By John Wasik –
When dealing with an investment adviser, where your money is kept is nearly as important as how it’s invested.
The question “who has custody of my funds?” should be an essential part of how you vet a financial planner, money manager or broker.
If your funds aren’t held in a separate account — not controlled by your adviser — then you’re asking for trouble. Just ask Bernie Madoff”s former clients or any of the thousands scammed in recent years by advisers who had easy access to client cash.
Long late to the game, the U.S. Securities and Exchange Commission (SEC) recently issued an alert on the custody issue. They apparently discovered that some broker/advisers aren’t following their rules on keeping client money in a safer place.
The agency did a recent wave of exams to see how advisers were treating client’s funds. Although the agency wasn’t specific on what it found, they had several reasons to be concerned. This is what they discovered:
Failure to recognize that they [advisers] have custody, such as situations where the adviser serves as trustee, is authorized to write or sign checks for clients, or is authorized to make withdrawals from a client’s account as part of bill-paying services.
Failure to meet the custody rule’s surprise examination requirements.
Failure to satisfy the custody rule’s qualified custodian requirements, for instance, by commingling client, proprietary, and employee assets in a single account, or by lacking a reasonable basis to believe that a qualified custodian is sending quarterly account statements to the client.
“Because the safeguarding of assets is central to investor protection, it is critical that investment advisers follow our rules when they maintain custody of their clients’ funds,” said SEC Chairman Elisse B. Walter.
It’s unlikely that the SEC will act as a cop on the beat when policing these issues, so you need to ask some questions:
1) Where is my money held? If the adviser says “in a discretionary account,” that’s the wrong answer. It should be held by an independent custodian/trustee such as a bank.
2) Who has access to my money? The access should be limited to you and your adviser when making trades or purchases, but only with specific permission.
3) How is my money protected? Typically, broker-dealers are covered by the Securities Investor Protection Corporation, which provides limited coverage. Know the limits of this coverage and understand your options in case your broker fleeces your account.
We can only hope that the agency will remain focused on investor protection when — and if — former prosecutor Mary Jo White is confirmed as the new SEC chief. The agency has improved in recent years, but still is a long way from being an effective deterrent against investment fraud. In the interim, you’re the best cop on the beat.