Gaeton Della Penna met many of his clients through his church. The Sarasota, Fla., financial adviser took their $3.8 million and promised safe investments with returns of at least 5 percent a year.
Instead, in May 2014, the U.S. Securities and Exchange Commission charged him with using some of the money on mortgage payments for his 10,000-square-foot home. Much of the rest was lost in risky trades. A year later, Della Penna pleaded guilty to running a Ponzi scheme. Last week, he was sentenced to almost six years in jail.
Malicious people rarely twirl their mustaches with glee. Incompetent advisers often speak and dress well. How do you know whether to trust someone with your money?
The question is at the heart of a debate in Washington over how financial advisers should be regulated. The Obama administration wants to require all advisers who handle retirement funds to promise to act as fiduciaries, a term for advisers who put their clients' interests first. (It isn't foolproof; Bernie Madoff claimed the fiduciary designation at one point.) The financial industry and members of Congress are fighting the proposal.
While they hash it out, here are some tips.
Don’t rely on the classic tells
Shifty eyes and nervous sweating aren’t necessarily signs, or the only signs, of a lie in progress. Clues from speech or behavior help subjects of lab studies tell the difference between lies and truth only 54 percent of the time, hardly better than chance. Lie detector machines can be gamed.
Academic studies contradict most people’s intuition about what lying looks like. “Even in law enforcement, they still teach stuff that doesn’t work,” said Jason Voss of the CFA Institute, an organization for investment professionals that is working on techniques to help its members catch liars and cheaters.
Do pay attention to that creepy feeling
By looking for liars with our eyes and ears only, we may be distracting ourselves from a better gauge of the truth. Our subconscious may do a better job, according to a 2014 study by researchers at the University of California, Berkeley Haas School of Business. If you have a vague feeling that something’s not quite right, trust your gut and do some extra research.
Bring a friend
Groups of people are better at detecting lies than a lone individual, according to a 2015 paper by researchers at the University of Chicago Booth School of Business. What made the difference, they concluded, was group discussions held after people met with a liar. Before buying into anyone’s sales pitch, talk it over with your partner or friends. Ideally, bring them along.
Watch out for jargon
The SEC this month accused three California businessmen of recruiting real estate investors "under the guise of investment seminars with buoyant slogans," including a promise of "indestructible wealth." Whatever the merits of that case, inspirational cliches, impenetrable jargon, and euphemisms are common means of distraction. Look out for "fact-deficient, obfuscating generalities," or FOG, research firm Rittenhouse Rankings advises. The firm analyzes earnings reports looking for FOG and uses the results to score companies on their executives' candor.
Root out liars with tough questions
Lying can be mentally taxing, and it gets tougher on liars if their questioners are creative and maybe a little ornery. According to a 2010 paper (PDF) on the topic, the goal should be to “raise the cognitive load” of a conversation in ways that trip up liars more than truth tellers.
In a law enforcement setting, this might mean asking someone to tell her stories in reverse order, or demanding he maintain eye contact throughout a conversation. In a financial adviser’s office, it might mean asking creative, blunt, or unexpected questions. The study showed that “unanticipated questions” boosted lie-detecting accuracy from no better than chance (50 percent) to as high as 80 percent.
Blunt questions can also lead to topics an adviser might be trying to avoid. Onora O’Neill, a philosopher and emeritus professor at the University of Cambridge, suggests: “Have you got any of your own money in your product?” Even if the answer is no, the reasons might be illuminating.
Do your homework, then set a trap
Liars have a disadvantage. They don’t know how much of the truth you know. The more research you do, the more clever questions you can ask and the more you can use a technique called “strategic use of evidence.”
A jealous spouse spots his wife at lunch with an attractive person. Later that day, he could ask the obvious question: “Who were you with at lunch?” Or he could hide what he knows and ask a subtler question: “What did you have for lunch?” If the lunch was an innocent outing with a new co-worker, she might casually mention that. If she's cheating, she might be led into an obvious lie: "I ate a salad at my desk."
Strategic use of evidence can be deployed by investors to spot liars, or even those who merely shade the truth. If you know a fund manager had abysmal results in 2008 but good results in 2009, you might ask: “How did you do in the financial crisis?” It's a red flag if they talk only about 2009.
Check their credentials
Doctors have medical licenses. Lawyers belong to bar associations. These professional affiliations mean practitioners must meet certain standards.
The business of financial advice isn’t a profession yet. Many who call themselves advisers are really more like salespeople, with no professional or regulatory obligation to act in their clients’ best interests.
Clients can ask their advisers if they’re fiduciaries, who do have that obligation. They can also seek out advisers with professional bona fides. Members of the National Association of Personal Finance Advisors, or NAPFA, for example, are both fiduciaries and fee-only advisers. That means they promise never to take commissions from financial firms as a payback for steering investors into certain products.
Potential clients can also look for—and ask about—professional certifications such as the Certified Financial Planner (CFP) and the Chartered Financial Analyst (CFA) designations. The acronyms mark an agreement to adhere to ethical standards and participate in special training in financial planning or finance.
That’s important because, as O’Neill, the philosopher, points out, it isn't enough to find an adviser who's trustworthy. It's also nice to get one who's competent.