In Search of the Next Madoff

By Jack Waymire

www.paladinregistry.com

The Bernie Madoff scandal has made one thing clear to Madoff imitators: how easily investors can be swindled. Here’s how to avoid becoming a victim.

Since Bernie Madoff’s name became synonymous with investment fraud, the press has reported on hundreds of legal and illegal investment scams. And because story after story documented how easy it is to rip off investors, there’s a good chance that all those reports will spawn thousands of new and improved scams.

How do you protect yourself? You can’t rely on industry regulators such as the SEC, FINRA and state securities commissioners—those authorities tend to only shut crooks down long after investor assets are gone. Your best defense is to avoid investing with bad guys in the first place.

That’s easier said than done, of course, but the first step is to identify the potential culprits. Unlicensed advisors and people with criminal records are obvious red flags, but how do investors sniff them out? And then there are the not-so- obvious wrongdoers: incompetent or unethical advisors who sell advice and products that generate poor results at excessive cost.

Weeding out criminals and incompetents is surprisingly complicated. Mandatory disclosure requirements for advisors’ credentials, ethics and business practices don’t exist. Unethical advisors are skilled at withholding unflattering information and know how to make themselves sound like ethical, competent financial experts. It’s up to the investor to know what questions to ask and how to distinguish good answers from bad ones.

And there’s one more thing: Most investors use subjective processes to select advisors, which benefits scam artists and low-quality advisors. Too many investors base their selection on advisors’ pleasant personalities, claims in sales pitches and promises of high returns for low risk. The bad guys know this—remember how many of Madoff’s victims thought of him as a friend? That wasn’t an accident. True, Madoff is an extreme example of illegality. But what about incompetent or unethical advice that could have contributed to a 30 percent decline of your assets over the last three years?

So how do you protect yourself from crooks and morons? By replacing the subjective process of choosing an advisor with due diligence that confirms the accuracy of information financial planners, investment advisors and money managers volunteer.

You can pay a third party, such as an online service, to conduct background checks for you; you should be able to hire such a researcher for as little as $100 to $400. (Think of it as an investment in your investments.) Or you can conduct your own due diligence using, for example, the free guide available on the website of my firm, paladinregistry.com. The guide describes the information you should validate and provides URLs for online resources.

In your research, focus on information pertinent to the ethics and competence of financial professionals. The ethics side of the equation is relatively easy: Regulatory websites such as finra.org and sec.gov detail investor complaints that resulted in advisors paying restitution to clients, paying fines to regulators or serving industry suspensions.

Competence is tougher to ascertain, as most advisors do not provide audited track records. You’re expected to select an advisor based on claims in sales pitches or references from sources who may be biased. Instead, focus on documentation of the advisor’s sources of knowledge—years of experience, education, certifications, designations and accreditations (such as CFA, CFA, CIMA and CPA).

How many years of actual experience does the advisor have? Did the advisor earn the college degree or buy one? Did the advisor add fake certifications after his name? Licensed and unlicensed advisors use these deceptive sales tactics far more frequently than you’d think—because, since most people don’t check, they work.

 

Like tobacco, bad financial advisors should come with warning labels. One damages your physical health, the other your financial health. Both are devastating because you don’t discover the consequences until after the damage has already been done.

Curator