Financial Focus: Madoff scam has lessons for investors

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Financial Focus: Madoff scam has lessons for investors

Sunday, January 18, 2009


In light of the Bernie Madoff Ponzi scheme scandal, what steps can investors take to ensure their money is invested soundly?

Dual roles a red flag

The Madoff Ponzi scheme has shaped up to be the largest such scam in history; potential losses amounting to as much as $50 billion in investors wealth. Bernie Madoff was a longtime industry insider who used his reputation and elite associations to foster trust. Unfortunately many investors allowed his personality to trump due diligence and full disclosure.

According to the Global Fiduciary Standard of Excellence, Practice 3.4 states that, "A due diligence process is followed in selecting service providers, including the custodian." Simply following this one screen would have eliminated Madoff as an investment manager because he also acted as the custodian, which gave him access to the investors' money.

Investors should see a big red-flag and when the same person serves as adviser, investment manager and takes custody of the investments. Experts agree that investment managers should not have custody of their clients' money. Rather, it is held in a separate "custodial account." Several large firms, such as Schwab, Fidelity and TD Ameritrade, provide custodial services for independent investment advisers and their clients.

To safeguard your wealth, you should consider utilizing an independent adviser who follows a proven investment process that adheres to fiduciary standards of excellence. When you do that, you can sleep well at night knowing that your money will remain your money.

Richard B Komarek



Diligently research any company you are considering wanting to invest with. Look for a custodian or a well-known clearing house responsible for recordkeeping with a national presence and subject to full liability to extent of the law.

SIPC (Securities Investor Protection Corporation) will protect you from failure of your broker dealer up to certain asset limits. A broker/dealer with SIPC membership means that there will be account protection up to a maximum $500,000 of which $100,000 may be in cash. For an explanatory brochure, please visit www.sipc.org. The account protection applies in the event a SIPC member firm fails financially and is unable to meet obligations to securities clients but it does not protect against losses from the rise and fall in the market value of investments.

Know your investments. Whether it is stocks or bonds, understand how the company generates revenue. If using an adviser, he or she should be explaining these components to you. In this Ponzi scheme, no one apparently understood where their money was invested. If your investment is always going up 10 years straight and everyone else is incurring fluctuations, you need to be asking in-depth questions. Your adviser or broker dealer firm should be contacting you at least four times a year to review your holdings and financial situation, and making updates to holdings when appropriate. This should help avoid your assets being moved or placed in less than sound investments without your knowledge or the opportunity to ask questions.

The opinions voiced in this material are for informational purposes only and is not intended to provide specific advice.

Leroy Simpson

investment consultant

Redding

222-6250

leroy.simpson@lpl.com

Four tips to avoid fraud

While it is unreasonable to expect individual investors to pick up on "red flags" that professional advisers missed, there are some basic things individuals can be aware of to help mitigate such problems in their own asset management programs.

1. Understand what you're investing in. Are you knowledgeable about the investments you own or the strategies your money manager is using? If not, then how would you know whether your investment performance deviated significantly what you would expect?

2. Understand your benchmark performance. Your adviser will benchmark your portfolio to a certain index based on your investor profile. When you get your statements, you should compare your performance to the benchmark to make sure they are reasonable aligned. Significant deviations are cause for questioning.

3. Obtain online access to your account that's available 24/7. Periodic statements can be faked a lot easier than data updated continuously during the market day.

4. Be skeptical of guaranteed returns and demand transparency. Markets are volatile and the best an adviser can do is tilt the risk/reward balance more heavily in your favor. Advisers cannot control performance. What they can do is be a source of knowledge and transparency as to how your money is being handled. In light of recent events, true advisers are even bigger advocates for their clients, as they feel betrayed by the conduct of Madoff even as investors feel victimized.

Robert Elmer

Financial adviser

LPL Financial

robert.elmer@lpl.com

Look for fiduciary standards

Investment professionals are licensed as registered representatives and/or investment advisers. We wear two hats, so to speak. As a registered representative (RR) we work for a brokerage firm and are licensed to profit from investment sales. An RR is required by FINRA to meet minimum suitability standards when selling investments. While all recommendations must be suitable and appropriate, there is no legal obligation for an RR to represent the best interests of the investor, avoid and disclose all conflicts of interest, or provide comprehensive or continuous support. Under "suitability" standards, it is ultimately up to the investor to ensure their broker exceeds minimum requirements. "Suitability" standards assume the investor can represent his or her own interests.

As an investment adviser, we are regulated by the SEC or one of the 50 states and are bound to fiduciary standards of care, which require we place the interests of the investor first and avoid and disclose conflicts of interest. Whereas a sales rep has the "opportunity" to put the interests of the investor first, an investment adviser has no other choice.

I would imagine Madoff investors are wishing they had avoided the conflicted sales-side and hired an independent and objective investment adviser bound to fiduciary standards of care.

Will Rogers once said that he was more interested in the return "of" his investment than the return "on" his investment.

If you're an investor, you've probably been shaking your head in disbelief over the events of the past few weeks. When working with an investment firm do your homework on the company and ask lots of questions. Make sure the company has a long track record in the industry.

Try to gauge the firm's client focus. Does it focus on the long-term individual investor, like yourself, or does it cater to big institutional investors? Research the firm's history and record of achievement using third-party research. Ask questions of your financial adviser about the company and of his or her individual credentials.

Finally, understand the investments in which you are invested and their realistic returns. You should meet with your adviser regularly, at least annually, to make sure your investments are meeting your financial goals.

Jason Richart

Financial adviser

Edward Jones Investments

Redding

Jason.Richart@edwardjones.com

Don't misplace trust

One common issue involving most of the financial scandals is the trust that individuals had in their adviser. My personal experience in talking to clients who have been involved with rogue advisers is their almost disbelief that their former adviser could have been so dishonest. I cannot tell you how many times I have heard the comment, "I cannot believe he could do such a thing. He was such a nice person."

Trust in your financial adviser is one of the most important features of the investor-advisor relationship. Information is confidential, advice is personal, any suggestions or recommendations should be in the best interest of the client and trust is paramount. Your adviser has to know almost everything about you in order to provide the best advice possible. This can be dangerous if the adviser turns out to be serving their own interest and not yours.

The first step is to trust your "gut" instincts. If suggestions sound too good to be true, they probably are. Watch out for the term "guarantee" or promises of investment returns in the teens or higher.

Individuals can check the FINRA (Financial Industry Regulator Authority) or the California Department of Insurance Web site (insurance.ca.gov) to see whether the adviser has any past or pending violations. Recognize whether the investments are "listed securities" and not private placements where there may be little or no regulations. The phrases from P.T. Barnum - "A fool is born every minute" - from 1600s England - "A fool and his money are soon parted" - unfortunately are as accurate today as they were during their own times.

Vince D'Amato

Financial Planner

Redding

244-5723

Create long-term plan

Many people throw up their hands in despair at what happens in the investment world. There seem to be so many things one cannot anticipate or control: political turmoil, rising oil prices, fluctuating interest rates, disappointing corporate earnings and more. As an investor, aren't you just at the mercy of these and other events?

Not necessarily. You can't alter the headlines, but you can manage your response to them - and that makes all the difference.

To stay in control of your investment situation, you need to create a long-term financial strategy - one that incorporates a diversified mix of investments suitable for your risk tolerance, individual goals and time horizon.

If you chart the course that's right for your needs, and you follow it relentlessly for years and decades, your chances of success are excellent. And that's the sort of news anyone would welcome.

Scott M Brown

financial advisor

Edward Jones

scott.m.brown@ edwardjones.com