HBO’s Wizard of Lies, featuring Robert DeNiro as fraudster Bernie Madoff, premiered recently. It follows up Madoff, a 2016 mini-series that featured Richard Dreyfus. As background to Wizard, a series of follow-up articles reviewing Madoff’s schemes and crimes have also appeared: The New York Post’s “Bernie Madoff’s Closest Prison Pal Is A Crime Boss,” The Atlantic’s, “No Movie Could Capture The Crazy Details Of Bernie Madoff’s Story,” and Town & Country’s, “How Bernie Madoff Took His Family Down.”
It was not just naive individuals who were taken for about $65 billion (net fraud of $17.3 billion) by Madoff; it was countless professional investors, mutual fund and asset fund managers, bank executives, financial advisors and other professionals in the investment arena that should have known better. One would hope that from all of the financial crime coverage the average investor would learn some basics to protect him or herself. But none of the TV portrayals or the countless articles are talking about the real lessons that average Americans investing for profit and retirement need to learn to avoid the same fate.
Here are the top five red flags – and lessons – that more seasoned investors should have seen and that average investors should learn from the Bernie Madoff scandal:
- There was no independent custodian
Investors should rarely if ever give their money to the same person or firm that is investing it.
Reputable advisors or management firms will have their clients fund accounts at independent financial firms, brokers or banks that have relationships with the advisors as third parties that clients give permission to manage the funds. In other words, the client writes a check or wires money to a custody holder who then holds the money in account until a third-party advisor registers with that firm with the proper paperwork signed by the client, which states they are the advisor directing the funds. Some respected custody holders are Pershing, TD Ameritrade, Charles Schwab and Fidelity.
Custody holders offer several protections. They are independent, well-known entities within the financial community that are accountable to federal and state laws and regulations, and governing organizations like the Financial Industry Regulatory Authority (FINRA), the Securities Exchange Commission (SEC) or the like. They also provide independent, secondary verifications, through their own monthly or quarterly statements, of how the money is being invested and used (i.e. the expenses and the cash flow). They are also independent, professional verifiers of the authenticity and reputation of the advisors managing said funds.
In Madoff’s case, there were two types of investors, those who invested directly with him and his firm, and feeder funds, like fund of funds companies. From various reports, it appears that investors sent money directly to a JP Morgan bank account that was not reflected on company records. Madoff, and his assistant, or assistants, who handled the investment arm’s administrative affairs, knew funds being channeled through Bernard Madoff Investment Securities (BMIS), formed in 1960 as a broker-dealer, were deposited in a separate account.
His brokerage firm was engaged in real operations. But, the funds targeted for investment ended up in the JP Morgan and affiliate accounts, and were never invested. These funds were used for redemptions, operational expenses, and Madoff’s own personal needs. There was no independent custody holder and financial statements and reporting only came from one source – Madoff’s own firm.
By Seaborn Hall, read the full article here.