How to Have Investment Safety In Your Brokerage Accounts

Investment safety is top of mind for investors these days as well it should be. In the an era of Bernie Madoff and MF Global investment scandals , investors must rely on themselves to make sure that everything is above board and they don’t incur fraudulent investment losses.

How do you make sure your brokerage accounts are safe? Of course there is no 100% guarantee but there are several steps you can and should take:

1. What’s in a name?

Just because a brokerage firm is generally regarded as reputable doesn’t mean it is. Do I need to remind you that Bernie Madoff (King Rat) was the former chairman of the NASDAQ stock exchange? As a result a great deal of trust was automatically bestowed upon this weasel. Enough trust to allow him to steal billions and billions from investors.

Jon Corzine is the former CEO of Goldman Sachs and of MF Global. He was also the 54th Governor of New Jersey after he was elected Senator from the same state. Quite a resume. Those credentials reasonably qualified Mr. Corzine as a trustworthy fellow. Yet as CEO of MF Global Inc, one of the largest firms that specialized in the futures market, the firm went bust. I’m not saying that Jon Boy is a thief of course. The courts will decide that matter. But MF Global clients are missing over $1 billion and he has no idea where that money went. Sorry…that dog just does not hunt if you ask me.

So the first rule to keep your money safe is to stay awake and ask questions no matter who you are dealing with. When people ignore this rule, they painfully learn the top reason why investors lose money.

2. Find out how the firm makes its money.

There are several ways stock brokers make money. Most make money on commissions and fees when you make investments. They have to make money somehow. If you insist on working with a commission broker, only work with brokerage firms that earn money this way and this way alone. At least these firms don’t have any interest in you buying one investment over another.

But some firms create their own mutual funds and ETFs and earn fees on these investments too. These firms have no objectively. They want you to buy their products. Why would you ever trust such a firm to make investment recommendations? I wouldn’t.

While I suggest that you refrain from working with such firms, having their own investment products doesn’t give them an easy way to steal from you. There are far more dangerous activities that some brokerage firms engage in that you should look out for.

First, if you don’t understand how a brokerage firm makes its money don’t trust them with your hard earned savings. Bernie Madoff’s firm posted high returns year after year yet nobody could explain how they did it. As it turns out, there was a good reason why they couldn’t explain it….Bernie wasn’t really making those profits. He was just playing a Ponzi game with investors’ money. Eventually, most everyone got hurt.

Other firms (like MF Global) trade on their own account and this is referred to as “proprietary trading”. If they are very aggressive and make the wrong investments they can run up huge losses. If that happens the firm could try to dip into the cookie jar – your cookie jar – to try to make up for those losses. Don’t open an account with firms that trade on their own account.

3. Take a look under the hood

You can check out your broker and your brokerage firm at the Financial Industry Regulatory Authority – FINRA. Had investors taken a look there before investing with MF Global for example, they would have seen no less than 35 problems. Most of those were reports by the Futures Trading Commission (the regulatory body the overseas firms like MF Global). The FTC audit found sub-standard supervision and poor record keeping practices.

The firm had real problems with failing to supervise a rogue trader who accumulated huge losses for the firm. Other incidents included multi-million dollar hedge fund losses that were concealed from investors for years. But both of these issues were in plain sight of any investors who checked the FINRA site. And had they done so it would have given most reasonable investors reason to pause before opening an account.

To be fair even high quality firms have occasional regulatory exceptions. Remember that brokerage firms and custodians deal with millions of customers and billions of transactions. No matter how straight they play, there is bound to be a few ruffled feathers and an occasional law suit. The trick is to find out what regulatory problems the firm has and how significant those problems are. You do that by first finding out what the problems are and then you ask questions.

4. Where is your firm headed?

Only deal with publicly traded brokers and read their financial statements and shareholder letters. Is the firm interested in proprietary trading (a risky endeavor)? Are they growing quickly? How?

Taking these four steps will help you avoid big problems. The bottom line is to basically do a little due diligence, ask questions and don’t invest if the answers don’t make sense to you.

Did you lose money with MF Global? Have you lost money in other brokerage scams? What happened and what would you do differently today?