Presentation on theme: "Presented to the Risk Management Association, Arizona Chapter"— Presentation transcript:
1 Presented to the Risk Management Association, Arizona Chapter Ponzi Schemes and Investment Fraud How they impact the financial services industry and What investors can do to avoid the conPresented to the Risk Management Association, Arizona ChapterOctober 8, 2009ByMike McCann, CFP®, AIF®
2 Bernard Madoff: Con Man Extraordinaire Bernie Madoff was arrested in December 2008 for investment fraud. He had masterminded a Ponzi scheme that spanned more than two decades and defrauded thousands of investors of an estimated $64 billion.He pleaded guilty in March 2009 and in June was sentenced to 150 years in prison.U.S. Department ofJustice photograph, 2008
3 What is a Ponzi scheme?“The Ponzi scheme is a house-of-cards swindle in which high returns are paid to initial investors out of the funds of later investors. While some initial payments are made to drum up new recruits, the vast majority of investors in a Ponzi scheme end up losing all or most of their money.”(source: North American SecuritiesAdministrators Association (NASAA)
4 Ponzi SchemesThe con dates back to about 1920 and is named after Charles Ponzi, who developed a scheme to profit on the varying currency exchange rates for International Postal Reply Coupons redeemed for stamps.The often bewildering variety of investment opportunities available today has created a virtual renaissance of the Ponzi scheme in recent decades.These schemes often prey on a specific demographic (also known as affinity fraud), such as seniors or a particular religion or ethnic group.
5 The “last guy” you’d expect to cheat you… What makes the Madoff scam so fascinating (apart from the sheer size and magnitude of the amount he swindled) is that he was the last person one would expect to cheat investors. Madoff had a long, illustrious career as an investment advisor.
6 Who is Bernie Madoff?Madoff founded the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960.He actively pursued a presence in the regulatory side of the industry. In the mid-1980s, he was elected to the NASD advisory council and served on several committees and task forces. He also served as non-executive chairman of Nasdaq in the 1990s.He was a prominent philanthropist who served on boards of nonprofit institutions, many of which entrusted his firm with their endowments.Madoff is Jewish and his Ponzi scheme preyed heavily on Jews, destroying the fortunes of numerous Jewish charities and institutions.
7 Nature or Nurture?In 1963, the SEC investigated Bernie Madoff’s mother. Gibraltar Securities, registered under the name of Sylvia Madoff, was one of dozens of firms investigated by the SEC for failing to file financial reports. She eventually withdrew her registration, and the SEC dropped the charges.According to reports in Fortune and The New York Times, Madoff's childhood friends don't remember his mother trading; the Fortune article hypothesized that perhaps Madoff's father, who had previously been in trouble with the IRS, put his wife's name on the application."Either way," the authors wrote, "one of Bernie Madoff's parents was involved in securities -- and got into trouble for it."(source: PBS Frontline)
8 Another bit of sad Madoff trivia… Madoff Investment Securities LLC was examined at least eight times in 16 years by the SEC and other regulators, but regulators were never able to uncover the illegal scheme.(source: Wall Street Journal, January 5, 2009)
9 Madoff’s Legacy Four Decades of Deals and Deception 1960s Madoff’s firm was initially housed in his father-in-law’s accounting firm in midtown Manhattan. He earned his living as a market maker – matching buyers and sellers who wanted to trade “penny stocks” that weren’t listed on the big exchanges. The firm eventually became one of the top market maker businesses on Wall Street.According to SEC documents, by 1962 he was managing investments channeled through his father-in-law’s accounting firm and business partner, Frank Avellino. The first investors were friends and associates.1970sMadoff's trading business skyrocketed through a controversial practice known as "pay for order flow,” in which which a dealer pays a broker for the right to execute a customer's order. This practice has long been called a "legal kickback."
10 Madoff’s Legacy cont.1980sAvellino and his associate Michael Bienes decided to drop their accounting services and work full time on recruiting clients for Madoff. By the mid-80s their cut had reached several million dollars a year.1990sMadoff started getting into bigger money when he took on management of several hedge funds. He used his position as chairman of Nasdaq to lobby Washington. His power and influence continued to grow. Yet, his investment advisory business was not even registered with the SEC.The SEC launched an investigation into Avellino and Bienes under suspicion they were operating a Ponzi scheme. They were fined and required to return investors’ money. Madoff claimed ignorance about his two front men operating illegally.
11 Madoff’s Legacy cont.2000Investment professional Harry Markopolos submitted 8-page memo to the SEC outlining his theory that Madoff was running a Ponzi scheme.2001Two major articles published in the financial papers called into question the legitimacy of Madoff’s dealings. Yet, Madoff’s success continued.2005Markopolos continued to write memos to the SEC. By that time, the SEC was receiving letters from others, as well.2006Madoff was finally interviewed by the SEC. Investigators said they “found no evidence of fraud,” though they did tell Madoff he must register as an investment advisor.
12 Madoff’s Legacy cont. Fall 2008 The collapse of Lehman Brothers in the September signaled the beginning of the end for Madoff’s house of cards. Credit markets froze and the stock market began its free fall. By November, hundreds of hedge funds shut down or stopped allowing withdrawals.Madoff told one of his sons that he was facing $7 billion in redemptions and having a hard time meeting those obligations. He also asked his wife to make wire transfers from a brokerage account to her personal bank account – totaling $15.5 million – so they would have cash on hand.December 2008On December 10, Madoff's sons told authorities that their father had just confessed to them that the asset management arm of his firm was a massive Ponzi scheme, and quoted him as saying it was "one big lie.” The next day, FBI agents arrested Madoff and charged him with securities fraud.(sources: PBS’s Frontline, Wikipedia)
13 How does a scandal like this impact reputable professionals in the financial services industry? Madoff was a smooth operator; the ultimate con man.Because of his misdeeds, we must raise the bar on our communication with clients. It means we have to work harder.This is not necessarily a bad thing.Improving communication & better educating clients are worthy goals, regardless of the circumstances that inspired them.
14 Spotting the Red FlagsOne of the easiest ways to spot an investment scheme is if the opportunity promises high, guaranteed profits.All legitimate investments involve some degree ofrisk. And, generally speaking, the higher thepotential return, the higher the level of risk involved.Another red flag of Ponzi schemes is when investors are pressured to reinvest or roll over profits.While long-term investing is generally a wiseapproach, investors should be suspicious of anypromoter or advisor who is reluctant to let themcash out gains.
15 Ponzi schemes only work when investors are kept in the dark. There are several good pieces of general advice thatwill help the average person shed light on their situationand avoid Ponzi and other investment scams:Work with financial advisors who were referred to you from a trusted sourceMake sure your advisor is acting as a fiduciary (get it in writing)Ask for disclosures on all forms of compensationAsk questions about the advisor’s style of investment managementMake sure you are truly diversified across a wide variety of asset classesCheck with either the SEC or FINRA for the advisor’s background
16 If it sounds too good to be true… This advice is no guarantee, unfortunately. Following it would notnecessarily have helped Madoff’s victims avoid being conned.The Associated Press recently reported on telephone transcriptsreleased from the investigation. In one tape from 2005, Madoffcoached a potential witness about fooling federal regulators,saying “you don't have to be too brilliant” to get away with it."The guys ... ask a zillion different questions and we look at themsometimes and we laugh, and we say are you guyswriting a book?“ (Source: Associated Press, Sept. 10, 2009)Bottom line:Madoff was a liar, a con man, a thief.He was really good at it.
17 It Happened Before. It Will Happen Again. Even with all the attention this scandal has gotten, we continue to hearnews of more Ponzi schemes and more victims. The SEC's failure touncover Madoff's massive scheme for so many years, of course, has ledthe agency to beef up its enforcement efforts. Here are some recent newsrelease headlines from the SEC:SEC Charges Detroit-Area Stock Broker Who Lured Elderly into $250 Million Ponzi SchemeSEC Charges New York-Based Money Manager in $40 Million Ponzi Scheme SEC Halts $50 Million Offering Fraud and Ponzi Scheme in Detroit AreaSEC Freezes Assets of Illinois-Based Hedge Fund Manager Who Was $2 Billion Feeder to Petters Ponzi SchemeSEC Charges Calif.-Based Hedge Fund Manager for Operating Ponzi-Like SchemeSEC Charges Operators of $80 Million Ponzi Scheme Targeting Korean-AmericansSEC Charges Colorado Advisor for Conducting Multi-Million Dollar Ponzi SchemeThe list goes on…
18 Keep Your Guard UpThese are just a handful of the SEC investigations into Ponzi schemes in the past few months.They are all examples of how the average person can still fall prey to a Madoff-type scam if they don’t take steps to protect themselves.This type of scam happens in cities all over the country, not just in New York.Con artists will continue to use the Ponzi scheme because, sadly, it works.
19 Beware the FaçadeInvestors should not rely solely on the character or reputation of their advisor. The Madoff scandal is a stark reminder that that so-called reputation can be hiding something sinister.The good news is that investors and financial professionals can do more than simply “be careful.”They can follow specific practices for investment fiduciaries designed to protect investors.
20 The Investor’s Best Defense – Global Fiduciary Practices The Center for Fiduciary Studies (Fiduciary 360) has developedGlobal Fiduciary Practices as a guide for investment fiduciaries tofollow to demonstrate prudence in managing investment decisions.These have been compiled in a series of handbooks:Prudent Practices for Investment FiduciariesIn addition to listing and explaining the minimum processprescribed by law, the handbooks include criteria that represent theGlobal Standard of Excellence.
21 Separate FunctionsIf you walk away today with just one piece of usefulInformation today, let it be this.The investor’s best defense against fraud is to maintain threeseparate functions of portfolio management.Investment CustodianInvestment AdvisorInvestment ManagerSeparating portfolio management functions is a keyrecommendation from Fi360. It provides a proven system forchecks and balances against potential fraud and conflicts ofinterest.
22 Periodic Table: Global Fiduciary Practices This Fi360 table shows how the functions are separated. A PDF version is availableonline at
23 Learn More The Center for Fiduciary Studies provides training for the Accredited Investment Fiduciary (AIF) designation, through Fi360.Fi360 offers a range of investment fiduciary education, practicemanagement, and support to the industry.This organization is a great resource if you want to learn moreabout investment fiduciary responsibilities and how to best serveand protect your clients’ assets.
24 Additional Resources http://www.MoneyAZ.com A copy of this Power Point presentation is available for download at
25 About Mike McCann, CFP®, AIF® President and FounderInvestment AdvisorPerspective Financial Services, LLCMike has worked in the financial servicesindustry since 1991, interacting directly withindividuals as an investment advisor and alsobehind-the-scenes in high-level tradingand managerial positions.He is a Certified Financial PlannerTMpractitioner and an Accredited InvestmentFiduciary®