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Is My Money Being Handled Badly?

Red Flags That Say Your Broker Relationship Has Gone Sour.

by Scott Woolgar

Investors may have feelings that their investment account is being mishandled, but many times, they don't know exactly what to look for, or when to speak up. Fortunately, most broker improprieties fall into a handful of categories. When you know where to look, mismanagement is pretty easy to spot.

Each year, hundreds of thousands of investors fall victim to advisors who mishandle their money – and, in some cases, perpetrate outright fraud. Sadly, only a small percentage of these injustices are actually reported.

Here are a few behaviors that should send up red flags:

Watch out for mixed signals

Many investors move their monthly account statement straight from the inbox to the file cabinet without really reading the information. However, a close examination of your investment account statement will give you a very clear idea of how your broker or investment advisor views your risk tolerance, investment goals, and net worth. If the account overview doesn't match your expectation, it's a red flag.

Inspect every trade

Naturally, the most important aspect of your account statement is actual trade information. Make sure you examine every trade conducted by your broker, and determine whether the broker called before or after the trade was placed – or at all. Failure to contact a client before executing a trade is not only a red flag – it's often illegal.

If the account overview doesn’t match your expectations, it’s a red flag.

Suitability: does it fit you to a “T”?

Investment law states that a broker is obligated to make recommendations that are consistent with a customer's investment objectives, risk tolerance, needs, and financial means. Your broker should call to discuss any new direction in your investment plan, to make sure it fits your investment goals. The legal test is “suitability.” If your broker skips this step, it's a red flag and could mean misconduct.

There is such a thing as too much advice

Each trade made by your broker must be marked as “solicited” or “unsolicited.” A solicited trade is one recommended by your broker, and as such, must be marked accordingly. If you are seeing an inordinate number of unsolicited trades, or you see a trade marked incorrectly, it should definitely raise a red flag.

Less is more

One of the most important rules of investing is diversification. If a broker concentrates an investor's portfolio in any individual investment or type of investment, then the risk associated with that portfolio is dramatically increased. If your account statement shows any single purchase or security comprising a substantial position of your total portfolio, you could be over concentrated. It's risky for you, and a red flag.

Stay off the inside track

If you've ever gotten a call from a broker professing to have “inside information”, then you should run, not walk, to the nearest exit. It's illegal.

If their boss calls you, you should call an attorney

One of the hottest red flags in the brokerage world is getting a call or letter from your broker's management. Usually this means that your account has been flagged for “drift”, or for not following the course indicated by your investment profile. Your first move should probably be to contact a securities attorney; and in no case should you sign anything sent to you under these circumstances. Don't speak up on your broker's behalf, and be particularly suspicious if anyone tells you it's a “routine” procedure or audit. There's no such thing.

Churning and the 5% rule

One way to tell if your broker is using your account to make more money for himself is to look for signs of “churning”. Churning occurs when a broker engages in excessive trading in a customer's investments, in an attempt to generate commissions. Here's a rule of thumb: if the commission you paid out over a given year is more than 5% of your account value, there may be a red flag.

Not selling

Any time your broker puts the brakes on a sell order from you, it's a red flag. There may be legitimate reasons why a broker would resist an impetuous or imprudent sell order, but there are plenty of reasons why it's better for the brokerage, than for you, to hold on to the stock.

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