by Paul Sullivan
Tony Guernsey has been in the wealth management business for four decades. But clients have started asking him a question that at first caught him off guard: How do I know I own what you tell me I own?
This is the existential crisis rippling through wealth management right now, in the wake of the unraveling of Bernard L. Madoff’s long-running Ponzi scheme. Mr. Guernsey, the head of national wealth management at Wilmington Trust, says he understands why investors are asking the question, but it still unnerves him. “They got their statements from Madoff, and now they get their statement from XYZ Corporation. And they say, ‘How do I know they exist?’ ”
When he is asked this, Mr. Guernsey says he walks clients through the checks and balances that a 106-year-old firm like Wilmington has. Still, this is the ultimate reverberation from the Madoff scandal: trust, the foundation between wealth manager and client, has been called into question, if not destroyed.
“It used to be that if you owned I.B.M., you could pull the certificate out of your sock drawer,” said Dan Rauchle, president of Wells Fargo Alternative Asset Management. “Once we moved away from that, we got into this world of trusting others to know what we owned.”
The process of restoring that trust may take time. But in the meantime, investors may be putting their faith in misguided ways of ensuring trust. Mr. Madoff, after all, was not charged after an investigation by the Securities and Exchange Commission a year before his firm collapsed. Here are some considerations:
CUT THROUGH THE CLUTTER Financial disclosure rules compel money managers to send out statements. The problem is that the statements and trade confirmations arrive so frequently, they fail to help investors understand what they own.
To mitigate this, many wealth management firms have developed their own systems to track and present client assets. HSBC Private Bank has had WealthTrack for nearly five years, while Barclays Wealth is introducing Wealth Management Reporting. But there are many more, including a popular one from Advent Software.
These systems consolidate the values of securities, partnerships and, in some cases, assets like homes and jewelry. HSBC’s program takes into account the different ways firms value assets by finding a common trading date. It also breaks out the impact of currency fluctuation..
These systems have limits, though. “Our reporting is only as good as the data we receive,” said Mary Duke, head of global wealth solutions for the Americas at HSBC Private Bank. “A hedge fund’s value depends on when the hedge fund reports — if it reports a month-end value, but we get it a month late.”
In other words, no consolidation program is foolproof.
But a blind faith in transparency can also be misleading. The concept has become a buzzword. Would more frequent and detailed reporting have helped Mr. Madoff’s investors when the S.E.C. missed the fraud?
“If a complex instrument is completely transparent, you’re still not going to be able to figure it out,” said Aaron Gurwitz, head of global investment strategy at Barclays Wealth.
He noted that a collateralized debt obligation — a type of security linked to the financial collapse — could be called transparent, while a simple structured note that limits an investment’s losses and gains could be utterly opaque because of the way it was created.
A simpler example is municipal bonds, which have been attracting investor interest because they are perceived as secure. While it is easy to get a price on bonds from large entities like New York or California, the same cannot be said for thousands of smaller issuers. The reason is that there is no designated market-maker for municipal bonds. So getting a price often can mean calling around to several sellers.
Here, though, investors’ fears could be assuaged with more information. However hard they are to price, municipal bonds have a default rate under 1 percent.
SIX RULES FOR HEDGE FUNDS Full information is key to investing in hedge funds now. When times were good, no one was bothered by rules that prevented investors from taking their money out when they wanted. But when the market collapsed in the fall, people suddenly balked at these lock-up provisions.
Mr. Rauchle said he believed that a simple six-step plan could benefit investors and keep hedge fund managers from having to submit to excessive government regulation. The first four points are straightforward: each fund larger than $100 million needs to register with the S.E.C. and have an independent custodian who holds the money, an independent administrator who prices the securities and an independent auditor.
But managers may balk at Mr. Rauchle’s last two proposals: he wants hedge funds to reveal how they price securities and to submit to an independent, quarterly analysis of their portfolios. Up until now, hedge funds have prided themselves on secrecy.
“This is about providing information and letting people decide,” Mr. Rauchle said. “I don’t think we should put an S.E.C. official in every hedge fund office. Nor do I think we should allow fund managers to stay behind this veil of secrecy.”
CHECKING UP While trust that your spouse is not keeping secrets from you is a critical to a sound marriage, trust that your wealth manager is not cheating you is a different story.
Kelly Campbell,an adviser in Fairfax, Va., and the author of a book coming out in July, “Fire Your Broker” (Riverfront Press) suggested calling the firm that actually holds your money to check on the manager. Most independent advisers use a separate custodial firm to hold their funds. (Mr. Madoff was his own custodian, which should have been a red flag.)
“It’s doing a little bit of your own homework,” Mr. Campbell said.
That type of checking is not hard. Dean Barber, an adviser in Kansas City and the host of the radio show “The Wealth Management Show,”said that just about every piece of information an adviser could get a client could get, too.
Of course, shadowing your investment adviser could be as unhealthy as fretting over your spouse’s fidelity. Mike Saghy, director of investments at PNC Wealth Management, said that to prevent this concern he steers clients with at least $1 million into separately managed accounts. This way they know what stocks and bonds they actually own — not how many shares in a fund they have.
“People are showing some angst over mutual fund holdings,” he said. “The want to know that they own a muni bond from the state of Pennsylvania and not a portfolio of muni bonds.”
RESTORING TRUST At the end of the day, living life fearing that the people handling your money are deceiving you is not good for you. Insisting on openness is one way to rebuild trust.
“There are no secrets in our industry,” Mr. Barber said. “If somebody tells you, ‘We have a special way of doing things but we don’t divulge how we do it,’ chances are it’s a scam.”
As harsh as this sounds, the alternative is not practical: even hoarding gold bricks in your basement requires a level of trust. “How do I know it’s not a lead bar painted gold?” Mr. Guernsey asked.