Selecting an investment adviser requires due diligence on your part. To protect against fraud, I suggest the following:
- Do your homework. The SEC has a website with tips on how to check out brokers and investment advisers: http://www.sec.gov/investor/brokers.htm.
- Never write a check or wire funds directly to an investment adviser to fund an account. Custodial accounts offer protection by safekeeping your cash and securities. With custodial accounts, funds are sent to a custodian for further credit to your account at the custodian. Firms offering such 3rdparty accounts are highly regulated, and limit the risk of one being subjected to fraud. You should ask potential custodians questions regarding their ability to protect you from financial crimes, especially their ability to keep crooks from withdrawing cash from your account. Also, make sure the custodian is a member of SIPC (the Securities Investor Protection Corporation), and whether the firm has private insurance to protect you beyond SIPC limits in case the firm fails – the current SIPC limit is up to $500,000 including a $250,000 cash limit. If you’re not sure about the safekeeping of your cash and securities, consider consulting an estate planning attorney who should be able to explain this process in-depth. It’s better to pay for a legal opinion than to become the victim of fraud.
- Understand fiduciary responsibility, that is, an investment adviser’s duty to put your interests first. Brokers often use the title “financial adviser/advisor,” but don’t have fiduciary responsibility. Financial advisers who are registered investment advisers with the SEC or one or more of the 50 states, do have fiduciary responsibility.
- If you require a financial adviser to trade for you, the adviser should only be empowered to trade in your custodial account, and not have the ability to transfer funds to other accounts, whether the other accounts are in your name or not. Suppose a corrupt adviser was able to use false identification to open an account elsewhere in your name, and then was able to transfer funds to that account for their personal use? Restricting transfers can help prevent this scenario. If you authorize your adviser to extract a “management fee” from your custodial account, according to the SEC’s definition of “custody,” your adviser has “custody” of your assets. If an adviser has custody of your assets, they could potentially divert your assets for their personal use. One can negotiate a fee arrangement whereby a financial adviser is paid via check, rather than direct debit. At minimum, you should be notified of any fund transfer requests immediately. For this scenario, you should consult your custodian regarding the specifics of receiving alerts, and ensuring your adviser can only extract the management fee to which you agreed upon, and at the specific interval agreed upon. Again, if you’re not sure, consider consulting an estate planning attorney.
- Educate yourself on fraud. The Association of Certified Fraud Examiners provides anti-fraud training and education http://www.acfe.com/home.asp. Other resources include Fraud College, a non-profit organization devoted to helping protect people from fraud: http://www.fraudcollege.info.
- Titles mean nothing. The fact that someone is a Senior Vice President, has a securities license, professional certification or advanced education, does not protect you from fraud. Titles also don’t ensure that a financial adviser is good or reputable. There are Certified Financial Planners (CFPs) and MBAs who cannot manage a portfolio, and people without a college degree who can. Your best defense is your financial knowledge. The greater your financial knowledge, the better your ability to judge the knowledge of others.
- Understand risk and returns. “The greater the risk, the greater the return.” If an adviser promises a high return with little or no risk, there’s a strong possibility they are lying. Be careful if considering investing in a business start-up. People hopeful of high returns are often the target of entrepreneurs seeking start-up capital, and most start-ups fail.
- Consider managing your own money, there are an abundance of free resources available to help self-directed investors. Most discount brokerage firms and broad-based financial websites offer an abundance of educational resources.