The U.S. can learn a lot from taking a look at what other countries are doing with their financial situations, both from what they do right and what they do wrong. Germany, for example, is economically strong and efficient, but its banks have let investors down badly, and a 2009 article in a major German magazine has the stats to prove it. In this article, we'll take a look at what has been happening in Germany for years and what North America can learn from this country's mistakes.
Banks: Looking Out for No.1
Germany is just one case of an international financial jungle in which misselling is rife and rampant. The leading German magazine Focus published a cover article entitled "Advised and Sold Out" on the appalling state of financial advice in the country. The financial crisis of 2007-2008 uncovered startlingly bad and unethical practices throughout the industry. These practices were also confirmed by various reports and investigations in the media over many years.
In particular, insiders have revealed how investors are systematically sold high-risk products that bring in commission, rather than lower-risk ones that better conform to their risk profiles. Even worse, when the losses are there and investors complain, the financial institutions invariably claim to have done nothing wrong. (Learn more about this subject in How Risky Is Your Portfolio? and Paying Your Investment Advisor - Fees Or Commissions?)
For instance, according to the Focus story, an 80-year-old man was advised to put 268,000 euros into a dubious real estate fund. The fund was then mismanaged and wound down, leaving the senior with losses of 100,000 euros. Given his age and financial circumstances, this was a totally unsuitable investment for him, but the bank made money off of it. Unfortunately, such cases of disastrous misselling are common.
Pressure to Sell, Sell and Sell again
In the Focus article, Hilmar Kopper, former head of Deutsche Bank, attributes this situation to greedy investors who are after 6% returns or more. However, the Focus study states the root cause is an ever-increasing pressure, one personal bankers and branches to sell. Due to this selling pressure, bank employee had to approach friends and neighbors to get her sales figures up to the required level. (It is not uncommon for investors to lose money through misselling or other ethically questionable practices. Read our related article Don't Take Broker Excuses At Their Word, to learn of some ways to protect yourself from being taken advantage of.)
In addition, Deutsche Bank, among others, tends to constantly cut back on administrative personnel to create room and appoint more advisors. This passes the pressure to sell and bring in capital onto the new advisors' shoulders, which means that people with extremely varied incomes, ages and preferences could end up with portfolios full of complex certificates, exotic Eastern European, South American and Asian funds, and participation in sundry "promising, not-to-be-missed" ventures, just so that quotas are met.
The pressure to sell may also result in advisors having neither the time nor the inclination to bother with even the most rudimentary market timing or strategies. In other words, they tend toward selling what's in the current list of "cash cows". This generally means avoiding low-commission, fixed-income investments, and pushing equities and packaged products.
The Focus article pointed to the fact that clients are encouraged to buy and sell with alarming frequency. The banks, such as the Dresdner, stated that this is merely based on "a systematic analysis of evolving and changing customer needs", but in many cases, it looks suspiciously like churning. (To learn more about churning, see Understanding Dishonest Broker Tactics and our Online Investment Scams Tutorial.)
In addition, Focus found that many investors were regularly informed that their funds were too big or too small, or not in the right sectors or the right places, so that they would do better with something else. All too often, the main goal of these investor alerts was generating a commission. Not for nothing is there a saying in German "ausser spesen, nichts gewesen", which means "apart from the fees, nothing happened". For the really unlucky ones, however, something did happen - massive losses.
An advisor at the Dresdner bank found a way out of this trade-off by honestly advising people to put their money into conservative investments and simply telling his boss that "the clients insisted on it".
Confessions in court
Some comments made during investment court cases are very revealing. According to the district court in Munich: "the ever-present insufficient clarification of risk by the employees of Commerzbank seems to be a systemic problem."
And, the provincial high court in Munich accused a bank of using promotional material "that seriously understated and misrepresented the real level of investor risk, and in many respects, kept totally quiet about it."
The Future of Banking
Changing this deplorable state of affairs will remain a major challenge as long as commissions are all that matter. There have been calls in the United Kingdom, for instance, to ban selling on commission because of the issues laid out above. Clearly, tighter controls need to be imposed on the financial industry to reduce misselling. The burden cannot be shifted onto the clients. Not only is it the responsibility of the seller not to missell, but the vast majority of buyers do not and won't ever have sufficient knowledge and understanding to defend themselves against unscrupulous financial advisors and institutions.
For the fortunate minority who are adequately informed, they can ensure - at least to some degree - that what they are sold is an intrinsically good investment and suitable for them. They can also document their risk profile and make sure that the broker knows that it is there in black and white. In general, experienced investors can look after themselves. But even so, only up to a point. The industry must be compelled to get its integrity act together, once and for all. (For more on broker issues, see Find The Right Financial Advisor, Is Your Broker Acting In Your Best Interest? and So, You Want To Take Your Broker To Court.)
Sadly, throughout the world, there is a temptation for bankers and brokers to sell what is best for them, rather than what suits the investor. This horror story from Germany applies to a greater or lesser extent throughout the world, including North America.
Unfortunately, preaching to the converted is a large part of the problem. The fact that you are reading this article probably means you already know enough to avoid being sold the wrong investments. What matters is to get this message to the broader public, where regulators and educational systems can make a difference.