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6 ways to keep ahead of fraudulent financial advisers

April 28, 2016

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

Financial advisers and fraud

A great deal of time and energy goes into trying to find an edge in investing. Sometimes though, the smartest move you can make is just avoiding financial mistakes. For example, not getting ripped off is a good start.

That is easier said than done. Financial fraud is big business. Unfortunately, the profit motive in separating people from their money is strong enough to inspire a tremendous amount of effort and ingenuity. A big part of the problem is that people are most vulnerable when they are seeking help, possibly playing into the hands of unscrupulous financial advisers.

Of course, there is nothing wrong with asking for help. Just don't act helpless when you do it.

6 things to look for to avoid financial fraud

Here are ways to avoid working with a potentially bad financial adviser:

1. Recognize the risks of financial fraud

Most people are aware that financial fraud exists, yet they naively think it won't happen to them. Recognizing just how prevalent this kind of fraud is might help people realize the odds are pretty good that someone in the financial profession will try to take advantage of them at some point.

A recent paper, "The Market for Financial Adviser Misconduct," found 7 percent of registered financial representatives were disciplined for misconduct between 2005 and 2015. Out of a population of 1.2 million advisers, that means that roughly 84,000 were found to have mistreated their clients.

That's a large number of people who are potentially trying to reach into your pockets. When you consider that many wrongdoers commit more than one violation, and that not all violations are caught, this means that any financial services customer faces a pretty good chance of being a victim at some point.

2. Check the record of advisers

Since financial fraud is so prevalent, the worst thing you could do is make it easy for one of those crooked advisers. The Financial Industry Regulatory Authority (FINRA) has a database that can show you the disciplinary history of any registered financial professional.

You would be wise to check out this database before working with any adviser, because those that have done wrong in the past have a tendency to commit further violations in the future. Repeat offenders break the rules five times as often as the average financial adviser.

3. Watch out for firms as a whole

Financial fraud is often not just the action of an individual. It can also be a sign of broader, institutional laxness. There are some firms that have way more than their share of violators. For example, the paper found that Oppenheimer & Company was the worst firm in this regard, with nearly one in every five of its advisers having a negative regulatory history.

The lesson, then, is to look at both the individual and the firm. Even if the individual you are dealing with has a clean record, frequent violations by the firm can be a sign of low hiring standards and poor compliance controls.

4. Steer away from rushed investment choices

A tell-tale sign of a scam is when someone tries to rush you into a decision. Never make investment choices in a hurry. Take the time to think about any decision, and perhaps talk to others about it. The more someone tries to pressure you to hurry up, the more you should slow things down.

5. Don't get greedy about high returns

One reason people fall prey to investment scams is they are trying to get something that is too good to be true. If an investment proposal offers returns that are way out of line with what alternative choices are offering, be careful you don't get greedy. Instead, you should get suspicious.

6. Re-evaluate your current investment program periodically

If you are regularly solicited by financial advisers trying to get your business, use this to your advantage. Periodically let a potential adviser review your current investment program. While you should keep in mind that the person trying to get your business has an incentive to poke holes in that program, it is also possible they will be able to raise some timely red flags about what your current adviser is doing.

The financial industry is highly-regulated, but that should not give you a false sense of security. Even after financial advisers commit a violation, they often remain active in the industry. More than half of violators keep their jobs even after committing a violation, and of those who do get fired, 44 percent find a job with another financial firm within a year.

In short, the regulators are looking out for you to some extent, but not as well as you can look out for yourself.

Comment: How do you protect yourself from fraudulent financial advisers?

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