Don't Become a Fraud Victim
By Ric Edelman
December 18, 2008
Warning signs for Madoff-style schemes
In one of the most shocking scandals to hit Wall Street in recent years — and that’s saying something! — investors have lost $50 billion or more in what has been dubbed “one giant Ponzi scheme.”
Bernard Madoff literally lived up to his name when he announced that an estimated $50 billion belonging to hedge funds, wealthy clients, celebrity charitable foundations and everyday investors is gone. Of the supposed $17.1 billion under his management in November 2008, according to regulators, only $200 million to $300 million was left last week.
For years, Madoff seduced investors by providing consistently high returns — which he delivered by paying off old investors with new investors’ money. But when the market crashed and investors started requesting withdrawals, the scam imploded. With no money coming in, old investors couldn’t be paid back. Madoff had no choice but tell his sons, who work for him, that “it was all just a big lie.”
The list of victims is sad yet impressive. It reportedly includes Steven Spielberg, Sen. Frank Lautenberg, real estate tycoon and publisher Mort Zuckerman, Holocaust survivor Elie Wiesel, New York Mets owner Fred Wilpon, GMAC Chairman J. Ezra Merkin and former Philadelphia Eagles owner Norman Braman, as well as hedge funds (and their investors) along with everyday investors. International institutions have lost money, too, including Royal Bank of Scotland, Spain's Grupo Santander and France's BNP Paribas.
Many of these investors lost millions of dollars. The life’s savings of some were wiped out entirely.
Madoff’s fraud is unprecedented in its size and scope. But it’s even more appalling when you consider Madoff’s previously sterling reputation. An international market maker, Madoff was the former chairman of the NASDAQ Stock Market, former chairman of the New York region of the NASD (the chief regulator of brokerage firms) and a generous philanthropist. His credentials were exceptional.
If some highly successful people could be suckered by Madoff, what can ordinary consumers do to make sure they, too, aren’t being victimized by their advisor?
Fortunately, there are steps you can take to protect yourself. In fact, Madoff’s own behavior offered several warnings that too many investors ignored. Consider the following tips:
- Beware any advisor who prominently touts his ethics, honesty and trustworthiness. Honesty should be a given — and anyone who aggressively promotes his honesty is raising a red flag. Madoff’s Web site bragged, “Clients know that Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm's hallmark.” By the same notion, some financial advisors invoke God as a marketing ploy by calling themselves “Christian (or Jewish or Muslim or whatever) financial advisors.” These individuals promote themselves at church groups, which can lead to a practice that federal regulators call “affinity fraud.” In that scam, crooks ingratiate themselves within a religious organization in order to steal money from the congregation and its members by promoting investments with high returns and no risk. Madoff apparently did this as well, making connections with wealthy members of the Jewish community. [At Edelman Financial, although we are trustworthy, we won’t be the ones to tell you that — that’s for you to judge.]
- Beware any advisor who asks you to make checks payable to him or his firm. The only check you should make payable to an advisor is for his fee. Checks for your investments, however, should be made payable to the brokerage firm or custodian handling your account (such as Schwab or TD Ameritrade.) By not depositing your money with your advisor, he will not have access to or control of your assets. [At Edelman Financial, you will never write a check payable to us (except for our fee) — checks instead are made payable to the custodian holding your assets.]
- Beware any advisor who issues his own statements. By maintaining your account with a national or regional brokerage firm, that firm will issue monthly statements. Having your advisor issue statements creates a huge conflict of interest. If you want to know your money is safe, call your brokerage firm. (Note: It’s okay if your advisor issues separate reports, such as performance data or tax information. But the statements themselves should come from a third party.) [Any account set up through Edelman will have statements prepared and distributed by your chosen custodian, which is unaffiliated with us.]
- Beware any advisor who uses a questionable auditor. An independent auditor should regularly examine the advisor’s books and records to ensure that clients’ money is being handled properly. Madoff hired a small auditing firm that reportedly operated out of a single 13x18 square-foot office, even though he was handling billions of dollars in assets. [Edelman Financial’s books and records are audited annually by KMPG , one of the “Big Four” accounting firms.]
- Beware any advisor who offers unusually high or steady rates of return. Every investor dreams of earning consistently high returns — which are too good to be true. Madoff’s investors received a monthly return of 1% for years and years. He even reported a 5.6% profit for the first 11 months of 2008 — despite the fact that the stock market had lost more than 40%. Claims of consistently good and unusually steady returns over a long period should be viewed with great suspicion. [At Edelman Financial, our goal is to produce returns that are competitive; we do not promise that they will be consistent.]
- Beware any advisor who touts testimonials. Past performance does not guarantee future results, which is why the SEC has restrictions on the use of testimonials. But Madoff built his entire business by word of mouth, currying favor on the social circuit at high-end country clubs. [At Edelman Financial we honor our clients’ privacy.]
- Never invest in anything you don’t understand. If you don’t understand an investment or strategy, don’t invest in it. Madoff refused to explain how he produced investment returns and clients joked that he put the money in a “black box.” They’re not laughing any more. [At Edelman Financial, our investment strategy is simple: build a diversified portfolio using mutual funds and exchange-traded funds, and hold those investments for long periods, rebalancing when necessary.]
One final piece of advice: Don’t expect regulators to protect you. The SEC didn’t know that Madoff was engaging in fraud, despite the fact that the agency audited him every other year.
Although the news of fraud is discouraging, remember that it’s nothing new. The country’s first investment offering, issued by Alexander Hamilton in 1792, was the victim of insider trading.
So, despite such people as Bernard Madoff, you can succeed with your investments. Simply take the time to educate yourself and be aware for warning signs.
As the Romans said, caveat emptor. Buyer beware.