Madoff, One Year Later: What You Should Know

Dec. 8, 2009 — -- Friday will mark the one-year anniversary of an event many in the investment advice business would prefer to forget.

That is the arrest of Bernard Madoff, kingpin of the largest Ponzi scheme in U.S. financial history. Now spending the rest of his life behind bars, Madoff brought on financial devastation for thousands with his thievery. His victims are still coping with the fallout.

In the year since Madoff's arrest, many investors have become more careful about whom they select to advise them on investment matters. Some, I'm sure, will not seek any outside help for fear of encountering a similar crook.

The sad reality, however, is that Madoff's multi-billion-dollar fraud will not be the last time a financial adviser is charged with stealing from clients. By my count, the U.S. Securities and Exchange Commission has brought fraud charges against more than a dozen advisers, brokers or hedge funds this year alone.

That's why I think it's worthwhile to revisit some of the steps you can take to make sure you're not the victim of financial fraud. Few of these recommendations are original, but I think we've all learned you can never repeat them too often.

Some of these suggestions I included in the first column I wrote about Madoff in the days after his arrest; others are new.

Trust but verify.

This is the attitude I would adopt when dealing with anyone you hire to help manage your investment portfolio. Even if you have an adviser you trust completely, you should still look over that person's shoulder.

Periodically, check on the adviser's actions and try to understand why the adviser is taking them. And if you don't understand, ask questions.

Don't adopt a total hands-off policy. After all, it's your money.

Know your custodian.

A custodian is the investment firm that holds on your behalf possession of your stocks, bonds, mutual funds and other securities. It could be a large firm like Fidelity, Vanguard or Scottrade, or a smaller broker-dealer whom you've never heard of.

If you're dealing with an independent firm, the custodian should be an outside third party. If you use a full-service brokerage firm like Merrill Lynch or Morgan Stanley, that firm will hold custody but there is separation between the broker and the custody side of the business.

Protecting Yourself From the Next Madoff

Be careful writing checks.

Never write a check to the individual adviser or to the adviser's firm when depositing funds into an account. Instead, the check should be written out to the custodial firm.

If it's a new investment account, as an added measure of protection, make sure the account is already set up and that you know the account number before depositing funds into the account.

Go online.

As soon as an investment account is set up, make sure you know how to view the account online. Don't wait; view the account online right away so that you become familiar with the site, how to access it and the information presented.

I would not do business with any firm that does not allow you to view your investment accounts online.

Once the account is up and running, check periodically to see what's happening and view any trades your adviser is carrying out.

Visit their office.

Many of the investment custodians used by independent advisers operate retail branches throughout the country. These firms include Charles Schwab, Fidelity, Scottrade and TD Ameritrade.

This offers another opportunity for you to check up on your account -- and what your adviser is doing -- by simply walking in and asking questions. And if you have concerns about what your adviser is doing, this is one place to bring those concerns.

I'm not suggesting that you should avoid doing business with a firm if the custodian does not have a local office, particularly if you live in a rural location. It just provides an extra level of assurance.

If there is no local office, then call the toll-free telephone number on your account statements to ask questions and raise any concerns.

Understand discretion.

Make sure you know the difference between discretionary and nondiscretionary authority.

Discretion is authority given to an adviser to place trades in an investment account without giving advance notice to the client each and every time. The adviser is supposed to follow guidelines agreed to with the client, but otherwise is authorized to buy or sell securities they deem appropriate.

Nondiscretionary authority means the adviser must check with you before placing a buy or sell order. This slows down the process, but it keeps you in the loop as to what's happening and when.

There are pros and cons to each approach; just make sure you understand the difference and how your adviser operates.

If you're not comfortable granting discretion to an adviser, do not grant it. Instead, seek out one that will work with you on a nondiscretionary basis.

Good Habits

Review statements.

Make it a habit to periodically review your account statements when they arrive. It's important to understand how your accounts operate even if you've handed off investment selection and implementation to someone else.

Some statements are better prepared than others, but it's always going to take a little work on your part to understand them.

Make sure you pay close attention to account activity. Many investors study their account values to see whether they have gone up or down, but then ignore the account activity portion of their statements.

That's a mistake.

You want to look at what money is going into the account and, most importantly, what's coming out. If you're not sure what to look for, then check for the minus signs. They usually signal some type of debit from an account.

Money can be removed for a number of legitimate reasons -- trading commissions, adviser fees or account transfers -- but make sure you know why. If you don't, ask.

No blank forms.

Quite often, for client convenience, advisers will prepare the voluminous paperwork that can be required to open an investment account or transfer assets. This is a common and legitimate practice.

But never sign a blank form that an adviser says he will fill out later. And, of course, review the documents you are signing before doing so.

And, if you'd like to an extra layer of comfort, tell the adviser you'd like to take the forms home to look over and then mail them yourself.

I can't guarantee these steps will inoculate you from the next Bernard Madoff, but they will go a long way toward reducing the chances of it happening.

Remember, trust but verify.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is founder and principal of Four Ponds Financial Planning in Falmouth, Mass. He previously worked as a financial writer and editor for The Providence Journal in Rhode Island. He is a member of the Garrett Planning Network, whose members provide financial advice to clients on an hourly, as-needed basis. Contact McPherson at david@fourpondsfinancial.com.