Bad Guys Never Follow the Rules

No amount of regulation can stop a determined cheat from preying on unsavvy investors. Here’s what several firms are doing to educate new investors on how to keep their money safe from predatory advisors.

The thousands of investors who trusted financier Bernard L. Madoff were all told the same thing – that he was a fiduciary and would put their best interests first. Those investors later became the victims of Madoff’s $65 billion Ponzi scheme, one of the largest investment fraud cases in U.S. history.

As Congress and various government agencies repeatedly raise the prospect of new fiduciary regulations, the Madoff case stands as a stark reminder that bad guys, by definition, ignore the rules. And for novice investors – or even savvier savers unknowingly in the crosshairs of an unsavory character – the warning signs that an unscrupulous advisor sees them as a mark may be hard to spot. “Advisors Magazine” interviewed several financial professionals from around the country on how they educate clients to tell the difference between a good advisor and one with a too good to be true sales pitch.

“Many criminal advisors may promise outsized returns, returns well beyond what a client should expect given their risk tolerance,” said Thomas Payant, CEO of Payant Wealth Management Group in Sun City Center, Florida. “It would be very difficult for any broker [or] advisor to consistently beat the market. We tell our prospective clients what risk-based return they may expect after we have a realistic idea of their risk tolerance.”

Most financial advisors who describe themselves as fiduciaries define the term, simply, as putting clients’ best interests before commission considerations or the firm bottom-line.

Financial professionals around the country listed client education as an investor’s main defense against predatory advisors. Financial literacy often lags among prospective investors, and misinformation stubbornly sticks in many potential client’s memories, which confronts many fiduciary advisors with a serious challenge. Client education is essential, however, and there are several steps investors can take to reduce the chances that they will be sucked in by an unscrupulous advisor.

“You can’t 100 percent protect a client’s from a ‘criminal advisor,’ but you can significantly reduce the likelihood of that event,” said Jason Labrum, CFP®, AIF, the founder and president of Labrum Wealth Management in Carlsbad, California. “Only work with an advisor who uses a reputable custodian for all of your assets. Work with advisors who are part of a [registered investment advisory] and not an ‘independent’ registered with a broker-dealer. Work with advisors who can, and will, tell you 100 percent of their compensation.”

steelingthemoney400x600The Madoff scheme left thousands of investors in the lurch. And these were not everyday investors who got scammed; Madoff had many, many financial professionals, bank executives, and hedge fund managers among his victims. In short, people who should have known better didn’t, despite the considerable warning signs.

As Labrum notes, investors should only work with an advisor who relies on a reputable custodian. Madoff’s firm existed without one and the external auditor he hired was far too small and inexperienced to watch over such a complex operation.

“We inform our clients from the onset of the relationship that we do not hold custody of any of their funds, and that all of their money is entirely in their name and held with a truly independent third-party custodian,” said Ara Oghoorian, CFA, CFP®, CPA, the founder and president of ACap Asset Management in Los Angeles. “We also let our clients know that we are not compensated by absolutely anyone other than our clients.”

If an advisor holds back basic information, prospective investors should walk. Clients always should know how much their advisor is being paid, what fees an advisor charges, whether commissions are in play, and what sort of risk profiles their investments entail. An advisor who avoids these topics, provides bare minimum information, or tries to create a sense of “mystery” – for example, describing something as a trade secret or unique method that cannot be disclosed – is one who probably should be avoided.

“The level of secrecy and mystery Madoff generated among clients and employees of his own firm should have been a red flag, as should the fact that Madoff charged no investment fees,” Advisor Perspectives reported in 2017, adding that a number of potential Madoff hires sounds the alarm when they could not receive clear answers to basic questions during job interviews; all were ignored at the time, however.

New regulations?

The Department of Labor’s (DOL) fiduciary rule died in federal court last year, but the Securities and Exchange Commission (SEC) continues to hint that their own proposed regulation will be coming in early 2019. SEC Chair Jay Clayton has taken fire from senators – specifically, Massachusetts Senator Elizabeth Warren –for his reluctance to use the word fiduciary in the existing rule proposals. Many financial services professionals, including fiduciaries, “Advisors Magazine” spoke to over the years felt the DOL overstepped its bounds when it first tried to implement the fiduciary rule. Now, with the DOL rule dead, some have had time to consider what an ideal regulation might look like.

“One of the benefits [of the DOL rule] would have been who is able to call themselves financial advisors,” said Chris Tuck, CFP®, a wealth advisor at SJK Wealth Management in Pennsylvania. “I still think it is confusing to consumers whether someone is just trying to sell them or advising them. Even though it isn’t quite as appealing of a topic, the industry needs to put more emphasis on planning instead of just products and the markets. More people need to understand the benefits of working on a plan and achieving a plan.”

Other advisors echoed Tuck, with ACap’s Oghoorian adding that the current “alphabet soup” of licenses and designations serves only to confuse potential investors.

“The CFP designation needs to be mandatory for all providing financial advice and it must be issued [and] managed by a governmental licensing agency, just like the CPA, MD, and law licenses,” Oghoorian said. “This raises the public credibility of the designation … Lastly, there should be a prohibition, imposed by the SEC or State, against using confusing titles to artificially elevate one's [marketability].”

confusion350x400Investor confusion around who or what a fiduciary is also further complicates finding a solution. Clayton, in remarks to a Senate committee in December, said that fiduciary responsibilities often can be “contracted” around, and that using the word could make any proposed regulation unclear.

“Unfortunately, there is not even one fiduciary standard, but many,” said Jamie Hopkins Esq., CFP®, RICP®, who serves as director of retirement research at the Carson Group in Omaha, Nebraska. “For instance, an ERISA fiduciary and a CFP professional holding oneself out as a fiduciary could have different standards of care.”

Professional qualifications like ERISA and CFP can protect clients to some extent, but ensuring that advisors are accountable to external organizations and accountability structures is paramount. Investors, however, do need to keep their emotions in check when considering the value of financial advice, as good salesmen often do not have the client’s best interests at heart.

“There are a lot of ‘asset-gathers’ roaming around, that are not fiduciaries, and the investing public is unaware of the distinction,” said John H. Bishop of Wellington Capital Advisors, an independent RIA in San Francisco. “Many investors are attracted to the personalities attached to a big-brand name sales folks, not realizing those individuals are beholden to the sales salary and incentives of the employer.”

Regardless of the regulations that may come from the SEC, investors will need to remain alert. Asking the right questions, carefully considering an advisor’s qualifications, and seeing through sales jargon will remain critical investor skills even if a new fiduciary regulation is adopted.

“There’s nothing that should ever be held as privileged from clients … All of that is going to come out eventually anyways, given people’s access to information today,” said Terry Wright, CIM, a portfolio manager and financial advisor with LT Wealth Management Partners in Vancouver. “The best relationship is going to be one that is long and sustainable and that’s going to come from making sure that all cards are on the table.”


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