How to Avoid Being “Madoffed”
May 28th, 2009
The simplest and best way to protect your investments from advisor fraud, is don’t give the advisor opportunity. In other words, don’t give him custody of your assets. Don’t give your advisor power to buy and sell securities without your permission. Give him a limited power of attorney to execute trades with your signed permission only. Don’t authorize your advisor to pay himself (deduct his fee) out of your account. Ask for an invoice and pay the fee with your credit card or a check. The more control you give the advisor over your money, the greater the risk of being defrauded.
If keeping control creates too much work for you, then at the bare minimum require the advisor to use an independent financial institution to hold your investments. Such an institution is called a custodian because it provides custodial services for advisors and their clients. An independent custodian gives you an extra layer of protection because it, not the advisor, generates the reports and values your assets. You should be very nervous if the only report you receive is the one prepared by your advisor or a custodian controlled by our advisor.
If the independent custodian is not a well-known name like Schwab, TDAmeritrade or Fidelity, you will have to do some additional background checking. Get the firm’s name and contact information. Call and ask for evidence that custodial services are provided to other advisors. Request copies of reports from an independent auditor. Visit the physical office. I’ve read that Bernie Madoff’s custodian had a small office in a remote location, with just a couple employees and no independent auditor. Do a Google search and check the yellow pages. Verify to your satisfaction that the custodian is truly independent and trustworthy.
Finally, I believe you can greatly reduce the risk of being defrauded by abandoning the strategy of active management altogether. There is no evidence that an active money manager can beat the market. Read the all time best seller ”A Random Walk Down Wall Street” by Professor Burton Malkiel or ”Winning the Loser’s Game” by Charles Ellis. I can’t prove it, but I suspect that most, if not all the Ponzi schemes and acts of fraud were committed by advisors who believed they could beat the market, even after subtracting their expenses. An advisor who sells his ability to predict the future (ie. pick winners and losers) has created almost impossible expectations (and pressure) for himself and his investment performance.
