Kathleen Tarr says AT&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, Tarr worked for Royal Alliance Associates, a brokerage firm owned by insurer American International Group (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.
Tarr and her business partner reaped hundreds of thousands of dollars a year in commissions and trips to resorts in the Bahamas and Florida. Not all her clients fared as well, and 37 have filed complaints against her, according to Financial Industry Regulatory Authority (FINRA) records reviewed by Bloomberg News.
Tarr and Royal Alliance say the investment choices were appropriate.
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“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. “There are days when I go to sleep and I can’t stop thinking about it.”
The complaints against 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 (IRA) in 2012, up about 60 percent in a decade, according to Cerulli Associates, a Boston research firm. As a result, IRAs hold $6.5 trillion, more than the $5.9 trillion in 401(k)-style accounts.
Former employees at major companies such as AT&T, Hewlett-Packard and UPS have complained that sales representatives lured them into rolling over their 401(k) nest eggs into unsuitable IRA investments.
While retirees generally can 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 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, D.C.-based group representing retirees.
Tarr’s clients paid higher fees in their brokerage accounts than they would have in their AT&T plan.
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.
She said she always made clear she worked for Royal Alliance, not AT&T, she said.
“I am forever besmirched, and that is really hard for me,” said 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.”
Federal regulators are targeting rollover abuse. Last year, the Government Accountability Office (GAO), Congress’ 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.
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, not taxed 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.
Typically, when employees retire or lose their jobs, they have the option to roll over their 401(k)s or, in most cases, leave 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 or an equivalent payment that could amount to hundreds of thousands of dollars.
Sensing a business opportunity, broker Richard McCollam, a West Point graduate and former U.S. Army captain, began marketing to AT&T employees with 401(k) rollovers and lump-sum pension payments.
Starting in 1994, 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 McCollam handled the back office, Kathleen Tarr, who joined him as a broker in 2002, prospected for clients.
Tarr had an unusual background for a financial adviser. She has a doctorate from the University of California, Berkeley, where she studied invertebrate physiology. She worked as a teacher, then in finance.
Tarr, who had just turned 50 when she teamed up with McCollam, had an easy manner with soon-to-be retirees. She would invite clients to hear her sing at a local Episcopal church, where she led the soprano section.
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.
McCollam said they recommended clients put 60 to 70 percent of their money in variable annuities. The balance would end up in nontraded REITs, including Oak Brook, Ill.-based Inland American Real Estate. The REITs generated dividends of 6 to 8 percent a year, providing an alternative to the vagaries of the stock market, Tarr said.
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 originally posted on its website in 2003 and updated in 2009. The annuities will increase costs, “generating fees and commissions for the broker or salesperson,” it 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 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,” Simonelli said.
McCollam said he, Tarr and Royal Alliance would generally receive a total commission of as much as 6 or 7 percent of the money that clients invested in variable annuities.
The mutual funds they selected would charge customers 2 to 3 percent a year in fees. Those fees were no higher than those of many mutual funds sold by brokers, Tarr said.
The brokers and Royal Alliance also got commissions totaling 6 to 7 percent for selling nontraded REITs, McCollam said. Typically, Tarr and McCollum kept 90 percent, giving 10 percent to Royal Alliance, McCollam said.
The pair signed up as many as 500 customers, most from AT&T, 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 percent and Tarr, 10 percent, McCollum said. He said they won sales awards, with Royal Alliance sending one or both to resorts in the Bahamas; Boca Raton and Orlando, Fla., Arizona and Texas.
Brokerage customers typically sign a contract giving up their right to sue in court and requiring them to submit to FINRA arbitration. These proceedings are generally confidential.
Sommers said 10 of his clients have filed arbitration claims against Royal Alliance, Tarr and McCollam, and he expects at least two more will too.
Seven of Sommers’ clients, including Lew, recently filed suit against Royal Alliance in Alameda County, Calif.
The complaint alleges breach of fiduciary duty, fraud and failure to supervise its brokers, leading to more than $1 million in damages. The former employees were placed “in totally unsuitable investments” that were “designed to maximize the commissions and fees” paid to the company and the brokers, according to the lawsuit.
In 2012, arbitrators awarded three former AT&T employees a total $1.4 million in damages and interest from Royal Alliance, according to a filing with a California court, where the company unsuccessfully appealed.
McCollam and Tarr said they did not appear at the arbitration to defend themselves and that losses suffered by the three customers were modest.
Tarr said she believed in the products she sold at Royal Alliance, but would have changed course if the brokerage had objected.
“Royal Alliance could have said to me five years ago, we’ve been looking through your book of business, we think you’re a little heavy on variable annuities, let me suggest alternatives,” Tarr said. “They never said anything. Nothing.”