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Protect Your Investments: 10 Years Later — What We Learned from Madoff

Amanda Steinberg  |  October 28, 2018

The Madoff scandal is a reminder of how important it is to protect your investments. Understand how your assets are managed.

Do you really know how your financial adviser is managing your money?

In 2008, the world first heard of the Bernie Madoff Ponzi scheme. Cheating clients out of billions of dollars, the scandal rocked the investment world. In 2017, HBO released “The Wizard of Lies,” a movie about the investment adviser and financier starring Robert Dinero. The scandal and the movie are important reminders of how important it is to protect your investments

Wealth managers, brokerages, investment advisers and fund managers are heavily regulated by the Securities and Exchange Commission in the sale and management of securities. What signs were missed to allow $50 billion in assets to go missing? Madoff’s Ponzi scheme taught us a few lessons on how we can keep our assets safe.

Don’t Believe the Hype

“The Wizard of Lies” co-producer Jason Sosnoff said, “You have to understand how Bernie was revered by his family and community. Everyone wanted access to his fund because they heard about the consistent returns.”

“But then he’d limit the access. And that made people want to get in even more. People were joining his country club just to get close to him. And this created the myth. The myth that Bernie was a genius and you were lucky if he’d take your money.”

“The thing about myths is [that] they usually get stronger over time. And then they’re like fact,” Sosnoff continues. “And that’s what happened with Bernie. Imagine the kids growing up around this dynamic of everyone wanting access to their father. Perhaps it’s one of our flaws that despite all the data and analysis we now use in making decisions, at the end of the day we love to believe in myths. And in the case of Madoff’s sons, [it was] the belief that the father is all-powerful, infallible.”

Takeaway: It’s important to have trust in your financial adviser, but don’t base your financial decisions on hype.

It’s OK to be suspicious

“[T]he main warning sign to those with more significant assets was that Madoff’s performance statements went in a straight line upward — showing annual growth of 12% per year. Investments never show consistent upward growth, but instead the normal ups and downs of the stock market. What was seen as Madoff’s ‘outstanding performance’ should have been picked up as impossible to achieve,” said Sosnoff.

A significant percentage of the funds Madoff managed were invested via other funds — such as pension funds, philanthropic trusts and other financial advisers. Many victims didn’t even know that their money was managed by Madoff because they only spoke to their direct adviser or feeder fund.

Takeaway: Be sure to ask your adviser questions if you suspect anything is off with your portfolio. If you think the results are too good to be true, you’re probably right. 

Protect your investments

What steps can we take to protect how our investments are managed?

Understand the custodian. First, understand your investment adviser’s custodian and make sure that this custodian is reputable. According to Investopedia, “a custodian is a financial institution that holds customers’ securities for safekeeping to minimize the risk of their theft or loss.” Examples of well-known custodians are Fidelity and TD Ameritrade; Madoff’s brokerage custodied its own assets.

Since the Madoff scandal, the SEC passed new regulations to increase the likelihood of discovering any misappropriation of funds by an adviser. 

Due diligence is a must. Prior to investing your money with an adviser, take time to speak with them, visit their office and speak with the firm’s other clients if you can. If something doesn’t feel right, don’t be afraid to look elsewhere.

Jim Dowd, CFA and board member of Worth Financial, ran the hedge fund advisory business at Bear Stearns a few years before the Madoff fraud was uncovered. “[W]e were invited to invest with Madoff, and their track record appeared to be excellent,” he recalls. “But we had a due diligence requirement to make a site visit prior to any investment, and Madoff would not agree to it. That helped us avoid a grave mistake.”

Do research on your adviser. Research your financial adviser’s public record. All registered investment advisers must file a form ADV with the SEC, which is a public record of all business operations, fees as well as assets. If the adviser has any penalties or fines, you will find records of these. 

Recognize typical market activity. All investments go up and down. If your personal portfolio’s performance report looks drastically different from a typical stock market index like the Dow Jones — such as showing consistent upward growth — ask your adviser for a thorough explanation.

Be proactive. Being proactive with your investments is a surefire way to avoid falling prey to a Madoff-level Ponzi scheme. Let your financial adviser know that you are constantly reviewing your investments and won’t hesitate to ask questions if something doesn’t make sense to you.

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