As the old Greek proverb puts it, ‘Where there is sea, there are pirates.’ And since modern-day trading is where the money is, you can safely assume that the pirate equivalent of the financial world is there, waiting for victims. In 2020, the Federal Trade Commission (FTC) reported that they’d received about 2.1 million reports of fraud from consumers. Consumers stated that they’d lost approximately USD$3.3 billion to fraud in the same year.
So yes, pirates thrive in the world of finance—in the form of fraudsters and scammers.
Trust is a crucial element when you’re dealing with brokers. After all, you’ll be entrusting them with your hard-earned money in order to achieve financial security. No one wants to be in business with a Jordan Belfort (the so-called ‘Wolf of Wall Street’) or Bernie Madoff, the brain behind America’s biggest investment scam. But how do you protect yourself from fraudsters like these?
It’s easy enough to check a trader’s credentials; it’ll take you just a few minutes. There are many legitimate and licensed brokers, and anybody can check and verify their credentials. If you end up having a hard time doing so, that’s a big red flag. Should that be the case and you’re starting to have some doubts, don’t be afraid to back out of the deal.
Signs Your Boker Is Legitimate
It’s estimated that one in 10 adults falls victim to some kind of fraud or scam yearly in the US. However, if your investment is performing poorly, it doesn’t necessarily mean your broker is running some sort of scam. Losses are a part of investment. Another cause of the sudden drop in your portfolio’s value may be a simple clerical error. If that’s indeed what happened, it can be easily corrected if you bring the discrepancy to your broker’s attention.
But when traders put their financial interests before their clients’, that’s a sure sign of fraud. That being said, here are a few tell-tale signs that a broker is legit:
1. A Good Track Record
The Internet might have made defrauding people easier, but it has also made it easier to find the honest ones by checking a company’s credentials and reputation. You can do a simple web search of the broker’s name and their company’s name. The search results could bring up reports or news about questionable dealings in the past, mentions on news websites, or even online forums like Reddit. Here’s another broker review you can also use to do a background check.
Additionally, you could search various regulatory agencies’ lists. Brokerage firms are required by law to register with state and federal securities regulators. The general public can view the registration information about them, such as disciplinary actions or sanctions imposed upon them.
Here are a few agencies you can check:
Securities and Exchange Commission (SEC) – The SEC’s Investment Advisor Public Disclosure (IAPD) is an essential data source about registered investment adviser firms or their representatives. You can check their professional background, together with their employment history, disciplinary events, or current registration status.
Financial Industry Regulatory Authority (FINRA) – Congress had authorized FINRA as an independent, private, not-for-profit organization that seeks to protect investors. It oversees brokers and ensures the integrity of the market.
It also ensures that any person or entity that sells securities has undergone testing and has been deemed qualified before being issued a proper license. FINRA also operates BrokerCheck, a website that contains information on traders and the firms that employ them.
State securities regulators – Your state also has regulators that most likely possess information about brokers and brokerage firms. That includes registration, licensing, and disciplinary actions they may have incurred.
2. Member Of The Securities Investor Protection Corporation
A legitimate broker should be a member of the Securities Investor Protection Corporation (SIPC), a not-for-profit corporation created by Congress in 1970 to provide insurance to brokerage clients. If a brokerage firm goes belly up, its clients are covered for up to USD$500,000, and up to USD$250,000 of that amount can be in cash. As an investor, always remember to invest with firms that are members of the SIPC.
3. Can Provide Verifiable Answers To Your Questions
A legit broker should be able to answer questions about what it can realistically offer. Ask about the firm’s experiences with clients whose needs are similar to yours. Whether you require a broker or a financial advisor, you should feel comfortable enough to ask a lot of questions. After all, they’re the people who’ll be handling your investments.
It’s also crucial for you to be aware of the expectations you’ll have with your broker and investment advisor. What’s more, you should know that investment brokers and advisors are held to two main standards: fiduciary and suitability.
Fiduciary Standard – Fiduciary standard is included in the Investment Advisers Act of 1940, which states that an investment advisor should put the interest of their clients first before their own. Under this Act, they’re urged to follow the course of action that would best serve their client’s interests no matter how it could impact their revenue or affect them personally.
Investment advisors who are worthy of trust avoid conflicts of interest, and if a potential conflict could arise, they should disclose it to their clients. That’s why the advice they give should be well-thought-out, analyzed thoroughly, and with their client’s best interests in mind.
Suitability Standard – The suitability standard, also referred to as ‘suitability rule,’ isn’t as strict as the first one. This standard simply states that an investment broker could give their clients suitable advice based on their specific circumstances, financial needs, and objectives. As long as their pieces of advice aren’t demonstrably bad, they aren’t constrained to give the best ones.
They can suggest investments that could result in higher commissions for them as long as it runs parallel with their clients’ main objectives. Moreover, they’re allowed to do this even if better investments for the clients are available. Brokers serve the firm they work for, and it’s enough that they recommend investments that they believe are suitable for their clients.
To put this in a different perspective, let’s say you’re shopping for a hybrid car, and you happen to approach the nearest Chevy dealer. You describe to the salesperson your car preferences, listing specific features, attributes, and other characteristics, which exactly describe a Toyota Prius.
The salesperson, under the suitability rule, can say that the Chevrolet Bolt also meets your requirements. What’s more, it’s in their showroom. The car may suit what you require, but it isn’t what’s best for you. Since you aren’t an expert on hybrid vehicles, you don’t have to be made aware of this fact.
However, under the fiduciary standard, the salesperson would be compelled to inform you that you’re describing a Toyota Prius. They would then advise you to go to a Toyota dealership instead. But they can tell you that they have a model, the Chevrolet Bolt, which is similar but not entirely the same. The Bolt is an electric vehicle and is more expensive. The salesperson in this scenario has informed you of your options and let you know about the conflicts of interest motivating them.
It’s best to remember that an investment advisor works under the fiduciary standard; an investment broker, on the other hand, follows the suitability rule. This way, you know what your expectations are supposed to be.
The world of finance presents plenty of opportunities for scammers to operate. However, there are several methods to find out if your broker is legitimate. A legitimate broker has a good track record and is registered at all the appropriate regulatory agencies. They’re also willing to answer all your questions and give you honest answers about your expectations.
Finding a legitimate broker as a beginner is an essential step, so take all the time you need. Working with the right broker may be the most important investment you’ll make.