By Peter Mastrantuono
The recent passing of Bernie Madoff brought back memories of the largest Ponzi scheme in history; a scam exposed by the 2008 financial crisis and which fraudulently separated $65 billion from primarily wealthy investors.
Investment fraud, however, did not die with Bernie Madoff. In fact, investment fraud is even a bigger threat today. The U.S. Sentencing Commission reports that securities and investment fraud has risen over 13% since 2015 and that the median investor loss in 2019 was $2 million.
To avoid becoming a victim of investment fraud consider these lessons of the Madoff scandal.
7 Lessons Learned
- Verify the existence of a third-party custodian. Your financial advisor should never hold your investments. Legitimate financial advisors use an independent custodian, such as Fidelity, Charles Schwab or TD Ameritrade to hold client assets. An independent custodian prevents a financial advisor from having access to your investments for his or her personal gain. Deposits into your account should always be made payable to the custodian.
- Understand the advisor’s investment strategy. Madoff used a “split-strike conversion” strategy that involved selling out-of-the-money call options on index futures, buying a representative sample of equities comprising the underlying the index and purchasing in-the-money puts. Huh? If you don’t understand an advisor’s investment strategy, you may want to stay clear of that advisor.
- Beware of performance that sounds “too good.” Madoff claimed to deliver above-average performance on a consistent basis. In fact, his performance reporting to clients showed returns that remained the same regardless of market conditions. If performance results sound suspect, they probably are.
- Check out your advisor. Bernie Madoff had the patina of respectability, traveling in the circles of wealth and celebrity and serving for a time as the chairman of the NASDAQ. Don’t rely on outward appearances. Check out a financial advisor on the SEC’s Investment Advisor Public Disclosure website or FINRA’s BrokerCheck.
- Don’t choose an advisor based solely on shared religious, ethnic or social background. Many of Bernie’s victims shared his Jewish heritage, relying on an assumed trust of mutual values and ethics. Every group has its bad apples, so assumptions about trustworthiness or competence based on belonging to the same group has its risks.
- Don’t be over reliant on regulators. Federal and state regulators charged with the protection of investors on the whole do a good job. They don’t do a perfect job. Indeed, the SEC received multiple tips that things were amiss at Bernie Madoff’s firm and made major mistakes missing the fraud. The lesson? Do your own homework.
- Don’t be fooled by appearances. Bernie burnished his reputation through outward displays, like multiple homes, large charitable donations and a bespoke wardrobe. He also didn’t have a website, creating the illusion that he didn’t need clients (but he might make an exception for you). Outward displays of success, braggadocious behavior or intimations of exclusivity are all caution signs.
Fortunately, the overwhelming majority of financial advisors are honest and hard working professionals, and are happy to answer all your questions about their background, experience and investment approach. Don’t hesitate to ask.
Peter Mastrantuono is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Peter worked for over 30 years in the wealth management industry, focusing on retirement planning, investing, asset allocation and financial planning.