Financial Adviser
Due Diligence

You want to background-check an advisory team. Or audit one that has been serving you for years. But how? The expandable text boxes below describe several techniques for financial adviser due diligence and explain the importance of each.

For wealth management situations involving $25 million or more in total assets, we offer customized analysis. Our consulting reports address financial adviser backgrounds, investment approaches, documentation, fees, performance, controls, Internet security practices, and areas of competitive advantage.

Financial Adviser Due Diligence

Due Diligence Basics

The first thing to know about financial adviser due diligence are the limitations. It provides no assurances about investment performance. Nor does it ensure discovery of work-history details you really should know before making a decision.

Nevertheless, the benefits far outweigh the shortcomings. Background checks prevent impulse decisions. They confirm claims about investment expertise and sometimes offer insights into personal character. They make in-person interviews more productive. Most of all, they give you a foundation for evaluating an advisory relationship.

Clarify the standard governing financial advice

“Suitability” governs some investment professionals. This standard means they can sell products which are suitable — but self serving.
Consider two hypothetical funds. A and B are both suitable for your investment needs. A has lower fees and a better track record, but the investment professional earns more money from selling B. If governed by suitability, he or she can sell you B and satisfy the regulatory requirements.
The “fiduciary standard” requires financial advisers to put your interests before their own. In the previous example, a fiduciary must recommend A.
Some professionals are governed by different standards at different times, making it hard to know who is operating according to what.
To solve this problem, download the fiduciary oath (drafted by the Committee for the Fiduciary Standard). If the financial adviser refuses to sign the oath, you are not working with a full-time fiduciary.

Check for fake credentials

Fake credentials are a leading indicator of future bad behavior
Start by examining professional designations, like the CFA or CFP. Many accrediting organizations enable you to confirm online that an adviser is entitled to use them.
The Financial Industry Regulatory Authority (“FINRA”) includes a database of more than 150 such designations with links to the issuing organizations. You can call the issuers. Or use the online verification services of those that provide them.
Use DegreeVerify, which is a service provided by the National Student Clearinghouse, to confirm academic credentials. The service costs about $15. You can use it to confirm most degrees offered by US colleges and universities. But international coverage is spotty.

Search "BrokerCheck" for disclosure events

Disclosure events contain information about customer and employer disputes, disciplinary actions, and financial matters like bankruptcies.
According to a 2013 study by the Wall Street Journal, about 13% of the investment professionals supervised by FINRA have at least one disclosure event.
A more recent study by Harvard Business School estimates that “one in twelve financial advisors have been disciplined for serious misconduct,” “roughly one-third of advisers with misconduct are repeat offenders,” and “prior offenders are five times as likely to engage in new misconduct as the average financial adviser.”
But disclosure events are not automatic indicators of high-risk investment professionals, especially if they result from disputes between financial advisers and their employers. Companies can behave badly too, but they typically have disproportionate power. If you see disclosure events and are considering an investment professional, we recommend that you ask him or her about it.

Search for bankruptcies

FINRA requires brokers to self-report bankruptcies. Not all of them do. If your adviser has filed for bankruptcy, is subject to FINRA’s jurisdiction, but has not reported the event — it is a red flag.
Federal, state, and municipal authorities each conduct bankruptcy proceedings. They maintain separate records, which means means that there is no failsafe method for most consumers to identify credit problems.
There are only workarounds. Google the investment professional’s name, state of residence, and the word “bankruptcy” in quotes.
Another resource is Pacer, which shows legal proceedings (including bankruptcies) in federal courts.

Search "IAPD" for disclosure events

IAPD is an acronym for Investment Adviser Public Disclosure. This website is the SEC’s answer to BrokerCheck. A growing number of investment professionals are leaving big brokerage firms to start wealth management firms known as Registered Investment Advisers (“RIAs”).
As a general rule, SEC supervises them if their assets under management exceed $110 million. For lower amounts, state governments usually take primary responsibility.
Like FINRA, the SEC posts individual profiles on its website. In fact, both organizations pull information from the same database, the Central Registration Depository or “CRD” for short.
But there are differences, which makes IAPD is must-visit website if your investment professional works for an RIA. Among them is “Form ADV,” in which companies profile their operations.
Download a PDF copy and, using your computer’s search function, find the following words or phrases: “material changes,” “fees,” “disciplinary information,” and “control persons.”

Ask mutual LinkedIn connections 5 questions

How do you know “X”?
What do you like about X? (Or, how does X excel?)
How would you like to see X improve?
During rocky markets, how does X communicate with you?
What haven’t I asked that I should ask?

Contact state authorities to dig deeper

To find contact information for the security divisions of state governments, visit the North American Securities Administrators Association (NASAA).
State regulators have access to valuable information from the CRD, which BrokerCheck and IAPD do not post. Ask them the next three questions.
- Has your adviser ever been the subject of an internal investigation? If the answer is yes, he or she is 11 times more likely to accumulate three disclosure events.
- Has your adviser ever failed the Series 7, 63, or 65 exams? The more times an adviser fails, the more likely black marks on his or her record according to the Wall Street Journal.
- Has your adviser ever filed for bankruptcy. BrokerCheck does not disclose credit problems older than 10 years. But brokers with poor credit histories are twice as likely to sustain customer complaints or regulatory actions.

Review insurance agents with state regulators

The 50 states are the primary regulators of the insurance industry. Working with the National Association of Insurance Commissioners (“NAIC“), state governments pass laws with substantial similarities.
On NAIC’s website, you can find contact information for their authorities. But state websites offer varying degrees of information about insurance agents subject.
Contact the insurance divisions directly in order to ask about agents subject to their oversight.

Investigate the firm's advisory culture

A client-first culture reinforces (but does not guarantee) ethical behavior. In its work histories for individuals, BrokerCheck highlights the firms expelled from wealth management.
Did your financial adviser ever work for one? Use BrokerCheck to investigate if colleagues (often listed on websites) migrated from the expelled firm to the current employer. Substantial overlap is a red flag.
Click due diligence to see a joint study by Stanford, U-Chicago, and U-Minnesota that identifies which brokerage firms, with more than 1,000 employees, have the highest percentage of professional misconduct. There is a more recent study, which you can find by clicking on Harvard Business School.
CEOs determine the character of their companies. Repeat our investigative steps for the CEO of your adviser’s employer.
Employee reviews on Glassdoor, the job search website, offer insights into firm culture.

Audit financial advice with these resources

FeeX is a website that calculates the expense ratios of funds in your portfolio. (We have no ties to the firm and do not warrant its results. We simply believe it is a helpful resource that increases transparency for investors.)
EMMA, which stands for Electronic Municipal Market Access, is a website hosted by the Municipal Securities Rulemaking Board. You can use it to see “markups” or “markdowns,” which are spreads earned by dealers when buying and selling municipal bonds for your account.
SPIVA regularly compares the performance of active money managers, by asset class, to their benchmarks. You will find this research helpful when evaluating financial advice.