By Teri Parker
Sometimes red flags are waving gently in front of us, but we are blind to their signals.
Many of Bernie Madoff’s clients failed to notice the warning signs that something wasn’t quite right. Madoff was the infamous architect of an epic securities swindle that lost billions in clients’ money. At one point, Madoff’s wealth management business was the largest in the world. He seemed reputable, likable, and well connected. The former Nasdaq stock market chairman was known for providing high, steady investment returns for his wealthy clients’ portfolios.
Unfortunately for Madoff’s clients, his wealth management business was a massive Ponzi scheme. Ultimately, losing billions of his clients’ assets earned him a 150-year prison term for his actions. As investors, we can learn from the red flags that Madoff’s clients experienced but for some reason chose to ignore. Madoff died in April in a federal prison.
Signs or red flags that something was not quite right
Clients were denied online access to their accounts.
All information was sent by mail.
Madoff’s firm served as its own broker-dealer and allegedly processed its own trades. (Typically, funds are held at a securities firm such as Charles Schwab or Fidelity, trades are placed on their platform, and confirmations of trades, monthly statements, and tax statements are mailed or emailed to the client directly from the custodian.)
It may be difficult to pull off such an elaborate Ponzi scheme, but there are signs that may reveal a poor advisor. Signs that may signal future problems are:
The adviser can’t clearly explain how they’re paid
Fee-only advisers are always paid either a percentage of assets under management or by a set project or hourly fee. This fee is typically 1% of the assets under management. A fee-only adviser does not receive any commission or other payments from the providers of financial products that they recommend. Often fee-only advisers have a fiduciary duty to their clients, meaning that they must place the client’s best interests first.
Fee-based advisers are paid by the client but also via other sources, such as commissions from financial products they sell to their clients. This could present a conflict of interest; the adviser could steer you to products that they will profit from, which may not be the best option for you.
Commission-only advisers earn their income by receiving commission on the products they sell you. Products for commission-based advisers include financial instruments such as insurance packages and mutual funds. The more transactions they complete or the more accounts they open, the more they get paid. Again, this could create a conflict of interest or at least call into question whether the adviser has your best interests in mind.
Spend some time researching the adviser. Access to the internet has made researching the credentials of a potential adviser an easy task. Confirm they are licensed, have a clear record and are not using a designation they do not have legally.
FINRA BrokerCheck: Fee-based advisers and insurance or annuity salespeople are governed by FINRA. Use the FINRA BrokerCheck tool at brokercheck.finra.org to investigate their history and qualifications.
Use the SEC Investment Adviser Public Disclosure website for due diligence on fee-only registered investment advisory firms at adviserinfo.sec.govCertified Financial Planner professionals are all listed in the CFP Board’s database, so you can verify credentials. letsmakeaplan.org
They guarantee a return that seems too good to be true
When an adviser promises or guarantees a return that does not seem realistic, it is most likely not. When investing in the stock market, the returns are not guaranteed and will be both positive and negative at various time periods. Historical returns can be referenced, but unless the investment offers a fixed return, future returns are unknown. If an adviser promises a specific return, ask for clarification and documentation to support the statement. And then do your research before you invest.
You are being pressured to buy a product
When an adviser is pressuring you to buy a product such as an annuity, do not commit until you understand what you are purchasing. Ask what commission the adviser will receive from the sale and how the surrender charge is calculated. A surrender charge is a fee that you will be assessed a contract is terminated.
According to annuity.org, the surrender period can be as long as 10 years and, in many cases, as short as three years. If you are not satisfied with the performance of your annuity, you will lose the amount of the surrender charge when you close the account and possibly even owe some income tax.
You are being asked to take on additional debt to invest with the adviser
If an adviser is asking you to take on additional debt or refinance your home to pull out equity to fund investments under their management, question whether or not you are comfortable with gambling the equity in your home. This is a sign the adviser has their own best interest at heart, not yours.
They are not discussing capital gains or losses before liquidating your taxable portfolio
When you establish a relationship with an adviser, and if you are transferring taxable assets from another adviser, the topic of capital gains or losses should be part of the conversation.
Be wary of an adviser who is not discussing the tax ramifications of liquidating your account. It could be a red flag of future problems if tax ramifications are not discussed initially, and as future changes are being made within the portfolio. This could be a sign that the adviser is thinking about their commissions more than your financial well-being.
The adviser is slow to return calls and follow up
Advisers are running a business and should clearly set the expectation of how often they will communicate with you. For the adviser to return the call by the end of the day or within 24 hours is standard business practice. Unless the adviser is on vacation, they should not be taking a week to return your call or reply to an email.
I would ask myself if they are not following up in a timely manner, what else are they not doing?
Before hiring a new adviser, spend some time familiarizing yourself with the industry. Conduct an internet search for potential advisers’ names and review their websites, including partner profiles, services offered, industries served, and any information for potential clients.
Following your initial discovery work, set up meetings and interview at least two advisers before signing an engagement letter. Remember, if it sounds too good to be true, it just might be.
Teri Parker CFP® is a vice president for CAPTRUST Financial Advisors. She has practiced in the field of financial planning and investment management since 2000. Reach her via email at Teri.firstname.lastname@example.org.