How to Make Sure Your Broker Is the Right One

More than $19.9 million Kazakhstanis lost because of the Ponzi scheme in 2020, according to official data. Alternative data suggests these losses might be bigger – about $1.1 billion.  Often, Ponzi scheme runners want their fraud to look like an investment or brokerage company. Sometimes it’s hard to distinguish grifters from real professionals.

As stock market participants noted, if a broker has a license there is almost no risk of fraud, because every broker is subject to scrutiny by state agencies. In turn, fraud makers just simulate a legal activity and do not sell securities for real.

However, even if you know that an investment firm is not a fraud, you should make sure that the person you talk with is an authorized representative of the company and the bank account you were asked to send money to belongs that a real company.

Ask Questions

The list of red flags designed by the U.S. Securities and Exchange Commission to determine whether a company is real or not is available at the investor.gov website. The first flag is unlicensed investment professionals; the second when you meet aggressive sellers who may provide exaggerated or false credentials; offers that sound «too good to be true»; “risk-free” investment opportunities; promises of great wealth and guaranteed returns; pressure to invest right now; and over-the-top, sensational pitches that may have fake testimonials.

There are three ways to avoid fraud, according to the SEC:

• Ask questions
• Research every investment opportunity thoroughly before you invest
• Conduct a background check on any investment professional

If you also follow the advice of professional brokers, you could significantly reduce the risk of messing with a fake investment company.

Does the Broker Have a License and How Could I Check It?

Even if a company has put its license number on the front page of its website, do some research and check if it’s true on official resources.
There are a lot of international jurisdictions where a broker can get registration. They might be different in terms of tax policies, the number of regulators and other nuances. In Kazakhstan, brokering companies are under the control of the National Bank and the Agency for Regulation and Development of the Financial Market of the Republic of Kazakhstan. The agency has a website where you can find all the information about brokers in Kazakhstan.

Russian brokers are regulated by the Central Bank of Russia; you can check any license on its website. Brokers licensed in Cyprus can be checked on the SEC website. In Belize, brokers are scrutinized by the International Financial Services Commission; in Dubai – by the Financial Services Authority; in the UK – by the Financial Conduct Authority; in Singapore – by the Monetary Authority of Singapore; in Hong Kong – by the Securities and Futures Commission; in Switzerland – by the Financial Market Supervisor. In Germany, a broker’s license can be checked on the website of the Federal Financial Supervision Service; in Ukraine – on the site of the National Commission on Securities and Stock Market; in Kyrgyzstan – on the website of the State Service for Regulation and Supervision of the Financial Market; in Uzbekistan – by the Agency for Market Development capital and so on (a complete list of global financial regulators is available at bis.org/regauth.htm).

Each of these jurisdictions has its requirements for auditing, retention of client assets, and other rules and policies that a broker must follow in a particular country.

If a brokerage company buys securities on behalf of a client, it must have a brokerage license or license for asset management and so on. If there is a license, a significant part of the risks for the investor is gone because this company is under the control of a regulator. Moreover, in the U.S. and Europe, all accounts under $500,000 have insurance.

How Can I Check the Financial Situation of a Broker? 

A key requirement of any national regulator for brokers is to reveal its report on financial results. The requirements for such a document might differ from country to country, but as usual, it’s published on a company’s website or by a regulator itself. Turnover, profit and other financial indicators must correspond to the scope of the broker’s activities. If its report is published on a regulator’s website, it means that the document was checked by the authorities. The highest standards for such kinds of reports are applied by the U.S. SEC. The agency keeps an eye on every auditor, who in turn should scrutinize brokers and verify their reports. This helps to detect fraud if it happens at the earliest stage.

The structure of a financial report usually includes a profit and loss statement, a balance sheet, a cash flow statement, a statement of changes in equity, as well as explanations and the entire company’s strategy. Any specialist interested in the company can look at the report and say whether that firm is profitable or not. Moreover, professionals can compare a company’s result over the period with the same rates in the previous period and understand the performance of that company.

On What Kind of Stock Exchanges Can Brokers Work?

Brokers are not allowed on the world exchanges off the street. It is common practice to put a broker through a set of examinations to get him a membership. There are about 400 stock exchanges in the world; the top five of them are as follows: New York Stock Exchange (NYSE), NASDAQ, London Stock Exchange Group (LSE), Japanese Stock Exchange Group and Shanghai Stock Exchange (SSE).

It is necessary to pay attention to if a broker has a presence in the rankings of exchanges and what kind of turnover his clients make.

If the broker does not have a membership in a major exchange, then he must have a correspondent broker to legally dispose of the client’s securities. At the same time, the broker or its partner must have accounts in large banks, which might be considered an additional signal about the company. It is not always easy to open an account in a foreign bank, because any broker should prove that it is not engaged in fraud. Sometimes big financial groups have their banks and brokers. Also, some brokers can be shareholders of the exchanges.

How Often Can Brokers Be Punished by a Regulator?

All the information about any violations is published by regulators. Any interested person can track the history of such violations for every brokerage company and see what was going on a year ago, for example, and how it’s going now. Almost all brokerage companies have violations. It simply means they are not fraud makers and regulators scrutinize them. However, if you notice an abnormal number of violations you should probably think twice before giving this company your money. 

Who Is Behind a Broker?

If you want to check a broker on your own, look at its big shareholders and executive managers. Many brokerage companies that follow the best practices disclose their ownership structure and management. The higher the professional level of executive managers of a broker, the fewer chances of meeting a scammer in that company. Also, a good source of reliable information about a broker is ratings that can guarantee additional control from the rating agency. If a broker is a member of any professional organization, it might be considered a good factor. In Kazakhstan, for example, this type of organization is the Association of Financiers of Kazakhstan.

What If a Broker Has a Foreign Origin?

Many brokerage companies have subsidiaries that operate overseas. If you are offered to sign a contract with some foreign company, it would be better to check whether it is a large foreign company or just an offshore company with a name that looks like a big name. Of course, it is possible to defend your rights abroad, but it would cost a lot of money and prove more difficult. 

The contract for the management of the client’s assets must contain a management mandate: what the company can do and what it cannot. All transactions must be carried out by a broker on behalf of the client. Therefore, there must be a form for submitting such orders. In addition, the company should provide clients with regular reporting of movements of money in the client’s account. And, of course, professionals would not promise or guarantee big profits, ever. It’s not true and would be a violation of ethics and laws.

If your assets will be kept by the broker you work with, his license must allow him to act as a nominee holder (depositary, custodian). Brokers have such licenses in most jurisdictions: Kazakhstan, Russia, as well as in several specialized offshore territories, such as Belize – this will allow you to vote at shareholders’ meetings, receiving dividends, and more.

Resume

There are responsible and irresponsible brokers on the markets. However, even those companies that follow all rules and have proper licenses can turn unreliable. The same rule can be applied to the banking sector.