made up its own statistics. Most are sustainable and real- but with too many insurance companies to begin with- some have resorted to unsustainable yields, extended mortalities, excessive lapse percentages, etc. in order to gain additional market share. Unfortunately with insurance, it can take some time before a consumer might recognize the problem- sometimes it never happens. Most recently however, some of the complaints have reached state regulators and enumerable lawsuits have been completed with major awards against the companies. Obviously, any such activity is unethical, but even so, until most recently, there was little within the industry to force almost any type of "acceptable" ethical standard. This has changed somewhat with the National Association of Insurance Commissioners attempts to change the industry by focusing on formalized written procedures and mandated statements to consumers regarding the policy costs and expectations.

The NAIC's requirements are not law and not all states or companies have required their use (though getting much better). But it is my contention that consumers might/should be able to reduce unethical activity in this industry by utilizing those companies who have already accepted such standards of practice and simply eliminate most, if not all, of the other companies. Admittedly, the consumer is required to do additional scrutiny- and for the average consumer it will not happen- but it is the only way I know of at present to reduce possible detrimental outcomes.

A second major problem which the industry has promulgated for years: commissions are, in many cases, excessive. However I feel that the offering of "free" trips and other awards has created an industry where even a well educated agent is swayed by the extra incentives that most companies offer. While excessive "trip taking" is not necessarily ipso facto a statement of unethical activity, it begs for further review. Again, in order to reduce such outside influences, the consumer should select only those companies following NAIC procedures and those agents with other designations and degrees.

I want to address the fact that the rating of a company in no way necessarily relates to ethics or viable policies. They are mutually exclusive.

FINANCIAL PLANNERS: Here is a real life example. In the first point, recognize again that insurance is probably the most difficult area to work with in financial planning. While it is possible to get independent and verifiable information about the working of a mutual fund from Mornginstar or about stock from Value Line or about a company for 10-K's and annual reports (yes, I know caveats apply), it has been nigh on to impossible to get the same level of information from insurance companies about literally any of their products. And certainly it was not available to individuals but primarily the rating services. Even if such information did become available to an individual, he/she probably would not possess the skills to qualify the information. As such, the industry had/has a lot of agents recommending the wrong product to the wrong people - and many times just for the commission. Many states recognized these problems and instituted far more extensive licensing requirements and continuing education courses. In California, one has to take a 52 hour course to get a license and then take 25 hours of continuing education each year for the next four years and 30 hours each two years after that. That is pretty extensive. If you want to provide insurance advice for a fee, you need five years worth of experience, take another exam and become an Insurance Analyst. That encompasses at least 167 hours of mandatory schooling before one is able to offer fee advice on insurance. This has been the law since 1957. However, literally every fee only planner in California (check statutes for your state specific laws- At least 32 states have licensing requirements for advisers who want to provide fee-based insurance advice. They are Arizona, Arkansas, California, Connecticut, Delaware, Florida, Georgia, Idaho, Indiana, Kentucky, Maine, Maryland, Massachusetts, Michigan, Mississippi, Montana, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Dakota, Oklahoma, Oregon, Puerto Rico, South Dakota, Texas, Utah, Vermont, Virginia, Wisconsin, and Wyoming.) have refused to adhere to this law since they didn't want to have anything to do with insurance or commissions- further that it would taint their background. So they have been offering fee advice on literally all areas of insurance under the guise that since they are investment advisers, they are exempt. Well, I fought this battle for eight years with this group finally taking key individuals to the State Department of Insurance. The State ruled that these people were acting illegally- as identified below.

But my comments go far beyond the stage of illegality. They involve ethics. These same groups are NOT required to take any courses in insurance ever, pay no money to the state department of insurance and are under no state auditing controls. While some may like that aspect, there is a fiduciary obligation- and ETHICAL obligation- to provide only advice on something wherein you have knowledge. Wouldn't it seem logical to a prudent man that one should have at least the same skills and knowledge base as the least required entity offering products? What about the more "extreme issue" of what should have an expert know or should have known.

I posted this comment on the issue of ethics in February 1998. It also picks up the fact that the national publications are not focused on ethics either.

UN WORTH Y: Worth magazine publishes a directory of planners it has found to be the best in the country. Some are good. Some are liars. Worth was notified in 1994 of the illegal activities of a number of its selected planners in California. It did nothing and these planners gained a completely undeserved reputation. Worth continued to extol the virtues of these same planners this past year. Worth was sent this letter after their 1997 edition of Best Planners. Never got a reply to either- which I submit is an error of journalistic integrity.

But I did pursue the issue mainly because I do not like liars and frauds- particularly when I witnessed a large group of California planners lie during an ethics course in 1995. (Judge William Rhenquist recently wrote for the supreme court, "A citizen may decline to answer a question, or answer it honestly, but he cannot with impunity knowingly and willfully answer with a falsehood.") So I spent the time to expose such illegal and unethical activity- effectively stonewalled at every turn by the organizations. NAPFA officers indicated for a long time that the Department had given them an absolution from the requirements of the law (letters on file)- Total Falsehood. An officer sent statements directly to members that California State law granted them an exemption. Again a falsehood, but to validate the State's position, I had the Assistant General Counsel and Chief, Compliance Bureau commit the State's unwavering position to writing. With the help of staff attorney Fred Butler of the Department (and a very ethical man), the State requested a meeting of the financial planning industry in July 1997. (The Department requested the input and attendance of IBCFP, IAFP, NAPFA, College for Financial Planning, and CPA societies.) The IAFP and College responded to Mr. Butler but did not show up. NAPFA neither responded nor showed up (doesn't that tell you something???) But to give you an idea of what the organizations thought of compliance to the law, a past officer of the Board of Standards said, "So, what's the big deal?"). After complete review by the State, it sent out to the attendees the following letter that clearly identifies the fact that such planner activity was at all times illegal. Apparently the organizations who have already received it are "very upset" with its contents and the absolute fact that its representatives were at all times violating the law.

Some of you might say "so what?", "who cares?" particularly in view of a jaded society that gave Clinton high marks irrespective of his sexual escapades. But a financial planner who lies about his/her capabilities, licensing and ethics is, I suggest, an entirely different matter. Once you have someone (or an organization) who lies and is unethical, wouldn't you be concerned about what they might do to you AND your MONEY?????? Admittedly, I cannot say that a properly licensed representative would not also do something illegal or unethical- but tell me again, where would you want to start?????

I will add this paraphrased commentary from a theology professor regarding what families do when they find out a child has done something wrong. "There always seems to be the type of family that would immediately punish the child. Then there is the other type. If the child did something wrong, they automatically defend the child to defend the family. That doesn't teach responsibility and it doesn't teach morality." I submit that the planning organization's rationale is the latter. Ethics has been merely a grouping of words without substance.

IT'S A LOT EASIER TO TALK ABOUT YOUR ETHICS THAN TO LIVE UP TO THEM.

Regarding 2006 licensing- California Life and Disability Insurance Analyst: Does the state still require licensing.

Here is an Email I got from a CFP who I have been talking to.

To: Licensing, Insurance

COMMENTS: Is it necessary for me to get the life & disability insurance analyst license if I charge a fee for a comprehensive financial plan where evaluation of insurance policies is part of that plan? I am a Certified Financial Planner practitioner.

Reply: Carol Boersma

Staff Services Analyst

Department of Insurance

Licensing Compliance Bureau

1-800-967-9331

I am responding to your email of July 28. I would conclude, based on the scenario you have provided, that you would need a Life and Disability analyst license. Please review the definition on our website.

http://www.insurance.ca.gov/0200-industry/0200-prod-licensing/0100-applicant-info/0100-producer-types/life-disability.cfm