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Custody of Assets - Avoiding Bernie Madoff Situations! - Episode 12

There can be quite a bit of confusion over how and where your assets are actually held when you have an investment account in general or when you have an account with a registered investment advisor (RIA) firm like mine. This week I cover what a custodian is and does and how to avoid getting Bernie Madoffed!

Listen to Episode 12 Here


You can listen online through the direct player above, or a much easier way to listen is by subscribing to the podcast through a free podcast app on your phone.  The podcast is available on iTunes, Spotify, TuneIn Radio, Google Play Music and Stitcher


What Is a Custodian? 

Here is a definition from Investopedia.com

A custodian is a financial institution that holds customers' securities for safekeeping in order to minimize the risk of their theft or loss. A custodian holds securities and other assets in electronic or physical form. Since they are responsible for the safety of assets and securities that may be worth hundreds of millions or even billions of dollars, custodians generally tend to be large and reputable firms. A custodian is sometimes referred to as a "custodian bank."

Custodians also send notices to customers when certain activities are conducted on their behalf or using their assets. So, if I make a trade or do a rebalance or something similar for a client, they receive a notification. Also, account statements are supplied to the customers to keep them abreast of the current holdings associated with their assets.

While my firm, which is an RIA or registered investment advisor, may manage your accounts, we have no direct access to your money! And believe me, I want it that way as much as you do. I don’t ever want there to be a misappropriation of funds where there is any possibility the fault could lie with myself or my team. So, we are both content.    

Some examples of custodians are any of the big banks like JP Morgan, Citibank, Bank of America, Wells Fargo, and also Schwab, TD Ameritrade, Interactive Brokers, Fidelity, Vanguard, E*TRADE, Bank of NY/Mellon/Pershing, etc….  

There has been a great deal of consolidation over the years, and just this past week, there have been reports that Schwab is in talks to purchase TD Ameritrade, which would create a $5 trillion custodian, which would be similar in size to Vanguard.   

What Does a Custodian Do?

Currently, my firm uses TD Ameritrade and Interactive Brokers as custodians, but there is now a new custodian in the works, and it is called Altruist. It’s in beta testing right now, and I did a demo with the them a month or so ago, and I have high hopes for it moving forward. It is being built specifically for RIAs (like my firm) and it should be rolled out within the next few months.

Most of these custodians have some powerful tools for advisors, but advisors often have to source other software for rebalancing portfolios, client billing or aggregating, and these other services can add great costs to an RIA. Plus, many of the tools offered by these older custodians seem to use software that is built on top of prior software causing it to be less than intuitive and a little clunky sometimes.

Altruist promises to combine much of this software into one platform while also making the client and advisor user experience much more pleasant and quicker! This is how Altruist describes its platform on its website: “A technology platform that helps your financial advisor give you a delightful experience with your money.” This all sounds pretty good. At any rate, if it can accomplish most of what it wants, this could be a great thing, and I am watching it closely. 

Although I may keep technology out of most of my interactions with clients, in meeting and workshops, I do like to stay up to date with all the efficiencies technology can provide, and we (my team and I) do use it substantially behind the scenes.  

An Advantage of Being an Independent RIA

One advantage of being my own independent RIA is I get to choose the best tech out there, and I can switch if something nicer comes along as opposed to being stuck in whatever the current platforms are being used at those firms that have a shop on every corner or some 100-year-old bank or brokerage firm.

The checks and balances between RIAs and custodians are key to whomever you choose to use as an advisor. And I recommend that you ensure that your custodian is not only separate from the RIA firm you use but also that the firm you use has no ownership or control over your custodian.  

Bernie Madoff Scandal

Anybody heard of Bernie Madoff? He had the largest Ponzi scheme in history until 2008 and 2009.  

As Warren Buffett likes to say: You never know who’s swimming naked until the tide goes out. Well, the tide went out in 2008 and Madoff went down.

It appeared legitimate too because he controlled the small company that served as his custodian. So, he could move money around whenever he wanted, including into his own pocket, and of course, he did. He could also fabricate statements from his custodian which allowed him to fleece some of the wealthiest people on the planet.  

His clients didn’t have proper checks and balances that investors should insist on! But how would you know this? Well, now you do because I’ve told you!

Downsides of Large Firms

The large Wall Street firms also serve as their own custodians. It could be argued, and is by many pundits in the financial planning community including Bob Veres, that your safest avenue is to work with a financial planner or investment advisor who has a custodial relationship with a separate, well-established institutional custodian.

This way you can usually get better service and enjoy improved safety of your assets.

Bob says (and I’m paraphrasing) but one of the oddities about the American financial marketplace is how so many consumers prefer to keep their assets at the large Wall Street firms – which famously have sales cultures driven by multi-million dollar bonuses to their brokerage sales agents, and whose BrokerCheck reports read more like rap sheets than profiles. If you don't believe this, simply type a famous brokerage firm name into the second box in the BrokerCheck website – https://brokercheck.finra.org/ – and you’ll get hundreds of thousands of listings of specific broker transgressions, fines, and examples where customers received arbitration awards after various kinds of financial abuse.)

The reason, of course, is that many people feel safer keeping their assets at a very large firm that they have heard of, rather than a smaller financial planning firm, even if that smaller firm often provides more customized service and has renounced predatory sales activities and commissions [by being a fee-only fiduciary firm like mine (shameless plug)].

The thing is, the large firms with the stadium naming rights, and fancy ivory towers and all their  grandfathered money may be a false comfort; the funds may actually be safer with the smaller planning firm than with the larger multinational firm that may or may not buy Super Bowl advertisements.

It should also be noted that the collateralized debt obligations (CDOs) and credit default swaps (which are is basically highly leveraged tools) are what helped lead to the 2008 and 2009 great recession, and they were sold and propagated by the same, large, branded firms! So, it’s hard to argue some of the distrust of the large Wall Street institutions is without merit.  They pretty much earned it.

Having custody at one of the institutions I mentioned before, but also being separate from that institution, is a very strong check and balance and is strongly embraced and supported by my firm. 

My firm never has direct access to your money, and therefore we cannot take it out or otherwise steal or misplace it. As I mentioned before, that is how I want it, as well how you would want it, because I don’t want that kind of liability.   

I hope this helped clear up any questions about where your money actually goes when you work with an RIA like my firm.

We will be taking a brief hiatus from the podcast to wrap up our end of year items and to spend time with family! Merry Christmas, Happy Hanukkah, and Happy Holidays to you and yours! We’ll see you next year!

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