There are important lessons to be learned from the events of December 2008, when it was finally revealed that Madoff had fleeced charities, banks, companies and individuals of billions of dollars. The best defense against a con artist such as Madoff and many others like him is to understand how they think and to remember a timeless adage. If it looks too good to be true, it probably is. Never be lured by the possibility of big profits.
Guaranteed Big Returns
Everyone likes to make money. Con men are aware of this and will try their best to take advantage of people's gullibility, greed or desperation. If a financial advisor says there's no risk, or minimal risk, then a client shouldn't get involved. A huge red flag in the Madoff fiasco was that he seldom reported any losses. Nobody else could replicate the kinds of returns he did.
Tip: With any legal investment, there will always be risk and volatility.
Black Box Money Management
'The details are confidential' is a phrase that should never be said by a money manager. Don't buy it. If the person or persons dodge, deflect or totally refuse to answer any questions from clients, it's a red flag that something illegal might be going on.
Tip: If there is no investment prospectus or disclosure statement given to show how the system works, walk away.
Affinity Fraud
Religious, ethnic and social groups are the most fertile environments in which to scam large numbers of people. Bernard Madoff targeted Jewish individuals and organizations, drawing them in at least in some measure because of a shared faith. Hucksters know that if they can gain trust within a group, the confidence game will work. This can take a while to set up but the payoffs will be huge.
Tip: Never jump on the bandwagon before investigating the investment opportunity with a microscope. Whoever is promoting the scheme might be a victim without realizing it.
Managers and Custodians
There is a rule professional gamblers follow to protect themselves from a scam or fraud, and that is to have a third party hold the cash until the outcome of a bet is known and winners are to be paid. In traditional asset management, a client's funds and assets are always held by a third party custodian, who is not the portfolio manager. Accounts are segregated from all other investor funds and institutional funds. The portfolio manager only has the authority to execute trades, and can't withdraw or transfer money.
Tip: Fraud is more likely to occur when the manager and custodian is the same person, as Bernard Madoff was. An investment manager who wants complete control of a client's money is hiding something.
Exotic Investments
Swindlers love to push poorly understood investment strategies; they include gold bullion, oil and gas production or anything that involves new technology. The pitches can have glitzy graphics filled with all kinds of numbers and technobabble, but investors still have trouble putting it all together. That's what con artists want to happen, because it keeps people from asking for their money back.
Tip: Real investing isn't hard. Stick to stocks, bonds and mutual funds, which are publicly traded and known as transparent assets.
Most money lost to investment scams is seldom recovered. Ask questions and never be pressured to put money into something right away. Can the money be withdrawn immediately, or must advance notice be given? Are there exit fees? These aren't questions that clients would want to ask for the first time if they need cash quickly. It was reported that Bernard Madoff didn't like to answer questions about his activities. Now everyone knows why.
Reference:
Five Steps for Avoiding Financial Fraud by Jane King, Forbes magazine, 23 March 2010.
Scott Hayden - Since joining Suite101 in early 2007, I've contributed articles about travel, history and health. My speciality is writing about workplace ...
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