How to avoid financial advisor scams

Financial scams are everywhere these days. Whether it’s phishing attempts through email and text messages or a fraudster impersonating a loved one on the phone, there are a lot of traps to avoid. There are also scams to avoid when working with a financial advisor, some of which are illegal and others just not in your best interest.

Here are some common financial advisor scams and the red flags to watch out for when meeting with an advisor.

Common financial advisor scams

1. Ponzi scheme

A Ponzi scheme is a fraud where current investors are paid “returns” with money that is raised from new investors. It is named after Charles Ponzi, who orchestrated the fraud in the 1920s.

Today, Bernie Madoff is more closely associated with the Ponzi scheme for the reported $65 billion fraud that was discovered in the wake of the 2008 financial crisis, the biggest Ponzi scheme in history. Madoff died in 2021 after serving 10 years of a 150-year prison sentence.

2. Churning

Churning involves an advisor buying and selling securities frequently in order to earn a commission on each transaction. This practice used to be common among stock brokers, but commissions on stock trades have essentially been eliminated thanks to online brokers. However, the practice could still happen with mutual funds, which is something to watch out for in your account.

Ken Mahoney, CEO of Mahoney Asset Management, says that even if a change is necessary between different funds, you can typically find a new fund within the same fund family that meets your needs, which can help avoid unnecessary fees.

If an advisor was buying and selling different mutual funds frequently, Mahoney says the firm’s compliance department should flag the transactions and question the behavior.

3. Pump and dump

Pump-and-dump scams often involve penny stocks that have been inflated due to misleading information or market manipulation, allowing the scammers to profit once the share prices have been bid up.

Be sure to research any investment recommendations thoroughly, even if they come from an advisor. You should be extremely skeptical of penny stock recommendations because of potential frauds and the limited financial information available.

Financial advisor red flags

1. High-pressure sales methods

Financial advisors who use high-pressure sales techniques may be more interested in boosting their bottom line than that of their clients. Advisors may create a sense of urgency or tell you that you’ll miss the opportunity if you don’t give them your money quickly enough. These tactics may not be a sign of fraud, but probably indicate they’re not an advisor you want to work with, Mahoney says.

A good advisor is patient and understands that it can be difficult for clients to hand over their hard-earned money to someone that may feel like a stranger. If you don’t understand an investment or overall financial strategy, ask the advisor for more information. They should answer your questions for as long as it takes for you to feel comfortable.

2. Guaranteed investment returns

One of the biggest red flags in the investment world is if someone is offering guaranteed returns. There is no such thing as a guaranteed return. There are safe investments and risky investments, but you should challenge anyone that says they have a guaranteed return for you.

3. Writing checks directly to an advisor

Mahoney says another red flag to watch out for is if you’re ready to commit money to an advisor and they ask you to write the check directly to them or to their firm. Typically, the money is held by a third party custodian who holds the assets and handles other items such as statements and online portfolio access.

“If someone is writing a check out, they have to be very careful — it really should be a third-party institution that holds the securities,” Mahoney says.

4. Lack of transparency

If a financial advisor isn’t willing to discuss certain information such as how they’re compensated or the fees associated with certain investments, you should probably look elsewhere for an advisor. Remember, you’re hiring them to manage your money, so they should be able to explain the fees you’ll be paying in clear terms.

You can also ask for their latest Form ADV, a mandatory form that contains information about the investment advisor and its operations, or find it online at adviserinfo.sec.gov.

5. Phony investment credentials

One of the challenges of working with professionals in the financial advisory industry is that there isn’t a single credential that signifies competence and ethical behavior. There are many different credentials with varying degrees of difficulty to obtain them. You could also run into someone that says they have a credential that doesn’t actually exist.

Be sure you’re working with a registered investment advisor (RIA), which are required to act as fiduciaries for their clients, meaning they must put your interests before their own. RIAs are also required to file regular reports with the Securities and Exchange Commission and have compliance programs in place, among other requirements.

Well-respected credentials in the financial industry include the certified financial planner (CFP) and chartered financial analyst (CFA) designations. You can check if your advisor holds either credential on the CFP and CFA websites. You can also use BrokerCheck, a service run by the Financial Industry Regulatory Authority (FINRA), to research advisors, brokers and firms.

What to do if you suspect financial fraud

If you suspect a financial advisor or firm is running a fraud or not acting in your best interests, you have a few ways to alert authorities. One option is to check with the firm’s compliance department to try to understand better what’s going on.

If there is truly fraudulent activity, you’ll want to alert the SEC or FINRA so that they can investigate the matter. Needless to say, you’ll want to get your money out of any firm you suspect of fraud as soon as possible.

Bottom line

Most financial advisors want what’s best for their clients, but it’s prudent to be alert for potential bad apples. Mahoney stresses that you should never give your password for financial accounts to anyone and be skeptical of anyone asking for your financial information. Ultimately, you need to trust the advisor you’re working with, so if your gut tells you something is off, it’s best to find a different advisor.

Bankrate’s financial advisor matching tool can help you find a trusted advisor in your area.