Wealth Management: The Critical Importance of the Independent Custodian

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When you hire a financial advisor, you usually don’t give money to that firm or person. Instead, your money is given to, and handled by, a “custodian.” The custodian is usually a large organization with a brand name that you’ve likely heard of. The custodian firm uses bank-level security and is in the business of managing large amounts (usually billions) of investor assets.


Value of the Wealth Management Custodian

The custodian is then legally responsible for holding your investments and keeping them safe. Custodians collect all your dividends and interest accrued on your investments.  They also send you monthly statements on your accounts.

Your advisor may direct trading in your account with your permission, but he or she may not withdraw funds.

It may be tempting to choose a financial advisor that also has custody of your assets – fewer names to remember, fewer statements in the mail. But the separate custodian provides you an extremely valuable, added layer of protection — one that can help keep your money safe.

With a separate custodian, you will receive one set of statements from your advisor and another set from the custodian.  This allows you to double-check what your advisor is telling you.


…but it has to be the Right Custodian

Bernie Madoff was an independent advisor, and a fiduciary to boot (learn more about the importance of a fiduciary). However, he didn’t use an independent, well-known custodian. Instead, Madoff investors got statements from “Bernard L. Madoff Securities.” With no well-established, independent custodian confirming that the numbers he was reporting were accurate, his investors had no double check on the status of their assets.

If his investors had been aware of the critical role of the custodian, that could have served as a red flag. The presence of a high-quality independent custodian can help you avoid these Ponzi schemes where new investor money is used to pay those who got involved first.

When advisors control both sets of statements, as Bernie Madoff did, there is the potential to use that to mislead clients into thinking their holdings are worth more than they actually are—or even show assets that don’t really exist.

Now, Madoff’s case goes further, because it turns out he did have an arrangement with a custodian, a small, new bank that you would not have likely heard of. It was so small that they never even checked up on Madoff, and simply let him do what he wanted.

The lesson here is: When you hire an advisor, ask what custodian they use.

What you want to hear: A large name brand custodian that has been in business for many years. Some of these are TD Ameritrade, Schwab, and Fidelity. If you’re working with a brand name advisor, however, they may have their own in-house custodian firm—for example, LPL or Wells Fargo. Regardless, the custodian should be a name brand you’ve heard of or one you can easily confirm.


Avoiding Others Like Madoff

Sadly, there are a few Ponzi schemes exposed most years carried out by financial advisors.  What can you do to make sure you don’t get caught in one?

Independent advisors are not legally allowed to take possession of your assets, other than their fees. So you should never write a check directly to your advisor. Instead the check should always be made out to the custodian (e.g., TD Ameritrade, Fidelity or Schwab).

If you’re asked to write a check to your advisor, don’t do it.  The only time that might be appropriate would be to pay for their fees, but normally those are deducted directly out of your accounts.  So be safe and ask questions first.


Nontraditional Investments

Some scams encourage you to invest in highly illiquid assets that don’t require a custodian. That may be real estate, mortgages, or other type of unusual securities. If you are asked to invest in any of those, be very, very cautious. A quality advisor is unlikely to want you to invest in things that don’t have liquidity (simply meaning they are not easy to quickly buy or sell).  If that occurs, get a second opinion and be ready to move your assets elsewhere.


The Good News

By simply choosing a financial advisor that uses an independent custodian, then only writing checks to the custodian, you’ve taken an important step. This prevents the advisor from being able to steal your assets.

Of course, this does not protect you from him or her selling you bad products or giving you bad advice, but it is one important victory that you shouldn’t discount.




John Odell, CFP® is CEO of Arroyo Investment Group, LLC, a fee-only financial planning and investment management firm based in Pasadena, California. As a GIPS®-compliant firm, we bring institutional quality, high performance investment management and comprehensive financial planning to individuals and families.  Together with Capital Research + Consulting, our sister firm, we collectively manage over $4 billion of assets for individuals and retirement plans.  Visit us at https://arroyoinvestmentgroup.com/.