The Investment Scientist

The Staggering Cost of Conflict of Interest

Posted on: April 8, 2009

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[picture of double dealing, enable image to view] 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.)

Get a 2nd opinion

Unfortunately, John’s experience is all too common among high-net-worth investors. According to FINRA chairman, 88% of self-proclaimed advisors are salesmen on commission, who are incented to maximize the firm’s profit. If you are like John, it behooves you to  get a 2nd opinion review to make sure you financial advisor is not one of them.

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

6 Responses to "The Staggering Cost of Conflict of Interest"

Good article. Keep telling people what happens with dishonest money managers.

Sounds like what I found about 12 years ago in my father’s (now deceased) account. There were five times as many trades as he owned stock. Over several months there had thousands of dollars of trading fees, and not one additional dollar into the account. I had a sharp discussion with the man. Then he had the nerve to call my father and tell him what a horrible daughter I was. We had lots of problems later, too. My new stock brokerage firm actually made a formal complaint, but that went nowhere.


Your horror story is not unique, it is happening every day. FINRA, the so-called self-regulatory body of brokers, has no teeth. It is primarily there to serve the brokers’ interest. What worries me and should worry all investors is Mary Schapiro, the new SEC chairman, was president of FINRA. I am afraid investors really have nobody to protect them other than themselves.

That’s why my services are gearing more towards helping people uncover conflicts of interest.

This is very scary. I also found the following article helpful


As a valued-stock investor, “when to buy” probably is not a big issue comparing to “when to sell”. What was your strategy in 2008 comparing to Mr. Oracle? I mean if you still keep valued-stock portfolio, even it has lost 30% to 40% value? If yes, what is your point to make your sturdy mind? I know you didn’t make your decision yet if the market has touched the bottom or going to Japan’s lost-decade.


Mr. Lin,

Great question!

I don’t know if the market has touched bottom or we are going to a Japan style lost decade. I am not a prophet. As I said before, it does not take the gift of prophecy to be a good investor, if that’s the case, nobody can be a good investor.

It takes careful planning and discipline to be a good investors. Please read David Swensen’s four point advice to individual investors …

[…] don’t need outside help to hurt themselves. I’ve been writing about how ignoring conflict of interest, hidden fees, and not taking the necessary time to do due diligence costs investors a great deal of […]

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.


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