Ask questions in light of the Year of the Ponzi

By DAVID MOON, Moon Capital Management, LLC
January 10, 2010


According to Investment Advisor magazine, 2009 was the Year of the Ponzi. It’s a good description; there were 150 Ponzi schemes last year, compared to only 50 in 2008. And those were only the frauds that were uncovered.

These questions won’t help you determine whether or not an advisor is competent or if he will help you outperform the S&P 500 or the Nasdaq. They may, however, help you avoid stepping in some huge holes.

Are you an investment advisor? The law actually says that everyone who gives investment advice isn’t necessarily an investment advisor. The distinction is technical, but it allows hundreds of thousands of non-advisor advisors (most with business cards sporting titles like “wealth manager” or “financial consultant”) to avoid the fiduciary standard requirements and related disclosures required of legally registered investment advisors.

How do you invest your own money? Do you invest in the same things that you recommend to your clients?

Have you ever been sued? Have you ever been involved in any arbitration case? Advisors who are registered with the SEC are required to report any suit or arbitration claim on their disclosure document, a copy of which they are supposed to provide you at the onset of a relationship. It can also be reviewed at the “Investment Advisor Search” section of the SEC website (www.adviserinfo.sec.gov.)

Advisors who are regulated by the Financial Industry Regulatory Agency (FINRA, a self-regulatory organization) have a similar form at their website, www.Finra.org. The FINRA disciplinary forms, however, do not include any reference to arbitration cases if settlement of the case included a confidentiality clause on behalf of a complaining client.

What is the source of most of your new clients? Perhaps I’m cynical, but I’m leery of people who trade on their relationships at church, Little League or Thanksgiving.

How long have you been in the investment business, advising clients? How many clients did you lose last year? I am amazed at the otherwise sophisticated people who trust their assets to someone who was selling pharmaceuticals a year ago.

Ask him to explain the role of the Fed in determining or affecting stock prices. If you don’t understand his answer, you likely won’t understand much of anything else he says either.
What assumptions are you using in making projections for my retirement?

Do you receive different levels of compensation depending on the specific investments in my portfolio?

Do you ever recommend investments that will have a penalty or charge to liquidate? If so, how will you inform me prior to making this recommendation?

Have you or any private entity under your control ever filed for bankruptcy? Have you ever defaulted on a mortgage – or any other loan – either partially or fully?

How many times have you changed firms and why?

This is clearly not an exhaustive list. Your process should obviously include queries about investment philosophy and quantitative performance. And there are plenty of other things you should do such as ask unaffiliated accountants and lawyers their opinion of the advisor.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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