On May 16, 2000, Hechinger and Gasparino at the Wall Street Journal reported that Merrill Lynch & Co had been embarrassed by two of the company’s own brokers, in separate incidents, resulting in a $750,000 total fine. Merrill Lynch also agreed to pay the $3000-$5000 cost of customer mediation, as well as a total of $100,000 to a fund for investor education.
The first broker’s name is Richard F. Greene, and the reason for his failure and humiliation is clear to index funds investors. As an active manager, Greene failed to ensure that his clients’ Risk Capacity™ matched their risk exposure. Although he does not seem to have devastated his clients intentionally, Greene also failed because of his stock picks and market timing. Merrill Lynch said there was no systematic problem, that the case included a tiny fraction of its 450 Massachusetts brokers, but the Massachusetts Securities Division alleges that as many as 400 clients lost $30 million!
State securities regulators contend that Greene invested his clients, and himself, in large concentrations of Genesis Health Ventures Inc, Eldertrust Inc, Indymac Mortgage Holding Inc, and Orbital Sciences Corp, little known, high risk stocks that later plunged in value. Greene ignored his clients’ capacity for risk and did not diversify —then, when the stocks lost 80 percent of their value, the high risk became evident. Despite a supposed good track record, Greene, 66, fell victim to the bane of active investors and the champion of index investors: diversification and the randomness of news and how it affects the stock market.
The second broker, Donald J. Martineau, pleaded guilty to defrauding clients of $6.3 million; two of his clients were his own brothers-in-law! Martineau admitted to cutting and pasting signatures from past fund transfer authorizations into current transfer forms! He would then wire the money into his own account. As an active manager, it seems Martineau felt compelled to steal because of his huge losses in options trading; the theory that active investing is akin to compulsive gambling seems to be supported by this. The emotional quotient that index advisors warn about, the need to beat the market, the illusion of control, desperate lows emanating from failure, resulted in an unsuccessful suicide attempt by Martineau in April 1998. John Macoul lost $245,000, and insists that Merrill Lynch knew about his brother-in-law’s turmoil long before his suicide attempt, while state regulators allege the company should have been aware of the actions of their broker. Merrill Lynch, learning the reason for Martineau’s attempt, fired him in August 1998.
About the Author
Founder and President of Index Fund Advisors, Inc., and author of Index Funds: The 12-Step Recovery Program for Active Investors. He is a Wealth Advisor, with an MBA from the University of California at Irvine and a BS in Pharmacy from the University of New Mexico with a specialization in Nuclear Pharmacy.