If you are going to hire a financial adviser, especially in these times, an extensive background check is needed before anything else. Even though Bernie Madoff’s 150 year prison sentence would scare most people onto the straight path, greed knows no bounds. I guarantee there will be the unscrupulous adviser who will swindle anyone and everyone they can. Here goes for some advice on how to try and avoid a crook and minimize the damage in case of misjudgment.
Ever heard the term “affinity fraud”? Dictionary.reference.com says this: “Investment scams that target members of identifiable groups, including elderly, ethnic, professional, and religious groups. Perpetrators of affinity fraud are often either members of the targeted group or individuals who enlist the assistance of leaders in order to exploit the trust of members of the group.” Some pretty twisted thinking, but that is what Bernie Madoff did.
Did you just become a little less trusting?
In other words, ask your friends, family, co-workers, professionals, or your dog for that matter. BUT, keep on digging when you have a recommendation. You can start this mundane but necessary task by checking their background, which includes disciplinary records and customer complaints, with regulators.
Now, we all know the Securities and Exchange Commission REALLY SCREWED UP when it came to Bernie “Ripoff” Madoff, and there is no doubt they will do a better job henceforth. This means you will also have to conduct your own background check.
Brokers are licensed by the Financial Industry Regulatory Authority, or FINRA. Investment advisers managing less than $25 million in assets are licensed by state regulators, while the SEC regulates those with more assets.
Records can overlap, so start with your state regulator. Marylanders can check on brokers and advisers by contacting the state Securities Division at 410-576-7048. The agency can provide more information than what’s available through FINRA because of a broader state public information law, says Securities Commissioner Melanie Senter Lubin.
FINRA posts brokers’ records online under BrokerCheck at finra.org. Even if there is no disciplinary blemish, be wary of a broker who switches firms every year, regulators say. You also need to know that advisers and brokers have different levels of responsibility to clients.
Investment advisers have a fiduciary responsibility to put their client’s best interest first. Brokers must make sure investments are “suitable” for the clients, which doesn’t necessarily mean the investment will have the lowest commission.
This could change, though. The Obama administration’s proposed regulatory reform calls for brokers to have a fiduciary duty to clients.
Watch for red flags
Madoff claimed returns of 10 percent to 12 percent year after year. No one can produce such consistently high results.
“Here you had to ask, ‘If Warren Buffet couldn’t do this, how could Bernie Madoff do it?’ ” says Leonard Rosenthal, a finance professor at Bentley University.
Be wary when advisers claim investment returns that are much higher than what similar investments are earning. “They can’t do that without taking a lot of risk,” Rosenthal says. Madoff didn’t take just anyone as a client, and his investors often felt lucky to be allowed to join his exclusive club. Exclusivity is often part of frauds because it “just pulls people in all the time,” says Lubin. “You can get something that you can’t get elsewhere.”
Look for outside custodians
Madoff served as the custodian of his clients’ assets, and thus was able to fabricate statements that showed investors were making money.
Choose an adviser that has an outside custodian, say Charles Schwab or TD Ameritrade, that will hold your assets and generate independent statements. Plus, you can always call the outside custodian to double-check your balances.
Similarly, look for an adviser with a reputable, recognizable auditor, says Fred Joseph, president of the North American Securities Administrators Association. Madoff’s auditor was a tiny, unknown firm, unusual given the billions of dollars he managed, Joseph says.
Diversify
Many of Madoff’s clients invested their entire savings with him, and their lives were upended when they lost all their money. “Simple advice, but very effective: diversify. Don’t put all your assets with one manager,” says Brian Bruce, a finance professor at Southern Methodist University.
Interview prospects
Meet with at least three professionals before hiring one. Ask advisers about their education, training, work experience and how they are compensated. Find out if the adviser has experience working with clients in your situation, say, a 25-year-old just starting out or a 60-year-old needing retirement and estate planning, says Gerri Walsh, vice president of investor education at FINRA.
Many advisers have an alphabet of professional designations after their names. Some are meaningful, others aren’t. None guarantees that an adviser is honest.
FINRA posts descriptions of the designations on its Web site. The group also offers online “Scam” and “Risk” meters, to determine if an investment might be a scam or if you’re at risk of becoming a victim.
Keep your eyes open
Once you hire a professional, don’t ignore your investments. Read your statements. Make sure there aren’t any transactions you didn’t authorize, Walsh says. If so, contact regulators immediately.
How to protect yourself. A quick and dirty summery of what you should do.
- 1. Trust, but verify.
Ask friends, family, co-workers or other professionals you work with for suggestions on financial advisers. But once you get recommendations, dig into the advisers’ backgrounds.
2. Watch for red flags.
Be wary when advisers claim investment returns that are much higher than what similar investments are earning.
3. Diversify.
Don’t put all your assets with one manager. VERY IMPORTANT!
4. Interview prospects.
Meet with at least three professionals before hiring one.
