Wall Street Potholes. Simon А. Lack

day through their fluctuating prices.

      The true value of Strategic Realty Trust didn't suddenly fall by 29 %; that move reflected the cumulative effect of not updating the value over the prior five years. This is why investors normally seek higher returns on illiquid investments, notwithstanding the sales pitch for NTRs.

      The point of this is to show how much important information can be buried in the lengthy legal agreements that accompany almost any investment. The challenge for the investor is how to navigate this territory. Penelope's experience is emblematic of an all-too-common problem for individuals trying to invest their money. They often find themselves sitting down with someone who calls themselves a financial advisor, when really they're talking to a salesperson.

      In fact, the illiquidity doesn't benefit the “long-term investor” as Sameer Jain misleadingly asserts, but the issuer. For it turns out that, if you want to sell your regrettable investment in a non-traded REIT, without a stock market listing the only realistic buyer is the NTR itself. Persuading investors that they should prefer illiquid securities, and then being positioned to be the only plausible buyer when a hapless investor wants out is the essence of the sales pitch described above.

      Penelope made this investment on the recommendation of the person who covered her at Ameriprise, a large brokerage firm (known as a broker-dealer from a regulatory perspective). Ameriprise, like other large brokerage firms, calls the people who deal with clients financial advisors. It's true they provide financial advice to Penelope and millions of others, but it doesn't mean they have a legal obligation to put their clients' interests first. The US regulatory structure recognizes two types of firm facing investors – broker-dealers and investment advisory firms. The difference is a subtle one, especially because many big firms operate as both. Broker-dealers generally charge commissions on trades you do, or in the case of bonds charge a price mark-up if they're selling you a bond they already own. Investment advisors charge a fee for their advice. The crucial difference is the broker profits when you do a transaction. They earn a commission, or a mark-up (or sometimes both). This can present a conflict of interest, in that a transaction may not be good for the client but is always good for the broker. Brokers are not required by law to put the clients' interests first, whereas investment advisors have a legal, fiduciary obligation to put their clients' interests ahead of their own.

      One of the confusing things is that a broker can employ people it calls financial advisors, but they are not the same as investment advisors, a term that's legally defined to mean someone advising you as a fiduciary.

      Who on earth wants to study the intricacies of US financial regulations? People just want access to honest advice. Calling someone a financial advisor places them in the same category as a doctor or lawyer, two professions that have a legal obligation to put the interests of their client (or patient) first. It's a bit like calling a car salesperson a transport advisor, or a real estate broker a housing advisor. Both will provide you advice, and the recipient of that advice will assess it with the knowledge that it's proffered by someone whose objectives are different than your own. There's nothing wrong with that as long as you know what type of relationship you're getting into.

      I should at this point note that many financial advisors at brokerage firms are honest people truly putting the interests of their clients first. I have friends who do just that, and I'm not trying to criticize a whole industry. But they're not all good, and the bad ones create a problem for their clients as well as for the rest of us.

      Some feel it would make a lot of sense for the people who work at brokerage firms and call themselves financial advisors to adopt a fiduciary standard, the same as investment advisors. (Yes, I know it's confusing. Financial advisors sound like investment advisors, but they're not.) If financial advisors had to meet a fiduciary standard it would make life far simpler for investors who choose not to become regulatory experts as they look for investment advice. But the brokerage industry recently lobbied successfully against such a move so it's unlikely to happen. I think that as long as a client understands their advisor's actual responsibilities they need not be a fiduciary.

      Penelope misunderstood the type of relationship she had with her financial advisor at Ameriprise. Penelope thought she was dealing with someone who was required to consider her interests first and foremost (like a doctor or lawyer) whereas in fact she was dealing with the equivalent of a realtor, someone who would get paid out of the transaction fees extracted from Penelope.

      This is where Inland American Real Estate Trust came in. The 10.5 % of fees (and potentially up to 15 %) that was to come out of the client's money the moment it was invested would typically be shared substantially with Penelope's “advisor.” So when Penelope was “advised” to make the investment, the advisor clearly had a conflict of interest. It's no different than a doctor prescribing medication to a patient and receiving a payment from the drug company that provided it.

      Whose Side Is Your Financial Advisor On?

      Some people who call themselves financial advisors sit on your side of the table acting on your behalf. These are Registered Investment Advisors (RIAs). They act as your agent and they're legally obligated to put your interests before theirs. Other financial advisors sit across the table from you, and their interest in the client's well-being is similar to that of any other salesperson. They generally work for brokerage firms (as opposed to investment advisory firms). Yes, they want you to invest your money in something worthwhile, but they also earn a transaction-based fee so products with higher fees benefit this type of advisor and inaction rarely makes them any money.

      Many if not most of the financial advisors who work for brokerage firms genuinely put the interests of their clients first. I have friends in the industry about whom I feel comfortable making this statement. And clients who invest through an RIA are charged an advisory fee as well as having to incur commissions on the investments they buy. This can make the use of a financial advisor who works for a brokerage firm appealing in that there are only commissions to be charged. However, I believe the potential for conflict of interest can represent a negative for the client. The protections for clients against being marketed a poor investment can be weak (which was why Penelope was persuaded to invest in the non-traded REIT). The brokerage industry successfully fought attempts to impose a fiduciary standard on their salespeople (who often refer to themselves as financial advisors) so the client is basically reliant on the quality of the person with whom they're dealing.

      My own business is a Registered Investment Advisor (RIA) and I am an Investment Advisor Representative (IAR). I'm pretty comfortable that although we charge a fee to manage money, the commissions charged on transactions by the brokerage firms through which we trade are low enough to not make much difference. If you trade online and infrequently, you minimize transactions cost, taxes, and the irrational impulse to try and profit from short-term market moves. The RIA has an obligation to put the client's long-term interests first. The financial advisor at a brokerage firm may put your interests first if he's so moved, but he may not be legally obliged to. As long as his recommendations are suitable and appropriately disclosed, then he's fine. He'll be paid based on his revenue production, and that production is often driven by transaction volume rather than the size of the accounts on which he's providing advice.

      So let's return to Penelope and the non-traded REIT, Inland American Real Estate Trust, which she unfortunately owned. It had no public market valuation and therefore no way for Penelope to sell her holding. It had performed very poorly since being initially launched, and the fees charged were shockingly high. In fact, even more surprising than the level of fees was the fact that they weren't actually illegal. You would think being charged 15 % of your investment would trigger some kind of securities violation, but it does not. I guess if it's there in the documentation you're expected to have read it.

      Nonetheless, I suggested to Penelope that she go back to Ameriprise, who had sold her this investment, and ask them to buy it back from her at the original price. She clearly had not understood what she was getting into, and in my opinion it should never have been sold to her. At first, Penelope was unwilling to do this. She felt the advisor she'd been dealing with was a nice person (albeit evidently not that good at providing financial advice), so Penelope decided to move on and hope that somewhere down the road the REIT might buy back her shares.

      A few months later, Massachusetts announced a settlement