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When Bad Firms Happen to Good Advisors

An alleged Ponzi scheme conducted and contained among a few top executives at The Stanford Financial Group was not in the plans for the 200-plus financial advisors who moved their careers and their clients’ fortunes to the firm. Could it have been avoided?

Bob Hogue's first taste of Stanford Financial Group wasn't aboard one of R. Allen Stanford's fleet of jets or his 120-foot yacht, the Sea Eagle Bikini. It began far more sedately in the firm's private dining room at the firm's Houston headquarters at 5050 Westheimer Road. Hogue was there on a recruiting trip and like dozens of other successful FAs who had joined the firm in recent years, he was treated well. A chef — recruited from one of Houston's finer restaurants — prepared the food, which was “delicious,” recalls Hogue. The waiter served it on flatware embossed with tiny Stanford Eagles. It was a nice presentation, says Hogue, but he was looking for more than a pretty lunch.

Having left Bank of New York when the firm sold its Houston and Dallas retail investment offices — where he was branch manager — Hogue was looking for the comfort of familiarity and people he could trust. Stanford offered service providers he knew well: Lockwood Financial's platform of money managers, with which he had already built his business on, top-notch client and data management technology provided by Odyssey Financial Technologies (a leading European vendor), and a custodial relationship with Pershing, the custodian he was already using. Adding to the appeal, Pershing guaranteed easy transition of client data, no change in account numbers, if Hogue and the three FAs in his Dallas office moved to Stanford. “There weren't any other firms offering all that,” says Hogue. He and the three other Bank of New York financial advisors joined Stanford's Dallas office in November, 2007.

Up until about a month and a half ago, many advisors would have envied Hogue for his position. Not only does his resume list a who's who of reputable firms — E.F. Hutton/Shearson, Chase Manhattan (he opened the first Investment Services office in Dallas), Lockwood Financial/Bank of New York — his CRD is spotless and he manages roughly $85 million in client assets, nearly all of it managed money for long-term clients.

But on February 17th, his life and career were thrown into disarray. That day, the SEC and the FBI raided Stanford Financial Group's Houston headquarters and leveled civil fraud charges against its billionaire founder, Robert Allen Stanford, and two top executives. The allegation: that they'd perpetrated an $8 billion Ponzi scheme fueled primarily by the sale of CDs (through Stanford advisors) for Stanford International Bank, the firm's Antiguan bank. Since that day, Hogue — a Dallas-based Stanford advisor who put $200,000 into just one of the CDs for one of his clients — and every other Stanford financial advisor and their clients have been snared in the web of the regulator's ensuing investigation. Their brokerage licenses, their clients' accounts and their own accounts were all frozen. (In mid-March, the SEC began reactivating advisor licenses and releasing client accounts with no CD exposure, but not Stanford advisors' personal accounts.) Worse, the SEC instructed Hogue and the others not to speak with their already furious and panicky clients — understandably a directive few have followed. Eventually the SEC will let all Stanford advisors and their clients back into their accounts and the lines of communication will open up. But the taint of fraud, even if it is ultimately contained to top executives, may leave an indelible mark. Some Stanford advisors worry that their reputations will never recover.

“This is the most gut wrenching experience of my life. It's taken me 20 years to build many of these relationships,” says Hogue. “I'm already damaged by this, but these past few weeks could devastate my career.” A relieved Hogue has since joined Oppenheimer Holdings, but Stanford may continue to haunt him.

How much did advisors know about the offshore high-yield CD allegedly behind the Ponzi scheme? Initial conversations with more than 200 Stanford clients who purchased the CD indicate they believe their advisors were unwitting enablers, according to James Dunlap, a Houston attorney interviewing prospective clients for a lawsuit against Stanford. (Some of the advisors even plunked down money of their own in the CDs.) But that “doesn't free those advisors of liability,” says Dunlap. In fact, Stanford advisors got incentives for selling the CDs, including a 1 percent commission and, depending on the size of the sale, eligibility for a 1 percent trailing fee for each year on the CD's contract, as well as trips and bonuses and invitations to the annual sales meeting, awarded based on how much money an advisor funneled into Stanford International Bank. The same perks weren't available for other investments. (Assets in SIB grew from $2 billion in 2003 to more than $8 billion in 2008.) Meanwhile, clients who put a lot of money in the Antiguan bank got white-glove treatment. Anyone with $5 million or more to deposit was flown to Antigua on one of Allen Stanford's jets for a personal tour of the bank, say Stanford advisors. Further, in November, 2007, FINRA fined Stanford $20,000 for failing to adequately state the risks involved in the CD investments and to disclose the potential conflicts of interest in the links between the broker/dealer and the bank. Stanford advisors might have taken notice before advising clients to buy the CDs. There is obviously a far tougher road ahead for those who did sell the offshore instruments, versus those who did not. Regardless, all of the firm's advisors are now dealing with the consequences, whether they helped to fuel the alleged massive fraud or not. They'll ask themselves the question, “Could I have avoided this?”

It's hard to say. Some contend that smart FAs should never have joined Stanford in the first place. But the firm was good at keeping up appearances and giving advisors what they wanted; it had made few regulatory missteps — or at least it hadn't been caught. Meanwhile, some financial advisors were just desperate to save their careers from an imploding Wall Street. And, for many, Stanford's own personal fortune and connections with celebrity served as a seal of approval for his business.

Little Firm, Growing Rep

Stanford, which was founded in 1995, grew explosively between 2005 and 2008. Five of the firm's eleven senior executives joined the firm last year, while the rest (excluding Sir Allen himself) came on board between 2005 and 2007. Stanford also reeled in 45 new FA recruits with $5 billion in client assets in 2008, raising advisor headcount to more than 200 and total client assets under management to $20 billion. It was an ideal time to lure discontented wirehouse advisors as Wall Street brands took on tarnish and the firms' stocks plummeted on waves of negative news. In fact, over the last few years, dozens of reputable FAs with spotless regulatory records took their clients and their careers to Stanford from prestigious firms. Stanford's deep pockets — filled by Sir Allen Stanford himself — allowed it to award competitive recruiting packages. Stanford offered upfront deals that combined cash and shares in the privately held Stanford (dubbed PARS) plus back-end bonuses for future business growth.

To those who might ask why an advisor would risk a move to a smaller lesser known firm like Stanford, the current state of many of the big firms could easily serve as a retort. Meanwhile, there was little evidence of trouble at Stanford in existing regulatory documents. The firm's regulatory record shows seven disclosed customer arbitrations between 2001 and 2007, four of them resulting in awards, three of them not. As for regulatory violations, the firm had a clean CRD until 2007, when FINRA BrokerCheck documents show the firm was hit with a handful of small fines ($10,000 to $30,000) for disclosure, supervisory and transaction reporting violations, all dispensed in 2007 and 2008. In April, 2007 the firm was fined for a net capital violation, the one clear “yellow flag” that something was not quite right, according to one securities attorney.

At the height of the market panic in November, 30-year Merrill veteran and $1 million-plus producer, Paula Sutton, joined the Houston office, Stanford's largest with 37 advisors — eight of whom had joined from Merrill in recent years. Like Sutton, nearly all of the advisors in the Houston office had clean CRDs — only two FAs had marks. Sutton couldn't be reached for comment, but a top producer at Morgan Stanley noted her departure from Merrill, saying only that “he was surprised” by it, since she was well known in the industry — and Stanford wasn't.

Stanford's biggest recruits joined the firm just before the Christmas of 2008. Chris Aitken and Stephen Thacker, two stars of the industry-leading Citi Institutional Consulting Group, managing nearly $6 billion in assets for institutions and wealthy individuals, announced they were joining Stanford to start up its new Institutional Consulting Group. (We were unable to interview Aitken before press time.) But they weren't the first high flyers to leave Citi's fabled Consulting group for Stanford. Eddie Ventrice and his partner Michael Bober joined Stanford in November 2006. The Arthur Andersen-trained CPAs managed $800 million for wealthy individuals and institutions. Ventrice's story is similar to Hogue's — he and Bober found the Stanford platform and technology comparable to Citi's and they already had a custodial relationship with Pershing. “It was a small but evolving firm and it had this Trump-like persona at the top,” says Ventrice, referring to the ambition and flash of Allen Stanford.

Obviously, advisors appreciated Stanford's connections to the wealthy. It offered them access to potential clients and it gave the firm some cache. “As small as it was, the firm did an excellent job of positioning the Stanford name in front of high brow customers,” says Hogue. There was a PGA tour stop, the Stanford St. Judes Championship in June. One of golf's biggest stars, Vijay Singh, and another rising talent, the young Columbian Camillo Villegas, both wore the Stanford Eagle emblem. Stanford sponsored the Miami Heat's largest annual fundraiser, the Heat Family Festival, and had exclusive naming rights for the arena's VIP entrance. All over the southeastern U.S., advisors had their pick of events to which they could escort clients. The Stanford name was behind big-time sponsorships of people, places and events throughout the well-heeled worlds of golf, polo, sailing, tennis and cricket, as well as charity and the arts.

The Firm

In early 2008, three months after he joined, Hogue sold a single Stanford International Bank CD to one client, he says. The client was adamant about staying out of the stock market, he explains. He regrets it now and he never sold another. Reflecting on his experience at the firm, Hogue says Stanford had the money managers, the technology and much if not all of what they promised him in the private dining room that day. But as the months passed, he says, a more shadowy impression of the firm developed. “I told my wife one night after dinner that I felt at times like I was working at The Firm,” he says, as in the novel by John Grisham. “There was the opulence, the sophistication and all, but there was also this mysterious center around the International Bank.” Hogue laughs at the absurdity of the coincidences: Memphis, the setting of the novel, is where a group of the analysts who supposedly monitored the CD portfolio sat; likewise, the Caribbean was where the money was held.

But the SEC complaint indicates that management wasn't at all mysterious about what it wanted Stanford advisors to do. The pressure to sell the CDs was powerful, from upper management on down to branch management. And yet, on at least one occasion, when asked to explain the returns on the CDs, visiting executives became evasive, Hogue says. It didn't feel like a cover up, he says. Rather it appeared even they didn't know what was in the portfolio.

According to the SEC's investigation, the marketing literature for the SIB CD said it contained “a well diversified portfolio of highly marketable securities issued by stable governments, strong multinational companies and major international banks.” That magic formula pumped out returns of between 10.3 percent and 15.1 percent every year from 1995 to 2008, when it lost 1.3 percent — a time when the S&P 500 fell 39 percent. Before the regulatory receiver took over the web site, a 2006 disclosure statement regarding SIB's CD portfolio reported 57.4 percent of the assets were in equities, 21.9 percent in U.S. Treasuries and corporate bonds, 13 percent in metals, 7 percent in alternatives and the rest in cash, mostly U.S. dollars. But the SEC's Feb. 16 complaint against R. Allen Stanford, his firms, his CFO James David and his COO Laura Prendergest-Holt, alleges that 81 percent of the portfolio was held in “unknown assets under the apparent control” of Stanford and Davis.

Others outside Stanford who spoke with Registered Rep. say experienced, upstanding advisors should have known to avoid Stanford: “I think a lot of the guys that went there recently were chasing the money,” says one investment consultant with Citi Institutional Consulting. Another advisor, the same Morgan Stanley advisor who knew Paula Sutton, says he too dined in Stanford's private dining room — in 2004 — but when it got down to business, he didn't like the lack of transparency — and all the talk about managers and the CD. “They talked up their access to managers and all that,” he says. “So I asked them to download their biggest client's portfolio and show it to me, without the name of the client,” he says. They refused. “That was a simple request. To see a statement, see if the returns matched what they were saying, see the managers,” he says. So he walked. It's not a question he would normally ask, he says, but Stanford was talking such a big game, and the firm was such a relative unknown. Of course, he now has the benefit of hindsight. Plus, Stanford had only offered him 70 percent of trailing 12 months production, and no company shares, a package that he called “piddly” compared to what the Street was offering at the time.

“The fear of course, is that we're tainted,” says Hogue. “But most of these people know me well, and they've been supportive through this.” One of those supportive people is Norm Nabhan, the director of foundations and not-for-profits at Citi Institutional Consulting. He knows Hogue from his days at E.F Hutton where the institutional consulting group was born. Nabhan also knows Ventrice and Bober as well as Aitken and Thacker. He says all of them are reputable advisors and he says it kills him to see these guys in the situation they're in — and the likely questions they face from clients. “For institutional guys who are paid by clients to pick money managers, hedge funds, etc. the fear of course is that clients will say ‘Well, jeez, you weren't so good at picking your employer.”

Of course, other firms have blown up recently, but other than Madoff, none have done so due to the sale of fraudulent investments to clients. The Madoff and Stanford debacles will no doubt heighten client and advisor due diligence. “At the very least, brokers need to run FINRA's BrokerCheck,” says Hardy Calcott, a partner with law firm, Bingham McCutcheon. He also suggests running the names of the firm's principles through FINRA's database. (Besides one personal bankruptcy, none of the 11 principles at Stanford had any marks on their CRDs.) Who audits the firm's books? Madoff used a no-name one-man shop to audit his entire operation; Stanford relied on an Antiguan accounting firm, also without name recognition stateside. Calcott says advisors would be wise to get a firm understanding of the company's governance structure, too — are there audit committee requirements? Is the board independent and competent, or stocked with cronies? Stanford's board included his father James, who told The Wall Street Journal he hadn't attended a board meeting in years; as well as O.Y. Goswick, a family friend from Stanford's Texas hometown, Mexia, who suffered a stroke in 2000 that all but totally disabled his speech — but didn't jeopardize his position on the board.

“Years ago, you'd ask around your city, your own firm, among your peers in the area to learn about a firm's reputation,” says Calcott. “Unfortunately, that's not enough anymore.” Investment bankers conducting due diligence on firms hire private investigators, usually to look into the principles. But if it comes to that, your gut is probably already telling you to look elsewhere.

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