How to Madoff-Proof Your Portfolio

How to Madoff-Proof Your Portfolio.

The long list of investors ripped-off by Bernie Madoff, according to the Wall Street Journal, hits close to home, includingmembers of the Hillcrest Golf Club of St. Pauland Oak Ridge Country Club in Hopkins. This is both unfortunate and troubling, and dare I suggest, preventable, at least to some degree. It’s a tough pill to swallow, but at least two common characteristics of those fleeced are (1) unmitigated trust of one man and his largely self-contained operation, and the (2) lack of diversification. So what’s an investor to do? Shouldn’t the regulators have discovered this before now?

I’m sure your Investment Professional (“IP”) is a good guy or gal; most are, and lie awake at night consumed with how to help you with your financial situation. But, don’t be afraid to question your IP about what’s going on with your money. Even good people sometimes do bad things; the pressure to do so is heightened when markets and incomes are down.

Mad Money’s Jim Cramer, along with a chorus of other industry professionals have called for SEC Chairman Chris Cox’s resignation, some even for the abolishment of the SEC altogether. This is an emotional and extreme reaction, for the same reason one wouldn’t call for the abolishment of the Minneapolis Police Department for failing to prevent a burglary of one’s home, while you were on vacation . . . having left your front door unlocked. In other words, yes, the SEC and FINRA exist to offer investors protection, but any investor’s best protection lies in the steps s/he personally takes to attempt to prevent this from happening in the first place.

Account Status.

Question: right now, where is your money, actually? Is it in a brokerage account at your broker-dealer, or a third party custodian? Or is it at the mutual fund or annuity issuer? Do you know the difference? If you invest with a registered investment adviser (“RIA”) or a broker/planner affiliated with a broker-dealer (“BD”), your actual investments are held either in custody (1) at that entity, or (2) at a third party custodian(while the RIA or BD is simply an intermediary). If (1), the entity is self-clearing, and your trade confirmations and statements will all reflect only that firm’s brand. If (2), you’ll likely still see your firm’s branding, but you’ll also notice the third party custodian’s branding as well. And if your account is direct to fund/annuity, you’ll only see the fund or annuity’s branding, with a reference to your broker as “dealer of record.”

So, which is better? It depends, but the key for you is to know where your money is, and how to control and access it. Most firms allow their brokers to choose how to set up accounts, so your broker should consult you on available options.

Account Operations.

When an adviser places a trade in your account, you should receive a confirmation in the mail within a few days of the trade, and an account statement at the end of the month in which there was a transaction. Now here’s the risk: if you’re investing with a wholly self-contained entity acting as adviser, custodian and BD clearing, like Madoff Securities, it’s obvious that should fraud exist, it is easier to conceal in that kind of environment than when outside third parties are used as custodian or clearing firm.

Proactive Steps to Sentinel Your Own Accounts.

(1) Review each trade confirmation and account statement immediately, both brokerage and banking (ID theft is rampant and you could be stuck with the bill if over 30 days);

(2) Don’t put all your eggs in one basket. Depending on your circumstances, it might be ok to invest with one financial advisor, as long as “all” of your money is not in his “one fund,” butsuitably asset allocated and diversified, no more than 20% in any one holding, perhaps some funds even direct with the mutual fund company or annuity provider;

(3)Talk to someone other than your personal broker/advisor to verify your account info and positions (broker-dealer back office or custodian);

(4) Test the waters: taking into consideration tax ramifications, consider generating some activity in your account like a small trade, exchange, withdrawal, etc. Remember, you are always in control unless you fail to exercise it. Even if broker has discretion, you can still trade in your own account. As of now, it appears that investors demanding redemptions was the death knell of Madoff’s fraud; prior to this down market, too many just relied on their Madoff, internally-generatedaccount statements and for years did nothing in their accounts.

Taking these steps still offers no guarantee that you’ll not suffer from a broker’s fraud or malfeasance, but at least when you are proactively watching over your stuff, you might just save yourself some money and heartache, if not protect yourself from outright bankruptcy or virtual poverty.