Retail mutual fund shares are classes A, B and C. They differ in the amounts of internal 12-b1 fees and also on the loads, or sales charges.  Read about it here:  The ABCs of Mutual Funds.  There is another class offered for many funds: Class I, which stands for institutional class. Class I shares are offered only to large investors, typically investment firms and minimum purchases are often more than $500,000. Class I shares’ fees are typically 40% less than those of classes A, B and C.

What does this have to do with you and me? The connection is that our 401(k) managers can make Class I funds available as investment options for our retirement account. Since Class I funds have exactly the same underlying investment positions as the A, B, and C class shares (ABCs), you would expect the fund manager would go with the better deal for us. Wouldn’t you be upset if he were paying higher fees than he had to?

Think about it this way. You want to buy a car. There are two identical cars on the dealer’s lot. One costs $5,000 more than the other. Which one would you buy?

Why would you pay $5,000 for an identical car? Why would a fund dealer provide ABCs which carry a higher fee instead of Class I shares? Maybe carelessness. Or maybe because the additional fee charged benefits the fund manager or plan sponsor. That is exactly what happens when your 401(k) investment manager provides retail (ABCs) mutual funds for you. They call it "revenue sharing". The plan sponsor receives "offsets" from retail mutual funds, that is, the 12-b1 fees. They don’t call it a kickback.

A recent court case should make 401(k) plan sponsors think twice before offering retail funds as investment options in the plan when investment class shares, Class I, are available with lower expenses. In a case in the middle district of California, Tibble vs Edison International, a group of plan participants went to federal court to complain about the plan buying non-institutional shares. Judge Stephen V. Wilson ruled that the company violated its duty of prudence by selecting retail shares instead of Class I shares for three of the funds held by the plan.

The Edison International Trust Investment Committee made retail share classes of three mutual funds available to participants in the Edison 401(k) Savings Plan. In deciding which funds to offer, the committee did not consider, let alone evaluate, other share classes of the funds. However, it did solicit and rely upon the advice of Hewitt Financial Services, an affiliate of the plan’s third-party record keeper. A class of plan participants sued the committee, Edison International, and others seeking damages under ERISA for alleged financial losses suffered by the plan, in addition to injunctive and other equitable relief on account of breaches of fiduciary duty.

Judge Wilson stated, "In light of the fact that the institutional share classes offered the exact same investment at a lower fee, a prudent fiduciary acting in a like capacity would have invested in the institutional share classes."

Daniel Sonin reported this case on on July 28. He reported that Edison is not an isolated instance. He asserts that "over ninety percent of the funds he has examined have purchased retail class funds when institutional class funds of the same content were available."

If Class I shares’ fees are typically 40% less than those of classes A, B and C, what would a 40% reduction in fees by offering Class I shares look like? Consider a fund of $200,000. For simplicity, assume no additions or withdrawals. Assume a rate of return of 8% minus annual fees of 2% for a net annual return of 6%. If the fees of 2% were forty percent lower, they would be just 1.2 % per year, allowing the fund to grow at a net 6.8 % per year. After ten years at 6%, it would grow to $358,170. At 6.8 %, it would grow to $386,138, a difference of almost $28,000.

If Judge Wilson is correct and the company is liable for lost income, that would make many fund advisors think twice about recommending retail funds.

U.S. District Court Judge Jack Weinstein when sentencing a former broker for securities fraud said:

"’What becomes evident in a trial like the present one, and in recent mortgage fraud cases, is how pernicious and pervasive is the culture of corruption’ in the securities industry."

Daniel Solin writing for Daily Finance  on January 24, 2010 reports:

"Eric Butler, a former broker with Credit Suisse, had a lot to be worried about when he walked into the U.S. District Court in Brooklyn, N.Y., on Friday for sentencing. A jury had found him guilty of misleading his clients into believing they were purchasing low-risk, auction rate securities backed by student loans, with federal guarantees. Instead, the hapless clients were sold high-risk, high-commission auction rate securities backed by home mortgage assets.

Butler altered the trade confirmations to make them appear to reflect securities backed by student loans. But the scheme fell apart when the auction rate securities market collapsed.

The government claimed losses exceeded $1.12 billion and asked for a sentence of 45 years in prison, plus significant monetary penalties. But Butler caught a major break. U.S. District Court Judge Jack Weinstein sentenced him to only five years in prison and fined him $5 million.

Judge Weinstein isn’t your run-of-the-mill jurist. He has been a federal judge for 43 years, is a prolific author and one of the most experienced and respected judges in this country. After the jury returned its guilty verdict, Judge Weinstein signaled his concern about allocating all of the blame for these misdeeds to Butler. Said Weinstein: "What becomes evident in a trial like the present one, and in recent mortgage fraud cases, is how pernicious and pervasive is the culture of corruption" in the securities industry.

He repeated these views on Friday, noting the reduced sentence took into consideration "the pernicious and pervasive culture of corruption in the financial-services industry," which is "beset by avarice."

Wake-Up Call to Investors

Weinstein left no doubt about his view of Credit Suisse’s culpability, stating that "[T]he blame for this condition is shared not only by individual defendants like Butler, but also the institutions that employ them."

This judicial validation of the pervasive greed and dishonesty in the securities industry should be a wake-up call to investors. It’s difficult to understand why investors continue to trust their assets to members of this industry. It’s bad enough that brokers generally lack the expertise to manage your assets. It’s worse that, if you’re a victim of broker misconduct, the mandatory, industry-run arbitration process is rigged to ensure you won’t recover any meaningful portion of your losses.

I appreciate Judge Weinstein taking corruption and greed in the securities industry into account as an argument against a long prison sentence for Butler. What’s your argument for continuing to place your trust in the securities industry? "

More here on Affinity Fraud:  Misplaced Faith?

The January 24, 2010 Lancaster Sunday News front page headline is "MISPLACED FAITH?".

Gil Smart’s article (read it here) explained an investment scam that  looks like an Amish version of the Madoff debacle.  Full details have yet to emerge, but it appears that the interest rates promised by John M. Sensenig were simply too good to be true.

Why do people, from all faiths, all regions, and all walks of life fall for these scams?

The Securities and Exchange Commission calls these schemes Affinity Fraud:

"Affinity fraud refers to investment scams that prey upon members of identifiable groups, such as religious or ethnic communities, the elderly, or professional groups. The fraudsters who promote affinity scams frequently are – or pretend to be – members of the group. They often enlist respected community or religious leaders from within the group to spread the word about the scheme, by convincing those people that a fraudulent investment is legitimate and worthwhile. Many times, those leaders become unwitting victims of the fraudster’s ruse.

These scams exploit the trust and friendship that exist in groups of people who have something in common. Because of the tight-knit structure of many groups, it can be difficult for regulators or law enforcement officials to detect an affinity scam. Victims often fail to notify authorities or pursue their legal remedies, and instead try to work things out within the group. This is particularly true where the fraudsters have used respected community or religious leaders to convince others to join the investment.

Many affinity scams involve "Ponzi" or pyramid schemes, where new investor money is used to make payments to earlier investors to give the false illusion that the investment is successful. This ploy is used to trick new investors to invest in the scheme and to lull existing investors into believing their investments are safe and secure. In reality, the fraudster almost always steals investor money for personal use. Both types of schemes depend on an unending supply of new investors – when the inevitable occurs, and the supply of investors dries up, the whole scheme collapses and investors discover that most or all of their money is gone. "

 Read more from the SEC on how to avoid affinity fraud:  click here.

Also check out  " Why scams work – analyzing the reasons people fall for scams"

All too often, there is no recovery available.  But sometimes, there is recourse, in which case the expertise of an attorney experienced in investment fraud or stockbroker fraud is required.

UBS is in trouble again.  This time for inducing a 77 year old Hong Kong woman who doesn’t speak English and who never finished primary school to sign documents in English, one making her a "professional investor" under SEC regulations.   They sold her an equity accumulator – a very complicated contract not unlike the fancy derivatives that caused this year’s financial crisis.  She lost $25.8 million. 

Melly Alazfaki writes for Daily Finance:

"Banks and businesses have one incentive: to increase their own profit. They can confuse the issue and offer as convoluted products/payment system as they want, but at the end of the day, their goal is their own bottom line. Consequently, when a bank pushes a product, it is doing so out of an attempt to gain money, not because it loves its customers.

If something is too complicated and cannot be properly explained by bank advisers, or understood by clients, why enter into such agreements? Notwithstanding possible negligence by the bank in this case as alleged by the suit, greed can often lead us to make the wrong choices. Chan, a woman who has accumulated millions through "hard work," should have known better — nothing is ever free and greed rarely pays."



Stephen Greenspan has written an article entitled Why We Keep Falling for Financial Scams, published in the Wall Street Journal on Janury 3, 2009.  See the article here.

Greenspan writes: 

"There are few areas where skepticism is more important than how one invests one’s life savings. Yet intelligent and educated people, some of them naïve about finance and others quite knowledgeable, have been ruined by schemes that turned out to be highly dubious and quite often fraudulent. The most dramatic example of this in American history is the recent announcement that Bernard Madoff, a highly regarded money manager and a former chairman of Nasdaq, has for years been running a very sophisticated Ponzi scheme, which by his own admission has defrauded wealthy investors, charities and other funds of at least $50 billion.

Financial scams are just one of the many forms of human gullibility — along with war (the Trojan Horse), politics (WMDs in Iraq), relationships (sexual seduction), pathological science (cold fusion) and medical fads. Although gullibility has long been of interest in works of fiction (Othello, Pinocchio), religious documents (Adam and Eve, Samson) and folk tales ("The Emperor’s New Clothes," "Little Red Riding Hood"), it has been almost completely ignored by social scientists. A few books have focused on narrow aspects of gullibility, including Charles Mackey’s classic 19th-century book, "Extraordinary Popular Delusion and the Madness of Crowds" — most notably on investment follies such as Tulipmania, in which rich Dutch people traded their houses for one or two tulip bulbs. In my new book "Annals of Gullibility," based on my academic work in psychology, I propose a multidimensional theory that would explain why so many people behave in a manner that exposes them to severe and predictable risks. This includes myself: After I wrote my book, I lost a good chunk of my retirement savings to Mr. Madoff, so I know of what I write on the most personal level."

Blogging credit to Professor Gerry Beyer of Wills, Trusts & Estates Prof Blog.

Neil Hendershot has a terrific post on his blog called "Liquid Trust" or "Living Trustworthiness"?   With tongue in cheek, he talks of buying trust in a bottle (like Love Potion No. 9) to solve the nation’s financial crsis.

"Liquid Trust is the world’s first Trust Enhancing Body Spray, specially formulated to increase trust in the wearer.

Scientists have recently discovered a chemical that makes people trust each other. For the first time, you can have the world in the palm of your hands…It all starts with Trust."

On a more serious note, what Neil points out is that in the midst of the most serious financial crisis since the Great Depression, we find ourselves in a world without integrity, without honesty and accountability. 

As David Francis says, writing for the Christian Science Monitor, when "so many people engaged in so many aspects of finance have lost their ethical compass and put their short-term personal gains above other considerations, such as was the case in the subprime mortgage market in the US, it can have a "profound macroeconomic impact." In other words, the broad economy gets hurt by greed and selfishness as ensuing financial losses mount and trust fades."

Which brings me to the current Congressional debate over whether Washington should enact an extraordinary bailout of the country’s financial system.   

Sen. Sherrod Brown, (Ohio-D), said calls from his constituents about the plan have been universally negative. He told the story of one constituent who drove to Washington:

"He quite rightly asked why we were rushing to bailout companies whose leaders got rich gambling with other people’s money,"

There is plenty of blame to go around for the current crisis.   Part of being trustworthy is being accountable. 

As House Speaker Nancy Pelosi put it:  If the bailout passes, "The party is over for this compensation for CEOs who take the golden parachute as they drive their companies into the ground. … The party is over for financial institutions taking risks [and] at the same time privatizing any gain they may have while they nationalize the risk, asking the taxpayer to pick up the tab,"

Reserve Primary Fund (Ticker RFIXX), a money market fund with $62 billion in net assets, today wrote off $785 million of debt issued by the now bankrupt Lehman Brothers, reports Christopher Condon for

The Board of Trustees of The Reserve Primary Fund issued a news release today (September 16, 2008).  In the release they stated that the $785 million write-off in Lehman Brothers debt brought their net asset value to $0.97 per share.  "Effective today and until further notice, the proceeds of redemptions from The Primary Fund will not be transmitted to the redeeming investor for a period of up to seven calendar days after the redemption.  The seven-day redemption delay will not apply to debit card transactions, ACH transactions or checks written against the assets of the Primary Fund provided that any such transaction from an investor, individually or in the aggregate, does not exceed $10,000." 

The Reserve, according to their website,  is "a leading  cash management provider for institutions, banks, brokers, advisors, and individual investors."  They created the world’s first money market fund in 1970.   The Reserve Primary Fund is currently rated AAAm by Standard & Poor’s (that’s their highest rating) and Aaa by Moody’s (also their highest rating).

This is the first time since 1994 that a money-market fund’s net asset value has fallen below the $1 per share level.

Jon Markham warned about this in December 2007.  See his article "Your ‘Safe’ Money Isn’t So Safe"  at MSN Money.  Markham, who was prescient indeed, says:

"Brokerages have pledged to shrink their exposure to SIVs [Structured Investment Vehicles] and tacitly pledged to support money market funds’ values in the event that the mortgage-backed securities in which they are invested go belly-up. But they are not obligated to do so — and in a doomsday scenario, which is not all that hard to imagine, brokerages will have a snowball’s chance in hell of making good on their winks and nods, considering more than $3 trillion is at risk."

What is a money market fund?

A money market fund is a mutual fund that pools investors’ money and invests in short-term, high-grade debt obligations issued by corporations, banks and the U.S. government. The fund manager aims to keep the share price at $1.00. The yield fluctuates over time.

I’ll bet you think of it just like a checking account that pays more interest than you can get at the bank. If you read the prospectus, you would have read something like this: "An investment in a money market fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund." Do you understand what that means? If you have $10,000 in a money market fund, market fluctuations could cause your investment to be worth less than that – maybe $9,900. Maybe $8,500. Did you realize that this is possible?

What happens when a money fund’s yield is less than its management fee? They can only pay out what they take in, minus expenses. Many money funds have been waiving expenses in the current low-interest rate environment. When a money market fund’s share price falls below $1  it is called  "breaking the buck."

Not so long ago – in early 2004, Vanguard founder Jack Bogle, referring to "breaking the buck,"  said:  "I don’t think anyone would do that."  Why? It would break investors’ trust in the $2.2 trillion industry, prompting many to take their money elsewhere. John Bogle and others like him thought that the fund companies would opt to close out the fund altogether and return money to shareholders rather than risk the net asset value falling below $1. The safety and security of the entire money fund industry would be called into question. Any fund company allowing their money market fund to break the buck would have a public relations nightmare on their hands.  That was 2004, now here we are.

Nevertheless, the point is, if you had read and understood the money market funds prospectus, you would have known that losing money in the fund was a possibility. And it could happen.

Note: A money market mutual fund is not the same as a bank money market deposit account. A bank money market deposit account is not a mutual fund – it’s a bank deposit and it is insured by the FDIC. Its yield is whatever the bank chooses to pay.

Bear Stearns, Fannie and Freddie, Merrill Lynch, Lehman Brothers.  What’s next?

And what about all the trust portfolios that are headed down?   Remember, the standard of care under the Prudent Investor Act is not measured by portfolio performance –  it is a standard of trustee conduct measured by how the trustee monitors, responds, and follows good procedures.

Click here for Alan Greenspan’s view.

Worst economy he has ever seen.


The failure of IndyMac Bank has caused many bank depositors to ask questions about FDIC – the Federal Deposit Insurance Corporation. According to FDIC 10,000 IndyMac customers could lose as much as $500 million in uninsured deposits. FDIC will pay claims between $4 billion and $8 billion to insured depositors. FDIC representatives predict that there will be more bank failures, but “it will be within range of what we can handle.”

What will the FDIC pay?

All types of deposits are covered – checking, savings, money market deposit accounts, and certificates of deposit. The amount covered is the account balance plus accrued interest up to the date of the bank’s closing and up to the insured limit. FDIC does not cover stocks, bonds, mutual funds, life insurance or annuities.

The basic FDIC insurance amount is $100,000 per owner per insured bank. Accounts maintained in different categories of ownership may be separately insured up to $100,000 so that it is possible to have deposits of more than $100,000 at one insured bank and still be fully insured.

There are 8 ownership categories that may be separately insured at the same bank.  The following 8 categories summarize the information available in the FDIC’s publication, Your Insured Deposits.:

1. Single Accounts. All single accounts owned by the same person at the same insured bank are added together, and the total is insured up to $100,000.

2. Certain Retirement Accounts. This category qualifies for $250,000 in insurance. It includes traditional IRAs, Roth IRAs, SEP IRAs, SIMPLE IRA’s, Section 457 deferred compensation plan accounts, self-directed 401(k) plans, and self-directed defined contribution qualified plans, and self-directed Keogh plan accounts.

3. Joint Accounts. For joint accounts owned by people where each co-owner has equal rights to withdraw funds from the account, each co-owner’s share of every account that is jointly held at the same insured bank is added together with the co-owner’s other shares, and the total is insured up to $100,000. For example, a husband and wife could have $200,000 in a joint account and the deposit would be fully insured. Using different social security numbers or reordering the order of names on joint accounts has no effect on how much insurance is available.

4. Revocable Trust Accounts. An “informal” revocable trust account is a pay-on-death (POD) account, an “in trust for” (ITF) account, or a “Totten trust.” “Formal” revocable trusts are created by a trust document as part of an estate plan. All deposits that an owner has in both informal and formal revocable trusts are added together, and the insurance limit is applied to the total. When two insured banks merge, the deposits from the assumed bank are insured separately for 6 months. This period gives the depositor a chance to move the account if necessary.

The owner of a POD (or other “informal” trust) account is insured up to $100,000 for each beneficiary if the account is properly titled, the beneficiaries are identified by name on the deposit account records of the bank, and the beneficiary is a spouse, child, grandchild, parent or sibling. Adopted and step children, grandchildren, parents and siblings also qualify. Note that the owner or grantor does not count for this insurance.

5. Irrevocable Trust Accounts. If the bank account records disclose the trust relationship, the beneficiaries are identifiable from the bank’s records, and the amount of each beneficiary’s interest is not contingent, then the interest of a beneficiary of an irrevocable trust established by the same grantor and held at the same bank are added together and insured up to $100,000. For irrevocable trusts, beneficiaries do not have to be related to the grantor. But since these trusts often contain conditions or give trustees discretion to make distributions, coverage for these accounts is often limited to just $100,000.

6. Employee Benefit Plan Accounts. This insurance “passes through” the plan administrator to each participant’s share.

7. Corporation/Partnership/Unincorporated Association Accounts. Deposits owned by one of these entities are insured separately up to $100,000 and are insured separately from the personal accounts of the entity stockholders, partners or members. Accounts held in sole proprietorship accounts or DBA (doing business as) accounts are not included in this category but are added to the owners other single accounts.

8. Government Accounts. These are deposits of the United states, any state, county, municipality or political subdivision, or an Indian tribe. Each official custodian of time and savings deposits of a public unit is insured up to $100,000. Demand deposits are separately insured up to another $100,000. Pubic deposits maintained in out-of-state banks are limited to a maximum of $100,000 in coverage per official custodian.

Any recovery of uninsured amounts will depend on the sale of the banks assets and may take some time. Not all uninsured amounts are paid.

Deposits with each FDIC-insured bank are insured separately from any deposits at another insured bank. You can have $100,000 in as many banks as you wish!

The goings on at Hershey Company are always of great local interest here in Central Pennsylvania. But of more than local interest is the litigation surrounding the management of the Milton Hershey School Trust and the attempt to sell the company.

Jonathan Klick of Florida State University College of Law and Robert H. Sitkoff of Harvard Law School have published  Agency Costs, Charitable Trusts, and Corporate Control: Evidence from Hershey’s Kiss-Off in 108 Colum. L. Rev. 749 (2008). Here is the abstract:

"In July 2002 the trustees of the Milton Hershey School Trust announced a plan to diversify the Trust’s investment portfolio by selling the Trust’s controlling interest in the Hershey Company. The Company’s stock jumped from $62.50 to $78.30 on news of the proposed sale. But the Pennsylvania Attorney General, who was then running for governor, opposed the sale on the ground that it would harm the local community. Shortly after the Attorney General obtained a preliminary injunction, the trustees abandoned the sale and the Company’s stock dropped to $65.00. Using standard event study methodology, we find that the sale announcement was associated with a positive abnormal return of over 25% and that canceling the sale was followed by a negative abnormal return of nearly 12%. Our findings imply that instead of improving the welfare of the needy children who are the Trust’s main beneficiaries, the Attorney General’s intervention preserved charitable trust agency costs of roughly $850 million and foreclosed salutary portfolio diversification. Furthermore, blocking the sale destroyed roughly $2.7 billion in shareholder wealth, reducing aggregate social welfare by preserving a suboptimal ownership structure of the Company. Our analysis contributes to the literature of trust law by supplying the first empirical analysis of agency costs in the charitable trust form and by highlighting shortcomings in supervision of charities by the state attorneys general. We also contribute to the literature of corporate governance by measuring the change in the Company’s market value when the Trust exposed the Company to the market for corporate control. "

The authors are critical of the PA Attorney General’s role:

 "Regarding trust law, our findings imply agency costs arising from the Trust’s charitable trust form on the order of $850 million, about 15% of the 2002 value of the Trust. Although the trustees controlled more than three-quarters of the shareholder votes in the Company, they failed
to impose a value-maximizing strategy on the Company’s managers. As we have seen, the market judged the Company as being $2.7 billion (or 25.5%) more valuable when the Company’s managers were expected to be subject to the market for corporate control instead of supervision by the trustees.

Moreover, instead of reducing the agency costs associated with the Trust’s charitable trust form, the Attorney General’s intervention made those agency costs permanent. Without any offsetting financial benefit to the Trust, the Attorney General forced the Trust to retain an asset that was worth $850 million more on the open market than in the hands of the trustees. While the sale’s detractors argued that the sale would hurt other stakeholders, such as the residents of Hershey and the Company’s employees, one wonders whether their gain offsets the preservation of such enormous agency costs. The $850 million in Trust assets destroyed translates roughly into $67,000 per resident of Hershey, or $62,000 per employee of the Company—plus the Trust’s exposure to uncompensated risk was continued."   (108 Colum. L. Rev. 749 (2008) pp. 815-816) 

Juan Antunez gives these cites for more background information:

"[t]he Hershey Power Play in Trusts & Estates Magazine by Pennsylvania attorney Christopher H. Gadsden, and Daniel Gross’s piece in Slate entitled Hershey Barred, whose subtitle says it all: How Pennsylvania officials screwed poor kids out of $1 billion by stopping the sale of the candy-maker. "

Blogging credit goes to Juan Antunez who writes the Florida Probate & Trust Litigation Blog as well as to Professor Gerry W. Beyer’s  Wills, Trusts & Estates Prof Blog.