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Industry Spotlight > RIAs

Rebuilding Trust

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Clients of RIAs want to know more now about the health of their RIA’s custodian, Tibergien says, something that may not have commonly come up before. But just about every client knows by now about the Madoff scandal, and while they may not understand just what a custodian or an auditing firm does, they do get the fact that there was little outside or third-party light shed on the operations of Bernard L. Madoff Investment Securities LLC’s broker/dealer or his RIA, which dealt with clients. It has been widely reported that Madoff’s firm produced its own client statements and did not have a third-party custodian. In addition, they reportedly used a very small accounting firm.

While Tibergien says there are many “advisors who produce their own statements,” obviously a statement from a third-party custodian or clearing broker can add a great deal of assurance and value in light of what allegedly happened at Madoff’s firm.

Overall, Pershing Advisor Solutions’ “clients remain confident about their approach to investing,” says Tibergien, but “less so” about business management and overhead. The malaise that has afflicted the global economy is affecting registered investment advisors as well. But it’s not simply problems with the markets and the economy that are issues for RIA firms; the scandals that have come to light over the past couple of months are making RIAs redouble their efforts to detect wrongdoing within their own firms. For that, he says, one of the things PAS clients are taking advantage of is Pershing’s anti money laundering (AML) technology–the same kind of technology, Tibergien notes, that was the undoing of “Client Nine,” better, if briefly, known as New York State Governor Elliot Spitzer.

Something else that small firms face in difficult times is a higher risk of “bad acts during a bad market,” Tibergien says, as employees or principals feel the stress of their own financial situation. An employee who is let go might retaliate, potentially sabotaging their former firm. That’s just one example of the “vulnerability of small firms,” he explains.

One thing that has surprised Tibergien in the current environment is that some RIA firms are “resisting the notion of regulation or supervision,” possibly in the form of FINRA monitoring RIAs as they do brokers. “But if I were an RIA, the issue would be how to restore trust in the RIA industry,” he says, suggesting “peer review” by firms that are not in a directly competitive position, “independent verification of books and records,” and “mock-audits” of the SEC-type examination. It’s an issue of rebuilding trust in the era of “Madoff, Lehman and Bear Stearns,” he says.

What is the role of the custodian in this environment? Tibergien says that Pershing takes an active role in monitoring behavior–not supervising, but monitoring–using systems that monitor patterns and look for outliers and other flags that are designed to alert PAS to untoward behavior. Even so, he adds, “fraud is really hard” to detect. However, he adds, “every criminal makes a mistake.” It might be using an unusually high number of social security numbers or processing an unusual number of powers of attorney, Tibergien asserts. It’s “not uncommon for Pershing to terminate relationships” with firms or to turn down a firm that wants to start a relationship if something seems off. It’s up to the advisors to have their fiduciary relationship with their clients, but if the custodian doesn’t perform its duties to monitor what’s happening at the RIAs and to “know” its RIA customer, then the custodian is “vulnerable.”

Due diligence is another area that is likely to be under the regulatory microscope after the scandals of last fall–with Dreier, Madoff and other alleged schemes coming to light. Can custodians help with that? PAS “does it already for its separately managed accounts platform,” Tibergien says, but they don’t have a separate due diligence gunslinger-for-hire outside of their platform. He acknowledges that it may be more difficult for advisors who don’t have an accounting background or specialized knowledge of the trading markets to conduct the level of due diligence within their own firm that is necessary–especially now.

Switching gears to discuss the current economic and markets scene, Tibergien notes that although the volatility has been tough on many firms, Pershing’s “asset processing” business has had “great volume” during this challenging period, which has been very good for the firm. Tibergien’s number-one priority for 2009 is to add more advisors to the PAS platform, and because of what he calls Pershing’s differentiated message–”no retail conflict–it’s all business-to-business,” he argues that PAS has become a “true alternative.” Last year, he says, PAS added 60 new advisors. Many of them were breakaway brokers who formed RIA firms which will custody at PAS and will also affiliate with a broker/dealer that clears through Pershing for the brokerage end of their business. And they have also seen advisors who are looking for a secondary custodian sign-on–just one more example of diversification.