Who Do You Trust?

Political correctness aside, it seems you need to go to some kind of Heavenly Source itself to make sure your trust is well placed. Recent news headlines indicate that serious problems can be encountered by placing your trust in some of those who act as intermediaries. More on that in a financial light later.

TRUST AND MONEY

When it comes to trusting someone with your money, the problems compound. Those willing to seize your savings far outnumber those wishing to help your savings grow. Even if you're lucky enough to find a money manager who truly wants to see your money increase to your maximum benefit, the chances are that manager cannot, in the long term, produce better returns than the market itself. And it is long-term growth that benefits you most. Depending on which report you believe, the Standard & Poor's 500 beats more than 70% of all money managers.

That said, it is painfully obvious to anyone who has been financially conscious since the calendar went from the 1900s to the 2000s that an impartial market can take your money faster than a crooked broker, an incompetent money manager, or a thief with a gun. Even with that sad truth, though, the S&P 500 still continues to beat the majority of money managers. Why? Well, for some it boils down to a question only slightly different from the one posed. That is, "Who do they trust?" — "they" in this case being money managers.

TRUST AND MONEY MANAGERS

Like you, the money managers must put their trust in the information they get from researchers to make their decisions on where to invest your money. The researchers they have to trust may be employed by the major brokerage houses, the big players with the wherewithal to conduct investigations into the stocks their firms choose to recommend. As I write this, David H. Komansky, the chief executive of Merrill Lynch, has just released a statement that says in part: "We believe strongly in the integrity of our research. It has served investors well for many decades. We have operated under policies and procedures designed to protect our integrity and the interests of our clients. The e-mails that have come to light are very distressing and disappointing to us. . . ."

The e-mails referred to were sent between the Merrill Lynch brokers and research staff members while the company was still hyping failed, or failing, dotcoms to the public. While publicly touting these doomed stocks, privately these researchers and brokers were making comments, in their e-mails to each other, that denigrated their highly rated stocks. While a stock like Internet Capital Group was plummeting from $212 per share on its way down to 34 cents per share, in public Merrill Lynch was still rating it very highly. Likewise, Infospace plummeted from $138 to $1.06, and took most of that fall with Merrill Lynch's highest rating.

After the New York State Attorney General's office's 38-page indictment hit the firm, the CEO made his public apology. Considering Merrill Lynch is one of the world's leading financial managers and a leading strategic advisory to corporations, governments, institutions, and individuals worldwide, what kind of shenanigans do you suppose go on at some of the less-watched financial companies?

TRUST IN WHOM?

The question of "Who do you trust?" grows harder to answer. For the most part, in situations involving our personal lives, you can trust everybody a little, and almost nobody a lot. When you are standing on the corner and the sign on the other side of the street blinks "Walk," you prepare to step off of the curb. You trust the signal would not tell you to walk if the mechanism that controls it had not given a stop signal to the crossing traffic. You trust those who program the mechanism, and those driving the cross-traffic cars. Still, if you are smart, you take a quick look both ways to make sure that the crossing traffic has taken the stop signal to heart.

Looking both ways for yourself is not so easy once you become an investor. At best, you have to do considerably more than just look both ways. You have to do some real searching into the manager or mechanism that will be giving the "Walk" and "Don't Walk" or "buy" and "sell" signals. This is called due diligence. Depending on how you choose to invest, that could be as simple as selecting a reputable manager and finding out what percentage of your investment goes to that company for managing the index fund you have purchased through them. If you choose to become deeply involved in trading your own portfolio, however, due diligence could become as complicated as backtesting the indicators designed for the charting software you use to track your securities.

Nevertheless you have to trust someone. You have to trust the people who manage the index fund, or the charting software programmers. In both of these extreme cases and all of the varying scenarios in between, you must depend on some kind of honest attempt by those you have trusted that your best interest is their goal. However, once you have done your best, if those you trusted were dishonest, then you can still get into real trouble.

If you have a single brain cell, you visit a used-car lot knowing that the chances are very good that the salesman is more interested in getting your money than in getting you a good deal on a reliable car. At every step along your life's pathway, you it's been proved to you that you must be careful when buying a used car. You know it, and they know you know it.

TRUST IN THE SEC?

In the securities industry it should be different. There shouldn't be any rotten apples. The Securities Exchange Commission (SEC) is supposed to keep all the apples in the barrel good so the small investor doesn't get financially ill because of some bad "(in) cider" trading, or other infraction of the financial rules. Right? Sure, there's a bad broker who gets caught now and then, but the SEC keeps a close watch on the big, national, and international corporations, right? The blue-chip stocks may fluctuate in price, but the regulators make sure they are not the financial equivalent of a bad used-car lot. I am almost sure of that, and you are too, correct?

Wrong, and if you still can't believe that your interests are not fully protected, I ask you to recall the following blue-chip stocks in the news of late: International Investment Trust, Enron, and Arthur Andersen. Or go back a few years. How about that firm named Drexel Burnham Lambert and one of its top traders, junk-bond king Michael Milken? Milken was caught for securities law violations, punished, and sentenced to 10 years in jail. The poor fellow had to actually spend not quite two years in an executive holding facility before he was released. Then, even with what he had given to his wife and kids prior to sentencing, he was only able to salvage about half a billion dollars for his activities. That's barely $250 million for each year he was in jail! Thanks to all the safeguards in place by those who are trusted to protect you and your investments, it is plain to see that crime surely doesn't pay — for you.

Then there are the institutions that insure your life. Surely they can be trusted. Sadly, no. One of the nation's largest life insurance companies, Prudential, recently agreed to pay policyholders at least $410 million to compensate the more than eight million eligible customers for misleading marketing tactics.

WHO CAN YOU TRUST?

So in the end, the question remains, "Who do you trust?" or more accurately, "Who can you trust?" The answer remains elusive at best. At worst, it is nearly impossible to find a standard answer in our current environment. In every aspect of our prevalent way of life, due diligence is fast becoming a basic staple, while trust has become a precious commodity.

Bruce R. Faber may be reached at BFaber@Traders.com.

SUGGESTED READING

Cooper, Charles [2002]. "The Last Dot-Com Victim: Truth," ZDNet News, April 22.

DeBlaise, Colleen [2002]. "Shareholders Sue Merrill, Blodget, Cite AG's Findings," Dow Jones Newswires, April 23.

Flood, Mary [2002]. "Bankruptcy Tip Of Iceberg In Forums Seeking Redress," Houston Chronicle, January 17.

Laderman, Jeffrey [1997]. "Why It's So Tough To Beat The S&P," sidebar, BusinessWeek, March 24.

Merrill Lynch press release, April 26, 2002, "Chairman And CEO Komansky Addresses Research Integrity At Annual Meeting Of Shareholders."

Parenting.com, "Figuring The Bill: Solving The Mysteries Of Life Insurance."

Zonana, Victor F. [1992]. "Milken To Pay $500M, Serve 40 Months Under Settlement," The MIT Tech, February 28.

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.