Financial Advisors

News of the Bernard Madoff, Allen Stanford Financial Grp and other scandals has provided ample evidence that financial fraud against investors is alive and well. It’s always a good time to review some of the principles that will protect one from investment / financial fraud. Let’s take a look.

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Of course, the first and foremost is having a trustworthy investment advisor and company. Know your investment company. A quick check on the Internet* can highlight any major problems or complaints your company may have had with the SEC or other government bodies. Many companies may show complaints against them. Carefully evaluate them to determine if your company’s business problems /policies are such that you don’t want to do business with them.

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A similar investigation can be done for your specific broker / financial advisor. If you find serious complaints with merit it’s time to move on. Interview your financial advisor. Of course they should be knowledgeable about the investment market place, asset class allocation, as well as specific financial products. They should also be able to explain their firm’s practices with regard to the money flow from their firm to their broker dealers and clearinghouse (see below). They should also be able to clearly explain their fee structure. Is your broker/advisor knowledgeable about theses practices? Or are they more of a salesperson, trying to steer you towards their own firm’s products? Of course, that doesn’t means there is fraud going on, but the less credible the information on these topics is, the more likely you’d be better off investing your money someplace else.

You should be able to track your reported investment returns relative to the returns observable in the market for a similar class of investments. For example, if your funds are being invested in value stocks (stable steady growth profile), and your financial statements claim to be beating the S &P 500 by leaps and bounds, you might want to wonder how your investment company is doing it. They may well have beaten the market. But it is worth investigating. They should be able to provide you with a list of securities in which they had your money for a given period, or a list comprising any given fund. You can check one by one what the performance of those securities was, and if it roughly matches (in aggregate) what they are telling you. It’s a big red flag if the numbers aren’t close. And a bigger red flag if your company tries to avoid providing any of this information.

The size of your investment company is not necessarily an indicator of quality, but I believe it is true that the larger companies are monitored more closely and less likely to foster systemic fraud. Of course, Bernard Madoff controlled and stole many billions of dollars, but the biggest problem there, besides lax SEC oversight, was that there was only a tiny core of people who truly knew where the money was invested. There was not adequate (or no) separation between the investment advisory function, the actual securities trading, the movement and reconciliation of the underlying money. This is much less likely to happen in a large publicly traded and audited firm.

As touched on above, all securities purchases on your behalf should be cleared through an independent custodian/clearinghouse. A of the financial statements sent to you should be periodically be examined by an independent auditor. If you don’t know who these institutions are for your investment company, you need to find out.