The characteristics often found among effective financial advisors – intelligence, persuasiveness, and dynamism – are also commonly found among crooked advisors. This, unfortunately, makes the hiring process fraught for RIAs as bad actors are often natural salespeople.
So how can RIAs safeguard against hiring rogue advisors? The first step in investigating applicants involves tapping criminal history databases that include regulatory filings and civil dispute litigation, explains David M. Shapiro, a former FBI special agent who coordinates the Fraud Examination and Financial Forensic program at the John Jay College of Criminal Justice in New York.
These public databases are helpful in “identifying past misconduct,” Shapiro says. Yet that information, often based on internal audits and criminal regulatory databases, has limitations as much of the best information comes from whistleblowers, which is harder to uncover.
Shapiro cautions that interviewing candidates in person to unearth past misconduct can be of limited use. Candidates, legally, don’t have to “admit to a prior misconduct that took place more than 10 years ago,” he says. “Most people tiptoe around poignant personal issues, especially about shameful issues.”
Hence, the interviewer has to delve beyond information gathered from databases to ascertain whether the institution cited on a resume actually granted a degree, whether the GPA is accurate, and whether any complaints have been filed with FINRA or SEC, Shapiro advises.
Shapiro recommends going beyond databases to “follow the money. You work around the edges, including credit reports. The more you find about their assets and money, the more you can find out about the person.”
When following the money trail, trained investigators can help scrutinize harder to find information. This can include direct evidence of cash disbursements including bank record receipts, and indirect proof of lifestyle changes such as acquiring real estate, automobiles, boats, new business filings, and financial obligations triggered by civil litigation judgments or a security interest filing.
Shapiro calls these signposts “yellow flags.” For example, an applicant who exudes self-confidence and earns $150,000 plus bonuses, but is saddled with $4 million in debt, has personal issues that demand investigation.
When one advisor was applying for a new position in Texas, Shapiro unearthed a dispute that the applicant had with his neighbor. It led to the applicant killing the cattle of his neighbor, which contributed to his not being hired. “The person’s response to conflict and potential violence” invalidated him as an employee, Shapiro says.
Asked what major trap most financial advisories fell into, Shapiro says most firms “don’t examine success deeply enough. There’s a temptation to accept good news, without too much thought or reflection.”
Investment managers, in particular, with a strong success record, can blindside HR and executive teams. “The person who is highly adept at self-promotion, and who is charming, and very successful in sales, and other investment strategies, can be a huge fraud,” Shapiro asserts.
Once an applicant becomes an employee, the due diligence shouldn’t stop, Shapiro urges. Employers should continually monitor new employees, especially during the probationary period.
Three indicators that serve as an advisor’s calling card can lead to a job interview—their book of business, clients, and the sum total of assets and revenue generated, explains Mindy Diamond, the president and CEO of Morristown, N.J.-based Diamond Consultants, an advisory recruiting firm in its 22nd year of operation.
After those three measuring sticks are evaluated, the firm drills down into the applicant’s record and job history, focusing on the frequency of job changes. “They’re essentially getting to know the advisor more and understanding him or her as a person, not just their book of business,” Diamond says. Because advisors are registered, any violation of a firm’s policy shows up on their compliance record.
But the key factor derived from multiple interviews entails assessing the applicant’s character. The Greek philosopher Heraclites famously stated that “character is destiny.” Firms often will take an applicant to dinner to see how he or she behaves, treats the service staff, and potentially deals with stress.
Determining why an applicant is changing jobs is also critical in assessing character. If the person has been with a firm for 30 years, the advisor may simply want to jumpstart their career. “If the applicant focuses on personal financial gain, this is not what you want to see,” Diamond says.
If the client doesn’t answer questions directly or withholds considerable information, that’s a red flag to Diamond to find another candidate. Lingering doubts often lead to an applicant being rebuffed.
More broadly, fraudsters are part of the American legacy, explains Edward J. Balleisen, a history professor at Duke University and author of Fraud: An American History from Barnum to Madoff. America has always had an “openness to salesmanship but the line between aggressive puffery and enthusiasm for some new idea and deception is often hard to find,” he says.
“Con artists thrive on the American Dream,” explains Maria Konnikova, author of The Confidence Game. “When anything is possible, why wouldn’t I sell you just that: anything?” she asks.
Fraudsters tend to exhibit three dominant characteristics – “narcissism, Machiavellianism and psychopathy,” says Konnikova. Machiavellianism stands out because “it enables con artists to get what they want, all the while their victims are thinking that it’s all their idea.”
However, con artists don’t deserve all the blame, argues Konnikova. She says the profit-driven culture of many advisory firms and banks creates an environment for fraudsters to thrive. “Firms lead by example, example being not what they say but what they do.” She noted that healthy corporate cultures that exhibit “open communication and leaders willing to take criticism tend not to have problems with dishonesty.”
Flagrant fraud has been spiking, Balleisen asserts. There have been more instances of “significant financial malfeasance, deception, fraud, and misrepresentation at some of the largest financial institutions in the country since the 1970’s,” he says. He attributes this rise to deregulation and the increasing impact of technological platforms, which have a low barrier of entrance.
Con men are often difficult to detect, Balleisen says. “They tend to be charismatic and effective readers of other people and are often able to ingratiate themselves with others.”
He noted that many con men show “affinity fraud” and exploit people who share the same background and values. At the outset, Bernie Madoff preyed on fellow Jews, whom he met through his synagogue and other affiliated associations.
One structural challenge in hiring advisors is that firms are generally seeking excellent salespeople who are other-directed, and often those people engage in self-deception, Balleisen cites. The astute salesmen can easily tip into “deception and charlatanism,” he says.
Konnikova preaches vigilance. “Be skeptical. Always. Especially when you least want to be, or when things are going splendidly.” Act like a journalist, she says. “Trust but verify. Always verify.”