The worst nightmare for individual investors is a financial adviser who loses a big chunk of their life savings on a wild bet.
It turns out that such a fate is more than just a bad dream. Too many investors are waking up to the fact that it’s a harsh reality.
Many large registered investment advisory firms, also called RIAs, buy “errors and omissions” insurance. This coverage is designed to pay off investment clients whose advisers make mistakes, choose unsuitable investments, or simply execute dumb decisions that cost investors a significant amount of money.
Unfortunately, when RIAs decide to save money by skipping E&O insurance, the people who pay the price for investing mistakes are too often the clients, not the firms.
Don and Julie Hale, a retired couple who divide their time between the small town of Union, Wash., and a rural area of Panama, sought relief in December 2018 from Bayley Financial Inc., a tiny RIA in Gig Harbor, Wash.
The Hales are represented by Patricia Vannoy of Lincoln, Neb., and David Gaba of Seattle, attorneys who are acting as co-counsel. They say the Hales lost approximately $400,000 of their life savings, because an adviser used their retirement accounts to place a large bet on Tahoe Resources, a precious-metals mining company incorporated in Vancouver, British Columbia, and headquartered in Reno, Nev.
In emails to the Hales’ attorneys, financial adviser Philip N. Bayley wrote: “They wanted 100% of the IRA to be in gold related investments,” because of a concern that the couple’s separate pension payments would lose value if the United States suffered hyperinflation in the coming years. “I am heartbroken about what has occurred to Tahoe Resources, the Hale’s [sic] account and their reduced financial peace of mind.”
Tahoe Resources fell from a closing price of $5.44 on April 19, 2018, to $2.20 on Nov. 13, 2018, a 59% loss. The price recovered above $3 the next day, when Pan American Silver PAAS, -1.71% announced it would acquire the troubled smaller company. Some Tahoe owners received cash, but most received Pan American shares. In another blow for the Hales, Pan American—which traded above $18 as recently as July 2018—fell to a close of $13.26 on April 12, 2019.
The Hales are unlikely to ever see any of their lost money. Bayley Financial had no E&O insurance. Bayley and his wife, Tove Koch, filed for Chapter 7 protection in U.S. Bankruptcy Court on Jan. 9, 2019. The Hales did not sue Philip Bayley, because the bankruptcy filing gives the Bayleys protection against creditors.
In an email to attorney Gaba on Jan. 11, 2019, Bayley explained that he has discontinued Bayley Financial, and that he is “looking to move to Sweden,” where his wife has family.
Bayley did not respond to four email and voice mail requests for comment.
“Only the very largest RIA firms have insurance,” explains Vannoy. “Your average RIA only has a handful of people working for it. Having 100 employees is a large RIA.”
For his part, Gaba says, “My experience is that 90% of the RIAs that have only one or two advisers do not have insurance.”
To be clear, no judge or arbitrator is going to return any money you lost just because the market went down. But part of the fiduciary duty that RIAs are expected to meet is to place clients’ funds into “suitable” investments.
It’s odd for a retirement account, which should be diversified into different assets for safety, to be concentrated on a single company—especially in a speculative industry such as mining. Since hitting a high on April 19, 2018, Tahoe Resources started vaporizing more than half of its shareholders’ wealth, but the VanEck Vectors Gold Miners ETF GDX, -1.48% which holds 48 different mining companies, is down a mere 3.2%, including dividends.
The lack of insurance by many RIAs adds up to a lot of problems for a surprising number of retail investors.
Joseph and Judith Musa are a married couple in Middleton, N.J. They signed up in 2004 with James Warren Vassas Jr., an investment adviser they crossed paths with at a local day-care center.
According to his website, Vassas worked for a variety of financial-services firms in New Jersey from 2002 through 2016. All of the companies reportedly had insurance coverage and a supervisory role. Vassas then opened and became president of Cairn Investor Services, a small RIA firm he founded in La Jolla, Calif. It has no E&O insurance and is independent.
Eventually, the relationship came to a head with the Musas filing a complaint against Vassas on Oct. 5, 2018, in New Jersey Superior Court, a case that is ongoing.
In their complaint, the Musas allege that they sought a “conservative growth” portfolio for their IRAs. However, they claim, the adviser instead rapidly bought and sold so-called 3X leveraged and 3X inverse exchange-traded products from providers Direxion, ProShares, and VelocityShare, which the couple documented using brokerage statements. Far from delivering three times the return of an index, 3X leveraged vehicles can hugely magnify the market’s losses.
The couple’s complaint also alleges that the adviser purchased an annuity and then switched it to another annuity from a different insurance carrier, generating commissions for himself but financial penalties for the couple.
The Musas’ attorney, Richard DeVita of Hoboken, N.J., says the couple lost over $100,000. He notes that the case is turning out like too many other RIAs he’s seen: “No funds, no insurance.”
In a response filed with the court on Oct. 30, 2018, Vassas denied all of the Musas’ claims. The filing said he was “under duress or fraudulently induced to enter into the deal” and requested a trial by jury.
Vassas did not respond to requests for comment.
WealthManagement.com, a website for financial advisers, says E&O insurance can cost $2,000 a year for coverage of $1 million. (The annual fee covers claims up to $1 million. It is not levied as a percentage of an RIA’s assets under management.)
E&O insurance covers you for a wrongful act, error, omission, or breach of fiduciary duty in rendering professional services to a customer or client.” A “breach of fiduciary duty” usually means that an adviser put an investor’s money into a security that was “unsuitable.” If an insurance company did not agree with a complainant that an investment was unsuitable, the investor would have to sue or seek arbitration, at which point a judge or arbitrator would decide.
To be sure, $2,000 is not nothing. But larger RIAs consider it a justified cost of doing business. There’s no requirement that RIAs have such insurance, however, and it appears that many of them do not.
How can you make sure your money isn’t shredded by an adviser?
• Ask about insurance. A legitimate RIA should demonstrate to you that it has E&O insurance in force, and for a large liability limit. (Any firm can be liable for claims of far more than $1 million in a single year.)
• Be your own investment adviser. You should certainly listen to a trusted financial adviser for guidance on financial planning, wills, trusts, and the like. But with today’s low-cost exchange-traded funds, you can and should diversify your accounts without transferring your money into anyone else’s hands. You can start with a Lazy Portfolio, a set of simple allocation formulas that MarketWatch has tracked for more than 16 years. Or use the newer Muscular Portfolios, about which I am an editor and author, that should be reviewed as often as once a month.
Keeping your money in your own hands is wise, whether or not a financial adviser has E&O coverage. This type of insurance typically doesn’t cover you against outright theft of your assets by a dishonest broker. That’s considered purely a criminal matter, not a genuine error or omission. As we’ve seen, trying to pursue any disputed case is expensive and time-consuming, and your success is not at all guaranteed.
Author Samuel Lover—what a great name for a romance novelist—wrote in 1837, “Better safe than sorry.” That adage is nowhere more true than in the financial-services industry.