Retirees suffer as 401(k) rollover boom enriches brokers

Kathleen Tarr says AT&T Inc. (T) employees looked to her as “their de facto 401(k) expert.” Visiting their homes and offices, she advised them on their retirement plans as they called up balances on computer screens.

Actually, Ms. Tarr worked for Royal Alliance Associates, a brokerage firm owned by insurer American International Group Inc. (AIG) She encouraged hundreds of departing AT&T employees to roll over their retirement money into the kind of risky high-commission investments that Wall Street's self-regulatory agency warns against on its website.

Ms. Tarr and her business partner reaped hundreds of thousands of dollars a year in commissions and trips to the Bahamas and Florida resorts. Not all of her clients fared as well, and 37 of them have filed complaints against her, according to Financial Industry Regulatory Authority records reviewed by Bloomberg News. Ms. Tarr and Royal Alliance say the investment choices were appropriate.

“It's scary,” said Maria Lew, a former AT&T administrative assistant and Tarr client whose account balance has fallen to $100,000 from $390,000. She fears she will lose her home, and her kitchen ceiling has a gaping hole because of a leak that will strain her budget to fix. “There are days when I go to sleep and I can't stop thinking about it.”

The complaints against Ms. Tarr and other brokers illustrate the underside of America's retirement rollover boom. Former employees shifted $321 billion from 401(k)-style plans to individual retirement accounts in 2012, up about 60% in a decade, according to Cerulli Associates, a Boston-based consulting and research firm. As a result, IRAs hold $6.5 trillion, more than the $5.9 trillion in 401(k)-style accounts.

A three-month Bloomberg investigation found that former employees at major companies such as Palo Alto, Calif.-based Hewlett-Packard (HPQ) Co. and United Parcel Service Inc., as well as AT&T, have complained that sales representatives lured them into rolling over their 401(k) nest eggs into unsuitable IRA investments. The investigation was based on interviews with retirees and brokers, confidential arbitration records and other documents.

COLD CALLS

While retirees can generally leave their savings in 401(k) plans, financial firms entice them with cold calls, Internet ads, storefront signs and cash incentives to switch to IRAs. They tout the advantage of the IRA's wide variety of investment choices over the typical 401(k) plan's limited menu.

Yet that appeal can also be a pitfall for retirees offered expensive and high-risk investments. IRAs often charge higher fees than those associated with 401(k) plans, giving brokers an incentive to promote rollovers.

“You're going into the wild, wild west when you take your money out of a 401(k) and put it into an IRA,” said Karen Friedman, executive vice president and policy director of the Pension Rights Center, a Washington-based group representing retirees.

Ms. ! Tarr's clients paid higher fees in their brokerage accounts than they would have in their AT&T plan. There's no way of knowing exactly how they would have fared if they had left their savings behind. Employees in 401(k) plans, including AT&T's, also faced losses during the 2008 financial crisis, though the market has since rebounded to reach new highs.

Ms. Tarr, who left Royal Alliance in 2010, stands by her advice, saying the investments held up well in a difficult market. She said she didn't even know about the commissions each investment paid and wanted to do what was best for her clients.

In a more than two-hour interview, Ms. Tarr said she often tried to talk customers out of rolling over their pensions, but that many were eager to have the lump sum to generate higher returns and leave money to their children. She always made clear that she worked for Royal Alliance, not AT&T, she said.

“I am forever besmirched, and that is really hard for me,” said Ms. Tarr, fighting back tears. “I am a minister's daughter and granddaughter. If anyone thinks I would do anything illegal, immoral or unethical, that hurts me where I live.”

Ms. Tarr's strategy of focusing on one big company isn't unusual. A broker for another AIG unit, FSC Securities Corp., cold-called employees of UPS (UPS), the world's largest package-delivery company, in the area around its headquarters in Atlanta, according to a June 2013 complaint. Nine customers, including six UPS employees, lost more than $1 million when broker Brian G. Brown rolled over their retirement money into high-risk investments, including oil and gas private placements, they said.

EXPERIENCED CUSTOMERS

AIG, based in New York, declined to comment on the complaint against FSC. In a filing responding to the allegations, FSC said most of the customers were multi-millionaires “with decades of investing experience” who understood the risks.

Mr. Brown left FSC in 2010 and works for another brokerage company in Atlanta.

The c! omplaint ! “hasn't been arbitrated, and all of it is not true,” he said in a telephone interview.

Federal regulators are targeting rollover abuse. Last year, the Government Accountability Office, Congress's investigative arm, found that a conflict of interest was fueling IRA growth. Financial companies that administer 401(k) plans misled GAO investigators posing as departing employees, telling them they would almost always be better off if they shifted to IRAs that the companies also managed.

The Labor Department has said it will propose rules in January that brokers and other advisers act in clients' best interests during rollovers, a so-called fiduciary standard. Brokers are generally held to the lower standard of selling products that are suitable for their customers, meaning that they don't have to put their clients' interests first as long as they select appropriate investments. In January, the Financial Industry Regulatory Authority Inc., the Wall Street self-policing group, warned members that it would heighten its scrutiny of IRA rollovers.

The Securities Industry and Financial Markets Association, which represents brokers, banks and money managers, opposes stricter regulation. It would hurt commission-based brokers, limiting consumer choice, according to the group. Disclosure rules are already sufficient to protect customers, said Ira Hammerman, the association's executive vice president and general counsel.

“Let the customer decide,” Mr. Hammerman said.

Bank of America Corp (BAC).s' Merrill Lynch and E*Trade (ETFC) Financial Corp. offer as much as $600 up front to anyone who rolls over a 401(k) into an IRA.

“If someone offers you $600 to roll over your IRA, you can be sure you are going to be paying a lot more additional expenses later,” said Mercer Bullard, an associate professor at the University of Mississippi Law School who heads Fund Democracy, an advocacy group for mutual-fund shareholders.

INCENTIVES 'COMMONPLACE'

Kristen Georgian, a Bank of Amer! ica spoke! swoman, said such incentives are “commonplace for many leading brokerage firms.” The company informs clients about their options, “including keeping their assets in place,” she said.

“We believe strongly in rollovers,” said Mike Loewengart, E*Trade's director of investment strategy. Clients benefit from more transparent fees and broader investment options in an IRA with E*Trade, he said.

In a 401(k), an employee sets aside money — often with a company match — in a menu of mutual funds, which aren't taxed until withdrawal and, in some cases, at all.

Once workers exit a company, they generally can leave the money behind, roll it over into an IRA, transfer it to another 401(k) or cash out and suffer a huge tax hit. In a rollover, customers set up IRAs with financial companies, preserving their tax deferral.

Though 401(k)s offer fewer choices than IRAs, large companies such as AT&T negotiate for institutional discounts on the funds they select. As a result, 401(k) participants paid less than half the average 1.4% annual expenses charged to all U.S. stock mutual-fund investors, according to a 2013 study from the Investment Company Institute, a Washington-based mutual-fund industry trade group.

Still, almost 18 million U.S. households hold IRAs that include rollover money, estimated a recent report from the Investment Company Institute.

After he lost his job in 2009, Manuel Gonzalez Martinez, a mechanical engineer for Hewlett-Packard in Puerto Rico, rolled over $150,000 from a 401(k) and a lump-sum pension payment to an IRA with UBS AG (UBS), the Swiss financial-services company.

His broker, Luis Roberto Fernandez Diaz, recommended Puerto Rico municipal bond funds with a 3% upfront sales fee and 1% annual expenses, according to his arbitration complaint with Finra, which lists 17 customer disputes against Mr. Fernandez from 2009 through 2014. Six of them have been settled.

Financial advisers generally frown on investing an IRA in municipal bonds ! because t! heir main advantage is tax avoidance, something that is already a feature of an IRA. Worse, the bonds plunged in value because of the deteriorating finances of Puerto Rico and are now worth only $90,000, Gonzalez said.

“I am stuck with the bonds,” said Mr. Gonzalez, 51. “They are a just a number on paper.”

UBS doesn't comment on individual arbitration cases, said spokesman Gregg Rosenberg. In a filing responding to the allegations, UBS said Mr. Gonzalez “invested very profitably in the funds” for years before the municipal bond market deteriorated.

Mr. Fernandez now works as a broker for Popular Securities. Teruca Rullan, a spokeswoman for Popular Inc., the parent company, said he would not be available for comment.

VULNERABLE WORKERS

At the time of leaving a longtime employer, workers are often confused and vulnerable to unsound financial advice. In 2010, Albert Grathwol stopped by a hotel to attend a seminar organized by Raymond J. Lucia Sr., a radio personality who also ran an investment firm. Mr. Grathwol was about to retire as a structural engineer for Aecom Technology (ACM) Corp., a Los Angeles-based engineering design company.

Signing up with Mr. Lucia's firm, Mr. Grathwol and his wife, Sandra, a former schoolteacher, invested $300,000 of retirement savings into non-traded real estate investment trusts. These REITs, which invest in property such as apartments and shopping centers, aren't traded on a public exchange, which means they can't easily be sold.

An alert on the Finra website warns that non-traded REITs are hard to cash in, may not be a diversified real estate investment and that commissions and other expenses can be as much as 15%.

Mr. Grathwol said his REITs' value fell by $100,000. “We were depending on it as our life's savings,” said Mr. Grathwol, 69.

The couple has filed an arbitration claim against San Diego-based First Allied Securities Inc., which acted as broker for Lucia's firm.

In 2013, the Securities and Excha! nge Commi! ssion's enforcement division moved to bar Mr. Lucia from the industry for allegedly misleading investors about the historical performance of the strategy he was promoting. Mr. Lucia has appealed. Marc Fagel, an attorney for Lucia, declined to comment because Mr. Grathwol's complaint is still in arbitration.

Joseph Kuo, a First Allied spokesman, also said the company doesn't comment on pending arbitration cases, while noting Mr. Lucia is no longer affiliated with the brokerage. In a filing responding to the allegations, First Allied said they were “baseless,” because the REITs were “only one part of a layered investment strategy” and the Grathwols were fully informed of the risks.

Employees at AT&T faced similar quandaries about where to entrust their savings.

Based in Dallas, the telecommunications company, with 246,000 workers, is one of the largest private employers in the U.S. AT&T's 401(k) ranks among the best 15% of U.S. plans in terms of fees, according to BrightScope, a financial information company that rates retirement offerings. AT&T funds, which are available only to employees, charge expenses as low as .01%.

Typically, when employees retire or lose their jobs, they have the option of rolling over their 401(k)s or, in most cases, leaving them behind in the same low-cost investments. At AT&T, they often have another big decision. Along with their 401(k), they can take a pension — a monthly fixed payment for life — or an equivalent lump-sum payment that could amount to hundreds of thousands of dollars a year.

Sensing a business opportunity, broker Richard McCollam, a West Point graduate and former U.S. Army captain with who had worked for insurer MetLife (MET) Inc., began marketing to AT&T employees with 401(k) rollovers and lump-sum pension payments.

Starting in 1994, Mr. McCollam worked for Royal Alliance, part of AIG's Advisor Group, one of the largest networks of independent brokers in the U.S., with about 6,000 representatives. While Mr. McCo! llam hand! led the back office, Kathleen Tarr, who joined him as a broker in 2002, prospected for clients.

“If you are like most AT&T retirees, you probably feel that you are drowning in information that may be confusing and frustrating,” according to marketing material saved by a former customer.

Ms. Tarr had an unusual background for a financial adviser. She has a Ph.D. from the University of California at Berkeley, where she studied invertebrate physiology. She taught briefly at UC-Irvine before quitting to raise three boys. She then went back to work as a private-school teacher and then in finance after her husband lost his job as a biochemist.

Like many at Royal Alliance, Ms. Tarr and Mr. McCollam worked out of their homes, in Contra Costa County, near San Francisco. Ms. Tarr, who had just turned 50 when she teamed up with Mr. McCollam, had an easy manner with soon-to-be retirees. The daughter of an Army chaplain and granddaughter of a Congregational minister and missionary, she would invite clients to hear her sing at a local Episcopal church, where she led the soprano section.

Ms. Tarr won referrals by word-of-mouth, meeting clients both at their homes and, by appointment, at AT&T offices across the San Francisco area.

Mark Siegel, an AT&T spokesman, said the company provides information about benefits, but doesn't endorse specific financial advisers, which aren't affiliated with the company.

Mr. Siegel said the company periodically sends alerts to employees, such as an email from last October, which warned: “You should research the individuals contacting you and their organizations before doing business with them.”

NONTRADED REITS

Mr. McCollam said they recommended that clients put 60% to 70% of their money in variable annuities. The balance would end up in non-traded REITs, including Oak Brook, Ill.-based Inland American Real Estate (IARE) Inc. The REITs generated dividends of 6% to 8% a year, providing an alternative to the vagaries of the stock market, Ms. Tarr sa! id.

In ! variable annuities, customers invest in mutual funds within an insurance wrapper, which offers a death benefit, typically providing heirs a minimum payout. Earnings are tax-deferred.

Investing in a variable annuity within an IRA “may not be a good idea” because it provides no additional tax savings over an already tax-advantaged IRA, according to a FINRA alert on its website. The annuities will increase costs, “generating fees and commissions for the broker or salesperson,” FINRA says.

Customers often choose variable annuities because they offer a guaranteed minimum lifetime income, which is assured no matter how their investments perform, said Andrew Simonelli, a spokesman for the Washington-based Insured Retirement Institute, which represents companies that offer annuities.

“While tax deferral is certainly part of the value proposition of annuities, it's not the only reason,” Mr. Simonelli said.

Mr. McCollam said he, Ms. Tarr and Royal Alliance would generally receive a total commission of as much as 6% or 7% of the money that clients invested in variable annuities. The mutual funds they selected would charge customers 2% to 3% a year in fees. Those fees were no higher than those of many mutual funds sold by brokers, Ms. Tarr said.

The brokers and Royal Alliance also received commissions totaling 6% to 7% for selling non-traded REITs, Mr. McCollam said. Typically, Ms. Tarr and Mr. McCollum kept 90% of their commissions, giving 10% to Royal Alliance, Mr. McCollam said.

Over time, the pair signed up as many as 500 customers, most from AT&T, Mr. McCollam said. Overseeing about $90 million in investments, their business generated about $600,000 to $700,000 in annual commissions — and $1 million in its best year, he said. As the founder of the operation, he would keep 90% and Ms. Tarr, 10%, McCollum said. He said they won sales awards, with Royal Alliance sending one or both to resorts in the Bahamas; Boca Raton and Orlando, Florida; Arizona and Texas.Doug Be! al, a $32-an-hour mechanic specializing in air-conditioning and fire detection, heard about Ms. Tarr from his union steward. Ms. Tarr visited Mr. Beal in his shop, where he worked outside San Francisco.

“I wanted something where I wouldn't lose a whole bunch if the market went crazy,” said Mr. Beal, a disabled Vietnam veteran.

When he retired in 2009, Mr. Beal invested $320,000 in variable annuities and REITs, rolled over from his pension and 401(k). He has since lost $60,000 because of a decline in the REITs' value, said Frank Sommers of Sommers & Schwartz in San Francisco, who represents 17 of Ms. Tarr's former clients.

PAYING BILLS

Mr. Beal is deferring his dream of moving up to Spokane, Wash., where he hopes to set up a shop to tinker with motorcycles and old cars, including a 1926 Model T Ford in his garage.

“It's making it a little harder to pay bills,” said Mr. Beal, 67, who also receives disability payments related to military service. “Thank God for my VA pension.”

Ms. Tarr cultivated some employees for years, such as Mae Holloway, who started her 40-year career at AT&T as a telephone operator and ended up overseeing maintenance in Oakland. Ms. Tarr would stop by Ms. Holloway's desk, encouraging her to come up with a budget for her retirement.

In 2008, Ms. Holloway, then making $69,000 a year, decided it was time to leave. She was 62 and figured she needed her investments to generate $3,000 a month. So, hoping she could have money left for her children after she died, she turned down the guaranteed $2,500 a month pension and took a $600,000 lump sum payment from her pension and 401(k). She rolled it over into an IRA, invested in variable annuities and REITs.

“If I do this, can you guarantee I won't go broke before I leave this world?” ms. Holloway remembered asking Ms. Tarr. “And she said yes. I told her no high risk. I didn't want to be aggressive.”

Ms. Tarr said she would have never made that kind of statement.

&#! 8220;I us! ed to call it the G-word,” she said. “I could never guarantee anything. That is the first rule of investing.”

Ms. Holloway lost about $90,000 because of the reduced value of her REITs, according to Mr. Sommers, her attorney.

“I'm losing sleep over it,” Ms. Holloway said. “I should have just left it. I wanted to leave money for my kids.”

Ms. Lew, the former administrative assistant with the hole in her kitchen ceiling, has a more immediate worry: paying her mortgage. An immigrant from Central America, she retired from AT&T in 2003 with an IRA set up by Ms. Tarr. Afterwards, they often discussed investments over coffee at Ms. Lew's kitchen table, as her prized green parrot squawked in a cage with a sweeping view of the parched hills surrounding San Francisco.

Ms. Lew started her withdrawals at $2,000 a month, then bumped them to $2,500. Ms. Lew said Ms. Tarr blessed the move — something Ms. Tarr disputes, saying she had warned against it.

By 2010, Ms. Lew noticed losses in her account. Her REITs have plunged $145,000, according to Mr. Sommers. To make ends meet, she is caring for neighbors' children. She will run out of money in three or four years, which could force her to sell her house.

“I was old-fashioned like my mom about planning for the future,” said Ms. Lew, 61. “I never thought I'd end my years worrying about money.”

'GOOD ADVICE'

Mr. McCollam said that Ms. Lew, Mr. Beal and Ms. Holloway showed modest gain in their account, when the dividends from REITs are taken into account.

“We feel like we gave as good advice as we could have given,” Mr. McCollam said.

In 2010, Royal Alliance dismissed Ms. Tarr and Mr. McCollam, citing a failure to follow a policy for pre-approval of variable annuities, according to a Finra filing.

“No client was adversely impacted by any omission by either Mr. Mr. McCollam or Ms. Tarr — all transactions were ultimately reviewed and determined appropriate,! 221; Lind! a Malamut, a Royal Alliance spokeswoman, said in a statement. “Further, the termina