Bernie Madoff is alleged to have conducted the largest investment fraud in history, causing investors to lose an estimated $50 billion dollars. But not everyone was deceived. Harry Markopolos, an independent financial fraud investigator, was certain that Madoff was defrauding investors, most likely through a Ponzi scheme. He issued a memo to the SEC in 2005 providing 29 red flags that the regulator should investigate. Unfortunately the SEC did not uncover the scheme which collapsed when investors required large redemptions during the stock market downturn in 2008.
Most individual investors can not afford to hire an independent financial fraud investigator to evaluate all of their investment choices. But they can perform their own due diligence to protect themselves. So what should an investor look for when selecting an investment manager?
Most importantly, investment managers should always use an independent custodian. Independent custodians, like Charles Schwab which Foster & Motley uses, allow investors to track holdings and restrict an investment manager’s access to funds. Bernie Madoff used his own company as custodian of client accounts. As custodian, he had full access to withdraw money from accounts and provide account statements showing trades that did not occur and account values that no longer existed. Madoff’s scheme would not have lasted long with an independent custodian contradicting his reported account balances and trades.
Investors should seek transparency in their investments. Madoff promised consistent returns but would not thoroughly discuss the investment strategy employed or disclose investment positions until after they were closed. If investors had seen the positions and activity in their account they may have known that its returns were not as great or as consistent as promised.
For individual investors, selecting an investment manager is often a question of who to trust. Unfortunately Bernie Madoff was seen as trustworthy by the thousands of people, including well known and supposed sophisticated investors, who have lost their savings. A few due diligence questions about who safeguards the account as custodian and requiring the ability to monitor the account activity may have prevented the fraud.