Whether it’s a stock market crash or a string of poor investment decisions, losing your money is the worst nightmare of every investor. For investors who work with financial advisors there’s a more specific fear — being taken advantage of and having money stolen.
While the vast majority of advisors earn the trust and confidence of their clients by doing their jobs with skill and integrity, there have been plenty of cases of unscrupulous advisors bilking their clients, none more notorious than Bernie Madoff. The former chairman of Bernard L. Madoff Investment Securities ran the largest Ponzi scheme in history, defrauding investors of $65 billion over the course of nearly two decades before he was arrested and sentenced to 150 years in federal prison.
Working with a financial advisor can be a great decision, whether it’s investment advice or financial planning that you need. However, before you trust someone with your money, here are the protections and warning signs you should know about.
What Is Custody and What Are the Rules Surrounding It?
Investment advisors registered with the Securities and Exchange Commission must comply with the custody rule, a provision of the Investment Advisers Act of 1940 intended to bolster the safeguards of client assets. Under the rule, financial advisors have custody of client assets when they hold client funds “directly or indirectly” or have the “authority to obtain possession of them.” This includes deducting fees from a client’s account.
The rule stipulates that client assets be held by a qualified custodian, which can be a financial institution like a bank or broker-dealer. While most advisors rely on third-party custodians to safeguard their clients’ assets, registered advisors may also technically be qualified custodians themselves.
The rule also requires qualified custodians to send account statements to clients, at least quarterly. Advisors, meanwhile, must have a written agreement with an independent public accountant to examine client assets “on a surprise basis every year,” according to the SEC. The third-party accountant who performs this audit will contact some or all of the advisor’s clients and confirm their holdings with those listed in the advisor’s records.
While the custody rule aims “to provide additional safeguards for investors against possible theft or misappropriation by SEC-registered investment advisers,” the SEC recommends investors continually monitor their investments and “exercise care when making investment decisions.”
Keep These Warning Signs in Mind
If you’re worried about the prospect of being taken advantage of by a financial professional, there are several warning signs to be on the lookout for. Of course, none of these scenarios automatically mean an advisor is stealing from you. However, they may indicate that your advisor operates with less transparency than others, doesn’t have your best interests in mind, or they are in fact taking advantage of you.
They’re Not a Registered Investment Advisor
Unfortunately, just about anyone can call themselves a financial advisor. This doesn’t mean they’ve passed any particular kind of certification or had some requisite training. However, any advisor registered with the SEC is legally required to abide by fiduciary duty and put the client’s interests ahead of their own. If your advisor isn’t registered with the SEC, they may not be a fiduciary, and as a result, may not be legally obligated to have your best interests in mind. If your advisor isn’t registered with the SEC, they also may not follow the custody rule and house your assets with a qualified custodian.
You Aren’t Receiving Account Statements
Qualified custodians must send statements to account owners, at least quarterly. As a result, if you’re not receiving statements from the financial firm that serves as your qualified custodian, that may be a red flag. If this is the case, the SEC recommends contacting your advisor and/or custodian and finding out why.
They Have Significant Disclosures on Their Record
The SEC requires financial advisors to publicly disclose past criminal, civil and regulatory actions taken against them. This can range from a monetary penalty an advisor paid for an alleged regulatory infraction to allegations of criminal behavior. Advisors must disclose these events on their Form ADV, documentation that’s updated each year. Members of the public can access advisors’ Form ADV documents on the SEC’s Investment Adviser Public Disclosure website. Beyond any legal and regulatory action taken against the advisor, look out for lawsuits filed against them in the past.
They’re Making Too Many Trades
Also be on the lookout for excessive trading within your account. An unscrupulous advisor or broker could engage in a high volume of transactions simply to generate commissions for themselves. This practice is known as churning, and while this may not seem like outright theft, it’s illegal.
Steps to Take to Protect Your Assets
If you’re concerned about potential theft, there are several precautions you can take to protect yourself and your assets.
First, you can hire an advisor only to give you advice, not directly manage your portfolio. Another alternative is to have an advisor manage your investments on a non-discretionary basis, meaning you’ll have final say on the individual trades and transactions they make. This is different from discretionary management, by which the advisor makes decisions on your behalf and doesn’t need you to O.K. individual transactions.
You can also consider writing checks directly to your third-party qualified custodian and limiting the amount of personal information you share with your advisor.
Lastly, do your proper due diligence while you’re in the process of hiring an advisor. You may be inclined to sign on with the first advisor you talk to, but try to interview at least three advisors. Ask about any certifications they hold, whether they work on a fee-only basis or can collect commissions for recommending certain products and services. Chances are that you’ll notice some differences between them, from the fees they charge to their investing strategies and the types of clients they typically work with.
Also use the SEC’s Investment Advisor Public Disclosure website to look up the advisors and check for any history of disclosures. To do this, search for the individual advisor or firm and then click on “View Form ADV By Section.” From there, select the “DRPs” tab. If the advisor or their firm has any disclosures, they’ll be categorized as criminal, regulatory and civil proceedings. A summary of the allegations will be included and how the case as resolved.
Bottom Line
Yes, an unscrupulous financial advisor can steal from you, so it’s important to take the time to hire a fiduciary advisor you can trust. Advisors who are registered with the SEC must act in your best interests and follow the custody rule, a set of regulations designed to safeguard your assets. However, you should still be cognizant of potential red flags and ways in which you can protect yourself from theft.
Tips for Hiring a Financial Advisor
- Be sure to hire a fiduciary advisor who puts your best interests ahead of their own. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Understand the difference between a fee-only and fee-based advisor. While the former is compensated solely by the fees their clients pay, the latter may collect commissions for recommending insurance policies or financial products in addition to client fees. This can create a conflict of interest. When receiving advice from a fee-based professional, you should make sure you know what it’s based on, in which role it is being given and how the advisor may benefit.
Next Steps
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