How To Avoid A Crooked Investment Advisor

by | Dec 18, 2008 | Investment

bernard-madof.jpgIn the most recent bad news from Wall Street, Bernard Madoff, former NASDAQ Stock Market chairman and founder of Bernard L. Madoff Investment Securities LLC, was arrested and charged with securities fraud.

What did he do? He allegedly collected money to invest from clients, made up false statements to show that they were doing well, and used new clients’ money to pay interest and withdrawals to existing clients. This is known as a Ponzi scheme and is estimated to involve more than a $50 billion loss for his investors.

His clients didn’t see this coming. Could they have? Let’s look at three key safety tips that would have prevented this from happening.

  • Know what you own. Stick to stocks, bonds, ETFs, and mutual funds that are publicly traded and listed on major exchanges like the New York Stock Exchange. They are valued independently at least daily, if not minute-by-minute, while the exchange is open. You can check their reported returns against your own portfolio. If you can’t look up the prices and performance in the newspaper or on the Internet, that’s a red flag and means you should ask a lot more questions.
  • Use an independent custodian. Madoff held his client assets, managed them, and priced them, too. See the conflicts of interest? Investment performance can look better if the prices reported to clients are manipulated, which is allegedly how Madoff showed winning year after winning year despite market turmoil. At our firm, our clients have an independent third party, TD Ameritrade, pricing each investment they own. We have no input on investment pricing, and that separation is a very good thing. Clients also get an independent statement directly from Schwab or T. Rowe Price.
  • Check on insurance. Our clients benefit from fraud insurance. The first part is Securities Investor Protection Corporation (SIPC) coverage for $500,000 per account. Fraud insurance does not protect against market declines, but it does protect against theft of securities and/or related fraudulent transactions.

One final thought: if an investment sounds too good to be true, it probably is. Reportedly Madoff claimed consistent annual returns of 10-12% with little volatility and no annual losses. Can you name any legitimate investor who can make that claim in recent years?

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