“Avoid conflicts of interest.” – David Swensen, Yale Endowment CIO.

Jose is the head of a ultra high-net-worth family. He has a number of accounts with Merrill Lynch (ML), the storied brokerage firm that paid their senior executives $4 billion in bonuses last year. Three of his accounts lost a great deal of money, not due to the market crash but to conflicts of interest.

Double dealing in Treasury

Jose has a Treasury account where his ML wealth manager purchases Treasury bills, notes and bonds for him. Last year was a great year for Treasury securities – the market turmoil caused investors to flock to them, driving prices up more than 10%. Jose’s account, however, lost 3%. How could this happen? Conflicts of interest. ML is a primary dealer in the Treasury market. They buy Treasury securities and resell them to their customers at a markup. It looks like the markup is so high it takes away all the customer profit.

Churning stocks

Last year, the S&P 500 index lost 38%. Jose’s stock account lost 62% by buying and selling largely S&P 500 stocks. How could this happen? Conflicts of interest again. ML is a brokerage, so the more trading of Jose’s stocks, the more commission they earn. No wonder there are hundreds of odd-lot bit-size trades in the account: Jose’s year-end statement was 377 pages long! .

Hedge funds and private equity

ML likes to tell their wealthy customers that they can put them in investment vehicles not available to the rest of us. Sure enough, Jose has an alternative investment account where the money is invested with a hedge fund. The good news is – the hedge fund is “making money.” The bad news is – the results are not audited, not even calculated by a third party, so the money may or may not be real. When I checked the SEC database, I found no record of either the fund or the fund manager.

I asked Jose, who is a good businessman: “Would you get into a partnership with someone you don’t know in which you contribute money and that someone makes all the decisions and does the accounting as well?” Jose said, “Of course not.” Jose was not aware his wealth manager put his money into just such a partnership for a rich referral fee. (Note: all hedge funds and private equities are organized as private limited partnerships exempt from regulation.)

Engage with prudence

Building and preserving significant wealth indeed requires the help of a family office/wealth management company who put your interest first. Unfortunately, the financial service industry is infested with conflicts of interest. No wonder Jack Bogle laments “Too much salesmanship and too little stewardship.” and David Swense mocks “It is a marketing industry.” The lesson: don’t rush into an engagement. Some damages resulted from haste can not be undone – remember Bernie Madoff? Take your time to do the due diligence.

Trust but verify

Once you engage a family office or a wealth management firm, you want to trust them, but also verify their decisions. It’s your money after all.

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