Put brokers, financial planners, and asset managers on the spot

Ask investment professionals questions that creep into uncomfortable territory and you'll be glad you did. Go ahead and say it: "How do I know you won't steal my money or defraud me?" How quickly and sincerely do they answer such a question?

In the wake of well-publicized frauds by Bernie Madoff and Allen Stanford, investors have expressed alarm and distrust, but many still take little action at the outset to make sure they're working with a professional they not only trust with their life savings, but that they genuinely like.

The Madoff case involved high net-worth and even famous clients who largely relied on word-of-mouth recommendations without running their own checks. That's a tough lesson that translates to all investors no matter the size of their nest egg. Of course, the tragedy of fraud is that sometimes even the most respectable of financial professionals can fall from grace and fail their loyal clients. Investors are also relying on regulators to do their jobs.

Claiming ignorance is not an excuse for skipping your homework. "It's the information age, but you'd be surprised at how little average investors use even basic Internet searches to pre-screen investment professionals," says Randy Shain, author of Hedge Fund Due Diligence and founder of BackTrack Reports, a New York-based firm that specializes in investigating the backgrounds of hedge funds, private equity investors, and financial services professionals.

Many of the early screening questions investors should be asking financial professionals, and themselves, fall under the "common sense" category. Yet that doesn't guarantee that investors are doing the asking.

1. Ask the manager to explain his or her strategy. If the explanation sounds too complicated or the manager can't explain it in layman's terms, be wary.

2. Get to know the manager and his or her personality before you commit.

3. Ask for a resume and even consider calling former employers to ensure accuracy. (Yes, you are allowed to do this.)

4. Ask whether the professional tends to work with people your age and at your income level.

5. Ask whether there have been regulatory inquiries into the individual or the firm, noting that if they fudge the truth, you will be able to check. This can be a good measure of honesty very early in the process.

6. Ask if the firm will cover fraudulent or even unethical actions by an individual it employs.

And the biggie, which you should ask yourself: Do these returns or other benefits sound too good to be true? Investors get caught up in marketing materials that show track records. But they may not ask the tougher questions of a manager or advisor: What's the negative scenario? What's the chance the worst will happen?

Knowing the experience level of your financial professional is important. During the boom real estate and credit years earlier this decade, some professionals were chasing new licenses with haste, combining a mortgage business with insurance and general financial planning. On top of that, some professionals operating under the broad umbrella of "financial services" even snagged a real estate license and were showing and selling homes. Some professionals can handle it, but others spread themselves too thin.

"The reality is there's not such a huge barrier to entry to financial services," says Shain. The barrier then lies with you and your decision to let a particular professional handle your money.

Three agencies are a good starting point for screening: the Financial Industry Regulatory Authority (FINRA), the Securities and Exchange Commission (SEC), and the National Futures Association (NFA).

To check the background of a broker, use FINRA's BrokerCheck or call (800) 289-9999. For an investment adviser, use the SEC's Investment Adviser Public Disclosure website.

You may also opt to call your state securities regulator. Contact the North American Securities Administrators Association at 202-737-0900.

To check out investments, ask first: Is this investment registered with the SEC or with my state securities regulator? Use the SEC's EDGAR database of company filings or call your state securities regulator.

Also check out NFA's Background Affiliation Status Information Center, or BASIC.

 

 

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