Five Unbelievable Financial Advisor Regulations

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GavelThe federal Securities and Exchange Commission (SEC), created after the 1929 stock market crash, regulates financial corporations. The agency was charged with ensuring that nothing inappropriate occurs in the investment world. As a result, hundreds of regulations of compliance for firms dealing with securities were created. These rules have not prevented the Enron scandal, Bernie Madoff’s Ponzi scheme or the financial crash of 2008. But they cost American corporations several billions of dollars in compliance every year.

To comply, most firms must archive and report massive amounts of information. Here are five of the more interesting regulations:

1. Financial advisors must designate in advance who to put the handcuffs on. A chief compliance officer is responsible to ensure the firm complies completely with every SEC ruling. You not only have to demonstrate your compliance with all their changing requirements, you have to show regulators that you are meeting the standards you set yourself.

The work of the chief compliance officer requires hundreds of hours a year. The average annual cost of compliance for a firm our size is $46,000. And even that amount of diligence won’t escape being cited. More than 70% of firms are found deficient after an SEC visit.

2. At all times, financial advisors must keep a count of their clients in each state. Each state requires advisors to pay a fee and file with the state if they have more than five clients who reside there. The advisor must maintain the running total even if a client moves or winters in Florida.

Texas requires filing for just one client, even if that client is just visiting for more than 30 days, and it charges $275 annually. Our firm’s total charges this past year were $1,810.

Imagine having to keep ever-changing documentation of every client’s current location and how long they had been there (is it more than 30 days?). You then have to determine how many clients you had in each state and whether you must pay and file with that state.

The task is so arduous that the chair elect of the National Association of Personal Financial Advisors refused the leadership role because he failed to file such registration papers within 30 days. He wrongly believed he had until his annual registration deadline to make the change.

3. Financial advisors may not use client testimonials in advertising. Advertising is one of the primary targets of SEC visits. This ban is so all-encompassing that advisors have pushed social media sites to allow them to turn off Facebook “likes” and LinkedIn endorsements, sometimes considered testimonials. Every statement of a client’s experience with an advisor used in an advertisement constitutes a fraudulent, deceptive or manipulative act, according to section 206(4) of the Investment Advisers Act of 1940.

Marketing specialists can’t believe what advisors are subject to. We’ve listened to several marketing brainstorm sessions only to shoot each one down with “and that’s against the law” as they suggest using phrases that resemble a client recommendation.

4. Financial advisors cannot plead the Fifth Amendment. In other legal settings, you are allowed to plead the Fifth anytime your answer could incriminate you, regardless of whether your answer actually does. In those situations, your lack of an answer requires the prosecution to look elsewhere for evidence.

During an SEC investigation, every question must be answered fully and completely. If someone asserts his or her Fifth Amendment rights in an SEC inquiry, the court is allowed to infer the answer would hurt the firm’s case. With any other corroborating evidence of a regulation violation, the court can assume the worst concerning the question you refused to answer and mete out punishment.

And yet there are still more consequences for financial professionals who take the Fifth. Many of them are required to be part of self-regulatory organizations that ban those who try to take the Fifth during investigations from ever dealing in securities again. It’s a tough price to assert a constitutional right.

5. Financial advisors are required to urge their clients to check up on them. When advisors send a statement to their clients, the SEC requires them to urge their clients to compare their custodian’s account statements with the investment reports provided.

At the end of the month, many funds are late computing their monthly dividends. These dividends must be put in the prior month for taxation, but sometimes they are not reported until after the end of the month. The statements from the custodian usually do not include these and are not corrected until the next statement. Often, because advisors delay reporting after the end of a month, their accurate account includes them.

It doesn’t matter if the advisors’ reports are more accurate and therefore won’t match. Advisors are required to urge clients to compare anyway.

Serving as chief compliance officer for an honest firm requires spending hundreds of hours that do not improve client service or increase the safety of their assets. Compliance is an expensive task that historically has not proven its worth to consumers. No perpetrators of a Ponzi scheme have ever disclosed their illegal behavior in their filing.

Ultimately, clients should learn how to protect themselves from Ponzi schemes. In 2009, we were asked what disclosures we thought should be required of financial advisors. We wrote a long series on how to safeguard your money that can be found on

You can use those principles as a checklist to evaluate investment advisors and the philosophy underlying their advice. If your financial advisor answers “no” to any of the questions, his or her actions are not illegal. It is just bad practice and could be a warning sign as more of the answers come out.

If you’re looking for a new financial advisor, we encourage you to do your research. In the end, the SEC won’t protect you from a bad financial advisor–only you will.

Photo used here under Flickr Creative Commons.

Follow David John Marotta:

President, CFP®, AIF®, AAMS®

David John Marotta is the Founder and President of Marotta Wealth Management. He played for the State Department chess team at age 11, graduated from Stanford, taught Computer and Information Science, and still loves math and strategy games. In addition to his financial writing, David is a co-author of The Haunting of Bob Cratchit.

Follow Megan Russell:

Chief Operating Officer, CFP®, APMA®

Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. She is the author of over 800 financial articles and is known for her expertise on tax planning.