4 Things You Need to Know to Protect Yourself From Investment Fraud

The following is adapted from The Investor Protector.

Every year, investors file meritorious cases against brokers, investment advisers, and financial firms for their misconduct. And, every year, the stack of unpaid investor judgments piles up.?

What does that mean for you? If you’re an investor, you’re at risk of investment fraud. Even worse, if you do fall victim to an unscrupulous advisor and sue, there’s a real likelihood that even if you win your case, you won’t see any money from it.?

Statistics released by FINRA (Financial Industry Regulatory Authority) show that in a recent five-year period, 27 percent of cases won by investors went unpaid. All told, those unpaid cases were for a total of $199 million in awards. That means, in one out of every four cases, an investor hires an investment fraud attorney, files a case, wins the case, then never receives payment.?

It’s not right, but until policies change, this will keep happening. So, if you want to mitigate the risk this will happen to you, you need to roll up your sleeves and start digging to learn more about the financial health of the financial firm that you are entrusting with your life savings. Look at audited financials, review your prospective advisor’s credentials, do a background check before you hire an advisor, and—perhaps most importantly—know when to run away.?

I can assure you that they truly are the best way to protect yourself from falling victim to the bad advisors out there.

#1: Ask for Financials

All FINRA (Financial Industry Regulatory Authority) broker-dealers (in other words, the brokerage firms) are required to file, on an annual basis, audited financials. These filings are free and publicly available on www.sec.gov/edgar. You can ask a firm for their financials by requesting Form X-17A-5, also known as a focus report.

Densely packed with financial details, these documents contain the broker-dealer’s net capital reporting. The higher the reported net capital, the more money the firm has in the bank. If you’re considering entrusting $1 million to a firm that’s probably managing tens or hundreds of millions of dollars collectively and has available capital of roughly $500,000 with no insurance, this report is where you would find these unfortunate, yet helpful, facts.?

The net capital of broker-dealers in this country spans a wide range. Some have hundreds of millions of dollars. Some report a measly $50,000 of net capital. You may even find that some firms report a negative net capital and promise the SEC that additional funds will be available soon.?

These reported financials are vital for your analysis of a firm’s financial solvency, yet the average investor rarely looks into them. My advice: if you are considering hiring a broker (especially one who works for a smaller brokerage firm that isn’t a household name), do your research to make sure a firm has adequate financial resources to cover any claims before you hand over your hard-earned money.

#2: Review Assets Under Management

The roughly 13,000 investment adviser firms in the United States (with whom approximately 100,000 investment advisers are affiliated) are not required to annually report net capital and don’t have the same filing requirements as broker-dealers. Instead, they must file Form ADV—a report containing the amount of assets under management—annually with the SEC. You can find Form ADVs at advisorinfo.sec.gov.

If you’re considering working with an investment adviser, you need to review the Form ADV before hiring them. This is just like reviewing the broker-dealers financials we discussed above.?

Just as with broker-dealers, the assets under management vary widely among investment adviser firms. Some manage more than $30 billion, while smaller firms manage less than $50 million.?

These are undoubtedly large numbers, but it’s important to remember that this is the summation of client money managed, not the available funds of the investment adviser or the firm. This number can, however, indicate the financial well-being of the firm. A firm that manages $30 billion is going to make a great deal more in fees than one that manages $50 million, and they’re going to be much better equipped to pay any judgments awarded against them.

#3: Do a Background Check

Believe it or not, the investment industry is littered with advisors who have been the subject of dozens of customer complaints, convicted of theft, or are operating without a valid securities license. But there’s good news: you can easily check your prospective broker or advisor out with a free background check. Go to brokercheck.finra.org, enter the person’s name, and presto! A report with the information you need to know appears.?

This report provides information about the licenses they hold and the states where they are registered; prior customer complaints and whether they are resolved; terminations; regulatory actions and investigations; criminal charges; financial disclosures, such as bankruptcy filings or liens; and whether they have disclosed involvement in any outside businesses.?

You can refine your search by entering extra details, such as the firm name, city, state, or zip code. That’s especially helpful since, with hundreds of thousands of brokers and investment advisers working in the United States, it’s likely that a single name query will turn up multiple results.

This public resource is not 100 percent accurate. Brokers are able, in particular circumstances, to erase reportable events in a process known as “expungement.” When that happens, you won’t have access to that information in the broker’s public report. Still, it’s far better to know some information than nothing at all.?

#4: Know When to Run Away

What happens if you search for prospective financial professionals, and they don’t appear on BrokerCheck? Run away.?

This likely means they are not licensed, which means you should not give them any money. One of the biggest problems in the investment world is the existence of unlicensed fraudsters promoting the sale of unregistered securities.?

We field an overwhelming number of phone calls from people who lost money in investment scams working with random, unlicensed people they thought were trustworthy. It’s heartbreaking to tell victims that nothing can be done to recover their lost money.?

Unfortunately, that’s the reality. These scammers have no licenses and no financial institutions to which they are affiliated and, therefore, no feasible way to pursue the recovery of the losses on behalf of the investor.?

Knowledge is Power

The majority of financial advisors who are properly licensed and registered have no disclosures on their reports, although a small percentage have many. In my experience, investors working with brokers who have an alarming number of disclosures have no idea of either the disclosures or the reports that are available to them.?

Brokerage firms certainly don’t openly offer this information at the beginning of a relationship. You’re never going to hear, “Hey, we’ve been sued 27 times because of this broker. Are you sure you want to work with him?” It’s up to you to do your research and decide whether you’re willing to take a chance. Remember, knowledge is power.

A quick review of BrokerCheck can potentially save you heartache, uncertainty, and a lengthy legal battle to recover your money. Yes, firms should carefully watch their brokers and advisors, but ultimately, you can do some homework and look out for yourself. You can even set up a simple calendar reminder to help you remember to check up on your broker on an annual basis. If your search returns anything questionable, you may need to reevaluate your relationship with that person.?

For more advice on how to protect yourself from investment fraud, you can find The Investor Protector on Amazon.

David Meyer is the managing principal of Meyer Wilson, a national law firm he founded to represent investment fraud victims in their fight against deceptive brokers. Meyer Wilson is one of the nation’s leading investment fraud firms, recovering millions of dollars for clients throughout the last 20 years. David is currently the president of two bar associations: the Public Investors Advocate Bar Association and the Ohio Association for Justice. Included in The Best Lawyers in America?, David has also been twice named “Lawyer of the Year'' by the publication in his practice area and location. For more information about David’s investor claims law practice, visit investorclaims.com.