What does this mean for the average investor who doesn't have the resources of the SEC? In my opinion, due diligence isn't just about checking some one's past. Yes, a felony conviction is very important even though it happened in the past. What's even more important is the future. The best way to decide whether to consider a financial or investment advisor is to look at whether they are being held to the fiduciary standard. When an adviser has a fiduciary duty to his or her client, he or she must act in the best interests of the client even above his or her own self interests. A Certified Financial Planner„¢ professional (CFP®) voluntarily accepts the fiduciary responsibility for his or her clients by choosing to be certified by the Certified Financial Planner Board of Standards, Inc. A Registered Investment Adviser (RIA) involuntarily accepts the fiduciary standard because it is required under the Advisers Act of 1940. A Registered Investment Adviser who is also a CFP® certificant must meet the fiduciary standard to his or her clients under two authorities. This is a very good start to choosing an advisor.
The next question to ask is whether the RIA investment adviser representative is also a registered representative with FINRA. A registered representative licensed with FINRA only needs to meet the suitability test on the day the investment is sold. There is usually only one reason why individuals are licensed with FINRA and licensed under the Advisers Act of 1940 as Investment Advisers: Commissions. RIA firms and their investment adviser representatives may not accept brokerage commissions. Advisers are required to take their advisory fees in a fully disclosed manner. This ensures that the client knows exactly what the RIA firm will charge them before they sign the portfolio management agreement. This also ensures that the Investment Adviser does not have a financial reason to churn the client because the advisory fees aren't based on transactions. Most advisers that are licensed both as registered representatives and investment adviser representatives do so because they would like to continue to sell and receive commissions on variable insurance products (variable annuities, variable life insurance). Independent RIA firms and their advisers (who are not FINRA licensed) can continue to work with variable insurance products that are no-load but they can't accept any kind of compensation on those variable products. They can include the variable insurance assets under the client's investment advisory agreement asset total for purposes of calculating the asset based fee.
We've also learned that bigger is not always better or safer! Take AIG, Bear Stearns, Citigroup, Washington Mutual, Wachovia, Lehman Brothers and the list keeps growing. We've also learned that the age of the firm is not a reliable factor in predicting how long they will be in business in the future. The only way to alleviate (you can never really eliminate all of it) this risk is to hire an independent financial or investment advisor who has no affiliation with any one investment, insurance or banking company. The adviser should also have a qualified custodian actually custody the client's assets. The qualified custodian should be totally independent of the financial or investment adviser. I believe the safest qualified custodian is a trust company. A trust company is not a securities broker-dealer and its only function is to custody assets for its clients. You'll notice that I refer to financial advisors and investment advisers. This is because they are not easily interchangeable. More on this subject in another post!
After reviewing everything we've discussed, the final determination in choosing a financial or investment adviser should be his or her credentials, experience and rapport that the client has with the adviser right from the start. Is there chemistry between the adviser and the client? Does the client feel like the adviser is accessible? Madoff apparently did not welcome any calls or questions from other advisers or clients. This is a bad sign. Will the client be passed off to the adviser's staff? This is usually a sign that you've hired an investment adviser and not a financial advisor. Would you hire the best attorney in town, pay the top billing rates and then speak to a staff/team member when you had questions?
The best way to choose a financial or investment adviser is to look at his or her credentials, assess their experience, consider their independent status, consider if they are dually licensed (both with FINRA and under Advisers Act), review their recommendations and assess how well you'll interact and communicate going forward. A client's top priority should be to plan to reach goals not to plan to achieve a certain investment portfolio return. An investment adviser is concerned about your portfolio return as compared to the market or an index. A financial advisor is concerned about how you and your family will achieve your short-term and long-term goals as well as your portfolio returns.
