Friends Don't Let Friends Become Their Financial Adviser

The story of Frank J. Russo, splashed on the front page of The Boston Globe on Monday, was the talk of the sandwich shop. Russo, of Wakefield, Mass., allegedly squandered roughly $20 million entrusted to him by some 250 investors, ranging from teenagers to senior citizens, purportedly nipping into his customers' nest eggs for almost a quarter century.

It's not much different from any type of confidence fraud, where someone steps into trouble based on the trust they have in the person setting the trap. What had the sandwich shop buzzing was that the bulk of Russo's victims reportedly were "relatives, friends and neighbors."

"I can't believe anyone could do that to a friend," Big Mark opined from behind the grill. And there was a chorus of agreement.

And then I stepped in and said "Go the other way. How could anyone let a friend do that to them?"

The difference is subtle, so I'll borrow from an old public-service ad campaign to put it a different way: Friends don't let friends become their financial advisers.

While the onus should be on the service providers because they should recognize the conflicts inherent in mixing business and pleasure, there's no denying that from the time a kid is old enough to sell Girl Scout cookies or raise money for a school trip by hawking wrapping paper, the sales process tends to start at home.

As grown-ups, people turn to friends and family for support and guidance, which sometimes leads them to the door of uncle Leo's financial-planning practice or cousin Frank's stock brokerage.

The ties that bind can become a problem in financial situations because they put people past an important step in the process of selecting.

Good financial advisers and rogues typically have charisma in common. They have a personality that engenders trust, because trust is an essential ingredient in any successful relationship. But trust is earned and that is where the family connection interferes.

In the Russo case, according to federal and civil complaints filed against him, Russo never registered as an investment adviser but managed at least two investment funds on his own.

Background check

Checking on a money manager's registration is the most basic background check a consumer can make; it is the absolute bare minimum of background check a consumer should undertake.

And any reasonable consumer probably would take that step, unless they felt like the adviser was part of the family. The relationship gets a rogue adviser past that initial wall of worry; consumers feel that they know the adviser's background, which makes checking it unnecessary. Even though a quick phone call or Web search can determine if an adviser is registered, it seems like a waste of five minutes.

"The first thing you ask any financial adviser — even if it's your uncle, your cousin or your own kid — is 'What does that mean?'" says Michael Unger, an attorney with Rubin & Rudman in Boston and a former director of the Massachusetts Securities Division. "You have to ask: 'Are you with a registered broker dealer, or are you an investment adviser? Are you registered with the state you are doing business with?'

"If the answer to those questions is 'no,' and they're not registered anywhere, you walk away. If they are registered, you check them out."

Unger notes that one other reason why rogue advisers frequently target relatives is because the trust barrier extends to when and where the check is being written.

Clients generally write checks to the brokerage firm that handles the cash; financial planners typically use a brokerage firm to act as custodian for their customers' cash. Once the money hits that brokerage system it's tough for the adviser to steal from it.

In most stories where a rogue broker or planner steals from customers, one telltale sign of trouble is the bad guy asking to take deposits in his name or the name of his firm rather than in the name of the custodial firm. Moreover, writing the check to the correct institution helps to show who has custody of the funds; if the check is misused, you may have some recourse against the bank.

Says Unger: "The check should never be written to your Uncle Leo, but to a recognized institution. It doesn't make a difference who your broker or planner is related to, who they know, who else they have worked with successfully. If they're asking you to write the check directly to them, you've got a problem."

Money on the line

Obviously, not every family financial affair ends with disastrous results, but few things kill friendships and ruin family relationships quicker than disputes over money. Any time a family member or friend becomes a financial adviser, the chances that both relationships will falter increases.

"This is just another form of 'affinity fraud,' where you are drawn in because of your ties through a church, school or, in this case, family or friendships," says Joseph Borg, securities commissioner in Alabama. "If you decide to deal with close family or friends, get an agreement up front on what services you will receive and what you will pay. Agree that this is a business, and what remedies you have, because if something goes wrong the friendship is shot anyway and what you will really want is the money back."

Before signing that agreement, do a complete examination of the adviser's background and disciplinary history; good advisers should want you to be comfortable with their record, so if your relative or friend objects it should raise a big warning flag.

The chances of finding a financial adviser who is a fraud are extremely low, but you'll be much better off finding it out before turning over your money and trust than you will be finding out that your broker or planner has used your money to make tomorrow's headlines.

Copyright (c) 2007 MarketWatch, Inc.