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Protecting Yourself From the Next Bernie Madoff

By: Rick Kahler | June 29, 2009

Bernard Madoff, former NASDAQ Stock Market chairman and founder of Bernard L. Madoff Investment Securities LLC, has been sentenced to 150 years in jail.  While the lengthy sentence may not offer much comfort to those cheated out of their retirement savings by Madoff’s Ponzi scheme, it does emphasize the magnitude of his fraud.

His clients didn’t see this coming.  Could they have?  Let’s look at three key safety tips that might have protected them.
 
Know what you own.  Stick to stocks, bonds, ETFs, and mutual funds that are publicly traded and listed on major exchanges like the New York Stock Exchange.  They are valued independently at least daily, if not minute-by-minute, while the exchange is open.  You can check their reported returns against your own portfolio.  If you can’t look up the prices and performance of any potential investment in the newspaper or on the Internet, that’s a red flag and means you should ask a lot more questions.
 
Use an independent custodian.  Madoff held his client assets, managed them, and priced them, too.  See the conflicts of interest?  Investment performance can look better if the prices reported to clients are manipulated, which is allegedly how Madoff showed winning results year after winning year despite market turmoil.  At fee-only financial planning firms such as ours, clients have an independent third party such as TD Ameritrade or Schwab pricing each investment they own.  The planning firm has no input on investment pricing, and that separation is a very good thing.  Clients also get independent statements directly from the brokerage house.
 
Check on insurance.  Our clients benefit from fraud insurance.  The first part is Securities Investor Protection Corporation (SIPC) coverage for $500,000 per account.  Fraud insurance does not protect against market declines, but it does protect against theft of securities and/or related fraudulent transactions.
 
One final thought: as always, if an investment sounds too good to be true, it probably is.  Reportedly Madoff claimed consistent annual returns of 10-12% with little volatility and no annual losses.  Potential investors should always receive such spectacular claims with strong suspicion.
 
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Finding an Ethical Financial Planner

By: Rick Kahler | June 8, 2009

One of the big local news stories in my area recently featured a young man who won millions in the lottery. Until a few weeks ago, this man had probably never thought about financial planning and certainly never even considered that he might need a financial planner. Yet now, for the sake of his and his family’s peace of mind, I hope he finds a competent, ethical planner as soon as possible.

If he asked me how to find a financial planner, here are some suggestions I would give him:
 
1. Ask for references from attorneys, accountants whose firms do not have a financial planning division, or friends who may have financial planners.
 
2. Do research on the Internet. Today’s technology means you and your financial planner don’t have to live near each other. There are lists of financial planners at the National Association of Personal Financial Advisors (www.napfa.org), the Financial Planning Association (www.fpanet.org), and www.consciousfinance.com.
 
3. Make sure anyone you consider has a CFP designation after his or her name. This is not in itself a guarantee of competence or integrity, but it means the person is a Certified Financial Planner who has completed accredited courses in the six areas of financial planning: estate planning, retirement planning, cash flow management, risk management, tax planning, and investments.
 
4. Look for a fee-only financial planner whose earnings come from fees paid by clients rather than commissions on investments or products. This insures that the planner’s fiduciary responsibility is to you.
 
5. Check out at least two or three planners. Read their websites carefully. Ask them to send you information on their firms. Interview them, in person or by phone. Don’t be afraid to ask tough questions; my next post will list some.
 
6. As you interview planners, use your intuition and common sense. Does the office appear organized and well-managed? Is the planner trying to "sell" you on one particular product? Does he or she seem to be making unrealistic promises about investment returns? Is this person willing to answer questions and explain things in terms you can understand? Are you comfortable with him or her?
 
You don’t have to know a lot about investments or financial planning to evaluate whether someone will represent you well. Yes, the financial planner is the financial expert, but remember this is your money and your life. You deserve a financial planner who will work as your partner to help you use your financial resources to create the life you want.
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Follow the Money

By: Rick Kahler | May 8, 2009

If you want to be sure your financial advisor is truly working for you, make sure you are a client rather than a customer. To a fee-only financial planner, you are the client. Like an attorney or accountant, the planner has a fiduciary responsibility to put your interests first.

To a stockbroker, essentially a salesperson who earns income by selling products, you are a customer. The broker’s fiduciary duty is to the company he or she works for. Brokers who combine product sales and investment advice have a built-in conflict of interest.

In recent years, brokerage firms have done their best to blur the line between investment advisors and product salespeople.

Increasingly, as technology makes investment information and processes more accessible, the traditional model of stockbrokers earning fees for investment services no longer works. There’s not a problem with brokerage firms charging fees for investment advice—as long as they are held to a fiduciary standard that requires them to put their clients’ interests first.

To date, this has not been the case. Some brokerage firms have been making money in three ways:

1.      Charging customers for financial advice,
2.      Selling those same customers their own product lines, and
3.      Selling those same customers investments owned by the firms themselves—investments the firms no longer wanted, like toxic paper.
 
The second and third of these practices clearly would not be permitted under a fiduciary standard. Obviously, then, the firms relying on those income sources have a strong incentive not to register with the SEC and bring themselves under the fiduciary regulation that applies to registered investment advisors.
 
It is more important than ever for consumers to educate themselves. Don’t rely on what someone’s business card or website says. Anyone can use terms such as financial planner, financial advisor, or investment counselor. Instead, demand that the “planner” sign a statement that you will be a client. Ask tough questions about fees and commissions.
 
Use your own common sense—and follow the money. Wherever the money comes from, that’s where the loyalty goes. Only as a client rather than a customer can you be sure an advisor’s loyalty is to you.
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Investor Watch Dog is a weblog designed to inform investors about hidden risks when they invest assets based on the recommendations of financial planners, financial advisors, money managers, insurance agents, and investment sales representatives. Some of Wall Street's biggest investment risks result from Ponzi Schemes, investment bubbles, conflicts of interest, bad advice in bear markets, lobbyist activities that promote industry interests, bad investment products, and anti-investor business practices. While some of these risks are worthy of front page headlines, millions of investors assets are much more frequently exposed to less newsworthy but exponentially more harmful investment scams, financial fraud, illegal investment products, bad financial advice, bad investment recommendations, misrepresentation, omission, abuse of trust, deceptive sales practices, and breach of fiduciary duties. The role of Investor Watch Dog is to shine a spotlight on legal and illegal business practices that undermine the financial interests of investors, retirees, business owners, professionals, executives, and other types of consumers who rely on Wall Street and its financial professionals for the advice and services they need to achieve their financial goals.