Top Financial Advisor Scams and How to Avoid Them
Bernie Madoff, the once highly regarded investment advisor turned Ponzi swindler, exemplifies the dark underbelly of the financial advisor field. At first, Madoff appeared to be the perfect financial professional for his clients. The rich and elite had no idea their stellar returns were funded by incoming Madoff investors. If the wealthy elite can get snookered by a financial advisor, what’s to protect the average individual from the same fate? Beware of financial advisor scams and learn how to protect yourself.
According to the Securities and Exchange Commission (SEC), “A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk.” The Ponzi scheme is a classic scam and incorporates components of other scams as well. The investment proceeds in this classic scam are simply the new investors monies doled out to existing clients. Without fail, the initiator of the Ponzi scheme siphons money off to fund an extravagant lifestyle. (For more, see: Biggest Stock Scams.)
The affinity fraud targets a particular group with its ploy, frequently in conjunction with a Ponzi scheme. This scam is effective because we tend to trust other members of our “tribe.” The cohort group might share the same religion, cultural background, or geographic region. This affinity targeting makes gaining new participants in the scam easier because there is a built in level of trust. To further con the participants, the scammer might belong to the group or pretend to be a member.
The following affinity scam-Ponzi scheme targeted Persian-Jewish community members in Los Angeles. Shervin Neman raised more than $7.5 million for investment in his so called hedge fund. He promised that the fund invested in foreclosed real estate which would be quickly bought and then resold for a profit. In reality, Neman used the money raised to fund his extravagant lifestyle and pay off new investors. (For more, see: Affinity Fraud: No Safety in Numbers.)
Misrepresentation of credentials is another way financial advisors scam the unsuspecting public. The field of financial planning is ripe for malfeasance because there is not one particular credential or licensing requirement to practice. In fact, there are dozens of financial planning designations such as certified financial planner (CFP), registered investment advisor (RIA), certified public accountant (CPA), chartered financial analyst (CFA) and many more. The public may not be aware of the designations, ethics, or requirements for a certification and thus may be receiving advice from someone with no education, experience, or background in the investment advising field. It’s quite easy for someone to hang up a shingle and start doling out advice. The scammer can then close up shop and walk away with the proceeds or swindle the unsuspecting clients with fake products. (For more, see: The Alphabet Soup of Financial Certifications.)
Promising or even guaranteeing higher than market returns for your investment is a common trick. The popular axiom, “if it’s too good to be true, it probably isn’t” is usually accurate. It is unlikely that an advisor can offer a client returns that are unavailable to the rest of the world. This scam preys upon the clients’ greed and dreams of easy money. If an advisor offers or guarantees returns higher than 12-15%, it is likely a scam. For example, over the last 85 years the U.S. stock market has averaged approximately 9.5%. This return is not a “safe” return, but quite volatile meaning there were many negative return years over the decades.
In 2012, owners of a Dallas voice over Internet Protocol (VoIP) offered Christian investors, affiliated with a private school, returns as high as 1,000% per year to invest in their company, Usee, Inc. As one would expect, they have been prosecuted by the SEC. (For more, see: Online Investment Scams Tutorial.)
Many stock brokers have been charged with the “churning” scam. Since traditional stock brokers are paid when their clients buy or sell a security, they can be motivated to make unnecessary stock trades to pad their own pockets. The churning scam involves the financial advisor making frequent buy and sell trades, which not only costs the customer in commissions, but usually results in sub optimal investment returns.
There are many other investment scams as well as additional varieties of the schemes mentioned above. Next, find out how to avoid falling prey to a shady investment advisor. (For more, see: 4 Dishonest Broker Tactics and How to Avoid Them.)
Vet and verify the financial advisor's background. Find out if the advisor has received any disciplinary action or complaints. These websites help uncover unscrupulous advisors: www.finra.org/brokercheck, www.adviserinfo.sec.gov, www.nasaa.org, www.naic.org and www.cfp.net.
Ask how the advisor is compensated. Is it by commission, assets under management, fee, or a combination of payment structures? If the potential financial advisor is unclear or hedges when asked about fees, walk away. Ask for the advisor's ADV Part II document which explains the professional's services, fees, and strategies. This document should also be available on the SEC's web site in the adviserinfo.sec.gov section. (For more, see: Find the Right Financial Advisor.)
Also ask for names of satisfied, long-term clients. Although a good idea in theory, this protection has a downside, as the referrals could be prescreened or friends of the advisor.
When discussing investment ideas and strategies, ask about the advantages and disadvantages of each recommendation. There are no perfect investments, and every financial product has a down side. If the advisor is unclear or you don’t understand the investment, it may not be for you. Although, you may consider gathering a second opinion. (For more, see: OMG, I Think I've Been Scammed!)
Do not give the financial advisor a power of attorney or ability to make trades without first consulting you. Require every financial action to be cleared with you first. Further, make certain you receive statements not only with the advisor’s letterhead, but also from the custodian, or financial institution which holds your money and investments.
THE BOTTOM LINE
Do not act in haste. Always take time to think about or “sleep on” a financial decision. An attempt to rush you should be a red flag. If there’s a good opportunity today, it won’t go away tomorrow. Don’t be afraid to walk away if an offer doesn’t seem right.