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Who's minding the nest egg?

Retirees hit the road, leaving their investments in a discretionary account. They find out the hard way the perils of allowing a broker to make trades without their permission.

When Lou and Susan Maas waved goodbye to the world of work and took to the road in their 32-foot RV, they happily left their retirement nest egg in the hands of a Clearwater broker.

"I didn't feel confident handling my money myself," said Maas, 58, who worked for GTE Corp. (now Verizon) as an equipment technician. "I had a considerable amount of money, and I didn't want to lose it. I just had complete confidence in Mike."

So did at least a half-dozen other GTE/Verizon workers and retirees who entrusted the late Michael Freiwald with the money they got in buyouts and pension payouts three years ago as GTE prepared to merge with Bell Atlantic Corp. Most of them knew very little about investing. What they have learned since, they learned the hard way.

Their experience offers a glimpse of what can go wrong when naive investors meet a confident broker and agree to give him total control over their accounts.

All the investors signed up for "discretionary" accounts, which meant Freiwald could buy and sell securities in their accounts without consulting them. Most had heard about him from co-workers, and even those who had just met him had no qualms when the arrangement began. They paid him an annual fee of up to 2 percent of the account's value for his services.

Ken Mader, 61, a repairman, put it this way: "Being ignorant, I thought "He knows what he's doing. I'm working 60 hours a week. I'm out in the heat. I don't have time for that. That's his job.' "

He and the others discovered that what they didn't know could hurt them.

"I found out growth is high risk," said Mader, who said his account dwindled from $127,000 to $61,000 before he cashed out. He lives in Palm Harbor and still works for Verizon.

When the Maases got around to checking their account from a campground, they discovered it had dropped about $300,000. Worth $1.9-million at its peak, the account eventually lost close to half its value.

Maas had been investing with Freiwald since 1996. He originally had the final say over trades in his account, but Maas said Freiwald explained that it would be better to relinquish that authority: "He said, "When you're on the road it's going to be real difficult. I would suggest that you just let me handle everything.' "

The Maases, who have settled in Morristown, Tenn., turned over his pension payout along with other savings and the proceeds from the sales of their Safety Harbor home and rental property he inherited from his parents.

George and Janine Byrd of Dunedin stayed in town, but their account fared worse under Freiwald's control: A $1-million portfolio withered to about $350,000.

"I look back and say how stupid I was," said George Byrd, 56, who worked his way up from repairman to manager in 30 years at GTE. Byrd said Freiwald told him he could afford to retire when his account hit the $1-million mark. He did just that and now needs to find other work to support a family that includes two school-age children.

Unhappy with their losses, the group of 10 investors hired Clearwater lawyer Jeffrey Coleman, who filed an arbitration complaint against Freiwald's employer, Raymond James Financial Services Inc. In it, the investors say the St. Petersburg company failed to properly supervise Freiwald when he misrepresented facts, bought inappropriate investments for their accounts and in some cases refused direct orders to sell their fast-shrinking stocks.

The investors say Raymond James should have been particularly vigilant because Freiwald had serious health problems. Although the investors say they didn't know it until their relationship with him neared an end, Freiwald was being treated for cancer while handling their accounts. He died last year at the age of 46.

Raymond James declined to discuss Freiwald's case but said that if an adviser asks for help because of health problems, the company provides it.

"If someone is on medication or has a long-term illness, they don't necessarily tell us," spokesman Larry Silver said.

He said Raymond James monitors all accounts for unusual activity and reviews discretionary portfolios quarterly, but that investors have a duty to complain if they think there are problems.

Silver said all the company's customers get a "bill of rights" that tells them how to take their complaints up the chain of command from the branch manager to the compliance office at headquarters to the filing of an arbitration complaint.

In this case, though, there was no branch manager. Freiwald worked as an independent contractor and ran his own office. Coleman said that when one investor questioned a trade, Freiwald acted insulted and informed the man that he was the expert and his actions shouldn't be questioned.

Freiwald's downfall was his overconfidence in the stock market and his own stock picking abilities. The investors got their GTE payouts in the spring of 2000, just as the stock market was beginning its downward slide. Over the next two years most stock investors lost money whether they were managing their portfolios themselves or letting somebody else do the job. However, Freiwald's style exacerbated the problem for his clients.

Although the GTE investors were retired or close to it, Freiwald put them in relatively aggressive stock portfolios. Along with bank stocks and blue chips such as General Electric and Home Depot, he bought stocks such as Nortel Networks, JDS Uniphase, Oracle Corp., WorldCom, Enron, Amgen, Global Crossing and Lucent Technologies.

The Byrds said they were particularly upset that Freiwald loaded up on $55,000 worth of shares in Avanex Corp., which makes telecommunications equipment, after promising them he would never put more than $25,000 in a single stock. He paid as much as $145 a share for the stock, which fell to less than $1 a share.

"When George retired, Mike refused to change his portfolio to a retirement portfolio," said Janine Byrd, George Bird's wife. "I said, "Shouldn't we change and get some bonds? What happens when there's a bad market?' He'd give George this "Why don't you shut your wife up?' look. When the account dropped to $750,000, we both agreed we wanted out and told Mike. Mike said I was a nervous Nellie and literally refused to get us out."

David Ball, 60, said Freiwald also refused his direct order to sell. Ball, who lives in Clearwater, said he turned over $250,000 from his retirement payout and other savings.

"I told him I had a medical condition and didn't know how long I'd be able to work," Ball said. "He said, "I'll fix it so your account will grow, so by the time you will retire it will be $350,000.' That sounded good."

But Ball couldn't stomach the losses his statement showed each month.

"I called and told him to get rid of the big losers and put the money in a savings account," Ball said. "He said, "No. I can't do that. You've got to leave them where they are. The market will come back.' "

Ball said his account had dwindled to $105,000 by the time he got it transferred to another broker. His medical condition has since forced him to retire, and he is waiting for a disability ruling from Social Security.

The other investors named in the case are Lee Hollingshead, Jill Little, Paul Nemzek and Peter Schmidt.

While the investors had the right to take back control of their accounts or to get a new broker, some stuck with Freiwald until he told them he was taking a leave of absence. They say they had assumed that he would take good care of their money and that Raymond James would be checking up on him.

"When I get on an airplane, there's never any expectation that I should be able to land that airplane," Janine Byrd said. "If the pilot is failing, it's not the passenger's job to take over."

But discretionary accounts come with no guarantees. The broker may make the decisions, but the investor reaps the rewards or bears the losses, whichever the account produces. There also is potential for broker abuse if investors don't watch their accounts closely and complain when something is amiss.

Because of the potential problems, some brokerages do not allow their brokers to sign up clients for discretionary accounts.

"We do not offer discretionary accounts because of a long-standing, firm belief that our clients need to know - before it happens - exactly what is going to happen in their accounts," said Pam Cavness, chief compliance officer for Edward Jones, a brokerage company headquartered in St. Louis. "They need to take part in every investment decision. We believe this is crucial to assure that we're making decisions that are right for them."

Other brokerages, including Raymond James, restrict the accounts. Raymond James says brokers who want to offer discretionary accounts must have appropriate training and experience, pass exams and have a clean disciplinary history. Freiwald had been in the brokerage business since 1991 and had only one complaint on his record, for misrepresentation in the sale of two bond mutual funds. It resulted in a $17,000 arbitration award against him and Raymond James.

Merrill Lynch says only 8 percent of its brokers are approved to offer discretionary accounts, but together they manage a hefty $7-billion.

"Most don't want to do them," said Linda Marcelli, who directs Merrill's Tampa Bay area offices. "They think they can achieve better results using a combination of money managers who do this work full time and have access to all the research."

But she said some clients want a broker to make their investment decisions for them.

"People who have really demanding careers don't want to be sitting in a board meeting, picking up a cell phone, okaying an instruction to their broker," she said.

Marcelli said Merrill restricts the stocks that can be purchased for discretionary accounts to those the company's researchers follow. Heavy concentrations in any one stock are not permitted.

Investors considering a discretionary account should use caution, said Tampa lawyer Guy Burns, who often represents investors in cases against brokerage companies.

"Don't grant that power to anybody that you don't absolutely trust, know well and have known for a good long time," he said. "It's amazing that people give discretionary power to somebody they've just met or just heard at a seminar. That's a pretty extreme thing to do."

Burns said investors also should insist on receiving written information about the broker's track record in managing discretionary accounts. He said investors also should stick with brokers working for large companies.

"You know at least if something goes wrong, that firm is going to be there," he said.

Burns said there are fewer problems with discretionary accounts than there once were because brokerages use computers to monitor trading activity. In addition, charging an annual fee to manage the accounts removes the incentive to trade excessively to try to generate additional commissions.

The investors who went to Freiwald for help are not the first GTE retirees to have problems investing their retirement payouts. Eleven years ago Burns won a $5.3-million arbitration award for former GTE president George Gage against two Cigna Corp. subsidiaries. Cigna-affiliated financial planners advised Gage to put his $1.8-million retirement payout into limited partnerships that lost most of their value. Burns also negotiated settlements for about 30 other GTE retirees.

Maas says he put too much faith in Freiwald when he took off in his RV.

"He kept saying, "Don't you worry about it. It's all taken care of. You can just go out and enjoy yourself.' "

These days Maas has his money at another brokerage. He said he still has a discretionary account, but he pays more attention to it.

"I'm always calling and questioning things," he said. "I didn't really know what to question before."

- Helen Huntley can be reached at huntley@sptimes.com or 727 893-8230.

Investors sometimes sign a document authorizing a broker to buy and sell securities without getting the investor's approval. Depending on what the document says, this authority may be limited to certain types of transactions or may be very broad.

Speed and convenience are the primary selling points for discretionary accounts. An investment opportunity might be lost if a broker has to get approval for a trade from a client who isn't immediately available. The primary disadvantage of the accounts is the potential for abuses such as excessive trading or unsuitable investments, which is why some brokerages ban them or limit their use. In addition, brokers usually don't have the training, experience or track records of the professional money managers an investor could hire instead.

Married couples will get some welcome relief from the tax bill passed last month. But Congress did not eliminate the marriage penalty and probably never will.

The thorniest problem is the big financial penalty single parents face if they get married. The tax law favors singles who provide a home for their children by putting them in the special category of "head of household." The down side is that they have to give up that status if they get married. For two single parents who both claim head of household status, the price of marriage can easily be $1,000 or more a year in extra taxes, even after the latest tax relief.

It's one of those unintended consequences that have a way of slipping into the tax law, said Bob Scharin, editor of Practical Tax Strategies, a journal published by Warren, Gorham & Lamont/RIA. "I don't see how they could come up with something that would solve all of these problems."

The marriage penalty came about partly as the result of Congress trying to make taxes fairer for single people. One-income married couples get a bonus, paying less in taxes than a single person with the same income. However, most two-income couples got a penalty because their combined incomes often put them in a higher tax bracket than they would face as single filers, plus their standard deduction was less than twice the deduction for a single person.

The new bill temporarily corrects those particular inequities for most married taxpayers. Congress increased the standard deduction for a married couple filing jointly from $7,950 to $9,500, double the single amount. In the 25 percent bracket, that's worth $388 in tax savings. But for two heads of household, who get a combined $14,000 in standard deductions, there is still a marriage disincentive of $1,125 in extra taxes.

The 15 percent tax bracket also has expanded for married couples, from $47,450 in taxable income to $56,800, double the single amount. The change is worth up to $935 in savings on income taxed at 15 percent instead of 25 percent.

That's nothing to sneeze at, but two people filing as heads of household can have a combined income of up to $76,100 before being bumped up to the 25 percent bracket. They also have more income taxed at the lowest bracket, 10 percent.

Congress, by the way, left the marriage penalty intact for the higher tax brackets. And the changes to the standard deduction and tax brackets will be scaled back in 2005 unless the politicians act before then to extend the revisions.

Q. I read that the government will stop issuing HH savings bonds next year. Should I go ahead and convert my EE bonds that are maturing in the next two years so I can keep postponing the taxes on the interest earned?

HH bonds are not a very attractive investment now that the interest rate on new bonds is only 1.5 percent. Savings bond expert Daniel Pederson said there are two instances in which conversion might be worthwhile:

- You are using HH bonds as an alternative to a money market account, which would pay even less.

- You expect your income to drop substantially in a few years. Buying HH bonds would allow you to delay taxation of the interest earnings on your EE bonds until you are in a lower tax bracket.

If neither of those situations fits, try timing your savings bond redemptions each year to avoid bumping yourself into a higher tax bracket. Then invest the money more productively. New EE bonds or I bonds are a better deal than HH bonds.

Q. I am a widow with stock and CDs in trust for my son. I also own a house and savings bonds in my name only. Is there any way I can prevent my son from having to pay taxes on the house and bonds when he inherits?

He won't owe any taxes on the house. The value of the house at your death will become his tax basis. His taxable gain, if any, will be based on appreciation from that point. The same is true for the value of the stock.

Savings bonds are a different story. Your son will owe income tax on the accrued interest.

Whether any estate tax is due depends on the size of your total estate and the law in effect the year that you die. So long as your estate is worth less than $1-million, you're probably safe.

- Helen Huntley writes about investing and markets for the Times. If you have a question about investments or personal finance, send it to On Money. We'll try to answer those we think are of greatest reader interest. All questions must be submitted in writing, but readers' names will not be published. Send questions to Helen Huntley, Times, P.O. Box 1121, St. Petersburg, FL 33731.