Don't let your investment adviser rip you off

Plus what you need to know if you've been burned by a broker

Consumer Reports Money Adviser: April 2012

You might not have lost money to Bernie Madoff or in Jon Corzine’s failed company, but small investors can get burned by investment advisers just as easily as the mega rich.

Consider these recent examples: An arbitration panel slapped Merrill Lynch with damages of about $880,000 for putting a client in her 80s into an all-stock portfolio. Raymond James Financial Services had to pay an arbitration award of nearly $1.8 million to an 87-year-old client after the firm took the client’s $3.5 million out of bond funds and put it into variable annuities and a variable life insurance policy.

Even investments that might seem innocuous could be wildly inappropriate. “It is huge when an 85-year-old single widow with no children close by gets sold a variable annuity with a 10-year surrender charge, leaving her little or no resources for daily living or long-term care,” says Mary Gibson, a certified financial planner in San Juan Bautista, Calif.

To protect yourself against such chicanery, here are some steps you can take:

Be on watch for possible signs of fraud

Large numbers of trades, unexpected fees, or a mysterious drop in your portfolio’s value are some of the most obvious signs that you’re being fleeced. “Churning” occurs when a broker makes successive trades in your account to generate fees. “Brokers often tend to churn accounts in December to meet year-end commission goals,” says Andrew Stoltmann, a securities attorney in Chicago. Common signs of churning are frequent trading in a single stock, or trading of mutual funds, bonds, or other non-equity holdings that are typically meant to be held long-term.

Some of the most abused products include variable annuities, private or unlisted real-estate investment trusts, and other alternative investments. Be cautious if you’ve never heard of a type of investment and it’s not listed on an exchange or anywhere else you can look it up and track its movement. Many swindles, like Madoff’s, are private investments that escape notice because there’s little or no oversight. Michael Kalscheur, a certified financial planner in Indianapolis, says that for the first three years of working with an adviser, “a good rule of thumb is to never buy anything you can’t find in The Wall Street Journal.”

Other warning signs may be more subtle. For example, if your adviser has a one-size-fits-all approach to investing, there’s a chance your asset allocation might not be a good match for your age or risk profile. The Merrill Lynch broker mentioned earlier put clients, regardless of age, into 100 percent stock portfolios.

Also be on alert for certain behavior. Did your broker, agent, or adviser seem unwilling to give you references when you signed up or appear evasive about answering basic questions? Did he or she fail to provide a prospectus or other background information on investments? Did the adviser make a recommendation that sounded too good to be true? If you’re not sure whether your broker behaved improperly, you might want to consider getting a second opinion from a fee-only financial planner.

Gather relevant documents

Collect all your monthly statements and any other correspondence, including e-mail, you’ve had with your broker or adviser. Review statements for inconsistencies and unusual fluctuations in the value of your investments. If you have an independent financial adviser, check that your statements are sent from a third-party custodian and are not prepared by him or her.

You’ll also need to find the contract you signed when you opened the account and any other papers describing the adviser’s services. If you use a registered investment adviser, you might have an investment policy statement that details what types of investments are appropriate for you as a client. You may have signed a limited power of attorney giving your adviser authority to make trades in your account and withdraw fees. Check the effective dates of the contracts; for some investments, such as annuities and insurance products, there is a 30-day look-back period during which you can cancel.

Determine what is actionable

Losing money isn’t in itself a cause for action against your broker. You need to show that your losses were the result of inappropriate behavior or a disregard for your stated preferences, or that the investments recommended were unsuitable.

If you’re defrauded by your stockbroker or your brokerage goes under, the Securities Investor Protection Corp. will cover up to $500,000 worth of missing securities, including up to $250,000 in cash. Many brokerages have additional coverage. Scottrade, for example, buys insurance that brings customer protections up to $25 million. TD Ameritrade insures up to $150 million per customer, and Fidelity insures up to $1 billion. Some companies also have federally insured bank accounts that hold the cash in your account.

Some financial products fall outside those protections. Variable annuities are insurance products, which are not covered by the SIPC or the Federal Deposit Insurance Corp. Check with your state’s insurance department to see what limit it sets for insuring annuities. Most states insure either $100,000 or $250,000, though a few go as high as $500,000.

Figure out where to file a complaint

If you think you’ve been victimized, your first step should be to contact your adviser or broker in case there’s been an honest mistake. If you don’t get satisfaction, talk with a branch manager or compliance officer at your adviser’s company, and send a letter explaining your concerns. If you need to go beyond the company, determine which regulatory agency has jurisdiction over your adviser. (See “Where to Complain,” below.)

You can also hire a lawyer to write a letter to the firm detailing your complaint. Tom Orecchio, a wealth manager at Modera Wealth Management in Westwood, N.J., says that usually gets the company’s attention before a formal complaint is filed. According to the Financial Industry Regulatory Authority, or FINRA, 79 percent of complaints are resolved through means other than arbitration, such as by direct settlement between the parties or by using mediation.

Consider mediation or arbitration

If all the parties agree, you can take your case to mediation, an informal, nonbinding process in which an impartial mediator helps you and the company find a mutually acceptable solution to the dispute. Mediation can be faster and less expensive than arbitration or litigation, according to FINRA, which provides both arbitration and mediation services. Many brokerage or advisory contracts require that you agree to arbitration if the conflict can’t be resolved through mediation. 

When you go to arbitration, both you and your brokerage company will have the right to select the members of an arbitration panel, which will have one to three members depending on the dollar amount at issue. You’ll be able to find out background information on each one, and you can reject anyone you think has a conflict of interest. You’ll probably want to have a lawyer represent you.

On average, arbitration takes about a year and clients win close to half of the cases. If you win, you might not get as much as you’d hoped, and your attorney will take a percentage—often a third—of the award, though some law firms charge hourly or flat fees. To find an attorney, contact the Public Investors Arbitration Bar Association.

It can be difficult to challenge an arbitration award that you think is unfair. You would generally need to file paperwork with your state court within three months of the decision, but check your individual state’s rules.

Where to complain

Several government agencies and industry groups have oversight of investment pros. So first you need to determine the appropriate regulator with whom you should file your complaint.

If your complaint involves a brokerage or a securities product, such as stocks or mutual funds, contact the Financial Industry Regulatory Authority (FINRA). You might also want to file a complaint with the state securities regulator. To identify yours go to the website of the North American Securities Administrators Association and click on “Contact Your Regulator.”

If your dispute is with an investment adviser, contact the Securities and Exchange Commission. If your dispute involves a certified financial planner, contact the Certified Financial Planner Board of Standards. You can also file a complaint with your state securities regulator.

If your problem has to do with an insurance product or annuity, contact your state insurance department, which you can find on the website of the National Association of Insurance Commissioners (click on “States & Jurisdiction Map.”)


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