Ask the right questions to minimise risk of fraud
The circumstances of the fraud perpetrated by disgraced financial adviser, Barry Kloogh, were released late last month. The case made for sickening reading. The blatant and egregious abuse of trust seems beyond comprehension.
In my column of June 2019, I outlined a checklist of questions that should be asked of ALL financial advisers. The idea of this checklist was to provide investors with a standard against which their current, or a prospective adviser, could be tested.
In light of recent events involving Mr Kloogh, I thought it would be valuable to revisit and update that checklist.
But firstly, I must emphasise that I am not suggesting these losses were inflicted by anyone other than Mr Kloogh. The fraudster was highly plausible and, in an absence of understanding about the type of safety measures that can exist within an advisory relationship, this fraud was able to occur for an extended period.
And this is the root of the problem – there is no single question that can be asked to avoid fraudsters. However, asking a series of questions can help to minimise that risk and enable investors to enjoy the benefits of receiving and implementing investment advice.
So what questions can you ask (and periodically re-ask) and what ‘red flags’ should you be looking for?
1. Who holds the ownership of the investments?
In pooled investments like managed funds and KiwiSaver you don’t own the underlying investments; rather they are owned by an independent trustee (e.g. The New Zealand Guardian Trust Company Limited). In wrap platforms, the investments must be owned by an independent custodian. In both instances, you should make sure that you receive independent confirmation of your investment.
At times Mr Kloogh was using an independent custodian and some funds were held there. However, at other times client funds were redirected for his personal use. Independent confirmation from the custodian would potentially reveal this.
2. Are you able to independently check your investment?
In this day and age, it should be a given that you can see your portfolio online. Sophisticated fraudsters have created online platforms with false reporting, but this is very rare.
Legitimate custodial platforms allow online access via an investor portal. If you are not offered this facility by your adviser, then you should ask for it before you part with your money.
3. Do you receive third party verification of your investment holdings?
In addition to receiving regular reports directly from your adviser, you should also receive a statement of holdings from a third party.
I suspect that, on the pretext of reducing the amount of paperwork that his clients received, Mr Kloogh arranged for all information from the custodian to be sent to his office. This allowed the on-going falsification of the records that were sent from his office to the client. Receiving what appears to be a duplication of confirmation direct from the custodian may seem like a double up but it provides essential reassurance.
4. Where are you depositing your investment capital?
It is important to make sure that your investment capital is being deposited to a custodian’s trust account or paid directly to the underlying investment provider.
This can be difficult in the case of a sophisticated fraud like the one perpetrated by Mr Kloogh. In this case the clients were asked to deposit funds to accounts which were named in such a way that they appeared to be those of the custodian or an underlying investment provider. It would only have been a highly suspicious client that would have checked that the number on the deposit slip corresponded with the custodian’s actual trust account.
5. Offers to invest in new opportunities and difficulties in getting money out.
Mr Kloogh appears to have played on the personalised nature of the relationship with time bound opportunities to invest and situations where access to capital was delayed. With 20/20 hindsight, we now know these ‘opportunities’ and delays were driven by his need to keep the Ponzi scheme operating. Any difficulty with making a withdrawal (within the agreed timeframes for an investment) can be an extreme red flag.
6. Does the firm operate a consistent advice process and how is this reviewed?
Few clients want to receive advice that is based on a ‘one size fits all’ approach. The provision of personalised advice is quite the opposite of this. However, at the other extreme, a highly complicated portfolio containing difficult to understand investments can make it more susceptible to fraudulent activity.
Investing in accordance with a well-documented financial plan, that is presented in a way that is easy to understand and clearly references the client’s financial goals and objectives, improves transparency. A plan of this type clearly sets out to clients what should be happening at any given point in time and makes it harder to be deceived.
Asking these questions (and others like them) will not eliminate the possibility for fraud, but it will make it harder for advisers to get away with it, and may prevent you from investing in the first place if you ‘get a bad feeling’ after asking them.
Despite Mr Kloogh, I believe that in general the Dunedin community is well served by a range of honest, hardworking investment advisers who care deeply about their clients. With interest rates at historic lows there has never been a time when advice is as essential as it is right now. It would be a pity if the actions of one rogue individual deters investors from seeking good advice and putting in place a plan for the future.
In my column of June 2019, I outlined a checklist of questions that should be asked of ALL financial advisers. The idea of this checklist was to provide investors with a standard against which their current, or a prospective adviser, could be tested.
In light of recent events involving Mr Kloogh, I thought it would be valuable to revisit and update that checklist.
But firstly, I must emphasise that I am not suggesting these losses were inflicted by anyone other than Mr Kloogh. The fraudster was highly plausible and, in an absence of understanding about the type of safety measures that can exist within an advisory relationship, this fraud was able to occur for an extended period.
And this is the root of the problem – there is no single question that can be asked to avoid fraudsters. However, asking a series of questions can help to minimise that risk and enable investors to enjoy the benefits of receiving and implementing investment advice.
So what questions can you ask (and periodically re-ask) and what ‘red flags’ should you be looking for?
1. Who holds the ownership of the investments?
In pooled investments like managed funds and KiwiSaver you don’t own the underlying investments; rather they are owned by an independent trustee (e.g. The New Zealand Guardian Trust Company Limited). In wrap platforms, the investments must be owned by an independent custodian. In both instances, you should make sure that you receive independent confirmation of your investment.
At times Mr Kloogh was using an independent custodian and some funds were held there. However, at other times client funds were redirected for his personal use. Independent confirmation from the custodian would potentially reveal this.
2. Are you able to independently check your investment?
In this day and age, it should be a given that you can see your portfolio online. Sophisticated fraudsters have created online platforms with false reporting, but this is very rare.
Legitimate custodial platforms allow online access via an investor portal. If you are not offered this facility by your adviser, then you should ask for it before you part with your money.
3. Do you receive third party verification of your investment holdings?
In addition to receiving regular reports directly from your adviser, you should also receive a statement of holdings from a third party.
I suspect that, on the pretext of reducing the amount of paperwork that his clients received, Mr Kloogh arranged for all information from the custodian to be sent to his office. This allowed the on-going falsification of the records that were sent from his office to the client. Receiving what appears to be a duplication of confirmation direct from the custodian may seem like a double up but it provides essential reassurance.
4. Where are you depositing your investment capital?
It is important to make sure that your investment capital is being deposited to a custodian’s trust account or paid directly to the underlying investment provider.
This can be difficult in the case of a sophisticated fraud like the one perpetrated by Mr Kloogh. In this case the clients were asked to deposit funds to accounts which were named in such a way that they appeared to be those of the custodian or an underlying investment provider. It would only have been a highly suspicious client that would have checked that the number on the deposit slip corresponded with the custodian’s actual trust account.
5. Offers to invest in new opportunities and difficulties in getting money out.
Mr Kloogh appears to have played on the personalised nature of the relationship with time bound opportunities to invest and situations where access to capital was delayed. With 20/20 hindsight, we now know these ‘opportunities’ and delays were driven by his need to keep the Ponzi scheme operating. Any difficulty with making a withdrawal (within the agreed timeframes for an investment) can be an extreme red flag.
6. Does the firm operate a consistent advice process and how is this reviewed?
Few clients want to receive advice that is based on a ‘one size fits all’ approach. The provision of personalised advice is quite the opposite of this. However, at the other extreme, a highly complicated portfolio containing difficult to understand investments can make it more susceptible to fraudulent activity.
Investing in accordance with a well-documented financial plan, that is presented in a way that is easy to understand and clearly references the client’s financial goals and objectives, improves transparency. A plan of this type clearly sets out to clients what should be happening at any given point in time and makes it harder to be deceived.
Asking these questions (and others like them) will not eliminate the possibility for fraud, but it will make it harder for advisers to get away with it, and may prevent you from investing in the first place if you ‘get a bad feeling’ after asking them.
Despite Mr Kloogh, I believe that in general the Dunedin community is well served by a range of honest, hardworking investment advisers who care deeply about their clients. With interest rates at historic lows there has never been a time when advice is as essential as it is right now. It would be a pity if the actions of one rogue individual deters investors from seeking good advice and putting in place a plan for the future.
This document has been provided for information purposes only. The content of this document is not intended as a substitute for specific professional advice on investments, financial planning or any other matter.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
While the information provided in this document is stated accurately to the best of our knowledge and belief, New Zealand Funds Management Limited, its directors, employees and related parties accept no liability or responsibility for any loss, damage, claim or expense suffered or incurred by any party as a result of reliance on the information provided and opinions expressed except as required by law.
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Peter Ashworth is a Principal of New Zealand Funds Management Limited, and is an Authorised Financial Adviser based in Dunedin. The opinions expressed in this column are his own and not necessarily those of NZ Funds. His disclosure statements are available on request and free of charge.
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First published in the Otago Daily Times on 11 August 2020, as 'Ask the right questions to minimise risk of fraud.'
