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The Rep Who Turned Into a Reformer

When Franklin Roosevelt was creating the Securities and Exchange Commission, he knew the perfect candidate to head up the new agency a Wall Street veteran notorious for his ability to manipulate stocks. Who better to teach the tricks of the trade to the new regulators than a master of the game, Joseph Kennedy? That's sort of the theory behind the business of former Smith Barney broker James Langston.

When Franklin Roosevelt was creating the Securities and Exchange Commission, he knew the perfect candidate to head up the new agency — a Wall Street veteran notorious for his ability to manipulate stocks. Who better to teach the tricks of the trade to the new regulators than a master of the game, Joseph Kennedy?

That's sort of the theory behind the business of former Smith Barney broker James Langston. In April, Langston founded the Investors Advocacy Group in the Dallas suburb of Frisco. His mission: To use his experience as a rep to help investors make sure that their financial advisor is on the level — and doing a decent job at a reasonable price.

“My motto is trust, but verify,” says Langston, 37, who walked away from the business two years ago because he says he was fed up by the sales practices of an industry he feels doesn't always put the interests of its clients first.

For a flat $250 fee, Langston will perform a “cost differential analysis” on a rep-recommended portfolio. He promises to find an equivalent or greater amount of savings from “hidden charges” or the analysis is free.

“I tell clients,” Langston says, “if you don't know how much money your broker is making, rest assured, he does.”

So is Langston just a guy with a new kind of hustle or a legitimate advocate for the hapless retail investor? Maybe a bit of both. Whatever his motives are, he insists his objective isn't to prevent brokers from making a living.

The Family Business

Langston has nothing against brokers — his brother is still in the business. “Brokers deserve to be fairly compensated,” Langston says. “My argument is that investors deserve to know upfront what they are paying.”

That, he says is the critical factor that is missing when clients decide where to put their money. In his view, current industry practices and even the SEC's proposed point-of-sale disclosure rules (see Registered Rep., April 2005), don't go far enough in explaining deferred sales charges, or “advanced compensation,” to customers.

“Every broker knows exactly how much compensation he or she earns from any given transaction and can figure out this amount before the client walks out the door,” he says. “Why can't the Securities Exchange Commission develop a Web site or software package that can assist the investor at the point of sale?”

“The regulatory bodies still insist that when a deferred load is used to compensate a financial advisor there is no sales charge paid unless or until the investment is sold,” Langston says.

The latest version of the SEC's proposed point-of-sale disclosure statement says that investors would pay “a sales fee for Class B shares” when the shares are sold “at the back end.”

“This statement, in my opinion, is misleading and borders on fraudulent,” Langston says. “The issue isn't just B shares. Anytime a deferred load is used to compensate a financial advisor, a sales charge is unequivocally incurred and paid. The industry cleverly calls this an ‘advanced commission.’ Well, who is advancing the commission, who is receiving the advance, who is responsible for repaying the advance and what is the ultimate cost of this advance?” Clearly, Langston says, the investor bears the cost.

“Don't the tenets of fair and ethical business practices dictate that the investor be entitled to fully understand and appreciate prior to affecting the transaction that he is, in fact, responsible for repaying this advance or commission?” Langston asks.

Asked about the possible implications of Langston's novel service, the NASD declined to comment. NASD spokesman Herb Perone says he is unaware of any similar companies.

Wild On…Annuities

If Langston is aghast at the way funds are sold, he's practically apoplectic about annuities (see related story on page 63). Most investors, he says, have no idea of the size of commissions that insurance companies pay upfront to brokers and what they get later if clients surrender the contract early. He relates the story of one individual with a $7 million retirement nest egg to invest who was sold on an annuity that Langston says “conservatively” netted the broker an upfront commission approaching $350,000, a number he clearly sees as outsized.

Langston worked for six years as a registered rep, starting with Merrill Lynch before moving to Bank One in New Orleans. Later, he says, he was heavily recruited by the Smith Barney office in the Crescent City. Then, about six months after joining Smith Barney, Langston says he came to the realization that being a rep was inconsistent with his core beliefs. He left Smith Barney voluntarily with a clean record of zero investor complaints or disciplinary actions by regulators.

“Maybe it was being raised a Catholic and going to parochial school,” he says. “I always remember my father, who was a physician, saying that he liked his work so much that if he had to, he'd work for free. I do have a knack for connecting with people and I decided I could either use my powers of persuasion for good or evil.”

After leaving Smith Barney in 2003, Langston first tried working as an industry expert with his sister, an attorney who handles brokerage arbitration cases. But the contingency fee approach of an attorney was lousy for cash flow, so he set about writing a book on industry sales practices and pondered a business model that would allow him to engage in his passion for helping consumers and also allow him to eat. The Investors Advocacy Group was the result.

How IAG Works

At $250 a pop, Langston recognizes that his hourly wage could get pretty slim if he puts too many hours into analyzing a client's portfolio, so he hopes to “make it up on volume.” Most of his clients have come from the Dallas area, where he moved so that he and his wife could be closer to her family. He says that he is encouraged by the response he has received from his local networking and advertising.

His system spits out a “Langston Matrix,” which presents clients with a graphic presentation that shows how much investing in different share classes will cost over differing time horizons. He calls it the kind of point-of-sale disclosure document that the industry should be required to provide.

“If I can do it, why can't they?” he asks.

Frank Coates is a former mutual fund sales and distribution executive with Dreyfus and Strong who now operates a consulting company that advises funds on governance and management issues. He thinks that Langston “is on to something if he's looking at the bigger question,” which is that most investors don't understand the difference between A, B or C fund shares, mutual fund wrap accounts or the numerous other ways funds are sold. But Coates contends that with today's open architecture platforms most wirehouse reps have “absolutely no incentive to sell one fund family over another.” And they may have plenty to lose if they get caught gouging by the compliance cops.

Problems are “more likely to come from the guy who works for a loose independent brokerage firm that doesn't have a compliance officer or branch manager looking over his shoulder,” he says. But even then, Coates believes that to the extent there is a problem, it stems more from “confusion” on the part of the investing public than it does from “organized efforts” on the part of reps to be deceptive.

“Fifty percent of fund investors probably think they are being abused,” says Coates — although he guesses that only a few have a legitimate gripe.

Langston acknowledges that his business isn't likely to win him a lot of friends in the brokerage industry, but he claims that former colleagues with whom he's discussed his efforts eventually, if grudgingly, concede that investors probably would benefit from the additional information.

“The issue is not me,” Langston says. “The issue is whether or not what I am saying is accurate. I have had many exchanges with brokers who initially wish to attack me and make the debate about me, but when the conversation eventually reaches the merits of my work the response is always, ‘Well, you have a point.’”

The Langston Investor Advocate Matrix — How it Works

To decide which fund share class is best for a client, Langston simply uses a kind of discounted cash flow model to compute the minimum cumulative costs of a mutual fund, based on the amount to be invested, the investment time horizon and the assumed rate of return, plus any loads and other fund expenses, but not including 12b-1 fees.

The chart below depicts the cumulative annual costs for a mutual fund in A-, B- and C-share classes, based on a $90,000 investment in a large-cap fund, an investment time horizon of 10 years and an assumed rate of return of 4 percent. As you can see, in Year 5, the A-share class is cheapest — the C share the next expensive and the B share the most expensive — with a minimum cost of $9,107.53.

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