Bernie Madoff created the largest investment fraud in U.S. history because people threw money at something that didn't exist. Yet the Ponzi scheme that conned people out of $20 billion and spanned decades might have collapsed sooner if people had asked a few questions, questions you should be asking.
In 12 surprising ways you can make sure you don't fall victim to the twin of Bernie Madoff.
"The Madoff problem has happened a number of times," said Greenberg & Bass Managing Partner James R. Felton, who co-authored the special report, "Bankruptcy Litigation Trends in California." "It’s probably not only the fault of the planner who puts people into this, but it’s at least a little bit the fault of the person who doesn’t take a step back and say, 'This is a little too good to be true' -- not 50% their fault, but maybe 10%."
Ponzi schemes involve a web of investors benefiting from those who come behind them. As the scheme accumulates people, it shows false profits. Needless to say, some of the best scammers have the ability to trick a large number of people out of their fortunes by making them feel that something is an up-and-coming jackpot. Madoff found a way to score the intimate trust of some of the world's wealthiest. Generally, certified financial planners have a code of ethics to live by. However, there are always a few who dance around the rules. But with these 12 questions, you can protect your money and your financial future:
1. If they can't tell you where your money is going to be held. If someone had just asked Madoff, "Who holds my money?" they might have exposed him and learned the truth before they lost their nest egg, said Michael Nadler, president of Nadler Financial Group, Inc. in Deerfield, Ill.
There should be a separation of duties between the person who takes custody of the assets and the adviser.
When Madoff had the money sent directly to him, it made him both the custodian and the adviser, which allowed him to create fictitious statements and pretend the money was there when it wasn't.
2. You're asked to make the check out to someone other than the custodian. If your money will be held by Charles Schwab, that's who your check should be made to. No one else. Also, never wire money to an investment adviser -- unless you'd like to fund the adviser's yacht fund.
3. If you find no proof that they're registered where they say they are. Ask: "Are you a registered investment adviser and with whom?" Then, check. They should be registered either through the U.S. Securities Exchange Commission, the state (if they're small), or, if they're commission-based, through the Financial Industry Regulatory Authority. "If they call themselves an adviser, and they charge a fee, but say, 'No, we're not registered with the SEC or the state's securities department,' that's a problem," said Nadler.
4. If a person has a record or regulatory issues on the SEC or Financial Industry Regulatory Authority websites. "If you see those, you should run. It means the person has a history of problems," said Nadler.
Doing your due diligence
Here are three steps you can take to learn more about your financial planner.
- Search disciplinary history and enforcement activity through FINRA's free brokercheck tool. The tool includes cases brought by the Financial Industry Regulatory Authority (FINRA), the Securities Exchange Commission or the state's securities regulator.
- Check their employment history. "If someone has worked at eight different employers over a five-year period, you should ask them questions about why they changed employers so often," said George Smaragdis, spokesman for the authority. Get the planner's resume on file with his firm, as well as his oral history, and look for discrepancies.
- Check the SEC's Edgar database to see if the investment you are considering is registered. "Ask if they're licensed and if the product is registered, then check with regulators to make sure. ... Most fraud involves unlicensed individuals, selling unregistered products, or both," said Smaragdis.
5. If you don't see a statement with your name on it from the brokerage firm, get your money back. Also, the brokerage firm should be sending the statements directly to you, not your adviser.
6. Is someone guaranteeing something that doesn't make sense? If market rates are giving 3% or 4%, and the person is promising 12%,15% or more, is asking you to put money in quickly, or wants you to make checks payable to an overseas account, chances are you're witnessing a Ponzi scheme. Ask how safe the investment is and how you can get your capital back. Is the person uncomfortable answering your questions? And remember, nothing is guaranteed.
"With Madoff, people were getting a consistent 10 or 12% on their money. ... When you get the same percentage for a number of years every month, it doesn't add up," said Felton.
7. If they call with a hot tip or a once-in-a-lifetime opportunity, get your running shoes. "That's not financial planning. That's a broker trying to reel you in with something. Unless you do due diligence, I wouldn't give them money to invest," said Nadler.
8. You're sharing investment profits or capital gains with a financial adviser (unless they're a hedge fund). Sharing a percentage fee with your adviser based on the assets is OK, but you shouldn't be charged based on your profits. A hedge fund may get 20% of the profits, but an adviser shouldn't charge that way. An excessive asset management fee is anything over 1.5% per year, said Nadler.
9. Your adviser asks you to sign something that's blank or not completely filled out. You wouldn't sign a blank check, would you? Don't sign any forms that could be tampered with later. "They could fill out wire instructions to wire the money into their own bank account," said Nadler. "All these things seem so far-fetched; it's unbelievable, but they happen."
10. If they ask you for full power of attorney. They shouldn't need it, and they shouldn't ask for it. Limited power of attorney is OK; it gives them the ability to trade on your account. But full power of attorney gives them the ability to write checks or withdraw money from your accounts. Then anyone in their firm can walk off with it.
11. If the adviser already knows what you need before consulting with you. The adviser isn't a mind reader and should ask you questions to pinpoint your exact needs. "Be leery of when an adviser recommends a product that is specific to their company," said Daniel Courson, financial adviser with Security Financial Management Inc. of Central Florida. Ask if the company owns any proprietary products.
12. They can't give you an understanding of the risks you'll be taking. Some investments start at a higher interest rate and slide back down to a miniscule rate after your money is locked in. Others can't be tapped into until you're almost 60. Others need account minimums.
"If someone is giving you a lot of fast talk and telling you how much you can make, and not telling you how much you can lose, that's probably not a good sign," said Susan John, chair of the National Association of Personal Finance Advisors (NAPFA), which promotes fee-only advising.
The Investment Answer: Ask the adviser to disclose how she is getting paid. Sometimes financial advisers make fatter commissions the longer your money is on lockdown within certain investments. Ask: Are they commission based (do they receive commissions for selling things such as insurance products or loans), fee based (flat, retainer or hourly), commission and fee based, do they make a salary plus bonuses from their brokerage firm, and does their company own any proprietary products (and what they are).
- Create a retirement savings goal
- Design an investment plan to reach it.
- Get a professional money manager to continually monitor and rebalance your portfolio
Sound complicated? Don't stress. Vanguard's new robo advisor service can help you put all of this (and more!) on autopilot, all for an annual gross advisory fee of just 0.20%.