While few risk advisers speak with their clients about the risks that can jeopardize their financial investments, we're well aware that the clients we serve are closely focused on the return on their investment account. From a risk management perspective, investors should first consider this advice from American humorist Will Rogers: "I'm not as interested in the return on my money as I am the return of my money."
Although remarkably few financially successful clients I meet with voice concerns over the risk of losing their investment assets due to embezzlement by a financial adviser, everyone understands adviser fraud can happen—just not to them.
How prevalent is the risk of financial adviser fraud, and how can investors ensure the safe return of their money? Uncovering the frequency of financial adviser fraud is far more difficult than one would imagine. In this excellent article for Frontline and PBS, author Jason Breslow presents a summary of extensive research conducted by professors from the University of Chicago and the University of Minnesota to explain why Will Rogers's concern is very real. Mr. Breslow reports that the study revealed 7 percent of advisers have been disciplined for a fraud dispute or some other form of misconduct, while concluding the actual rate of fraud is likely much higher. Over 20 years of data (August 1999–September 2019) collected by the investment industry's self-regulatory organization, the Financial Industry Regulatory Authority (FINRA), reveals 7,819 people were barred for life from the investment management business. This equates to an average of more than 1 person barred per day for the 20 years of data in the Central Registration Depository. The majority of these cases are for fraud.
Commercial Trial Law, a popular legal blog authored by Mazin A. Sbaiti, Esq., offers the following insights for some additional perspective on this risk.
The following are additional risk factors to consider.
Articles from FINRA, the Securities and Exchange Commission, and other entities offer advice on how to avoid becoming a victim of adviser fraud. The following recommended best practices appear rather obvious, and it is hard to imagine financially successful investors will find them especially illuminating.
Notably, FINRA does provide investors access to a free online tool, BrokerCheck, to research the background and experience of financial brokers, investment advisers, and firms. In short, even savvy investors who exercise caution are vulnerable to the loss of investment assets due to adviser fraud.
Unless an investor has fidelity bonds covering their managed assets with each of their advisers, a gap in coverage may exist for the majority of many financially successful families' invested assets. Fraud and intentional acts are specifically excluded from an investment firm's errors and omissions insurance. While most financial advisers have professional liability policies, such policies exclude coverage for criminal acts by the adviser. Coverage for investors through the Securities Investor Protection Corporation is designed to protect from the insolvency of an investment firm. A limit exists of up to $500,000 for securities, including $250,000 for cash held in a brokerage account but only when the asset management firm goes bankrupt and customers' assets are missing. Larger investment firms may have some form of crime insurance, but aggrieved investors should expect the need to retain counsel to demonstrate a crime has taken place.
A new form of insurance coverage, Capital Shield, is the first personal crime policy that provides blanket coverage for managed investments. This represents the majority of most family's total assets and was uninsurable until now. In the event of a covered loss, the policy will pay at the time that the proof of loss is accepted and the perpetrator is indicted. The risk transfer to the insurer includes their legal costs to pursue the claim, which are inside of the policy. As with any form of insurance, conditions apply. The minimum limit of insurance is $1 million, and additional increments of $1 million may be purchased up to a maximum of $10 million. The annual cost is in the range of $1,500 premium for each $1 million limit increment.
While not inexpensive, this new form of coverage provides peace of mind and valuable asset protection for those who want to insure "the return of their money." Coverage is underwritten by Berkley FinSecure, a Berkley Company, and is not currently available in all states.
Risk advisers provide an extremely valuable service by helping clients to understand and manage a wide range of risks. In addition to helping clients to understand and protect their tangible assets and their financial assets from lawsuits by third parties, shouldn't risk advisers also offer guidance to clients to also protect what is usually their largest asset—their financial investments—from losses caused by fraudulent acts of a financial adviser?
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