South Florida Ponzi Schemes — No Rest For The Wicked

Rothstein House and Yacht

In December 2008, as the Madoff story broke, we sent an email to all our clients reminding them of critical safeguards they need to follow to avoid being the victim of investment fraud.   At that time, reading through the list of Madoff victims, we couldn’t help but recognize the names of neighbors, acquaintances and community leaders. 

South Florida has always been a rich hunting ground for Ponzi schemers.  After Madoff, R. Allen Stanford and most recently Scott Rothstein  became household names in these parts, earning their places in the major league of fraud.  Florida investors lost an estimated $850 million to Stanford, who was convicted last week on 13 of 14 criminal charges.   Rothstein was sentenced to 50 years in federal prison for engineering his $1.4 billion Ponzi scheme in South Florida.  Of course, in addition to the big three, there have been numerous other minor league Ponzi players; it seems almost every week there’s some new financial fraud story in the papers (just Google “South Florida Ponzi scheme” and you’ll get no shortage of material).

For that reason, we thought it would be helpful to revisit our 2008 column written in the Madoff era, and update it for today’s investors.  In the world of fraud, it seems “the more it changes, the more it stays the same.”  So here’s advice for all investors on how to keep their money safe and stay out of trouble.

Rule #1:  Use an independent custodian. 

Your custodian’s job is to hold and protect your assets, collect your dividends and interest, and process your securities transactions.  Always make sure your assets are held with an independent custodian like Charles Schwab & Co., Fidelity, or a big-name brokerage firm.  The key word here is independent.  Your custodian and investment manager (that’s us) should be independent of each other, and your investment manager should not have the power to withdraw assets from your account. 

For example, like most Registered Investment Advisors (RIAs), we manage your accounts using the custodian’s Limited Power of Attorney forms.  This allows us to access information about your account, handle administrative matters, and permits us to trade (buy and sell) investments.  However, only you are allowed to withdraw funds from your account.

In Madoff’s case, his firm acted as the brokerage custodian and investment manager.  There were no checks and balances.  When Madoff the investment manager stole from the accounts, Madoff the custodian forged statements to hide the theft.  This would not have happened if the client assets had been held by an independent custodian.

What should have tipped off the victims?  The statements clients received were not issued by a well-known brokerage firm.  Instead, they were prepared by Madoff’s own firm, without the customary disclosures and details.

At the time, Marketwatch Journalist Robert Powell, whose wife worked for a Boston charity and participated in a 401(k), both advised by Madoff, reports that he found his wife’s 401(k) statement a little odd: 

“What the statement didn’t contain was any footer with the usual legal mumbo jumbo, no mention of SIPC insurance, or the broker-dealer through which securities are cleared, or anything that is normally found on 401(k) statements. Nor did the statement contain the names of any listed securities or mutual funds.”

Andy Serwer, an editor at Fortune magazine, reports a similar experience.  “I was looking at my neighbors “statements” from Madoff and they were ridiculous.  Nothing in them.  Just “balance at the beginning of the period” “balance at the end” kind of stuff.  Why bother with all the other numbers?”

Rule #2:  If it looks too good to be true….

When someone is claiming to have investment results that are far better than peers or the overall market, or performance that is amazingly consistent in an inconsistent world, don’t be impressed.  Be skeptical and stay far, far away.  Journalist Powell describes his reaction on reviewing his wife’s 401(k) statement, managed by Madoff (italics are mine): 

“Fast forward to October of (2008). Her 401(k) statement for the nine months ended September 2008 arrives and once again the account was up 6% or so — it’s hard to tell exactly. Now, I’m thinking that maybe her 401(k) plan provider is the Joe Kennedy of his time. He’s the one guy who’s making money in a down market, he’s the guy on the other side of the trade. He’s the next Bill Miller or Peter Lynch. In fact, my wife and I even discussed upping her contribution to her 401(k) plan given what’s his name’s success.”

Stanford sold investors fraudulent CDs from fictitious foreign banks, racking up over 2000 victims in Florida, many middle-class investors looking for a safe place to put their money. According to a March 9, 2012  Sun-Sentinel article, “initial investors collected a satisfying interest rate 1 or 2 percentage points higher than the going bank rate. That encouraged others to plunge in, the usual pattern for a Ponzi scheme.”

Remember the saying “there’s no such thing as a free lunch”?  Keep repeating it to yourself.

Rule #3:  Investors need to do their homework.

To learn more about his wife’s 401(k) account, journalist Powell tried to look up information on Madoff online.

“Curious, I tried to learn more about her employer’s 401(k) plan provider, the Bernard L. Madoff Investment Securities LLC. Unfortunately, I found little information about the firm on its Web site, nor on the Securities and Exchange Commission and Financial Industry Regulatory Authority (FINRA) Web sites. So, I dropped the matter, failing to take note of what, in retrospect, was one of the red flags.”

Legitimate firms leave a data trail.  They have regulatory filings, tax filings, are registered as business entities with the state, and may employ accountants, auditors, and attorneys who can be interviewed.  If you cannot locate sufficient information on a business and its officers, that is indeed a red flag.    

In the past, we have been asked by clients to review information on their other advisers, proposed investments, or perhaps check out a retirement plan offered by an employer.  On more than one occasion, we have uncovered enough questionable information that we have advised clients to not participate in sketchy investment or retirement plans, and not work with advisers whose regulatory filings raise more questions than they answer.

Rule #4:  Don’t invest in what you do not understand.

So-called investment experts may try to bamboozle you with their foolproof, can’t-lose strategies, many of which are so complex you can’t begin to understand them.  Before you plunge in, just remember the story about the emperor who had no clothes.  No one wants to be the first to appear unsophisticated and say they do not understand.

Be especially careful when the investment strategies involve exotic or alternative investments, hedge funds, or other complex schemes.  Investing in mutual funds, stocks and bonds can be very straightforward, and the marketplace is usually highly liquid, regulated and transparent.  Investments trade and are priced to market every day. But most hedge funds and other “alternative” investments are reserved for high net-worth investors who are presumed experienced and sophisticated enough that they do not need the protection of government regulation.  That means the adviser offering the investments may not be registered with any government entity, and standard investor protection measures do not apply.

For this reason, the institutions, charitable foundations and wealthy individuals who invested with Madoff were expected to have done their own “due diligence” or in-depth research.  It’s possible that even the most thorough research may not turn up every instance of fraud, but in the Madoff case, there were enough “red flags” and skeptics who avoided doing business with Madoff to suggest that a little bit more homework might have saved investors a lot more money.  Unfortunately, that did not happen, and the results are tragic.

We want to reiterate to clients that our firm and Charles Schwab, the independent custodian we use to hold client assets, do and will continue to do everything within our power to make sure your assets are protected.  This is something we take very seriously, so that our clients may never become the victims of fraudulent or improper practices.  If there are any questions we can answer about your financial security, please do not hesitate to ask us. 

Our firm has been approached several times by representatives of non-traded hedge funds and alternative investment managers to see if we would be interested in investing client funds in their investment products. While non-traded hedge funds and other alternatives offer some attractive performance features, we have always turned down the invitation because we are not comfortable with the “black box” nature of these investments.  We prefer to see how funds are invested and verify that client funds are secure.  Until those concerns can be addressed, we will choose to not participate in these ventures.



About Mari Adam

Mari Adam, Certified Financial Planner™ has been helping individuals and families chart their financial futures for over twenty-five years. Have a question about your financial situation? Ask Mari!

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