Saturday, December 20, 2008

How to Avoid a Bernie Madoff Scenario

Many questions will be answered in due time as to how high net worth investors, corporations and endowments were duped by Bernie Madoff. How did his ponzi scheme last for so long without being detected? Were investors naive, or was his firm simply that good at scamming the public? Nobody knows at this point. However, most people feel a $50 billion fraud could not have been pulled off by one person.

Although it's too late to help these investors, there are certain safeguards everyone can take to avoid a future situation. Some are simply based on good old common sense and others require due diligence.

  1. Keep it Simple - Investing doesn't have to be complicated. Equity markets go up more than down over time. Fancy hedging techniques often aren't needed to make money. Long term objectives and an understanding of your risk tolerance is a great starting point. Simple everyday mutual funds or exchange traded funds that you can look up in the newspaper will suffice. You certainly don't need the 'exclusivity' of hedge funds to make money.

  2. Work with a Certified Financial Planner (CFP) - In several States, you can hang a shingle on your door that says 'Financial Advisor'. You don't have to have any accreditation's and do not need a license. This is downright scary. Unfortunately, the defacto financial capital, New York, is one of these States. Do yourself a favor - start with an accredited individual. The Certified Financial Planner (CFP) designation is the gold standard in the industry. Individuals go through a rigorous program (often several years) just to complete the prerequisites to sit for the Board of Standards national examination. These individuals are dedicated to both putting their clients needs first and improving the financial planning profession.

  3. Is your Financial Adviser Registered - Individuals managing over $25 million on a fee basis will have to register with the Securities and Exchange Commission (SEC). Under this amount, they are required to register in their state. A state-by-state list of regulators can be found at National American Securities Administration Association (NASAA). Most Advisers with a sizable client base will be registered with the SEC and the website is a great source of information for registrations and legal filings. Any filed complaints on an Advisor will appear here. It can also be found on the FINRA website as well. Years ago, several former NFL players (Simeon Rice, Eric Dickerson & Shannon Sharpe) were duped out of more than $10 million by a slick Chicago Financial Advisor by the name of Donald Lukens (now doing jail time). If any one of these investors would have taken the extra step to contact the SEC to verify registration status, they would have avoided this financial mess. A quick SEC scan for Lukens would have revealed the advisor was a fraud. There were no Advisers registered by that name.

  4. Hot Money - Be leery of firms reporting amazingly steady returns. If Warren Buffet can lose money on occasion, so can you. Nobody can show remarkably consistent steady returns year after year (as Madoff did) in good & bad markets. Portfolio Managers are human and believe it or not, make mistakes. This falls into the common sense category, 'If it's too good to be true', ... you know the rest.

  5. Quality of Quarterly Statements - Who's preparing your quarterly statements? If it's coming directly from the Advisor, this is a red flag. Everyone knows the hedge fund world is largely unregulated. The last thing you need is questionable financial statement showing up in your mailbox. Mutual funds, or wire houses (ie. Merrill Lynch, etc.) will generate their own statements and avoid this conflict of interest.

  6. Diversify Your Accounts - We all know about asset allocation. This takes it a step further. When you start accumulating assets of greater than $500,000, consider using more than one investment account. Spread the wealth. This doesn't necessarily mean use more than one Financial Advisor, but simply have your money invested with two different firms. Not only should it further diversify your holdings, it should add an additional layer of comfort knowing your assets are invested under roofs.

  7. Be Aware of Affinity Fraud - This may be a new one to most. Affinity fraud simply refers to homogeneous groups of people. Scams often occur when an individual claims to be of a similar background and thus has a following within this circle. This could be be ethnic, religious, elderly related or professional. Bernie Madoff had a religious following and somehow developed the nickname the 'Jewish Bond'. I'll be the first to admit, there is nothing wrong with a homogeneous group. It's often a source of comfort. However, due your homework. Don't assume what's good for one is good for another.

This Bernie Madoff debacle is troubling. One bad apple is casting a shadow of doubt over an industry already wrestling with a trust issue. Many wonderful, long standing firms, and portfolio managers will struggle to raise money and retain clients because of this incident. Hopefully, the more main stream investments... mutual funds & ETF's... will continue to attract money - as they should. Transparency is a wonderful thing.

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