April 22, 2005
Mr. William Horton
Horton, Maddox & Anderson, LLC
One Central Plaza
835 Georgia Ave
Chattanooga, Tenn 37402
RE: Glen Smith vs. Samoan Financial Advisors and David Johnson
Dear Mr. Horton,
Pursuant to your request, I have completed a review of the above case. This examination has included the deposition of Glenn Smith of June 18, 2004, David Johnson of June 18, 2004 and the Exhibits to the deposition of Glenn Brumlow, June 18, 2004.
I have found extensive inconsistencies in the plan, process and products offered by Johnson, et al. Specifically I noted the written statement of Johnson on September 7, 1997 at the initiation of the relationship wherein he states that "over the next 12 months we will Dollar Cost Average into your new portfolio using no load funds." First, as expressed below, DCA does not work, has not worked and universally will not work in the future. It reduces returns two thirds of the time versus lump sum investing. Secondly, Samoan Express and Johnson and his supervisors were fully aware that a fraud was taking place. Samoan Express does not have No Load Funds. To signify that to a naive investor is just plain wrong, illegal and fraudulent.
Next is the letter to Smith referencing a meeting between the two on June 9, 1998. "We reviewed your goals. The retirement was to have approximately $23,000 in income annually. At this goal your monies would last until age 88. If you were to retire a year earlier, you will have money, but would run out before age 88." Smith did not have sufficient funds to last to age 88- or anywhere close. Per the data below, in order to have a 95% chance of reaching age 88, he would have needed $285,000. He was already $160,000 underfunded at the time of that letter. Samoan Express and Johnson either knew or should have known that the statement was false- certainly giving Smith a completely false sense of security that his retirement was in order and that his trusted advisers could provide the income he needed. That they failed is evidenced by the huge losses he sustained.
The Samoan Express financial plan utilizes a flat rate of return over the 20+ years of retirement. That is not valid. The problem is that the volatility and inconsistencies of the market over individual time frames
makes it effectively impossible to utilize a singular return for retirement purposes. In some periods of statistical historical returns, the yields might have been very favorable. In other time frames, the retiree would never have had sufficient funds over his lifetime. Numerous studies (WSJ, Bernstein, etc.) have shown that in order for a retirees portfolio allocation to work over time, the retiree cannot take out more than about 4% annually in order to have a 95% chance of retaining the portfolio for the actuarial lifetime.
In Mr. Brumlow's (Brumlow) situation, he wanted an additional $1,000 before taxes to add to his Social Security. (The $21,000 in the deposition is incorrect- per extended conversations with Brumlow. It's supposed to represent a $2,100 per MONTH income- roughly $1,000 net after tax more than his Social Security provided at that time). While I would have preferred an actual budget to validate specific costs- particularly someone with limited assets- and believe it mandatory in order to do competent retirement planning, the conversations with Smith regarding his requirements seem satisfactory for this report. I chose a free web site- Fireseeker.com- to determine the feasibility rate for the extra $12,000 from Brumlow's account- actually any account set up for retirement with a fixed allocation (save for rebalancing.). It uses 108, 23 year periods to account for the various payment periods and simply shows what was possible. Of course, one can use different start dates, time frames, periods of payments, but this simple and easily observable analysis clearly displays what happens. Obviously there are numerous other software programs- but they are using the using the same historical numbers. There are variations to the input- how much is invested in stocks versus bonds and so on, but Fireseeker is simple and direct and competent.
I note from the Samoan Express's website on March 30, 2005, "regardless of the asset allocation strategy you choose and the investments you select, keep in mind that a well-crafted plan of action over the long term can help you weather all sorts of changing market conditions as you aim to meet your investment goal(s)." Possibly acceptable- except a retiree would need a lot of funds in order to be able to withstand volatility in returns over time. The question before us is whether Smith had the adequate funds in order to "weather all sorts of changing market conditions". Simply stated, he never came close. He could not retire and withdraw $12,000 from his asset base and even come close to statistically covering his income for his actuarial lifetime. Samoan Express knew this then and knows this now. Unless a retiree has a large portfolio, the funds will not be adequate. Johnson 's comments about the ability to retire and Samoan Express's plan are not valid and both knew- or should have known- that. I submit that they both were clearly aware of the inability of Brumlow's account to provide retirement income as stated.
By simply analyzing a "basic" request of a retiree who needs $12,000 gross income annually beyond Social Security, requires a (mandatory) offset for inflation, estimating a lifetime of 23 years (as identified in the Johnson plan though longer than Brumlow's statistical actuarial lifetime), has a mutual fund expense ratio of 1.7%, utilizes an allocation of 50% stocks and 50% bonds results in an initial account value of $285,000 that would produce a success rate of 94.7%. (A 5% "failure" rate is considered acceptable in planning. 100% is not "realistic" since it must account for the very worst of times.) In other words, in about 5% of the time, a portfolio would have been depleted before 23 years.
Yet Brumlow's account was not greater than roughly $125,000- over a 56% reduction from the statistical 95% probability that he would have enough money for his lifetime. There is no way that Johnson /Samoan Express could remotely indicate that there were sufficient sums for retirement- but that is exactly what they did. They actually should have told Smith that he had to work longer to build up his retirement kitty and/or complete a formal budget to determine if his retirement costs could be cut. At that point, another analysis would have been required to validate the 95% success rate. Pursuant to such fundamentals, Brumlow's account was effectively $160,000 less than required in order to safely provide for retirement.
Reference is made to the investment plan for Smith made up by Samoan Express or Johnson on September 6, 1997. Under the proposed allocation, it shows that Smith would have $210,197 at age 68. It is based upon a static return that has little reference to reality. While it does state it is a hypothetical illustration based on assumptions made, it does not state that the assumptions do not reflect the statistical history of the market with its extreme volatilities. Further that if the market declines precipitously at any point- similar to the past dips of 1973 and 1974- and certainly at the initiation of the plan- that the allocations and returns projected would be meaningless. The use of a flat and stable return does not makes sense without the clear statements of uselessness given such volatility. Per Peter Berstein, ""Understanding that we do not know the future is such a simple statement, but it's so important.............anything can happen. There really is such a thing as a "paradigm shift," when people's view of the future can change very dramatically and very suddenly. That means that there's never a time when you can be sure that today's market is going to be a replay of a familiar past."
