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Financial Misconduct: A Rare Occurrence with Devastating Consequences

Zoe Team

Jun 20, 2019

5 min read

A financial advisor reviewing a plan with two clients at a table

Key Takeaways

Financial advisor misconduct is rare, but fraud can be devastating to your personal wealth.
Common scams include Ponzi schemes, pump-and-dump tactics, and account churning for commissions.
Vetting advisors via BrokerCheck and monitoring your statements are essential for protecting your assets.

Frequently Asked Questions

What are common warning signs of financial fraud?

Watch for unexplained fees, high trading volume without authorization, secret investments, or an advisor who avoids answering your questions or meeting in person.

How can I verify an advisor’s record?

Use FINRA’s BrokerCheck tool to search your advisor’s name. It lists regulatory actions, criminal history, and any history of fraud or professional bars.

Why is choosing a fee-only advisor safer?

Fee-only advisors are fiduciaries, meaning they must legally act in your best interest. They earn no commissions, reducing incentives to push harmful or unnecessary products.

If you’re like many people, the phrase financial misconduct makes you think of high-profile criminals like Bernard Madoff, whose glorified investment pyramid schemes stole $20 billion from more than 16,000 investors, most of them wealthy and well educated. If you’re a bit older you may remember the Enron scandal, when CEO Kenneth Lay falsified financial results that ultimately sent the stock price from $80 to penny stock status, costing investors more than $74 billion.

While these scandals generate a great deal of press coverage and public outrage, most investors who use financial advisors aren’t significantly affected by these activities.

Why? Two reasons:

Because most investors invest in
mutual funds
, which invest in many different companies, which helps to mitigate losses due any one stock’s downward spiral.

The overwhelming majority of financial advisors are honest, law-abiding professionals who are committed to delivering positive results to their clients.

As with any profession, there are always a few bad apples who make the rest look bad. That’s why it’s important to thoroughly research the background of any advisor you’re considering, whether you’re looking on your own or starting with our database of vetted, fee-only advisors.

What is financial misconduct in the investment industry?

There are many ways that companies, banks, mutual funds and financial advisors can break the law. Most of the methods that affect individual investors involve some kind of financial fraud. Here are a few of the most common schemes.

Ponzi or Pyramid Schemes

In this classic scheme (which Bernard Madoff perfected to steal billions from his trusted clients), an investment advisor promises huge returns for clients. But instead of investing in the market, these “returns” are generated by money coming in from new investors. Early investors (those at the “top” of the pyramid) get paid first, and their misplaced belief in the advisor convinces them to recommend the scammer to their friends. The advisor usually ends up spending most of the money or diverting it to offshore accounts, while sending fictional account statements to investors showing how much their account is growing.

The problems start when new investors dry up and existing investors want to cash in. Suddenly they discover that their “miracle earnings” are completely fictional and all their money has been stolen. By then the advisor (and his conspirators) has either left the country or has been arrested. Those who got suckered into the scheme have little chance of getting their money back.

Pump and dump scams

An unscrupulous broker sends you an email or letter offering you the opportunity to get in the ground floor of an “undiscovered low priced stock” that is on verge of taking off. As the scammer convinces more investors to buy the stock, shares go up, making it appear like you’ve hit pay dirt. But the investor (and his fellow scammers) already owns many shares of the stock, which they bought at flea-market prices. When they believe the stock price has peaked, they sell all of their stock immediately, taking their profits before the stock price plummets, leaving most investors with worthless shares.

Churning

Brokers make part of their income through the commissions they earn by buying and selling stocks for their clients. Some take advantage of this arrangement by churning, constantly buying and selling stocks to maximize their trading commissions, even though the trades themselves don’t lead to meaningful profits for clients. But churning isn’t limited to stocks. Brokers also earn commissions from sales loads charged by mutual funds. These may be charged when the investor purchases shares or when they sell shares. Churning can occur when a broker convinces a client to sell out of one fund and invest in another solely for the purpose of generating more commissions. Churning violates Financial Industry Regulatory Authority (FINRA) regulations, and brokers who are caught doing it may lose their licenses. But since brokers place millions of trades per day, it’s up to investors to examine their account statements to see if it’s possible that churning has taken place. If they believe it has occurred they can file a claim against the broker.

Protecting yourself from financial advisor misconduct

The best way to protect against financial advisor misconduct is thoroughly investigate the background of any financial advisor you’re considering using.

FINRA’s BrokerCheck site provides background information on all licensed brokers and investment advisers. Any regulatory actions taken against an advisor for fraudulent or criminal behavior will be listed. Want to see what this looks like? Search for Bernie Madoff, who is still listed there even though he has been barred from the profession for more than a decade.

But just because an advisor you’re considering has a clean regulatory record doesn’t mean that he hasn’t committed financial misconduct−or won’t do so in the future. Once you hire this professional, it’s up to you to monitor their behavior to identify potential warning signs.

These may include:

Recommendations of complicated investment or insurance products whose fees and expenses are not fully disclosed.

A high volume of trading activity in your account that you don’t remember authorizing.

Miscellaneous fees charged to your account that are not clearly explained.

Unexplained transfers of money from your bank to your investment account.

Failure to return your phone calls or email attempts.

An unwillingness to meet with you in person to discuss your concerns.

It’s particularly important to monitor these activities on behalf of your elderly parents, whose age and deteriorating physical and mental conditions often make them vulnerable to financial fraud.

One potential solution: Choose a fee-only advisor

While there’s no guarantee that an advisor you choose won’t “go bad,” one way you can protect yourself against unethical behavior committed by brokers is to choose a fee-only investment adviser or financial planner. These advisors are paid directly by you, usually in the form of investment management fees based on the value of the assets they manage for you. If they’re only creating a financial plan for you, they’ll generally charge a fixed fee. They don’t earn commissions and are required by law to act in a fiduciary capacity, which means that they must always act in your best interests when recommending investments and managing your portfolio. We can help you find a fee-only advisor in your area who has passed our rigorous vetting process.

While these scandals generate a great deal of press coverage and public outrage, most investors who use financial advisors aren’t significantly affected by these activities.

Why? Two reasons:

Because most investors invest in
mutual funds
, which invest in many different companies, which helps to mitigate losses due any one stock’s downward spiral.

The overwhelming majority of financial advisors are honest, law-abiding professionals who are committed to delivering positive results to their clients.

What is financial misconduct in the investment industry?

Ponzi or Pyramid Schemes

Pump and dump scams

Churning

Protecting yourself from financial advisor misconduct

The best way to protect against financial advisor misconduct is thoroughly investigate the background of any financial advisor you’re considering using.

These may include:

Recommendations of complicated investment or insurance products whose fees and expenses are not fully disclosed.

A high volume of trading activity in your account that you don’t remember authorizing.

Miscellaneous fees charged to your account that are not clearly explained.

Unexplained transfers of money from your bank to your investment account.

Failure to return your phone calls or email attempts.

An unwillingness to meet with you in person to discuss your concerns.

It’s particularly important to monitor these activities on behalf of your elderly parents, whose age and deteriorating physical and mental conditions often make them vulnerable to financial fraud.

One potential solution: Choose a fee-only advisor

Disclosures: Zoe Financial, Inc. ("Zoe Financial") is an investment adviser registered with the U.S. Securities and Exchange Commission. Registration does not imply a certain level of skill or training. Zoe Financial provides investment advisory services and access to independent registered investment advisers through its platform. The information provided by Zoe Financial is for educational and informational purposes only and should not be construed as personalized investment advice or as an offer to buy or sell any security. All investments involve risk, including possible loss of principal. Past performance is not indicative of future results. Clients should consult with their own financial, tax, or legal professionals before making any investment decisions. The material presented by Zoe Financial is for informational purposes only and is not intended to serve as a substitute for personalized investment advice or as a recommendation or solicitation of any particular security, strategy, or investment product. Material presented has been gathered from sources believed to be reliable, however Adviser cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. Past performance is no guarantee of future results. Zoe Financial does not provide legal or tax advice, and nothing contained in these materials should be taken as legal or tax advice. SEC Registration does not constitute an endorsement of Zoe Financial by the SEC nor does it indicate that Zoe Financial has attained a particular level of skill or ability. The sole purpose of this material is to inform, and it in no way is intended to be an offer or solicitation to purchase or sell any security, other investment or service, or to attract any funds or deposits. Investments mentioned may not be appropriate for all clients. Before making any investment, each investor should carefully consider the risks associated with the investment, as discussed in the applicable offering memorandum, and make a determination based upon their own particular circumstances, that the investment is consistent with their investment objectives and risk tolerance. Lower expenses do not guarantee better investment performance. Certain information contained herein may constitute forward-looking statements. Due to various risks and uncertainties, actual events, results or the performance of a fund may differ materially from those reflected or contemplated in such forward-looking statements.

Disclosure: This page is not investment advice and should not be relied on for such advice or as a substitute for consultation with professional accounting, tax, legal or financial advisors. The observations of industry trends should not be read as recommendations for stocks or sectors.

Investment advisory services are provided by Zoe Financial, Inc. (Zoe Financial), an investment adviser registered with the U.S. Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training. Learn more about Zoe Financial on the SEC’s Investment Adviser Public Disclosure website. Brokerage services are provided by Zoe Securities LLC and Apex Clearing Corporation, members of the Financial Industry Regulatory Authority Inc. (FINRA) and Securities Investor Protection Corporation (SIPC). Learn more about Zoe Securities and Apex on FINRA’s BrokerCheck website.

The information in the visuals above is for illustrative purposes only and does not represent an actual user's account, balance, or return. Zoe Financial does not provide tax or legal advice.

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