Four questions to ask your advisor, plus tools to do your own research
Bernie Madoff, mastermind of the biggest investment fraud in history after he defrauded more than 40,000 people of over $65 billion, died at the age of 82 in prison on April 14, 2021.
Considered by many to be the archfiend of the financial world, his death will haunt the financial industry for years, despite his 150-year prison sentence that he started more than a decade ago.
The epic Ponzi scheme Madoff ran underscored a harsh reality: many folks don’t understand what we do as advisors.
We must draw sharp contrasts for clients between how we operate and how Madoff did. For instance, Madoff was custodian for his clients’ assets, a big red flag.
Madoff also generated his own statements for clients, which were major works of fiction. Clients need to be told that their money is with a third-party custodian, who can generate independent statements.
For example, at Patriot, we custody with Charles Schwab. All our client’s assets are in Charles Schwab accounts that they own. We simply have limited powers of attorney to trade and deduct fees from these accounts as part of our management.
Avoiding Another Madoff
So how do you make sure you don’t run into the next Bernie Madoff? One way is to assure that your advisor does not oversee every part of your investing.
Here are four questions to ask your advisor:
- Who is selecting my securities?
- Who is executing my trades?
- Who is keeping custody of my assets?
- Who is verifying my performance?
Madoff controlled the first 3 exclusively. For the 4th, he was able to find a small outside auditor to help him with his scam and sign off on the phony returns.
Your advisor might be selecting securities for you but listen carefully to how they answer the next three questions.
Do Your Homework
Check to make sure that your advisor has no adverse actions at the Securities and Exchange Commission, the Financial Industry Regulatory Authority (FINRA), state securities departments, and state insurance commissioners.
Below are just a couple of sites you can use to look up your advisor:
It is tedious because, by some estimates, close to 5% of financial advisors will receive a client complaint in their lifetimes. For perspective, consider that the American Bar Association found that 8% of attorneys receive complaints annually. The American Medical Association says 5% of doctors are sued each year.
For advisors, lawyers and doctors, sometimes these complaints are frivolous. Sometimes they are not.
Madoff Had a Record of Paying Fines
A little research would have told clients that Madoff paid $15,500 in fines, stemming from a 2005 violation. Details from the Form ADV on the SEC’s website are sketchy, but it appears that his firm withheld required information from the Nasdaq exchange.
A Madoff client wanting to buy or sell a stock had filed a limit order, which means that the customer wanted a specific price or better. This information is necessary for bidders to see what the market for the stock is like. The Madoff client who bid had the right to have that order entered into the market.
Oddly, the SEC still maintained a listing for his firm, Bernard Madoff Investment Securities, even though it is defunct. If you just emerged from a coma after Bernie had been in prison for a few years, you might have thought the Madoff outfit still existed. The reason for the continued listing, according to the SEC, is legalistic. Madoff’s firm needs to be registered with the agency so victims can make claims on its assets.
As a practical matter you couldn’t invest with the firm if you tried because the firm is out of business and its founder was in prison for 150 years. Now, he’s no longer alive.
One More Thing
It has been over 10 years since Madoff went to prison and his recent death will surely resurrect more client concerns with respect to their financial advisors.
At Patriot, we strive to constantly do what is in our clients’ best interest and that includes being clear about how we work. If any financial advisor balks at your 4 questions or doesn’t want to provide you with their Form ADV, don’t walk away. Run!