Madoff-Proof Your Portfolio

It’s been nearly three years since the world learned about the multi-billion dollar Ponzi scheme perpetrated by legendary investment manager Bernie Madoff. It was the single largest case of fraud in U.S. history. Its scope reached well beyond Madoff’s direct clients, affecting clients of other advisors that hired Madoff to advise on their funds, numerous charities and endowments, and many in the Jewish community that had entrusted their life savings to Mr. Madoff.

Let’s be clear on one thing: these types of investor fraud cases, as large and prominent as they may be, are actually quite rare. By and large, the vast majority of advisors and firms are honest and ethical, and very, very few investors will (thankfully) ever experience any type of fraud in their lifetime.

With that being said, it is still important as an investor to protect your own interests, and be your own best advocate. I occasionally have clients or acquaintances ask me how they can avoid or detect if there is a problem with their accounts. I have my own set of “checks and balances” that all investors should follow to help minimize the likelihood of “impropriety” by their advisor or financial institution (or in many cases, a simple error or omission):

1. Always review your statements. This may the single easiest way to identify a problem as soon as it happens. Whether you receive them monthly or quarterly, by mail or electronically, make sure to review them in a timely manner. All too often when markets have dropped, investors choose to ignore their statements until times get better. Laziness is also a factor. Just do it. Scan your statements, compare the opening balance to the prior statement’s closing balance, and review all the activity and fees.
2. Get online access. Even if you don’t want to receive your statements electronically, every time you receive your paper statement, log on and compare what your online balance says, versus what your paper statement says. One of the easiest ways to cover up fraud is for an advisor to create their own fake paper statements and send them to clients. Comparing the online balances to your statement may detect this.
3. Call your bank, custodian, or brokerage firm and ask them to verify the balance. But don’t call your advisor’s local office. Call the firm’s 800-number or home-office/customer service center. After all, they won’t have any idea if your advisor is doing something fraudulent, and will not have the ability to cover anything up. You don’t necessarily need to do this every month. Maybe once or twice a year (assuming you do not suspect anything in the interim).
4. Make sure you understand your investments. You don’t need an MBA in Finance. Just ask for a good explanation of the investments from your advisor. If they do not include widely followed stocks, bonds, mutual funds, ETF’s, annuities, etc., make sure you understand what they are. Be mindful of promises of returns that seem “too good to be true”. If you are not comfortable with the explanation you are receiving, use your CPA or a knowledgeable friend or family member as a sounding board.
5. Never, ever, ever make checks (or give cash) payable directly to your advisor. Even if you work with an independent advisor, checks should always be made payable to the custodian, bank, brokerage firm, or insurance company they operate through, NOT your advisor or their advisory firm. A big exception would be for professional services (ie. fee-only financial planning services) that your independent advisor performs for you (and generally be paid to your advisor’s advisory firm directly, not to your advisor personally). But this payment should be separate and distinct from funds that you are depositing into your accounts.

Chances are you will never experience financial fraud in your lifetime. But the key is to be vigilant and aware.

Robert C. Henderson is the President of Lansdowne Wealth Management in Mystic, CT. His firm specializes in financial planning and investment management for individuals approaching retirement or already in retirement, with a focus on the particular needs of women that are divorced or widowed. Mr. Henderson can be reached at 860-245-5078 or bhenderson@lwmwealth.com. You can also view his personal finance blog at http://lwmwealth.com/blog.