Checks and Balances Curb Abuses

A system of financial advisors, broker-dealers, third-party custodians and regulators creates checks and balances to curb abuses. Here’s what investors should look for.

The large, high-profile fraud cases against Bernard Madoff and R. Allen Stanford have many investors concerned that what happened to clients of those firms could happen to them. The organizational structure of those firms permitted them to operate outside many of the checks and balances created by regulatory agencies to prevent these types of abuses. Understanding how those checks and balances work can help you discriminate between legitimate investment services businesses and those operating on the fringes.

Custody of Assets – One of the key components to protecting investors is the use of an independent third-party custodian to hold investors’ assets. When you make an investment or transfer assets to your account with your financial advisor, those monies and securities are never in possession of your financial advisor or his firm. Your checks for investments are made to the third-party custodian. In the case of Bernard Madoff, investors made checks payable to his company or him personally.

Statements and Confirmations – Another role of the independent third-party custodian is to produce the confirmations and statements that document activity in your account and to distribute those documents to you. Your financial advisor’s broker-dealer periodically audits account statements to ensure that the client address, securities positions and transactions match with their records. As a final check, your financial advisor’s firm reviews client statements as well to ensure accuracy of the data reported by the custodian. Because Madoff did not use an independent custodian, his firm was able to create bogus statements, and clients or employees who asked questions were simply asked to leave.

Regulatory Oversight – Investment firms, broker-dealers and third-party custodians must comply with the rules and regulations of the Financial Industry Regulatory Authority (FINRA), which conducts periodic audits of broker-dealers and their representatives. In addition, fee-based advisory firms fall under the auspices of the Securities and Exchange Commission (SEC), which also conducts periodic audits of investment advisory firms and their representatives. Broker-dealers and their representatives must also comply with the rules of state securities commissions for each state in which they do business.

Broker-Dealer Oversight – To ensure compliance with state and federal regulatory bodies, broker-dealers have multiple layers of supervision and auditing to ensure their representatives comply with all regulations as well as the broker-dealer’s internal policies. Again, the broker-dealer and your financial advisor never have possession of your monies or securities – those are held by the custodian. Madoff acted as his own broker-dealer, allowing him to basically monitor his own business, via his brother and niece acting as compliance officers. Your financial advisor and his or her firm understand the importance of ensuring the safety of your investments against misappropriation. They should welcome any questions you may have about their company, their broker-dealer, their third-party custodian or regulatory agencies. You can do your part by closely reviewing your transaction confirmations and account statements and promptly bringing any questions to your financial advisor’s attention. You should settle for nothing less than complete transparency in his or her relationship with you. Article by Securities America

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