By Robert Powell, MarketWatch
Last Update: 12:01 AM ET Jul 20, 2012
BOSTON (MarketWatch)Maybe its the heat and the drought. Or maybe this is what happens when interest rates are low. Or maybe its nothing more than a few good and some less-than-good advisers gone bad.
Whatever it is, there seems to be an increasing number of high and not-so-high profile advisers and brokers who are taking advantage of those who are trying to salt away some money for those rainy days called retirement.
High-profile cases in point:
Former NAPFA chairman Mark Spangler faces criminal charges of diverting $41.7 million from investors into risky start-up ventures in which he had an ownership stake. He was indicted in May.
Also that month, the Labor Department filed in U.S. District Court in Idaho a complaint against Matthew Hutcheson and others alleging that Hutcheson had violated the Employee Retirement Income Security Act. The complaint alleged that, toward the end of 2010, Hutchesonwho has testified several times before Congress about the need for advisers to be fiduciariesused more than $3.2 million in retirement plan savings of workers from multiple employers for his own personal benefit and in an attempt to purchase an interest in the Tamarack Resort, a failed ski and golf resort in Idaho.
Not-so-high profile cases in point:
In June, the Securities and Exchange Commission (SEC) charged 14 sales agents who allegedly misled investors and sold securities for a Long Island-based investment firm at the center of a $415 million Ponzi scheme. The advisers reportedly promised investors returns as high as 14%, with 99% of it being risk-free.
In Virginia, an adviser has been sent to prison in connection with an investment scam that victimized retirees and parents who were saving to send their children to college. According to regulators, the adviser sold parents annuities that he falsely claimed were insured by the Federal Deposit Insurance Corporation.
To be fair, the above cases are the exceptions to the rule.
More advisers seemingly do right by their clients than wrong. But these cases do serve to remind investors that they should never let their guard down, especially in a world where advisers may be trustworthy one minute and not the next.
In general, regulators say there are three simple steps that you need to follow to make sure that you and your money arent separated: Know your broker; know the product; and get a second, unbiased third-party opinion.
Heres the deeper dive into what regulators say you can do to protect yourself from rogue brokers and advisers, especially those who are tempting you with high or stable returns in a low-interest rate world.
Know your adviser
Long before the need for background check, the regulators say you can avoid dealing with rogue brokers and advisers by not taking cold calls, by throwing away direct mail pieces, and dismissing advertisements on the Internet.
And they warn against selecting an adviser just because they are the president of a professional association, have testified before Congress, or have stellar testimonials and references. Such badges, history has shown, are no guarantees that you are working with adviser who will always work in your best interest and who will always be above and beyond reproach.
If you do plan to work with an adviser or broker, you must do as a thorough a background check as possible. Doing so wont stop you from dealing with a good adviser who eventually goes bad. But it will, if nothing else, help you avoid dealing with a broker or adviser who has red flags.
Seniors, or anyone for that matter, need to make sure that they know who they are dealing with, said Jack Herstein, the president of the North American Securities Administrators Association (NASAA). Before dealing with a stranger, try to get as much information about them as possible.
Its always important to investigate before you invest, said Lori Schock, director of the Office of Investor Education and Advocacy, at the SEC.
FINRAs BrokerCheck is among the resources that you can use to check out your prospective broker or adviser. Its a free tool that helps you research the background of current and former Finra-registered brokerage firms and brokers, as well as investment adviser firms and representatives, is among the tools available.
According to FINRAs website, BrokerCheck features professional background information on about 1.3 million current and former Finra-registered brokers and 17,400 current and former Finra-registered brokerage firms.
Another resource is the SECs Investment Adviser Search, which provides information about current and certain former investment adviser representatives (IARs), investment adviser firms registered with the SEC and/or state securities regulators, and so-called exempt reporting advisers that file reports with the SEC and/or state securities regulators.
The Investment Adviser Public Disclosure (IAPD) also provides links to FINRAs BrokerCheck system which contains information about brokerage firms and registered representatives of brokerage firms.
Check out the Investment Adviser Public Disclosure site here.
And still yet another resource is your states securities regulator. Learn how to contact your state securities regulator at this NASAA website.
The first step that any investor should take before they do business, especially with a new broker or a new investment professional, is to use BrokerCheck to do a background search, said Gerri Walsh, who is the president of Finra Investor Education Foundation and a vice president of Finra Investor Education. Make sure they are licensed either with Finra as a registered representative or with the SEC or a state regulator as a registered investment adviser.
Then, examine their background. Examine, for instance, where somebody has worked, how stable their employment has been, what licenses they hold, whether there have been any legal or disciplinary actions against them, whether theres been any customer complaints or a lawsuit, what states they are registered to do business in, and whether they have filed a personal bankruptcy. (You can also the ZIP Code search function in the SECs investment adviser search tool to see which advisers are licensed and registered in your city or town.)
A large percentage of investment fraud cases could have been prevented if people had just done this due diligence said Schock. Its important to do a background check before you give someone your hard-earned money.
So what in particular should you be looking for? Any broker who has changed firms numerous times in a short period of time, such as four firms in five years, thats likely a red flag, said Walsh. And thats something you should consider.
And if a broker has a history of complaints or disciplinary actions, you should think twice before trusting your money to them, Walsh said.
To be fair, there are many advisers in BrokerCheck and the SECs IAPD who have squeaky clean records, and its just a fraction of them might become a bad apple at some point. But theres no way of knowing that in advance.
The reality is that the first time somebody runs afoul of the securities laws is the first time anything will show up in their BrokerCheck or in their IAPD report, said Walsh.
Others agree that its hard to screen out the good adviser who might go bad someday, but they did offer some words of wisdom and comfort. If you have a person who is out to commit a fraud one way or the other the best thing you can do is when your monthly or quarterly statement comes in, make sure that they reconcile with what you have done in that month or quarter, said Herstein. If a person is falsifying statements, however, theres not a whole lot you can do until the fraud blows up.
And Schock had this to say: You are a first victim, then it makes it extraordinarily difficult. To avoid the possibility of being a first victim, Schock recommends that you have more than one adviser. You want to be diversified, she said. Dont keep all your eggs in one basket, with one adviser. Spread out your money with different advisers or different brokers. Just in case in you end up in that small percentage who are dealing with a rogue.
When you have people committing fraud, its tough for the average investor to basically realize that, said Herstein. If you are going to buy investments ultimately you have to have that trust in the person you are dealing with.
Know what you are buying
In addition to checking a brokers or an advisers public records, Walsh and others recommend talking to the adviser about the recommendations that they make and why those recommendations are appropriate for your individual circumstances. You always want to ask about the product, Walsh said. You want to find out every aspect of the investment.
Ask about the risks, the credit rating of the issuer, the fees, and the possibilities that you could lose money or lose your principal entirely investing in whatever recommendation the investment professional is making. When it comes to investing, investors cant always control their returns, Walsh said. But they can control their costs.
Now in a world where people are earning next to nothing, few would blame you for investing with someone that promises above-market or stable returns. Dont bite the apple. There is no free lunch.
Its always important to look out for promises of steady returns or above-market returns, said Walsh. And the reality is that in this low-interest rate environment there are a lot of products that are alternative investments that have complex systems that provide returns.
For instance, there are some notes that depend on the performance of derivatives or esoteric indexes. If youre being asked to buy a product of this sort, find out what your return is based on and the risks associated with the underlying indexes. You want to understand fully the product that you are investing in, said Walsh.
Finra, for the record, this month warned investors about investing in exchange-traded notes or ETNS.
Read the Finra warning on exchange-traded notes.
Walsh also advised that investors carefully weigh whether to invest in structured products that have guarantees of return of principal. Those often have costs and other risks that are aligned with the product that you should take into account, Walsh said.
And, Finra warned investors about structured products last year. Read that warning.
Some products might be perfectly appropriate for investors that can take risk and who are looking for a short-term investment and understand how those products work, but that same product may be completely inappropriate for a different investor, said Walsh. And for someone who is in retirement, unless they have money that they are willing to lose, they dont want to be taking that kind of risk.
Others agree. If you have no idea what you are buying and your adviser cant explain it to you, dont buy in to it, said Herstein. Dont buy something that you know nothing about, he said.
For her part, Schock noted that not all products are registered with the SEC. However, doing a search of the product in the SECs EDGAR system, which track holds the records of publicly traded securities such as mutual funds, is a good place to start ones due diligence of a product recommendation. If its not registered in EDGAR, its not necessarily an immediate red flag of fraud, said Schock. But its a sign that you need to do more due diligence and perhaps check with your states securities regulator, your states insurance commissioner, or someone. If the products are not registered and you cant find any registration information then thats a red flag.
Visit the SECs EDGAR.
Schock also said many investors who are searching for higher rates of return are falling prey to pitches. People are seeking higher returns and that may mean that they are willing to take on more risk even though they may not know they are taking on more risk, said Schock. For folks who are in retirement or getting ready to retire, they are counting on their principal being able to generate some type of income and thats why when we see products that are guaranteeing 6% interest, well there are no guarantees in investments.
And, she noted that investors who are trying to play catch-up are especially susceptible to offers with guarantees or above-market rates of return. They dont think they are where they should be at this stage and age in their lives and careers with their retirement planning, Schock said. And they so desperately want to have more yield.
Get a second or even third opinion
Also, the regulators recommend that you ask an attorney, CPA or some other adviser who doesnt have a vested interest and whose judgment your trust to review your advisers investment recommendations. Its a great idea to get a second opinion or even a third opinion, especially in this environment where yields are particularly low, where weve got low interest rates on standard more secure products, said Walsh. They might ask questions that you havent thought of and they might have other ideas that what your investment professional recommended.
For her part, Schock said getting a second or third opinion is part of your due diligence. But dont solely rely on that advice, just in case in might affinity fraud. If you have rogue CPA and a rogue attorney working in concert with a rogue adviser, youre not likely to get an honest assessment. Obviously thats a worst-case scenario, she said. But having more professionals look at it, helps.
Of course, the real worst case would be ending up with a rogue broker or adviser when you could have avoided it in the first place.
Robert Powell is editor of Retirement Weekly, published by MarketWatch. Follow his tweets at RJPIII.
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