Regardless of the arena, strategic assessment is a necessity.
Following is our C360 process:
- Collect your data with a good intelligence gathering process.
- Assess your data.
- Verify and validate
- Re-assess one more time.
Sunday, December 21, 2008 (SF Chronicle)
What investors can learn from Madoff scandal
What can investors learn from the Bernie Madoff scandal?
It's not clear exactly how Madoff allegedly bilked wealthy and supposedly sophisticated investors out of $50 billion in a Ponzi scheme.
Unlike hedge funds, which are essentially unregulated, Madoff registered as an investment adviser with the Securities and Exchange Commission, but not until the SEC forced him to do so in 2006. For decades before that, he operated solely as a broker-dealer, which is also subject to scrutiny by the SEC and Financial Industry Regulatory Authority, the securities industry's self-regulator.
It will be awhile before we understand how the SEC failed to detect the fraud until Madoff's sons, who worked with him, turned him in this month.
But based on what we know so far, here are 10 lessons for investors who work with registered investment advisers.
1. Don't buy what you don't understand. Madoff reportedly told clients he invested in blue-chip stocks and then hedged his positions by trading put and call options on the Standard & Poor's 100 stock index. Although this is a fairly common strategy, it's hard for people who are not financial wizards to comprehend. "If you can't understand the strategy, you have no business investing," says Jay Gould, an attorney with the law firm Pillsbury Winthrop Shaw Pittman.
/// *** Don't build a plan if you do not understand what you are assessing
2. If it sounds too good to be true, it is. Madoff claimed to earn 10 to 12 percent, year after year, with nary a down month. In the real world, such consistent returns are as improbable as doubling or tripling your money in a year.
/// Perception is reality. Always look at the grand picture. Ask yourself does it make sense?
Other firms using a strategy like Madoff's could not figure out how he made such returns in up and down years. Some brought their concerns to the SEC.
"Real put-option strategies can and do provide fairly consistent income, but not in all markets," Gould says.
3. Know where your money is and who is watching over it. Registered investment advisers must place client assets with a qualified custodian, usually a bank or brokerage firm. Advisers can use an independent custodian, which provides an extra layer of security, or an affiliated custodian, which apparently is what Madoff did. The custodian must provide quarterly statements, either directly to the investor or to the adviser to give to the client. "If the statement is delivered by the adviser, that is where there is the potential for the adviser to manufacture the statement," says Clifford Kirsch, a partner at the Sutherland law firm in New York. Madoff allegedly faked statements to make it look like his clients owned securities when in fact their money was being used to pay off other investors. If your money is with an adviser, find out where it is held, whether the custodian is affiliated with the adviser and what safeguards are in place to make sure the adviser can't swipe your money. If you give your adviser discretion to make trades in your account, do not give him or her permission to withdraw funds. And make sure statements are sent directly to you. "Nowhere is (Ronald) Reagan's old adage more applicable than in this case: Trust but verify," says Mercer Bullard of Fund Democracy, an investor advocacy organization.
4. Audit the auditor. If the client receives statements from the adviser (instead of the custodian), the adviser must submit to an annual surprise audit by an outside firm.
Madoff's sole auditor reportedly operated out of a tiny office in suburban New York. A legitimate firm of Madoff's size would have employed at least one brand-name auditor. If your adviser has an auditor, be sure it's reputable.
5. Are your assets insured? Most brokerage accounts are insured against fraud or embezzlement (but not against market losses) for up to $500,000 per account by the Securities Industry Protection Corp., a private, nonprofit entity.
Many brokerage firms purchase insurance that covers additional losses. Find out what insurance your account has and who provides it. (For more, see www.sipc.org.)
6. Diversify. Some Madoff victims had virtually all their assets with his firm, which violates the first rule of investing: Don't put all your eggs in one basket.
"One would never want to have all their assets with any one manager, no matter how brilliant or safe they are," says Joyce Linker, a principal with ThinkEquity who helps clients of the San Francisco bank evaluate money managers.
7. Beware of affinity groups. Many scam artists recruit clients through religious, ethnic or work groups whose members know and trust each other.
Madoff's clients included many wealthy Jewish people and nonprofits in New York and Florida who found him through word of mouth. "We've seen more people steal money in the name of God than any other mechanism," says Wisconsin securities regulator Patty Struck.
8. Understand fees. Sheryl Garrett, head of the Garrett Planning Network, an association of fee-only financial planners, says investors should fully understand how their advisers are compensated.
"Strongly consider not giving anyone trading authority or the ability to withdraw their fee from your account. You can write a check for the fee," says Garrett.
9. Stick with funds. If all of the above seems like too much work, stick with mutual funds, which are much more closely supervised.
10. Don't assume the SEC will protect you. "It's unacceptable that the SEC is not providing the basic level of protection that investors ought to be able to rely on," says Barbara Roper, director of investor protection for the nonprofit Consumer Federation of America. "They ought to be able to assume that the SEC is weeding out those kind of obvious con artists for them."
Unless things change at the SEC, Roper says, "Good luck. You're on your own. Cross your fingers. And hope for the best."
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E-mail Kathleen Pender at firstname.lastname@example.org.
Copyright 2008 SF Chronicle