San Antonio Express-News (Sunday)
CIVIC LEADER TARGETED?
The Smart Money S.A.: The odd case of Randall H. Fields and the Texas State Securities Board.
In May, the Texas State Securities Board revoked attorney and financial adviser Randall H. Fields’ state securities license — a move that struck me as very odd.
In their disciplinary order, state regulators said Fields had violated his fiduciary responsibilities to clients as he aggressively traded options on their behalf — and that these violations amounted to “fraudulent business practices.”
It was odd because you don’t expect somebody like Fields, 72, to receive such a sanction.
Fields served as chairman of Baylor University’s board of regents in the mid-1990s. He chaired the Deacon Council at Trinity Baptist Church in San Antonio. He served as president of Northside ISD’s school board during four terms as a trustee.
The NISD’s Randall H. Fields Elementary School on the far Northwest Side is a testament to his clean reputation and service to the school district, San Antonio’s largest.
Why the heck would someone with Fields’ history of civic leadership risk wrecking his reputation with financial shenanigans of the sort state securities regulators accused him of ?
The violations the securities board cited him for are rooted in one of the more complex — and risky — investment strategies.
From Express-News Staff Writer Patrick Danner’s May 20 article on the securities board’s action against Fields:
“In a statement, state regulators said Fields ‘utilized an aggressive, high-risk strategy that involved simultaneously buying and selling call or put options at different strike prices to realize immediate profit based on the price spreads.’ Call and put options are a right to buy and sell shares at set prices.”
Two of Fields’ clients — they began investing with Fields in 2014 — were conservative with their money, but regulators said Fields put capital of theirs into options trading anyway. The TSSB also alleged that he told the clients, wrongly, that he’d only earn fees if they made money on the trades.
A scalp for the TSSB?
For his part, Fields said the situation “amounted to a gross misunderstanding between myself and former clients.”
“They proceeded to file a complaint with the Texas State Securities Board,” he said. “The TSSB needed a scalp — and mine was the nearest one within reach.”
Clint Edgar, the board’s deputy commissioner, responded in a constrained manner when I brought up the scalp comment, saying, “When we see serious misconduct we pursue it.”
In this particular case, Edgar said, “This was a consent order. Not everything that we would allege would come out unless there was a public hearing.”
Fields claims that in the roughly 10 years he ran a high-risk options-trading strategy, clients of his who participated broke even overall. He said he invested his own money and his family’s on exactly the same terms as his clients.
I could not independently verify Fields’ statements, but they seem pertinent to his story. I don’t have access to what the TSSB might know beyond what’s in the order, which Fields signed off on. We’re left guessing.
But here’s where I come out: The regulators focused on smallpotatoes errors to punish Fields. The issue of his investment strategy and pay scheme was the bigger problem. In my view, they were deeply unwise — but legal and not punishable offenses.
The consent order, at least as written, seems to nitpick.
Field’s strategy was limited to investors categorized as qualified eligible participants, or QEP, which means they had a minimum of $2.1 million in their securities accounts. Fields typically traded only a fraction of a client’s net worth, no more than 30 percent of their accounts.
On the two main issues he was sanctioned for, Fields said, he was accommodating customers in a way that led to minor disclosure infractions. In his telling, they were technicalities, peripheral to Fields’ business.
Sterling references
I spoke to two former investment advisory colleagues of Fields with knowledge of his practices. Both are still in the industry and requested anonymity. One told me he didn’t “want to get in any way crosswise with the Texas State Securities Board.”
Both effusively praised Fields. One of his former colleagues said, “Randy is an upstanding citizen. I think the world of him. He has an unimpeachable reputation.”
The other said, “The guy’s like a saint. If there’s a fault here, it’s that he didn’t defend (against the TSSB’s allegations) more rigorously.”
Their assessments make me sympathetic to Fields’ side of the story. But I don’t think that takes him off the hook. Fields’ primary error, in my opinion, is in not reflecting on the nature of his trading strategy. This was a big error — but not necessarily a fraudulent one.
The strategy
Fields followed an options strategy for clients in which he sold short-dated options on the S&P 500 index and simultaneously bought the same options.
By pairing a sale and a purchase of options on the broad stock market, Fields and his customers could collect money by taking a very short-term risk, typically three to five days.
By trading between 1,000 and 3,000 contracts at a time, Fields could make anywhere from $30,000 to $150,000 per trade within a week. If the stock market stayed steady over that three- to five-day period, that’s the profit they would keep.
But when markets got volatile — as they did in late 2018, to everyone’s detriment — that same short-term trade, of that many contracts, could lose $500,000 to $1.5 million.
There’s a Wall Street description for this style of strategy. On the trading desk at Goldman Sachs, where I once worked, we called this practice “picking up nickels in front of a steamroller.”
Strategies like these are com
mon and totally legal — and unwise. Over time, they tend to work, then work again, then work again and then … your portfolio gets absolutely killed.
But maybe the worst of it was the compensation structure Fields established for his trades. Again, totally common, totally legal and unwise. Fields got paid 25 percent of the client’s gains per month. Yet if the client lost money one month, Fields didn’t have to return any of the fees he’d collected the previous profitable month.
So the “it works, it works, it works and then you get killed” approach results in consecutive monthly fees to Fields, and then no return of previous fees the month the client gets slammed.
This is a “heads I win, tails I do not lose” payout. This somewhat resembles things I myself used to do, once upon a time. I have my regrets.
I asked Fields if he had any regrets about the strategy.
“I regret ever meeting those two people,” he said. “We rocked along nearly five years with that structure. With monthly reviews, face-to-face meetings, there was not a question about that. Either those two gentlemen misunderstood from the start or they were disappointed. I can’t crawl into their minds. On numerous occasions, I asked them whether they wanted to stop.”
Later, he added: “Yeah, it’s an aggressive strategy. For everybody, I would have been a little less aggressive with the amounts allocated. I was allocating an exposure of about 30 percent of an account at any given time.
“That’s hindsight,” he said. “You can look back at any given time and say, ‘Here’s the strategy that would have worked best at any point in time.’ When you project into the future, it’s throwing at a dart board.”
Fields is right, to a point. Only with hindsight do we know what worked and what didn’t.
I also asked whether he regretted
his method of compensation, earning 25 percent of gains but giving up nothing for losses.
“In hindsight, I would have done that differently,” he said. “To the state securities board, it was a problem. The other side is, this is not a savings account. This is not a passive mutual fund. This is an aggressive trading fund.
“It’s something that worked in the past, but we can’t guarantee that it’s going to work. Would I recommend it to anyone who hesitates to agree? No. Would I do it again, knowing what would happen down the road? No, I wouldn’t. Certainly not with these individuals.”
Listening to Fields, I hear a tremendous amount of investment wisdom. But I still have deep reservations about what I see as the toxic combination of the strategy and his compensation scheme.
At the end of the day, however, his strategy and his compensation weren’t what the TSSB sanctioned him for — even though, in my opinion, that was the worst part.
Complaint No. 1
One complaint was that he had could have used an online, lowfee options trading platform, but instead chose to pay higher fees to a human broker. These higher commissions for “broker-assisted trades” were not specifically disclosed to clients. The TSSB’s consent order stated, “Respondent (Fields) received the advantages of time and convenience while his clients received no advantage at all.”
This claim doesn’t ring true. It portrays Fields as choosing a lazy method of trade execution, abdicating his fiduciary duty. What seems more likely true is what Fields says, which is that his trading volume got too large for the lower-cost electronic platform. He needed to use a human broker who charged a higher commission.
Complaint No. 2
The second complaint was more serious. Fields was accused of making calculation errors after he offered to limit his own compensation for the two unhappy
clients. This kind of compensation limit is known as a “highwater mark,” and this is how it works: His clients had to make returns above a certain level before Fields got paid his 25 percent fee.
Regulators said Fields incorrectly calculated the high-water mark.
The TSSB noted — rightly — that these fee restrictions are advisable when dealing with volatile markets. On the other hand, there’s no law against not having a high-water mark, and Fields said he never offered it to anybody else except his two unhappy clients.
These clients eventually took their unhappiness to the TSSB.
Fields said he offered to redo any mistaken calculation — “What I told the board was, ‘If I’ve miscalculated, I will correct it’ ” — but he never got the chance.
The TSSB consent order also said he told his clients, “I only make money when you make money.” Without a correctly calculated high-water mark, that statement obviously would be untrue.
However, Fields denies making that guarantee to the two clients. “I never said that — I would never say that to any client,” he said.
Of course, Fields and his lawyer did sign the consent agreement that included that allegation.
Learning wrong lessons?
Fields doesn’t see his strategy as flawed. He believes he got unfairly scalped by regulators.
Fields’ unhappy clients probably have the impression that Fields’ actions — the subjects of their complaints — were to blame for their losses. I disagree. Fields’ legal, but flawed, options trading strategy and compensation scheme were to blame for their poor results.
The TSSB mostly elides the issue of the strategy itself, in favor of disclosure enforcement.
The TSSB’s Edgar seemed frustrated with my semi-exoneration of Fields. But, of course, he could not show me more than what was in the public consent order. So I don’t know what else he knows that wasn’t made public.
These differing perspectives are all dissatisfying to me. I’m interested in this case because when we sanction people for the trees but miss the forest, we learn the wrong lessons.
The real problem here is massive fees for a questionable investment strategy that could lead to potentially mediocre or bad long-term results.
In the meantime, for readers — whether you are a QEP or a much more modestly wealthy investor — I’ll continue offering the same advice over and over again: Please stick to simpler, lower-cost strategies.
And never pick up nickels in front of a steamroller.