Fraud and Abuse in the Financial Planning Industry

The legitimate financial planning industry is growing today at an explosive pace — and so is the volume of multi-million-dollar fraud committed by the con men and swindlers who constitute the “dark side” of this relatively new and unregulated financial service sector.

A financial planner provides a master plan for all aspects of an investor’s finances, including securities, real estate, tax planning, savings and insurance. But unlike members of long-established professions, financial planners are not required to meet industry-wide licensing and testing standards. H. Wayne Howell, president of the North American Securities Administrators Association (NASAA) and director of the Georgia Securities Division, explains: “As things stand today, anyone can hang out a shingle and call himself a financial planner.”

A new NASAA/Council of Better Business Bureaus (CBBB) review of customer complaints and state enforcement actions in 20 states has uncovered more than $90 million in fraud and abuse in the last three years in the underside of the financial planning industry. The survey found that hundreds of con artists calling themselves financial planners used abusive tax shelters, phony real estate partnerships, bogus money market accounts and elaborate Ponzi schemes to strip investors of millions of dollars.

CBBB President William H. Tankersley commented: “While there are many fine financial planners, we are concerned about the swindlers working the fringes of this fast-growing industry. There are a number of bad apples out there who call themselves financial planners but end up doing much more harm than good.”

State securities regulators and the Council of Better Business Bureaus (CBBB) are alarmed at the epidemic of fraud and abuse currently plaguing the financial planning industry. One state securities official refers to this emerging crisis for consumers as “the Wild West frontier days” of financial planning. The flurry of fraud in this new financial services industry is fueling efforts among federal, state and industry trade group officials to draw up regulations for financial planners.

Recent Fraud in the Financial Planning Industry

• A Sacramento man committed suicide in February shortly before local authorities were to arrest him on 49 felony counts of grand theft and fraud related to his financial planning firm. Hours later, the firm was forced into bankruptcy proceedings, leaving 250 California investors without a penny of their $7 million investment. The planner was later exposed as a Ponzi scheme operator who had promised 22 percent annual interest in what turned out to be phony real estate partnerships, equipment leasing deals and money market funds.



• A Phoenix-area financial planner doing business in 1983 as “Money Tree Financial,” enlisted about $1.1 million from 40 Arizona residents in an abusive tax shelter known as “Rex Rabbit.” The shelter centered on a supposed “super rabbit” with a mink-like pelt that would be sold at a premium to major New York city department stores. The planner said the meat of the top-grade rabbits would be freeze-dried and sold at over $16 an ounce to South Korean mercenary soldiers guarding Saudi Arabian oil fields. The shelter promoter claimed that the slaughtering of the Rex Rabbits would be timed to take maximum advantage of the federal investment tax credit (ITC). After he was exposed by Arizona Corporations Commission officials, the financial planner was able to return less than $50,000 to investors.



• Two Maryland financial planners raised $2.4 million from more than 243 Washington, D.C.-area investors in 1983 with the promise of annual returns of 30-40 percent. Maryland Securities Division officials said the pair claimed to be making stock trades, but the investment later turned out to be phoney paper transactions involving real and imaginary companies. One of the self-proclaimed financial planners funneled a share of the funds into a chain of retail computer stores and the other promoter used at least $84,000 of the funds for his own purposes.



• The Georgia Securities Division handled six cases in 1984 of insurance agents who operated as financial planners without the knowledge of their employers. The Division sought the indictment this spring of one moonlighting “financial planner” who converted $100,000 of the savings accounts and investments of his elderly Medicare supplement insurance clients into worthless certificates of deposit. State securities investigators uncovered several cases of homemade certificates of deposit (CDs) that were typed out, while others were written on notebook paper in longhand.

The Rise of Financial Planners

Originally, the term “financial planner” was loosely applied to any of a number of personal financial advisors, including brokers, attorneys, accountants, and insurance agents. But in the last two decades, “financial planning” has evolved into an multi-billion-dollar industry, with thousands of advisors who plan and monitor investors’ overall finances, rather than just a single aspect or two.

Under a law drafted a quarter of a century before the birth of the modern financial planning industry, the federal Securities and Exchange commission (SEC) requires the registration of “investment advisors.” A total of 37 states also impose their own versions of this federal Investment Advisor Act. Though these laws were meant to encompass all individuals providing investment advice at a cost to their clients, fewer than 10,000 investment advisors are registered with the SEC. It is estimated that there are 200,000 self-proclaimed financial planners in the United States, which means that many thousands who should be registered as investment advisors under federal and state law are not.

The financial planning industry is in the midst of a meteoric rise today, fueled by the emergence of well-heeled young professionals, two-income families, the graying of the American population and aggressive advertising. Industry groups estimate that there are 10 million Americans -- many of them middle-income wage earners -- who could use financial planning services. That estimate takes in about 15 percent of American households. A national survey conducted in 1982 found that 5 percent of U.S. households were already signed up with financial planners.

Learning the Financial Planning Ropes

There are three basic types of financial planners:

1. FEE-ONLY. Some financial planners who concentrate on upper-income clients charge a fee for their services but do not have products of their own to promote, such as stocks or real estate partnerships. These planners charge either an annual fee based on assets and investment activity or an hourly fee of $50-$200 or more. The claimed advantage here is that the planner does nothing more than give advice and is not burdened by the potential conflict of interest in promoting an investment product.



2. COMMISSION. Some planners charge no fee, but do get a commission on the investment products they sell, for example, 8.5 percent on a mutual fund or 3.5 percent or more of a tax shelter investment. The argument here is that since a financial plan requires investments, the customer benefits from the convenience of “one-stop shopping” and would, in any event, have to pay a commission no matter where the product is purchased.



3. FEE/COMMISSION. Some planners charge a fee for the financial plan and a commission for the sale of products. The claimed advantage here is that the fee is usually much lower than those charged by fee-only planners.

No matter which type of financial planner you decide to do business with, you should get the following services for your money:

1. A clearly written and individualized financial plan, including a balance sheet of assets versus liabilities, and a projected cash flow statement for at least one year. This plan should include a precise definition of your financial objectives and the steps you will take to achieve them.



2. A discussion of the amount of risk you are willing to tolerate in achieving your financial goals.



3. Specific suggestions for improving your personal cash management.



4. A detailed description of the assumptions underlying your financial plan, including projections for shifts in the rates of inflation and interest.



5. A range of investment choices, with the pros and cons for each course of action. You should be provided with several alternatives.



6. Additional advice, if needed, from other professionals, including lawyers, accountants and stockbrokers. This is particularly important if you do not already have established contacts with professionals in these areas.



7. A specific schedule for monitoring the progress of your financial plan, including periodic opportunities for reviewing your objectives and checking on the performance of your planner’s advice.

Prospects for Consumer Protection

State and federal securities regulators have expressed concern in recent months that the financial planning industry is subject to little or no effective oversight. A major SEC official recently described the federal Investment Advisor Act as a “charade.” The SEC administrator explained: “Whenever I see ‘registered with the SEC’ on an ad (for a financial planner), I want to laugh. People think that is equivalent to the Good Housekeeping seal of approval, but it isn’t.” Registration under the Investment Advisor Act means that an applicant has paid $150 to the SEC, filled out a short form and waited 45 days for it to be processed. No professional standards must be met or tests passed to secure the SEC registration.

In March, NASAA conducted the first-ever national hearings on new approaches to regulation of the financial planning industry. So far this year, a number of states -- including Hawaii, California, Minnesota, Maryland, Oregon, Maine and Arizona -- have considered either legislative or administrative rules for regulation of financial planners. NASAA and the SEC are now drafting a tougher, expanded Investment Advisor Act, which would require federal and state registration of all planners and disclosure of key information to potential clients. Additionally, the International Association of Financial Planners (IAFP), an Atlanta-based industry trade group, proposed in June that Congress create a self-regulatory organization which would allow the financial planning industry to police itself in much the same way that the National Association of Securities Dealers (NASD) oversees stockbrokers.

The Red Flags of Financial Planning Fraud and Abuse

1. Determine if a “planner” has a criminal record or a history of securities-related complaints. Even if information is not available directly about financial planners, state securities agencies and Better Business Bureaus (BBBs) may have information about the previous business and investment-promotion activities of a financial planner. Check out the promoter before you turn over your financial records or funds.



2. Be on your guard for possible Ponzi schemes. Self-styled financial planners with little or no experience have become prime vendors for Ponzi schemes, the house-of-cards swindles in which a few initial investors are paid interest out of the proceeds of later investors, who end up with nothing when the bubble bursts and the promoter pockets most or all of the remaining money. In this often confusing era of financial deregulation, Ponzi schemes masquerade as tax shelters, precious metals, commodities, high-tech stocks, and other new investment vehicles. The trick is to avoid financial planners who urge you to put your money in anything with “guaranteed” rates of short-term interest far above prevailing market rates. This no-risk promise is the No. 1 sign of a possible Ponzi rip-off.



3. Avoid financial planners who give you few or no alternatives in your investment plan. Regard any such pressure as a “yellow light” that may be signaling the planner’s intention to steer you into a fraudulent scheme. (This also may indicate that the “planner” is primarily or even entirely a salesman of a specific product and is more interested in his commission that in your financial well-being.) The securities division of the Oregon Corporation Commission recently shut down a financial planner who charged a $1,500 fee to analyze a client’s tax returns, draw up a financial plan and a will. Though he never made good on producing the financial plans or the wills, the self-proclaimed planner did urge over 2,500 clients to put immediately an average of $4,000 into what later was determined to be an abusive tax shelter scheme.



4. Will you provide references from three or more clients you have counseled for at least two years? Take the time to check out the individual track records of a financial planner. Get the names of several long-term clients and ask them about their level of satisfaction, returns, and intentions about staying with the financial planner. Avoid financial planners who pressure you to rely on the word of one or two new clients, since a planner promoting a Ponzi scheme may line you up with a handful of early investors who were paid off in order to lure new investors like yourself.



5. Will I be dealing with you or an associate? If your planner will be turning over all or most of the day-to-day work on your financial plan to a junior associate, take the time to check out that individual as well. Don’t rely on the reputation and credentials of one planner if another planner will actually do the work.



6. May I see examples of plans and monitoring reports you have drawn up for other investors? Make sure that these documents meet all of the financial plan criteria described above. Pay particular attention to the frequency and quality of the monitoring reports, since these updates will be vital to recharting your financial objectives.



7. What financial planning trade associations do you belong to? Industry groups provide training and membership services to financial planners. Get the names of the groups to which the planner claims to belong. Ask about the additional university or trade education and listing standards he or she claims to have met. Take the time to call and determine if the planner is telling the truth. Several recent cases of major investment fraud have involved financial planners making false claims about their titles and training.

For More Information . . .

The securities administrator in your state, province or territory is responsible for protection of investors and ensuring that complete information is available for many types of investments. If you have concerns about questionable or suspicious practices on the part of a financial planner, contact your securities administrator. For the phone number or address of your securities regulator, telephone the North American Securities Administrators Association at (202) 737-0900. Contact information is also available on the association’s web site at www.nasaa.org. Your prompt action could save other, less vigilant, investors from a possible swindle.

The Council of Better Business Bureaus (CBBB) and the Better Business Bureaus of the U.S. and Canada answer inquiries on companies located in the areas they serve. Before putting money in an investment plan, it is a good idea to contact your local BBB for a reliability report on the company you intend to deal with.

The Investor Alert is a quarterly program jointly sponsored by the CBBB and the North American Securities Administrators Association (NASAA), the organization representing all 65 state, provincial and territorial securities regulators in the U.S., Canada, Mexico and Puerto Rico.

Issued 1996

This publication was compiled by the North American Securities Administrators Association and the Better Business Bureau and is furnished to you by the Texas State Securities Board.