Investors have every right to be nervous and concerned about their investment. After the worst market decline since the Great Depression, not only did investors lose a lot of value of their holdings, but the ugly face of greed was revealed in several high profile cases of fraud.
The largest of these was Bernie Madoff, who built a Ponzi scheme that lasted for more than two decades. He used the lure of very high, but false, investment returns to entice investors to place their investment capital under his control, then used the incoming funds to pay earlier investors what they mistakenly thought was a return on their invested capital. Mr. Madoff, about 70 years of age, recently was awarded a 150 year prison term for the audacity and scope of his crime.
Two other cases of fraud have impacted investors right here in the Sarasota / Bradenton area. The smaller of the two is Arthur Nadel, and investment advisor who ran a scheme similar to Madoff, but on a smaller scale with investors losing several hundred million, instead of the many billions lost in the Madoff case. The other, which is just now getting to the trial stage, is the Stanford Financial fiasco. In this case, Allen Stanford and his firm bilked billions from investors by selling them certificates of deposit issued by a bank in Antigua, promising returns as high as 16 percent.
Of course, we now know that the money from new investors was used to pay the previous investors, a classic Ponzi scheme that can only go on for so long before it blows up. Mr. Stanford has not yet gone to trial, but the chief financial officer has plead guilty to three counts of fraud, so obviously, things were not all OK in paradise.
What can you do as an investor to avoid being taken by these unscrupulous individuals and their scams? Here’s a few things to pay attention to:
1. If it sounds too good to be true, it probably is. Advisors touting outsize returns with low risk should be considered very carefully before investing your money. Very few investors consistently achieve results way above average, and in particular, do so without taking risk. Understand your investment objectives, have realistic expectations and use common sense to avoid being lured in by claims that are unlikely to occur.
2. Who has custody of your money? All of the cases of fraud in the last year or so have a common theme. They all involved investors giving custody of their money to the advisor or his firm directly. You can avoid this by dealing with an advisor who uses a qualified custodian to hold the investment capital and the securities which are purchased with it. Examples of qualified custodians would be brokerage firms, banks and mutual fund firms, who are registered with either the Financial Industry Regulatory Association (FINRA) or the Securities and Exchange Commission. These firms are regulated and the individual investment advisors ability to access the funds is limited and more easily monitored by the client.
3. Audit financials and verify positions. If you do make an investment with an advisor who takes custody of your funds, one of the best defenses against fraud is an audit of the financial statements and verification of positions owned for each client by a reputable certified public accountant. In the Madoff case, investments in the 10’s of billions were being audited by a one man CPA firm. Investors should be wary of the potential that a fraudster could buy off the auditor to have him falsify the reports. I suppose there is no way to be certain, but checking up on the auditor would be time well spent.
The easiest way to avoid losing money to a scam artist is to keep custody of your funds with a qualified and reputable custodian. Most are members of the Securities Investors Protection Corporation which covers losses of up to $500,000 for fraud and many of these firms have purchased additional coverage privately to bring peace of mind to their clients.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing.