Recent news stories report that RIAs are fretting over the SEC's announcement that, as part of the process of reviewing certain RIAs, it plans to contact clients directly. This isn't something to fear. You should rejoice. It's ultimately better for all RIAs—as long as they're not doing anything wrong. Never pass up an opportunity to instill greater client confidence. And this SEC action will certainly do it.

HOW NOT TO BE A MADOFF

This decision most specifically impacts dually registered firms—i.e., RIAs who have also registered as broker-dealers. Some advisors claim contacting clients only spooks them—adding to angst in an already tough environment. This is wrong. If you operate honorably, there is no reason to fear. If your firm both manages and custodies assets, welcome the review—specifically because so many clients do fear that their advisor may be the next Madoff-like vanishing act.

The SEC is 100% justified in its actions. To my knowledge, no media commentator yet has nailed the problem's core: Nearly all Ponzi-style embezzlements, big or small—both the sensational recent ones and those throughout history-have occurred when the chief decision makers also take custody of clients' assets.

It's virtually impossible for an advisor to embezzle if he or she doesn't have custody or isn't somehow connected to the custodian. When the two are not connected, barring some grand improbable collusion, there can be no embezzlement. The advisor doesn't have access to the funds, just like any other nonconnected person or entity doesn't have access. Separating the two functions is prophylactic. End of story.

Bernard Madoff and R. Allen Stanford, on the other hand, both took custody of assets and made the decisions—a toxic combo. An intentional con man will set up a business this way to make it easy to embezzle.

Others just fall into it. Note, it's now alleged that Madoff started managing money with honest intentions. His arraignment statement claimed he didn't misapply client funds until the early 1990s, in response to the recession, in what he intended as a short-lived solution. It's no excuse, but had he set up his firm so he had no access to client monies, he simply couldn't have succumbed to the temptation. He would have had to admit to a rocky year, as thousands of honest RIAs do every year.

Most likely, all of you have already read and heard more about Stanford and Madoff than you would like. I have a book being published this summer entitled How To Smell a Rat: The Five Signs of Financial Fraud. Two signs are obvious, but always ignored: Returns that are too good to be true and no independent custodian.

Look for the bad years that demonstrate integrity. But even more important, in the 37 years I've been in this industry I've never seen one client embezzlement that didn't involve combining custody with decision making. It's basic. The SEC knows this cold.

That doesn't mean there aren't valid reasons to combine them. There are. But if you do, you must implement procedures to ensure a firewall between custody and decision making. Otherwise it's a disaster waiting to happen. Hence the SEC's desire to focus inspections here. It should and it will.

PUT OUT THE WELCOME MAT

You should welcome the regulators with open arms. My advice to most RIAs is: Don't take custody. It makes your life simpler. But regardless of whether you do or don't, always welcome the SEC's scrutiny. Embrace the Feds' talking to your clients. The more you set up like Madoff, with direct or even indirect access to clients' assets, the more you want the SEC all over your clients.

You want every single opportunity to demonstrate that your shop is squeaky clean. So long as your firm does nothing wrong, you should easily pass muster. Afterward, your clients will have additional confidence in you and your firm—a major positive.

Think of this process like a potential Good Housekeeping seal of approval. Think like a marketer: You can use this. Be completely open to the SEC and your clients about allowing the interaction—make it as easy as possible for everyone involved.

Soon afterward, when the SEC has formally completed its inspections, regardless of the outcome, I'd hold a conference with clients. I'd ask those clients who interacted with the SEC to speak openly about their experiences in front of other clients. Few of your competitors would dare to do this, and you will win big for it-it's great marketing. Little else could give you greater credibility.