As i write this (2.4.09), I am listening to Harry Marcopoulos, the “whistle blower” who outed Bernie Madoff and also apparently a fine Greek-American!
He made two very interesting points that I agree would dramatically cut down on financial fraud:
The first point was that there are entirely too many GREEN LAWYERS working at the SEC trying to find financial fraud. He recommends seasoned Wall Street FINANCIAL Executives who already made their money and want to serve the public. If top line former Wall Street executives and front line investigators were on the job, people with extensive FINANCIAL AND ACCOUNTING EXPERIENCE, and with financial incentive to find fraud, they would NOT be intimidated by a well-respected, and feared Wall Street crook such as Madoff.
I imagine it must be difficult for a 27 year old recent law school grad to bring a complaint against a guy like Madoff. If instead it were a successful former executive, with graying hair or “no hair” (Marcopoulos pointed this out!), who wasn’t intimidated by Madoff, we would probably have stronger investigations. Marcopoulos repeatedly stressed the lack of financial experience and knowledge of the staff of the SEC during his Senate testimony.
The second point that could have helped avoid some of these problems, and something that applied to Madoff particularly, was that he was his own CUSTODIAN. In many firms, including how I do business, the advisor does NOT have custody of the underlying assets. I can buy and sell for clients but can not cash out or remove any holdings from a client’s account.
Madoff was his own custodian, according to Marcopoulos, which means he could manipulate the actual assets. Many large financial firms use State Street or Mellon/Bank of NY/Pershing to do their custody work. Some companies such as Fidelity have their own clearing/custody operations. In these cases, the assets are separate from the money manager and with Madoff, apparently they weren’t.
In a few local examples of financial fraud, it was reported that the clients made checks out directly to the advisor! Anecdotally, I lost out on a referral to a client to an advisor who ended up stealing over $20M from clients (see the story here)! This advisor, reportedly, set up limited partnerships which he could use to funnel money to support his personal desires.
What can you do to prevent this?
1. make sure that if you use an advisor, that there is an independent custodian/clearing firm.
2. If you use a private money manager who does have his own limited partnership fund or hedge fund (such as how Warren Buffet started – all these guys aren’t bad you know!), insist on seeing who the INDEPENDENT AUDITOR is. You want a fund that is audited annually by a reputable auditing firm – likely it will be a regional firm for a smaller fund. You could certainly contact that auditor to make sure everything is real!
3. If you are very worried, use a bank custodian. I have researched a few and one that I do like is Pensco Trust. Being a bank custodian adds another layer to oversight (FDIC, OTS) on top of the existing securities regulators.
If you have other questions, feel free to share for the benefit of readers. Of course I make no recommendations and offer no advice with this article. This material is for your information only. If you want advice, seek an independent tax/financial advisor.
Note: I will be traveling again to the West Coast today. As usual, I will give you updates on the real estate/job/economic picture in Silicon Valley/San Francisco.
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