Ten years ago this month, Bernie Madoff’s Ponzi scheme unraveled in front of the world. Like a bad nightmare, the swindler made $65 billion evaporate from people’s lives. With the benefit of hindsight, there are legitimate questions investors should have asked of Madoff that are just as relevant today.
There will always be another con-artist. You cannot prevent someone determined to commit crimes—but you can hold them at arms-length. Furthermore, many fraudsters start with legitimate intent, but something happens. Possibly they make bad investments, borrow too much or live an unsustainable lifestyle. At that moment, something changes. This point may be the first day of your relationship with them—or it may be many years in. As such, smart investors must perform due diligence repeatedly throughout the tenure of the relationship.
Every person is different and deserves an investment program that complements their goals. At a minimum, this requires knowing how long you can invest funds, how much volatility you can withstand, how much income you require, etc. A good relationship with an advisor requires knowing your destination.
A favorite question to ask is whether an advisor has a fiduciary mandate or a suitability standard. Different investment advisors have differing levels of care owed to a client. A fiduciary is legally obligated to do what is in the client’s best interest—and not just sell them a product. If an advisor is not a fiduciary, determine how that will affect you.
Although the fiduciary question remains relevant, recognize that Bernie Madoff was a fiduciary. That is part of what made his deception that much more devious. As stated above, some people are intent on doing bad things.
One key reason Madoff perpetrated his fraud as long as he did was that he was the “investment advisor” giving advice and the “broker” that produced client statements. This made it easy to alter brokerage statements to say what Madoff needed them to say to keep the scam going.
In comparison, our clients get statements and trade confirmations directly from Charles Schwab or TD Ameritrade—a third party custodian. Neither Schwab nor Ameritrade works for our firm. Rather, they work directly for the client. That gives clients a much better, independent, audit trail. Although Schwab or Ameritrade may like us, they are not going to risk prison for us by falsifying statements.
No one works for free and generally many conflicts of interest can be identified by tracking the flow of money. As such, does an advisor work on commission or are they a fee-only advisor? If paid on commission, know that different products pay different commission levels. There are incentives for an advisor to recommend one product over another as commission rates can run from pennies to 10% or 15%. There is also a difference between being a fee “only” advisor compared to a fee “based” advisor. Although the terms sound similar, they are not. A fee “based” advisor charges a percentage of assets plus a variety of commissions.
Request, in writing, the ways an advisor, or their firm, will derive compensation or benefit from managing your money. Some firms offer ski or golf trips for pushing certain products. If they will not spell it out in plain English, walk away.
Nothing is “risk free.” Whether investing in U.S. Treasury bonds, CD’s or stocks–they all have elements of risk. If someone tells you an investment strategy is “risk free” this should be a significant red flag that they are either deceiving you or they don’t understand risk.
To keep the charade going Madoff told investors they would earn returns of about 12% annually. He knew greed would override logic. Investors should have asked, “How will you do this?” and “Is this too good to be true?” No investment delivers returns of this nature with no volatility.
Do a background check. Whether through FINRA, the insurance commissioner, state securities board or the SEC, there are many ways an advisor can be checked out. Determine if there are patterns of being sued or sanctioned.
Lastly, not all relationships last. If you move on, are there termination fees which may hold you hostage?
This offers a starting point. As with all things, common-sense and regular monitoring are necessary to avoid scam artists and keep your investment plan on target.