How to fend off the Wolves of Wall Street

As the movie, The Wolf of Wall Street, opens, the NY Post recently featured an interview with Josh Shapiro, someone who worked for Jordan Belfort, the main character in the film, and the bait and switch tactics of the firm:

You got on the phone and pushed a stock that people know, say, Dr. Pepper. But then you said, “Really, it’s my IPOs — that’s where I’m going to make you the most money.” You got the account, and then you started selling them on our IPOs — very enticing initially, but if you bought, you lost. There was no way to win.

We used to joke that they used to get a couple of bums off the street, throw them in the shower, put a suit and tie on them, and say, “Listen, buddy, for the next couple of hours, you’re the president of Czech Industries.”

When a stock collapsed, the mentality was that even if you lost thousands of dollars you’d buy more — instead of relating to a client that it crashed, you’d say it’s trading at a discount. And it worked because everyone wanted to make money.

One criticism from early reviews of the film was that it seem to idolize the fast-cars-fast-women bacchanalian lifestyle of Belfort and ignored the victims of Belfort's scams. Here is one example from the New York Times Dealbook:

Left untold is the story of the victims, disparaged as “garbage” by Mr. DiCaprio’s character in the movie.

For many of them — small-business owners and people like Steve Orton, a State Farm insurance agent from Alpharetta, Ga. — the publicity for the movie has brought back the old pain. Still, Mr. Orton said, while “it kind of sickens me, I really feel like I owe it to myself to complete the circle to see it.”

Ken Minor, a real estate appraiser in Gilroy, Calif., said the experience “hurt me pretty bad.” He drew on a home equity line of credit to buy stocks with Mr. Belfort’s brokerage firm, Stratton Oakmont, and still has not repaid it. “I’m not a rich guy,” he said, “and I’ve been paying for it ever since.”

How to fend off scam artists
How ironic that the Wolf of Wall Street opens for broad release on Christmas Day, which is more culturally attuned to sharing with family and with the spirit of giving. Perhaps it was intended more as a celebration of Saturnalia, which was a Roman festival held in mid/late December that featured wild partying and the abandonment of everyday decorum, as per this account from Wikipedia:

Seneca looked forward to the holiday, if somewhat tentatively, in a letter to a friend:

It is now the month of December, when the greatest part of the city is in a bustle. Loose reins are given to public dissipation; everywhere you may hear the sound of great preparations, as if there were some real difference between the days devoted to Saturn and those for transacting business. … Were you here, I would willingly confer with you as to the plan of our conduct; whether we should eve in our usual way, or, to avoid singularity, both take a better supper and throw off the toga.

The more important takeawy for investors is to take the proper steps to avoid the scam artists that still prowl Wall Street looking for marks. Part of the problem was that investors didn't know what they were doing, or they were just looking to gamble with their savings, which was Josh Shapiro's belief, as he stated in the NY Post interview [emphasis added]:

But these were not grandmothers we were calling on the phone. These were qualified investors, who had, basically, a gambling habit. In my mind, I just can’t imagine how some guy in Texas that’s never seen me, that’s never met me can send me $50,000. I just don’t understand how.

To avoid these pitfalls, I have three suggestions:

• Look for investment advisors who adhere to the fiduciary standard;
• Use the 5Ps of investment manager selection; and
• Make sure you have an investment plan.

Fiduciary duty vs. suitability standard
The first line of defense against investment scam artists is to ensure that your investment advisor adheres to the more onerous fiduciary standard, rather than the looser suitability standard. Here is the key difference between the two. When an investor creates an investment portfolio, he has two key decisions to make:

1. What to buy?
2. How much to buy?

The fiduciary generally has to consider both questions and the investor usually gives the advisor the authority to buy and sell on his behalf. The advisor with the suitability standard only has to think about the first one and has to consult with the investor, who then gives the advisor the trade order. Moreover, the advisor who is a fiduciary is subject to personal liability for the well-being of the investor should he act in an imprudent manner.

Supposing that there is a highly speculative investment with high profit potential. An advisor subject to a suitability standard can call up virtually anyone and pitch the idea, because as long as it might has a place in the investor's portfolio, e.g. 0.5%, he is not breaking any laws or regulations.

5Ps of investment manager selection
Another way of weeding out the pretenders is the manager selection process used by many institutions to select investment managers. To illustrate, I wrote the following to someone who tried to solicit me as a client for their investment advisory business:

The principal process used by many institutions to select managers consist of the 5Ps:

People: Who are they?
Performance: Interesting but less relevant as past performance is not reflective of future returns
Philosophy: Do you have an edge on the market? If so, what is it?
Process: How do you implement your "edge"?
Portfolio: Does the portfolio reflect the principles outlined in the philosophy and process statements?

As part of my evaluation process of your group, please outline your investment philosophy and process.

The 5Ps framework is a great template for evaluating advisors. Investors can to use their own judgement as to the biographies of the people, their investment philosophy and process make sense and fit with their needs and comfort zones. Reputable professional managers who have a well-defined process should have no trouble answering such questions. As for the less scrupulous, well...


Know where you want to go
Finally, take some responsibility for your money and know your investment objectives. Remember the Alice in Wonderland passage of Alice's conversation with the Cheshire Cat?

"Would you tell me, please, which way I ought to go from here?"
"That depends a good deal on where you want to get to," said the Cat.
"I don’t much care where--" said Alice.
"Then it doesn’t matter which way you go," said the Cat.
"--so long as I get SOMEWHERE," Alice added as an explanation.
"Oh, you’re sure to do that," said the Cat, "if you only walk long enough."

If you don't have an investment plan, how will you know when you get there? For more details, I would suggest reading my previous post entitled The ABCs of financial planning as a primer on this topic.

Once you've adopted these steps, you should have a much better idea of what you want; where you want to go; and better protection against the Wolves of Wall Street.


Addendum: One sure bet
I have long believed that one of the ways to nurture youth is to give them a focus in their lives, whether it be music, sports or other pursuits. This is especially critical during their adolescent years as they start to form their own identities. It's one of the key reasons why I became involved with the Vancouver Youth Symphony Orchestra Society. Participation in a VYSO orchestra teaches young musicians to focus on both their individual musical and orchestral skills. The latter is particularly important as many people can learn to play music, but a different skill is required when the conductor points to a section and have them all play the same sound at the same time. (That's why often school bands have "muddy" sounds - it's because they haven't learned orchestral skills.) It's much like the difference between learning to walk and learning to march in formation.

This holiday season, I am launching my personal appeal for support of the VYSO's Margitta Krebs Bursary, named after the much beloved conductor of the VYSO Debut and Junior Orchestra who is retiring after 29 years.

Margitta Krebs is celebrating her 29th season as Conductor of the Vancouver Youth Symphony Orchestra's two junior string orchestras and she will retire at the end of this season. She has now seen several generations of VYSO musicians proceed from Debut to Senior ranks and is proud to have launched them. Over the last 29 years, the Debut and Junior String orchestras have tripled in size under Margitta's enthusiastic leadership.

The VYSO is excited to announce that it is founding the Margitta Krebs Bursary Fund to honour Margitta's longstanding contribution to the VYSO. The bursaries will be open to students in the Debut and Junior Orchestras and their graduates as they proceed through the Intermediate and Senior Orchestra ranks. The Margitta Krebs Bursary is intended to financially assist students who might otherwise be unable to participate in orchestral training.

If you are in the Vancouver area, please come to Margitta's Farewell Concert on Sunday, May 4, 2:30pm at the Nikkei Centre in Burnaby, B.C. The Junior and Debut Orchestras, consisting of musicians ages 8-13, will close the season with a medley of the best, featuring everything from Ashokan Farewell, to an assortment of fun favourites and a stirring finale of Bach's Brandenburg Concerto No. 3. Special guest conductor for this piece will be Mr. Roger Cole, VYSO's Senior Conductor and Artistic Director. The full calendar of the VYSO's concerts this season can be found here.

Please consider contribute to the Margitta Krebs Bursary Fund by clicking here. It's a sure bet that you'll feel better about yourself by supporting efforts like this to the young discipline and focus in their lives.

The Vancouver Youth Symphony Orchestra Society is a registered charity and tax receipts are available to contributors who are Canadian residents.



Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. (“Qwest”). The opinions and any recommendations expressed in the blog are those of the author and do not reflect the opinions and recommendations of Qwest. Qwest reviews Mr. Hui’s blog to ensure it is connected with Mr. Hui’s obligation to deal fairly, honestly and in good faith with the blog’s readers.”

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this blog constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or I may hold or control long or short positions in the securities or instruments mentioned.