More On Legal & Compliancefrom The Advisor's Professional Library
- RIAs and Customer Identification Just as RIAs owe a duty to diligently protect their clients privacy and guard against theft, firms also play a vital role in customer identification. Although RIAs are not subject to an anti-money laundering rule, securities regulators expect advisors to address these issues in their policies and procedures.
- Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
Financial advisors are buzzing about the SEC's announcement of its $30 million fraud case against New York-based "advisor to the stars" Kenneth Ira Starr, and a lot of what they're saying goes to the heart of current issues such as fiduciary duty, transparency and custody rules.
When asked what advisors should tell their clients in the wake of the fallen Starr, brokers, RIAs, and lawyers interviewed by InvestmentAdvisor.com all pointed to the importance of using cold, hard facts to reassure clients about the safety of their assets.
"They should tell their clients that they're using a third-party custodian," said Susan John, chair-elect of the National Association of Personal Financial Advisors (NAPFA). "They should tell them to review the statements they receive from their third-party custodian against the statement they receive from their advisor."
John added that if clients are anticipating purchase of a security that's not publicly traded, they should both review and understand the offering documents with their advisor before committing to a purchase. "And it would also be a good idea to have a third party such as their tax advisor or an attorney review.
According to the SEC charges, Starr pulled the wool over his clients' eyes by arranging many limited partnerships for a small pool of "qualified" investors, an arrangement that allowed him to hide his financial dealings. The SEC charged Starr on May 27 with fraud and sought an emergency court order to freeze his assets after he allegedly stole $7 million in client money to buy a multimillion-dollar apartment.
"The concerns that clients have are, 'Are my assets safe?'" said Thomas Giachetti, a Stark & Stark attorney who serves as chair of the Princeton law firm's securities group and is a NASD registered representative and former investment banker. "It's very simple. All clients that have accounts at major custodians have signed an agreement, and the advisor's written disclosure agreement should make clear that it does not maintain physical custody of the assets, but rather that they are maintained at the designated qualified custodian. And last, each client generally has direct electronic access to their account at the qualified custodian and should receive a monthly or quarterly statement directly from the custodian confirming the integrity and market value of the assets."
Even if there isn't any wrong-doing, people and institutions make mistakes, which is why everyone should check all credit card, bank, and brokerage statements, noted Atlanta-based certified financial planner Bobbie Munroe of Fraser Financial. "That said, I know, and I suspect most advisors do, which clients are unlikely to even open theirs. That puts a big target on their backs for would-be wrongdoers," Munroe said.
Peter Cowenhoven, a principal at Delessert Financial in the Boston area, which manages about $330 million of assets on a fee-only basis, said the Starr case is a good argument for regulation.
"The biggest message we impart regarding Madoff, Starr or other frauds is that it is an absolute no-no to hire a small advisor that custodies assets in-house," Cowenhoven said. "We make it very clear that our clients' accounts are held through third-party custodians such as Schwab or Fidelity in the client's name, which are financially strong and well regarded nationally. Clients typically don't understand the difference between custody and the advisory service."
In the end, the Starr case has made the issues of transparency and fiduciary duty timelier than ever, said Jay Hutchins, a CFP with New Hampshire-based Wealth Conservatory.
"The whole issue of fiduciary duty and accountability has gone public," Hutchins said in an e-mail. "Folks are learning about the difference between brokers and advisors; about fee-only versus commission and fee-based. They are also beginning to get the message that they cannot rely upon the government or SROs to protect them from thieves. This is particularly difficult for folks who are really financially unsophisticated or declining (generally due to age) in cognitive capacity. Who can they trust? My answer is simple: no one. The attorney should be watching the accountant, who should be watching the investment advisor, who should be watching the custodian. This is not a personal affront to anyone, it is simply good business."Read a story about the SEC's fraud case against Kenneth Starr from the archives of InvestmentAdvisor.com.