3 Ways to Avoid Financial Advisors Who Have Scammed Customers Before

Verify an advisor's track record first, then consider trusting them with your money.

Matt Krantz
Matt Krantz
Feb 17, 2019 at 5:00PM
Investment Planning

You check Yelp before hiring a plumber and scan TripAdvisor prior to picking a hotel. But do you look for negative reviews when looking for a financial advisor? You should.

Many folks seek professional financial help at some point, whether they're facing a major life milestone or getting help with their portfolios. The numbers tell the story: 40% of Americans used a financial planner during at least part of the past five years, according to the CFP Board. Employment of personal financial advisors is expected to grow 15% through 2026, largely driven by aging populations. This growth beats the expected 10% growth of financial professionals and 7% growth of all professions, according to the Bureau of Labor Statistics.

Man in business suit with fingers crossed behind his back is shaking hands with a woman in a business suit.

Image source: Getty Images.

Your goal should be to find a financial advisor you can truly trust. Pinpointing skilled and trustworthy financial advisors and avoiding those who have put other clients in a bad spot or steered people wrong in the past is a good place to start. But how can you know?

Developing a basic understanding of the financial advice industry and learning about free online tools where you can check the track records of financial pros can help you hire the best possible advisor. Before trusting anyone with leading your financial future, go through the below steps for avoiding shoddy advisors.

1. Learn if the advisor is a broker-dealer, investment advisor or commodities broker

Anyone can call themselves a financial advisor, which is problematic. It's up to you to find out enough about an advisor to determine if they have the proper licenses and registrations. This technical detail is a crucially important one, because the type of advisor you're considering will determine the registration they need and how you'll verify it.

Broker-dealers and Registered Investment Advisors (RIAs) face different standards due to how they've registered and whether they have fiduciary duty or not.

Brokers are only required to sell investments that are suitable for clients, while RIAs must act as fiduciaries, meaning they're required to put clients' best interests before their own. Brokers are often paid by charging commissions, while RIAs usually charge fixed rates or by the hour.

Brokers or advisors who trade securities like stocks, bonds, and mutual funds for clients must be registered with the Securities and Exchange Commission (SEC) and be members of governing body Financial Industry Regulatory Authority (FINRA). Registered investment advisors only have to register with the Securities and Exchange Commission. 

Many advisors can act as both brokers and investment advisors, and if that's the case, they must be registered with both the SEC and be a member of FINRA. Insurance advisors, too, can be investment advisors, brokers or both. Commodities brokers, firms, and advisors who conduct trade in derivatives like options must register with the U.S. Commodity Futures Trading Commission.

Before working with an advisor, learn which type they are. This distinction will make more sense as you dive into the databases.

2. Check the right database

Once you know what kind of advisor you're dealing with, it's time to do some digging. Your first step should be FINRA's BrokerCheck, a database of brokers and their firms.

Enter the name of the advisor you're considering. If the person is a broker, you'll find FINRA's information about them including the advisor's number of years of service, the exams they've passed, and state licenses they carry. Most importantly, you'll find their "disclosures," which include any disputes they've had with past clients. Read these closely, as they can often be red flags.

Sometimes, even if an advisor isn't a broker, they'll still appear in BrokerCheck. You may find a link from BrokerCheck to an investment advisors' registration at the SEC's Investment Adviser Public Disclosure (IAPD) website.

You can also search for investment advisors directly at the IAPD's site. While it's not as user-friendly as BrokerCheck, you can still check on the individual's credentials and find out if they've been in a dispute before by downloading their registration, or Form ADV. As for commodities brokers, you'll need to check the Background Affiliation Status Information Center (BASIC). You'll find the registration information on them, as well as any issues they've had with a client in the past.

If you can't find an advisor in any of these databases, beware.

"I would strongly advise against working with a 'financial advisor' who is not registered with one of those three entities," said Colleen Honigsberg, assistant professor at Stanford Law School, who studies advisor registration practices.

3. Dig deeper: Look for "expungements"

You've done your homework and your potential advisor is properly registered. Good. They have no major past disciplinary actions. Ever better! But to be safer still, dig even deeper.

Don't just search the individual's registration, but also check their firm's registration. Each of these databases allows you to search by the advisor's name or by the firm's name. Look for previous disciplinary actions taken against the firm. Even if an advisor checks out, it's a red flag if their firm has a bad history, as dubious practices may be broadly practiced, said Honigsberg.

Be especially wary of advisors with erased, or "expunged," charges. Finding expungements is more tedious, but possible by searching FINRA's Arbitrations Online Database

FINRA allows brokers to contest disciplinary actions, and which can be expunged from their BrokerCheck records if their reason is compelling enough. These actions are more common than you might realize, said Honigsberg. Between 2007 and 2016, there were 6,600 expungement attempts, which represents more than a tenth of all alleged misconduct reported. Of those, 70% were successfully erased, according to a paper co-authored by Honigsberg

Expungements are surprisingly common:

Year Number of expungements requested Percentage of expungements granted
2016 549 72.9%
2015

505

68.7%
2014 642 73.5%
2013 751 67.1%
2012 854 73.2%
2011 822 76.4%
2010 821 70.5%
2009 878 66.5%
2008 401 57.1%

Data Source: Colleen Honigsberg, Stanford Law School.

It's also a good idea to check FINRA's list of individuals it has barred, who are listed in a regularly updated table.

Lastly, you should lean on advisor certification organizations who have done the hard work for you in terms of researching these professionals. The Certified Financial Planners (CFP) Board administers the Certified Financial Planner designation. It's certainly reassuring to see the CFP letters behind an advisor's name because extensive education and testing is required to earn that mark.

But always verify that an advisor claiming to be a CFP has actually passed the requirements on the CFP Board's website. Additionally, the CFP Board publicly calls out some advisors and firms who have failed to meet its standards, so search the site for any mention of the advisor or firm you're considering.

An advisor can be an invaluable guide as you strive for your financial goals. Make sure you can trust them first.

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