A common concern from investors is how to avoid investment fraud.
In recent years, I have seen victims from Madoff, Nadal, Stamford and Brasota. As fraud appears to be increasing, it can be helpful to better understand simple prevention measures that can greatly reduce your risk.
There are three basic parties to investment advice.
1) The financial adviser
2) The investment manager
3) The custodian
The financial adviser provides guidance on strategy -- the WHERE and WHY -- your money is invested.
The investment manager(s) provides guidance on tactics -- the HOW -- your money is invested.
The custodian holds your money in addition to providing access and reporting.
Sometimes two or even all three functions can be handled by the same company.
A reputable custodian
"Prevention is better than cure." The first line of defense is to look at who has your money. We all like simplicity, but protection can be greatly enhanced through checks and balances. By separating the custodian from the financial adviser, you can greatly reduce the risk of fraud. By doing so, your adviser never has direct access to your money.
Never write a check to your adviser or your adviser's firm; it should always be directed to the name of their custodian. The adviser, subject to a power of attorney, can only direct money to other accounts in your name.
Custodians are responsible for maintaining records and statements of all transactions that take place in an account. A custodian's accounts are further audited by an independent accounting firm.
Custodians are liable for forged signatures and therefore audit and provide oversight over advisers. A reputable custodian is equipped with technology to provide transparency and fraud protection. When technology fails, the custodian will have insurance in place to cover financial losses from fraud.
Adviser due diligence
Financial advisers are regulated through either the SEC and/or FINRA depending on their licensing. Licensing dictates compensation and oversight. The SEC has oversight over investment adviser representatives and who charge a fee for their services and act in a fiduciary capacity. FINRA has oversight over brokers who charge commissions for their services and held to suitability standards. Some advisers wear both hats to give their clients a broader set of options and tools. A quick google search for "Brokercheck" will bring you to a FINRA site that provides Disclosure Events and Registration History for both types of advisers. Put a reminder in place to check your adviser's record at least once a year on the 'Brokercheck" site.
If an adviser has advanced credentials such as a certified financial planner or chartered financial analyst, she will be subject to ethics requirements and any disclosures will be documented for consumer review at the respective association websites. Check cfp.net or the appropriate association site once a year.
Beyond an adviser's history, pay attention to their advice. Are they pushing a product or a solving a problem? Do they take the time to truly understand your situation and customize solutions? Will they work with your other advisers and provide transparency and disclosure? Do your other advisers know them and the quality of their work?
Independent investment management
A last consideration is to have performance reporting handled by an independent party from the investment manager. If your adviser is also your money manager, it might be worth hiring an outside party to provide an annual reporting.
A few bad apples
In the modern world of instant information, a google search for fraud and financial adviser can cause you much distress. Don't rely on a brand name to protect you. People, not brands, are accountable for their actions. Type in just about any brand name and you will likely find pages of lawsuits and news articles. There are some bad apples in all professions.
Your ability to protect yourself from fraud will come from understanding the most common areas of exploitation and using preventative measures to minimize your exposure. Focus on creating checks and balances between the various functions to provide greater oversight.
Gardner Sherrill, CFP, MBA, is an independent financial adviser with Sherrill Wealth Management. To learn more visit sherrillwealth.com.