It’s Time for a New Broker

Every so often, a story so perfectly illustrates what can go wrong when you trust someone with your money that it serves as a kind of user’s manual for any investor who comes along afterward.

And so it is with the tale of Philip David Horn, the Wells Fargo broker who recently pleaded guilty to trading in clients’ accounts, canceling the trades and helping himself to the profits. He may very well end up in jail, just as soon as the federal judge can figure out how much money is at stake and how to make those clients whole.
All the juicy stuff is here, as my colleagues Jessica Silver-Greenberg and Susanne Craig laid out in a front-page article last month. There are the country club solicitations (and confrontations), the brokerage firm that finally figured out what was going on after more than two years and the chastened Mr. Horn putting 800 hours into volunteer work and begging the judge to keep him out of prison.
But on the other side of those trades were sophisticated clients, including a lawyer and retired pharmaceutical and aerospace executives. They didn’t notice what was going on, something that Wells Fargo’s lawyer pointed out four times in just a few minutes at a hearing last month in Los Angeles.
So should Mr. Horn’s clients have seen this coming? Perhaps not. But could they have? In hindsight, there were four signs that things weren’t quite right.
BROKER BRAGGING Mr. Horn reportedly bragged on the Braemar Country Club golf course in Tarzana, Calif., about his trades and then pulled paper records out of the trunk of his car in the country club parking lot to back up his boasts.
This is objectively odd behavior. Pitches should take place in an office or at a meeting spot of a potential client’s choosing, over a sober deck of PowerPoint slides perhaps.
And if financial advisers are going to toot their own horns about the good they’ve done for others, you should be hearing about how they persuaded clients not to sell all of their stocks in the first quarter of 2009 when stocks were at their nadir, even though they desperately wanted to. Or you should be hearing that the adviser regularly informs clients of perfectly legal tax-saving maneuvers that they never even knew about. And you should be looking for an emotionally intelligent counselor who can negotiate a truce between you and your spouse over spending disputes.
If brokers want to brag about past performance, however, ask them this: Can you show me audited, long-term results across every part of all of your clients’ portfolios? And can you guarantee that your good calls were related to skill and not luck? 

BROKER TRADING The couple who suffered the most losses had multiple accounts with Mr. Horn, and their monthly statements, in aggregate, often ran more than 300 pages. Mr. Horn hid his in-and-out trading among all that verbiage.
Like it or not, if you’re putting your money in somebody else’s hands, you have the responsibility to read every line of your statements every month. People like Mr. Horn, who was a friend to many of his clients until he wasn’t, count on the fact that you won’t. 

“I think the victims were picked because they weren’t paying attention to their accounts, because each and every trade was documented,” said Stephen Young, Wells Fargo’s outside counsel in this case, according to a court transcript of a sentencing hearing in January. 

Then if there is a lot of trading going on, you have the right to ask why. In a 1999 paper in the American Economic Review titled “Do Investors Trade Too Much?” Terrance Odean, now a professor the Haas School of Business at the University of California, Berkeley, answered in the affirmative. 

His 1999 research, which examined a group of discount brokerage customers, found that on average the things investors buy actually underperform the things they held in the first place. Their returns are reduced through trading. 

In a 2009 paper that Mr. Odean wrote with three others, the group tried to figure out exactly how much individual investors lose by trading. Using data from Taiwanese investors, they determined that the answer was a whopping 3.8 percentage point penalty annually on overall portfolio performance. In an e-mail this week, Mr. Odean said that he believed that these conclusions could be extended to brokers trading actively for their clients, though he has never studied this explicitly.

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