Question: Is there a way to protect myself from Ponzi–type schemes such as what was allegedly done by Bernard Madoff?

A BuyandHolder

Answer:

Some are saying it’s the largest Ponzi scheme in American history. Others are hedging a bit and saying, it’s one of the largest. Either way, it’s been disastrous for those who invested with Bernard L. Madoff Investment Securities. We sincerely hope that you were not among them.

As devastating as the news has been, it has also inspired those of us who write about the financial world to remind our readers that there are steps one can take to avoid being the victim of a Ponzi scheme.

It also reminds us to remind you not to be the least bit shy or feel any intimidation at all when it comes to asking questions of so-called financial experts and gurus. After all, some very smart and prominent Americans were fooled by Mr. Madoff, along with some well known charities with hard working presidents and dedicated boards of directors.

Some of the advice in today’s column will sound familiar – a bit cliché like. That’s because when good ideas and sound advice actually work, they often become clichés.

Lesson #1. Diversify. The first lesson is one you’ve heard before: diversify. Granted, any money you might have placed in Mr. Madoff’s hands (or the hands of any con artist) would have been lost, but if you didn’t put all your money with him, at least you would have some left.

We have talked about diversification previously in this column --advising you not to put all your money in one stock and not to put all of your money only in stocks. That remains sound advice, along with our recommendation of setting aside three to six month’s living expenses in a savings account, bank CD or a money market fund. That should be done before investing in the market. Again, Madoff investors who have this emergency nest egg have a much needed cushion.

Lesson #2. Run a check. You would if you were looking for a new doctor. So, if you’re searching for a financial advisor or individual stockbroker, find out as much as you can about that person. Most advisors are chosen based on personal referral. Referrals are a good place to begin...but again, look at what happened to people whose friends and colleagues referred them to Madoff.

In addition to using referrals, insist upon meeting the adviser in person. If he or she is too busy, forget about it. If he or she seems too smooth, forget about it. If he or she talks down to you, uses a lot of fancy jargon or spins stories, forget about it.

On the other hand, if you feel positive about the person during your interview, at the end, ask for the names of current and, if possible, former clients. Then call and talk to each one. Ask their opinions. Listen carefully.

Lesson #3. Forget promises. Ask tough questions about the adviser’s performance. Don’t believe in unusually high returns. You know what the market is doing. How mutual funds are performing. Where the Dow and S&P 500 are. What interest rate bank and credit unions are paying on savings accounts and CDs. If someone promises you triple those amounts, it should send up a very red flag.
And, a good adviser should never promise you a specific return – returns are unknown except in the case of interest-bearing investments.

Lesson #4. Don’t believe the phrase “it’s proprietary.” When you ask what research, strategies or techniques the adviser uses, you should receive clear answers. Walk away if you’re told “it’s proprietary.” All secret schemes are to be avoided.

Lesson #5. Know where you’re money is being held. Your assets should be with a third-party public custodian. For example, here at BuyandHold, trades are cleared through Oppenheimer & Co. Inc.

When making deposits into your account, you should never be asked to write a check made out to the adviser's firm or an individual. The check should be made out to the name of a broker-dealer or mutual fund firm or insurance firm, whichever is the custodian of the money.

Lesson #6. Read your monthly statements. Each one should specify the names of the securities held, ticker symbols and account values.  If you have any doubts about the truthfulness of a statement, ask your accountant to read it with you.

Lesson #7. Go with SIPC. Only invest with a brokerage firm that has insurance provided by the Securities Investor Protection Corporation, known as SIPC. The organization’s website explains why:

“SIPC is the U.S. investor's first line of defense in the event a brokerage firm fails, owing customer cash and securities that are missing from customer accounts. SIPC either acts as trustee or works with an independent court-appointed trustee in a brokerage insolvency case to recover funds."

The website further explains:

“The statute that created SIPC provides that customers of a failed brokerage firm receive all non-negotiable securities - such as stocks or bonds -- that are already registered in their names or in the process of being registered. At the same time, funds from the SIPC reserve are available to satisfy the remaining claims of each customer up to a maximum of $500,000. This figure includes a maximum of $100,000 on claims for cash.

$TIP: For more information about SIPC, read its own publication: "The Investor's Guide to Brokerage Firm Liquidations."