February 17, 2012
Commentary by Joseph Warren
Perhaps it’s the great recession and the gradual pace of the economy's recovery that has uncovered them, but the number of suspect and unethical undertakings revealed in the financial services arena over the past few years is greater than anytime I can remember in my career. While the dark shadow of these mischievous acts looms over my entire industry, I know that no level of regulation can guarantee that your money is being held by the ethical standards I believe it should. Ultimately, the responsibility of insuring such rests on the investor. Given my 19 years of experience, I offer some basic steps for investor protection.
Before I get too far, let me clarify the subject. These steps are intended to address the basic concept of custody and practical matters of ethics that anyone who has the responsibility of holding someone else's money should abide. This is not about a money manager's investment prowess, a subject I'll address in a future edition. Simply stated, the following will help you validate if your money is where you think it is:
1) Investigate and understand the institution that actually holds your money. Do you recognize the name? Did you or someone you trust read the disclosures on the account application? Is the term hypothecation in the agreement? What rights does the custodian have to borrow money from your account? If you don't know or can't find these then ask the institution you’re considering to explain and verify. If you don't understand their explanation, do business elsewhere.
2) Are your accounts covered by Securities Investor Protection Corporation (SIPC) or the Federal Deposit Insurance Corporation (FDIC)? SIPC deals specifically with investment accounts held at broker-dealers registered with the Securities and Exchange Commission. SIPC’s role is to return funds and securities to investors if a broker-dealer registered with the SEC holding these assets becomes insolvent and it covers the first $500,000 held within your account. The FDIC is an independent agency of the U.S. government and it protects depositors of insured banks. The standard deposit insurance amount is $250,000 per depositor, per insured bank, for each account ownership category.
3) What insurance coverage does your broker-dealer have beyond $500,000? Almost every large broker-dealer has coverage beyond SIPC and you should know the amount.
4) What investments do you actually own and are they being valued by the investment manager or a third party? This subject can be tricky because many invest via mutual funds or private investments companies and their underlying holdings aren't publicly disclosed at all times. Mutual funds are one of the most highly regulated investment vehicles, however. In all my years I don't remember a single mutual fund that was able to commit fraud. But to validate, take your fund symbol and type it into Yahoo Finance or Google. That should give a good idea of what was in it last time it filed its holdings and how it’s invested. If you don't get any results from the Web, call your broker and investigate. Private investment companies/funds are more difficult as they are often invested in more exotic instruments than stocks and bonds and valuation is done by the money manager, which is difficult. But private funds require accounting and are often audited. Seek out the accountant and auditor before investing. Be suspicious if the fund doesn't have either.
5) What underlying assets are in your money market? Many money market funds have the ability to invest in non-Treasury instruments. Funds often purchase commercial paper of financial institutions or sovereign debt of foreign countries. In 2008, the Primary Reserve Fund "broke the buck" because it held Lehman Brothers’ paper which plummeted in value when they declared bankruptcy. Many people consider money market the equivalent of cash. But there are underlying assets in money market and you should know the risk. For absolute safety, find a money market that can only invest in Treasuries.
6) Ask your broker or bank representative exactly what they personally are invested in or where their money is held. Our clients take comfort in the fact that we hold the same positions they do. If your broker isn't doing something fairly similar to what you're doing you should ask why.
Several cases have emerged of recent that demonstrate the greed and guile of those rotten few within our industry. Be it acts of Madoff, Rajaratnam or the insider trading network currently under SEC investigation, they all tarnish our image. But the motive for writing this article is the MF Global case. While details are still emerging, it seems as if MF Global utilized regulatory rulings that few knew existed and coerced its regulator into continuing to permit questionable borrowing.
As a commodities broker, MF Global was under the regulation of the U.S. Commodity Futures Trading Commission (CFTC). The Commodities and Exchange Act of 1936 set forth that customer’s assets were required to be segregated from firm’s assets. (Be certain that everyone in the securities industry and the futures business knows the line between customer funds and broker funds is sacrosanct!) However, firms could invest customer’s cash “in excess” but only in the safest assets, such as Treasuries. But unbeknownst to many customers, a ruling in 2000 allowed MF Global to invest in sovereign debt of other nations as well, like that of Greece, Italy and Spain. To top it off, a 2005 ruling allowed MF Global to lend themselves their customers’ cash in exchange for things like sovereign debt and it permitted them to do it without customers’ knowledge or consent. The trouble is that when the value of the sovereign debt falls MF Global has to post cash to cover its loans, which they didn’t have. If this is done by a broker that has SIPC coverage, then the aforementioned protection applies. But MF Global was a commodities broker and there was no such protection. Tragically, $1.6 billion of customer money is still unaccounted for some five months after its bankruptcy. This differs from Lehman Brothers, as to my knowledge, all customer securities and funds were returned to the customer or transferred to another broker. The ones who lost were people that invested in Lehman Brothers and its creditors, which all knew there was some level of risk.
To me this is the most egregious violation of the fundamental ethics of our business. What makes it even more disgusting is that it might just have been legal! While my legal opinion is not much better than my branzino recipe, there is a very real chance that no one will be prosecuted for this despicable act. Regardless, merely conceptualizing this act of circumvention reaches beyond the ethical standards of the financial services industry as it tears at the very fibers of morality. Imagine conjuring up a way to borrow money from the very clients that keep you in business while not properly informing them that you are borrowing or that what you are doing with the borrowed money is speculative and there is no backstop. The only solace I can find is that the executives that conducted this act will have to face themselves in the mirror, be it at their beach house or their penitentiary of jurisdiction, every day forward knowing that this conduct was simply wrong and that fact can't be contested.
The vast majority of financial brokers and professionals exhibit the highest ethical standards and steward their clients’ funds to the best of their ability. Client investment goals, be it a second home, early retirement or helping a child leave college debt free, are met every day. But since these accomplishments garner no media attention, the positive things our industry produces are easily overshadowed. Tragically, a few rotten apples somehow nudge their way in and occasionally linger for too long. But the misdeeds of a few confirm the high code of ethics by which firms such as Warren Capital practice. Our clients trust we hold their interests above all else and they understand and appreciate our transparency and principles. My proof is the number of referrals we get. But as much as I think we should, I realize we don't hold every investment dollar out there and there are investors that choose to do business elsewhere. So, I author this as a field guide to everyone with assets as I consider part of my duty as a financial professional to help implement basic standards of investor protection.
As always, I appreciate your continued trust and confidence.
February 08, 2012
Commentary by Stuart Brown
Higher tax rates did not keep presidential candidate Mitt Romney from accumulating his wealth from 1984-1992 when he ran Bain Capital. Top income tax rates back then were higher than today’s 35%.
Other than 1991 and 1992 when top income tax rates were set at 31%, from 1984-1992 rates ranged from 38% to 50%. Capital gains rates were set between 21.2% and ordinary income tax rates (then 33%) vs. 15% today. Despite higher taxes, this was the time Romney amassed his fortune and supposedly created jobs as a private equity manager.
By 2006, when Romney left office as governor of Massachusetts, capital gains tax rates had been reduced to 15% theoretically in order to stimulate job creation. So how many jobs were created after 2006 in exchange for that generous tax rate?
The answer is not many and Romney wasn’t the only one choosing instead to enjoy his tax holiday. 1984-1992 capital gains taxes averaged 21.5% and income tax rates 39%. Unemployment averaged 6%. 2006-2011 both capital gains and income taxes were lower, averaging 15.5% and 35% respectively. Yet unemployment averaged 7.2%. Lower taxes did not accompany higher employment.
From 1984-1986 the capital gains taxrate was 20% and unemployment averaged 7.2%. When capital gains rates were raised from 1986-1990 from 20% to 33%, unemployment dropped to an average 5.9%. Then as tax rates were lowered from 1990 to 1993 from 33% to 21.2%, unemployment rose to 6.7%. The capital gains tax was held stable from 1993-2002 and unemployment averaged 5.22%. But, no surprise, from 2002-2011 when rates were lowered from 21.2% to 15% once again unemployment rates rose; this time averaging 6.5%.
|
|
cap gains tax rate
|
unemployment rate
|
|
84-'86
|
22%
|
7.2
|
|
86-'90
|
Raised to 33%
|
5.9
|
|
90-'93
|
Lowered to 21%
|
6.7
|
|
93-'02
|
21%
|
5.2
|
|
02-'11
|
Lowered to 15%
|
6.5
|
Apparently “job creators,” when offered lower tax rates, prefer sitting back and enjoying their extra income. Or maybe at times when more flows to the bottom line, it pays to do more with less through “gains in productivity.” What has been sold as “trickle down” has proven instead to be a highly successful “soak up” economic policy.
Actually, I doubt there is a causal relationship here. There is no evidence people wait for a favorable tax environment to turn on their creative spigots. Whatever tax rates are, the right time to start a business is when there is a good business idea.
December 30, 2011
Commentary by Stuart Brown
For this week only…All is quiet
All is quiet the week before the New Year celebration. Could it be Europe has stumbled into a solution of their debt crisis with the circularity of the European Central Bank (ECB) lending billions to the banks, which in turn deposit the funds with the ECB (rather than face counterparty risk by lending to each other or businesses)? Or have the hedge funds, like Congress, simply taken the last week off?
The ECB, still at work, is quietly buying billions of Italian sovereign debt and that has helped keep rates tame. (If paying seven percent marks the end of the world, the debt problem can’t truly be solved.)
In the US, for all the brinksmanship and bluster of the year, the budget has barely been trimmed by a few billion. Bruised by the payroll tax debate, Congress went home leaving the President to quietly ask for another trillion dollar hike to the debt ceiling this week.
(In the spirit of getting something for nothing, who will ever want to see a thousand dollars less in their paycheck? Like the unfunded prescription drug add-on to Medicare, the payroll tax holiday is another Trojan horse bringing forward the day of insolvency.)
But next week, with the Iowa Caucuses, the volume of the political discourse will be turned up again. Congress reconvenes and Wall St. will get us back in the swing of things. There is a trillion dollars of European debt to refinance in 2012, along with another trillion of junk bonds and some hefty Treasury borrowings.
Everyone knows all the woes. Seems to me, that must then, be already priced into the market. It is what is not priced in the market that will prove important as the new year unfolds.
Stocks began the year with a P/E of 17 and ended at 14, or an Earnings Yield of over 7%, historically a tremendous value in light of the thirty-year treasury paying under 3%. Over the next few weeks companies will report their fourth quarter earnings, which are expected to be generally pretty good.
For all its gyrations 2011 was a lot of nothing. The New Year may still be volatile, but is starting from a better valuation and so may very well be more profitable.
I want to thank you for your continued confidence. I hope 2012 comes with great happiness and health and the joy of loving family and friends.
August 09, 2011
Commentary by Warren Capital
WASHINGTON, Aug. 9, 2011 -- It appears that the Fed is on the edge of more monetary easing, and that at the inner circles of the Fed they are becoming concerned about what remaining arrows they have in their quiver to energize the economy.
However, there are options: a Fed-backed Infrastructure Fund.
Washington, D.C. based money manager Joseph Warren, founder of the Warren Capital Group wealth management firm, proposed an infrastructure fund to the Fed in November. (See Letter to Chairman Bernanke here) Such a Fund could be used for building and improving schools, roads, water systems and the electric grid across America.
"If the Fed is going to create money out of thin air, why not build the value of the country rather than bail out those who made bad decisions and can't pay their debts," Warren says, adding that he understands there may be technical difficulties to be considered.
"Naysayers might point out that this type of Fed funding is completely outside the realm of the Fed. But this is no more outside the intent of the central banking system than bailing out AIG or buying Lehman's Maiden Lane mortgage portfolio," Warren offered in his Nov. 16, 2010 letter to Fed Chairman Ben Bernanke.
"The government is already in the market of helping states and municipalities with their infrastructure needs through the Build America Bond program. Furthermore, this cannot be derailed by an incapable Congress as the Fed can actually create these new dollars and this plan does not add to the deficit."
Warren did receive a response from the Fed, and neither Fed policymakers nor anyone else has come up with a legitimate rebuttal of this concept.
Warren says he's hoping that someone in the administration, Congress, the Fed or any other able entity will at least consider an infrastructure option.
A creation of an Infrastructure Fund by the Fed could pump real jobs into the economy, Warren says.
This idea is timely given the Fed meeting today.
"After the events that have transpired in Washington of recent, I am truly concerned that very few policy makers have quality ideas on how to improve the economy and that our country will be permanently impacted by more of the same. Policy makers don't know how lucky they are that treasuries rallied yesterday," Warren says.
Warren Capital Group is a registered investment advisor specializing in wealth protection and growth for high net worth individuals, institutions, foundations, and corporations. As a fee-based private wealth management firm, Warren Capital Group assists clients with asset allocation, risk management, estate planning and liability management via mortgage services. Warren Capital Group and its independent financial advisors are based in Washington D.C.
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July 27, 2011
Commentary by Joseph Warren
Right now the political rhetoric in Washington is thick as I’ve ever heard as the debate over the debt ceiling is coming to a crescendo. While I believe the majority of America would simply like some compromise between parties, the elected show no signs of that consideration as they are retracting further into their respective political burrows. This comes as no surprise, and I expect that even if an agreement is reached before August 2 it will have little impact on the indebtedness of the United States. Therefore, I take it upon myself to present reality.
We can all point fingers at Congress and its inability to enact legislation. But in theory, politicians are here to represent their constituents. Given such, the reality is that either citizens of this nation don’t have the civic fortitude to deal with the indebtedness for which we are all now responsible, or they haven’t made clear what policy they are willing to accept to correct this imbalance. Whatever the case, dealing with our imbalances can be done if handled practically.
It’s important to recognize that while the $14.3 trillion in treasuries is an obligation of the government, the ultimate responsible party is every American citizen. That means that because of previous policy and our lack of action every citizen of the country has become indebted by roughly $45,800 to treasury investors. In addition, government expenditures for the year will be approximately $3.55 trillion while incoming revenue will be $2.38 trillion. So, not only do you owe a huge sum but to simply prevent yourself from incurring another $3,751 in debt by year end you must take action! Here are some options:
1) Given that government receipts can only cover 67 percent of expenditures, take out a piece of paper and calculate the dollar value of every benefit you receive from the government. Once calculated, reduce that overall number by 33 percent and write down which of those benefits you are willing to reject.
2) Look back on your tax return for 2010 and examine what deductions you took. Remove a third of those deduction going forward so your tax obligation is increased by 33 percent.
3) Prepare a check written to the U.S. Treasury for $3,751.
4) If you have treasuries in your investment or retirement accounts repudiate your ownership in four of those securities thereby alleviating the U.S. Treasury of $4,000 worth of its obligations.
While none of these options are very appealing, this only gets us through year end. Your next priority is to figure out how to pay off the $45,800 you already owe. We can all whine and moan about how we got here, but that doesn’t change the reality that you owe it and are paying interest on it. The good news is that you have more time to pay off that debt. The bad news is that it’s going to take a much more drastic combination of the aforementioned options to get whole. While these actions are necessary, communicating what you’re willing to do is just as vital.
I’ve been searching the net for records on the volume of phone calls, emails and letters that have been made to Congress in the last few weeks and the data is sparse. The best that I can tell is approximately 3 percent of the U.S. population has made contact with his or her representative of late. I live in the District and politics supersedes any other topic including the weather in this town. So, I’m not sure how much this subject stirs the blood of the general public. But I do believe that remaining 97 percent would care that they are on the edge of incurring nearly $50,000 in debt at the behest of ill-directed policy if they actually recognized their looming obligation.
I also know that most Americans truly care about this country and are willing to endure some personal sacrifice for the benefit of the nation. The question is how much do you care? If there can be such a thing as a call to action in this day and age than this is it. (To find your representative visit http://www.congress.org/congressional_staff). It is no longer acceptable to simply point fingers and dodge the issue. If you decide not to participate, realize that those of us who do take action will determine the fate of your responsibility.
Short Term Consequences
Because of our reputation and what we deliver, we bring on many new clients each year. What we often hear during the initial consultation with a prospective client is that they can’t afford to take a loss like they have experienced in the past. The alarming thing is that even though much time has passed since they took such losses, they have done nothing to protect themselves against that experience going forward. That’s usually the time we explain our process as independent financial advisors and how we differ from all other money managers. While we’re not predicting it, the next few weeks could prove why we invest the way we do.
Even if my call to action sweeps the nation and it starts tomorrow, the effects will not take hold for some time. Therefore, investors might face some unique circumstances for the next few weeks related to the debt ceiling debate and the potential effects on the financial markets of a treasury default. We always look to the markets to measure the amount of trouble looming, and right now indicators remain stable. But we are keenly aware of how quickly things can change.
Whatever happens, you must have a plan in place to deal with unprecedented circumstances, like a treasury default. Our clients take solace in the fact that we do have a plan and the ability to act quickly if needed. If you’re not a client and you don’t have your plan in place, consider this your wakeup call and see our phone number is below. As always, I appreciate the continued trust and confidence.
