Tuesday, May 09, 2006

Misled about risk, affluent clients win $900,000 in arbitration

In March of 2000, Suzanne Carruthers and her husband placed several million dollars in a managed-investment program overseen by Smith Barney, via Citigroup's Fiduciary Services Affiliated Managers Program.

By October, 2003, the Carruthers' portfolio showed a loss of $1.23 million. The couple went to arbitration seeking to have their loss made good, charging that they had been misled as to the riskiness of the investment mix they were sold.

According to a former SEC economist who testified on the couple's behalf, their loss would have been only $330,000 had their money been invested in a balanced fund of 60% stocks, 40% bonds.

What's more,, said economist Craig McCann: "The presentation materials I reviewed were, false and misleading is a strong term, but were very close to that, if not that. They are based on assumptions that are not just differences of opinion, but are factually wrong, and, more importantly," the analysis was "framed in such a way to lead investors to choose more risky portfolios than they otherwise would."

The three-member arbitration panel ruled that Smith Barney should pay the Carruthers $900,000 — that is, $1.23 million less the hypothetical $330,000 they would have lost anyway.

According to a press release from the law firm that represented the Carruthers, they were presented with grossly misleading asset-allocation numbers:
The Carruthers had been shown figures indicating that the asset mix recommended by the broker had a better than 75% chance of achieving their target return. According to McCann, that mix actually had less than a 38% chance of providing the retirement income the Carruthers wanted. McCann testified that the entire sales presentation appeared to be "tactically designed" to push a potential customer in the direction of a riskier portfolio
Said one of the firm's lawyers: "Citigroup claimed that our arguments had to be wrong because they and their predecessors have been doing business this way since 1973. In my opinion, this award sends a message that you aren't entitled to mislead customers, no matter how long you've followed your successful business model."

The Wall Street Journal (subscribers only)
warns that the award "may lead to similar cases being brought by affluent investors who lost money in portfolios that contained more risk than they say they were led to believe."

What were the odds that a hypothetical 60-40 stock-bond mix would have met the Carruthers' retirement goals? On that question the news reports are (oddly?) silent.


Jim Gust said...

From 2000 through 2002, large cap stocks lost 14.6% per year, though they bounced back during 2003. Over that period long term government bonds gained nearly 11% per year, according to Ibbotson's 2006 yearbook. Hard to see how a 60-40 mix there gives you so large a negative return. Must have been some specially weird equity component

I've never been entirely comfortable with the Monte Carlo simulation element of asset allocation presentations. Seems like it turns investing in "controlled gambling."

Anonymous said...

The analysis still shows them a 25% failure of success for their desired income. I don't see anything indicating a 100% guarantee. If Vegas gave you a 3-out-of-4 chance you'd probably take. But when that 1-out-of-4 turns up, you can't turn around and sue the house! The deposition also states Suzanne Carruthers made her money from investing, as well as a Wendy's franchise. For someone to successfully run the numerous Wendy's franchises as she did and make money for many years in the stock market and then turn around and cry wolf.....shame on them. Maybe we should take them to court over slow drive-thru service. Yeah, pretty unreasonable, but so is the settlement they received.

Keyser Soze said...

If Vegas said you had a 1 in 100 chance of winning on a slot machine, and in fact you had a 1 in 1,000 chance, and you could prove that, you would in fact have a good case comparable to the Carruthers. They didn't sue because the 25% chance of a shortfall materialized, but because the truth was there was a 62% chance of that shortfall. What's more, a shortfall is very different from an absolute loss.

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