The Financial Industry Regulatory Authority (FINRA) and other financial regulators work hard every day to protect investors from fraud, scams and financial professional misconduct. But at the end of the day, a diligent and vigilant investor is her own best first line of defense.
The vast majority of registered
financial professionals are
trustworthy individuals who act
with integrity. Unfortunately,
some are not.
A qualified investment professional can help you make sound investment decisions, assist with financial goal setting and keep you informed about how the economy and financial markets are affecting your investment portfolio. So it is no surprise that more than half of Americans rely on a broker or professional advisor to help them make at least some investment decisions, according to a recent study on U.S. investors by the FINRA Investor Education Foundation.
The vast majority of registered financial professionals are trustworthy individuals who act with integrity. Unfortunately, some are not. That's why FINRA encourages investors to "ask and check" with BrokerCheck before investing with a financial professional.
And investors can stay vigilant throughout the course of their relationship with their broker by keeping an eye out for signs of misconduct. There are certain behaviors that FINRA examiners and enforcement staff see time and again that raise red flags and often warrant disciplinary action, and sometimes expulsion from the financial industry.
Often, these red flags aren't too difficult to spot. Here are four behaviors that should have you asking questions.
1. Asking for a Personal Loan
An investment professional should almost never ask to borrow money from you. FINRA rules prohibit brokers from borrowing money from their customer except in certain circumstances, such as if the customer is a family member.
While you may like your financial professional and have a desire to help him out if he falls on hard times, the loan, if not repaid, can increase your chance of financial harm. Unfortunately, such cases often come to FINRA's attention only after the financial professional has failed to repay their customer.
For example, one California-based broker asked a customer for a personal loan totaling more than $67,500 in violation of FINRA's rules and his firm's policies. The broker accepted the money through multiple partial withdrawals from a variable annuity belonging to the client. His customer only complained when the broker failed to make timely payments. In 2016, the broker was ordered to pay $75,000 to repay his customer with interest, and FINRA permanently barred him from acting as a broker.
If your financial professional asks for a loan, check with the firm regarding their policy regarding such transactions.
2. Sales of Promissory Notes
You should be wary of any pitch for a promissory note. A promissory note is a form of debt that companies sometimes use to raise money. Bona fide notes are marketed almost exclusively to corporate and accredited investors. While they can be legitimate investments, many promissory notes sold widely to individual non-accredited investors are fraudulent.
Problems with promissory notes fall into three main categories: fraud and deception of investors, unregistered securities and unregistered sellers. Securities that are unregistered are a concern because that means they lack certain Securities and Exchange Commission mandated disclosures designed to protect investors by providing them with information necessary to evaluate their investment. Unregistered sellers, on the other hand, have not passed any FINRA qualification exams and are not supervised by FINRA member firms.
In one notable case, FINRA barred a Washington, D.C.-based financial firm and its CEO from the financial industry for the fraudulent sale of promissory notes. The firm and its CEO were ordered to pay $13.7 million in restitution to 59 investors, the majority of whom were current and former NFL and NBA players. That decision became final last year following an appeal.
While the victims in this case were former NFL and NBA players, plenty of ordinary investors risk losing money to such investments, as well. In fact, there have been instances of financial professionals attempting to issue a "promissory note" in exchange for a personal loan (see above).
Read FINRA's Promissory Note Investor Alert for more information on how to protect yourself.
3. Using Personal Email
Exercise caution if your financial professional begins communicating outside official channels.
One way that FINRA protects investors is by requiring that registered firms preserve and maintain records and other documents related to their business. This includes communications with clients such as the emails or text messages between a broker and his customers.
This documentation afforded by the channels allows firms and regulators to ensure your broker is recommending investments that are appropriate for you and isn't making any false claims, and helps ensure that you agreed with any investment decisions or approaches in question.
In general, FINRA and SEC rules do not prohibit the use of personal email systems or accounts as long as the firm captures and retains those records as they would those originating in the firm's systems. However, since maintaining outside records can be difficult, many firms have internal policies prohibiting the use of such accounts.
FINRA often finds that when a broker uses personal email or other means of communication not compliant with the firm's policy it is to circumvent important investor protection rules and regulations.
For example, last year, FINRA suspended one individual for 60 days and fined him $7,500 for using a personal email account and a personal phone to communicate with a client. FINRA found that his messages to his client made inappropriate predications and exaggerated claims about securities he had invested in for the client in violation of FINRA rules. In one instance, he sent a text message that said, "I can make you $1000 in a day if you give me $2000 tomorrow" — a claim no financial professional should make.
4. Asking You to Write a Check to a Person or Entity Other than the Firm
As a general rule of thumb, if you are investing through an account at a particular financial firm, you should make all deposits directly to the financial firm — and you should double check that you have the right deposit information.
If your financial professional pitches an investment that requires you to write a check to him or to a third party, proceed with caution and verify with the firm that this is in fact its protocol. It could be a sign of fraud or a sign that the financial firm doesn't approve or sanction the investment.
In one case this year, FINRA permanently barred one broker when it found that he had instructed a customer to write an investment check to a fraudulent account. The broker had pitched the client on a $20,000 real estate investment. To take advantage of the "investment," the broker instructed the client to write a check to the purported real estate investment group.
In fact, he had the customer write the check to a fake business owned by the broker. There was no real estate investment. Instead, the broker deposited that cash and used it for personal expenses.
If you suspect improper business conduct from these or any other behaviors, contact the firm's compliance department in writing. Retain a copy of your letter and other related correspondence with the firm. If you do not receive a satisfactory response to your complaint from the firm, contact FINRA.
Remember, it's your money, and your investment professional works for you. You should never feel pressured by your financial professional or uncomfortable with his conduct.
Subscribe to FINRA's The Alert Investor newsletter for more information about saving and investing.