Who can you trust? Finding an honest broker.

As much as any industry in America, the financial services industry depends upon trust.   Stockbrokers, especially, have always conducted much of their business over the telephone.  When you agree to buy a stock, for example, your broker trusts that you and every other customer will put a check in mail to pay for it. 

And so, too, do consumers have a right to trust that their brokers, insurance agents, bankers and the host of other professionals in the financial services industry will act like the professionals that they profess to be. The financial markets are heavily regulated, and everybody in it is expected to play by the rules.

That, of course, doesn’t mean there aren’t a few bad apples at even the best firms, or that there aren’t people who go out of their way to prey upon unsuspecting investors.  The question is:  how do you spot a broker who may potentially be a problem?

The SEC, NASD and virtually every other consumer website would send you to the NASD’s Brokercheck, which accesses the NASD’s Central Records Depository. This is where the NASD keeps records about customer complaints, arbitration claims and regulatory actions that are filed against any stockbroker. 

Public access to this site was supposed to help consumers make informed choices about stockbrokers.  And we recommend that you do, indeed, check this site, before you do business with any broker, and periodically thereafter.  But, beware, this site doesn’t tell the whole story.

Just because a broker’s record is clean, doesn’t mean that the broker has done everything right. Many firms are sloppy about reporting customer complaints, or mis-categorize complaints into non-reportable categories.  And many reportable items only stay on the broker’s public record for a short time, falling off after two years.

Worse, the NASD and SEC have condoned a system of expungement, which has cleaned the records of some of the worst offenders.  Let’s say a broker has three customer complaints that go to arbitration. The NASD created their Broker-check system specifically so consumers would have exactly this type of information.

But each of the cases settles at the last minute. As part of each settlement, the complaining customer agrees to expunge the record of the broker.   So the broker had three customer complaints that the firm paid to settle, and the next customer who checks on the broker sees a clean record.  Be careful. 

Investment advisors have the potential to be worse because the NASD doesn’t police this group, and the SEC audit system miss a great many firms.  Investment advisors, it seems that they frequently fail to report customer complaints or arbitrations, even though the SEC requires reporting of these events and specific disclosure to potential customers.

People want a financial professional they can trust.  Many people seek out someone they believe they can trust, who happens to be selling investments, rather that someone who really knows about investments who they don’t necessarily know well enough to trust.  This, too, can be a problem.  

Year in and year out, the FBI includes affinity fraud, among its top ten investment scams. These scams prey upon members of identifiable groups, such as religious or ethnic communities, the elderly, or professional groups. The fraudsters who promote affinity scams frequently are - or pretend to be - members of the group. They often enlist respected community or religious leaders from within the group to spread the word about the scheme, by convincing those people that a fraudulent investment is legitimate and worthwhile. Many times, those leaders become unwitting victims of the fraudster's ruse.

These scams exploit the trust and friendship that exist in groups of people who have something in common. Because of the tight-knit structure of many groups, it can be difficult for regulators or law enforcement officials to detect an affinity scam. Victims often fail to notify authorities or pursue their legal remedies, and instead try to work things out within the group. This is particularly true where the fraudsters have used respected community or religious leaders to convince others to join the investment.

Many affinity scams involve Ponzi schemes or pyramid schemes, where new investor money is used to make payments to earlier investors to give the false illusion that the investment is successful. This ploy is used to trick new investors to invest in the scheme and to lull existing investors into believing their investments are safe and secure. In reality, the fraudster almost always steals investor money for personal use.  Both types of schemes depend on an unending supply of new investors - when the inevitable occurs, and the supply of investors dries up, the whole scheme collapses and investors discover that most or all of their money is gone.

So, who can you trust? Yourself. Investigate. Check out regulatory filings and references.  Ask a lot of questions.   Understand enough about the investments you are making to spot inappropriate investments or other problems, early.  And keep on top of what is happening in your account.  If you see losses that you didn’t expect, get out. 

Remember:  This is clearly one area where “an ounce of prevention will be worth a pound of cure”. Getting the wrong person to advise you about investments can be very, very expensive.