In December 2008, Bernard Madoff, a widely respected money manager and former chairman of the Nasdaq Stock Market, was arrested for securities fraud.
Operating a classic Ponzi scheme,* Madoff fleeced $50 billion from banks, charities, 401(k) plans, a US senator and many individual investors by using funds from new clients to pay off older ones. Faced with mounting losses, he confessed to perhaps the biggest scam in Wall Street history, prompting investors everywhere to wonder just who they can trust.
Red flags that Madoff’s clients should have been alert to — and that no investor should ignore…
Profits that sound too good to be true. Even Warren Buffett loses money sometimes. Madoff’s fund returned about 1% to 2% every month. Such a steady performance should have raised eyebrows — but it opened wallets instead.
Fuzzy investment strategy. Madoff reportedly would say, “It’s a proprietary strategy. I can’t go into it in great detail.” Investors who cannot decipher a fund’s methodology on their own should ask a fee-based adviser whether it makes sense. If the adviser can’t make sense of it, stay away. While the independent review may cost $500 or more, it can save you a fortune.
Obscure accountants. The accounting firm that Madoff used was a little-known company that reportedly operated from a tiny office staffed with only three employees.
Trap: A big-name accounting firm is no guarantee either. In fact, it can lull investors into a false sense of security. Feeder funds, which market investments from other companies, may retain a major accounting firm to audit their own books — but not necessarily the books of the investment managers they “feed” into. Investors should find out who is auditing the company where the money ends up.
Promise of exclusivity. Madoff’s clients were invited to join an exclusive circle. Not just anyone could invest. The marketing approach was, “It is a privilege to invest with us.” It is not unusual for exclusivity to be based upon a minimum required investment of a substantial amount, but in Madoff’s case, you typically had to know someone to get in.
Unwillingness to answer questions. Investors who asked too many questions were actually kicked out of Madoff’s fund. At the least, you should be given sufficient detail to allow you or your adviser to understand the investment strategy being used and how results are calculated, reported and audited.
Allocate wisely. Don’t put all your money in just one or two investments. Anything can go bust. But also beware of too diversified a portfolio. Tracking more than 15 or 20 investments is difficult.
Don’t invest solely on the say-so of a friend or colleague. The recommendation may be well-intentioned but naïve. It’s your money. Do your own due diligence.
Review monthly or quarterly statements. In some cases, the statements from Madoff’s firm did not even contain the names of any securities — which should have raised eyebrows, at least.
*Ponzi schemes are named for Charles Ponzi, who swindled thousands of New Englanders in a 1920s postage stamp speculation scheme.
Source: Dan Brecher, Esg., a securities attorney in New York City who specializes in claims against brokerage firms.
