Safeguard #1: Do Not Allow Your Advisor to Have Custody of Your Investments

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Lock and Gold CoinsI was recently asked if investors should trust their financial advisors. And my short answer, you may be surprised to hear, was no.

Given all the greed and deceit revealed last year in the world of financial services, this question of trust could not be more timely.

If your advisor is not a fiduciary, he or she has no legal obligation to act in your best interest. Only about 7% of those working in financial services are fiduciaries, so the odds are your advisor is probably not.

Simply put, the term “fiduciary” applies to those who have the legal responsibility to manage other people’s money. Fiduciaries are required by law to act in the best interests of their clients, beneficiaries or retirement plan participants.

Both the National Association of Personal Financial Advisors ( and the Center for Fiduciary Studies ( require its members to sign and uphold a fiduciary oath. In contrast, brokers and agents are not fiduciaries and often must disclose the following in writing: “Your account is a brokerage account and not an advisory account.” And “Our interests may not always be the same as yours.”

Being a fiduciary is the bright white line that separates those who sit on your side of the table and legally must act in your best interests and those who sit on the other side of the table and have no such obligation.

In addition to the all-important fiduciary requirement are several other safeguards that you should insist on. Foremost among them is that your financial advisor should not also have custody of your investments.

Custody refers to the entity that is legally responsible for holding your investments and keeping them safe. In the old days, custody literally meant keeping the paper certificates secure. In contrast, a contemporary custodian offers a range of services that investors commonly take for granted.

When securities are bought or sold, the custodian delivers or receives ownership of the shares in exchange for the agreed amount of money. This process, called “settlement,” usually takes one to three days after the purchase or sale.

At one time the physical certificates had to be transferred. But U.S. legislation in 1975 enabled markets to use the Depository Trust Company (DTC), a unified central securities depository. Holding securities electronically or in “street name” makes it easier to transfer and keep track of them. Now the certificates do not move physically. Instead they are transferred via book entry settlement between securities account holders called “members” or “participants.”

While the securities are being held for you, your custodian provides asset services, which amounts to exercising rights and obligations on your behalf.

Custodians collect all the dividends and interest accrued by the investment. They relay any corporate information or actions that affect your investments and provide a standard and streamlined way for you to receive information, exercise rights or vote proxies.

Having a financial advisor who does not have custody of your assets gives you an extra layer of accountability and oversight. Fiduciaries review potential custodians to determine the best one to house their clients’ assets. They analyze the fees and expenses charged in exchange for the services offered. Then fiduciaries keep an eye on the chosen custodian on behalf of their clients.

With a hedge fund or private equity, there is much less accountability. No one–except the individual investor–is watching to see if fees and expenses are reasonable. If the managers of a private equity pay themselves well, their salary is simply an added expense.

The safeguards and monitoring of advisor and custodian work mutually. The custodian sends its own set of statements, a way for you as the investor to double-check what your financial advisor is telling you. Being defrauded is much less likely when you are receiving independent statements.

The custodian also prices your investments, ensuring that everything is really worth what your advisor says it is. When advisors provide their own valuations, they might use the opportunity to manipulate client investments.

Imagine a hedge fund or private equity investment where contributions and redemptions must be requested ahead of time. If net investment flows are into the fund, illiquid assets can be priced high so that investors buy fewer shares. But when net investment flows withdraw money from the fund they can be priced lower, so investors receive less money. If management is also invested in the fund, they can do the exact opposite when moving their own contributions and withdrawals to maximize their profits and minimize that of other investors.

It is even more frustrating when your investments are unknowingly leveraged in nontransparent hedge funds or private equity. Much of your investment may be used as collateral against speculative investments in the hopes of a profit great enough to break high-water marks and justify bonus fees. You may or may not understand these investments. Nor may you understand if they are in your best interest or only in the best interest of your advisor. Using a reputable third-party custodian can help ensure that reporting about your investments is transparent.

Not having custody of your investments may limit some of your advisor’s services. So be it. Your advisor can help you with the paperwork to transfer money in or out of your investments but should not handle the money itself. Always make the check out directly to the custodian, never to your advisor.

You can give your advisor limited power of attorney to makes trades on your behalf and take out a fee, but your custodian should both watch out for excessive fees and make withdrawals by your advisor impossible. Your advisor may be able to transfer money between your accounts but only between those you own completely.

Do not allow your advisor to pay bills on your behalf. If paying bills is required, use a third-party service and ask your advisor to make sure it is reputable and honest.

As fiduciaries, we put all of these safeguards into practice to help secure our clients’ investments. We instigate these because part of being a fiduciary means avoiding conflicts of interest and implementing secure practices. By separating your custodian and your advisor, you’ll have peace of mind, knowing that the fees you are paying are reasonable and your assets are secure.

Photo by Megan Marotta

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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.