Published January 13, 2015
By Daniel NardelloFormer Federal Prosecutor
Much has been written about the red flags that should have alerted investors to the dangers of investing with Bernie Madoff.
[caption id="attachment_5249" align="aligncenter" width="257" caption="Bernard Madoff on January 5 (AP file photo)"][/caption]
The list of investors who have fallen victim to Ponzi schemes is growing as charges are broughtagainst Nicholas Cosmo in New York, Arthur Nadel in Florida, and Joseph Forte in Pennsylvania for fraud against their investors. To those who have lost their money, or have reaped fraudulent profits that may have to be returned, the struggle to recover their money (or to keep their money in the case of those who cashed out) will undoubtedly drag on as everyone fights over the scraps.
Feeder funds --which, in theory, are funds that earned their fees by conducting due diligence for their investors before investing with Madoff --appear to have been blinded by Madoff's incredibly consistent and positive returns, the types of returns that the funds could market to increase their client base and revenues.
And let's keep in mind that among the myriad of individuals who lost money were smaller investors who never knew that their money was ultimately invested with these schemers as their funds moved through a daisy chain of other funds, each earning fees through the placement process. It is evident that there needs to be a higher standard of accountability for all companies along the investment daisy chain. Further, as always seems to happen when significant fraud is exposed, there are calls for stricter regulatory controls. But given the past failures of the regulatory agencies to adequately police the investment community, what can individual investors do to protect themselves?
Review any available relevant materials (e.g., a prospectus, any investment guidelines) before investing with a fund or investment advisor. Determine whether your advisor or fund invests directly in stocks/bonds/options or invests in other funds (such as the feeder funds that provided billions of dollars to Madoff). If your advisor/fund invests in other funds, find out whether there are any limits on the percentage of assets that can be invested in one fund. Many investors did not realize that the funds they invested in served merely as pass-throughs placing all of their assets with Madoff. Even aside from the risk of fraud, it is always a good idea not to put all of your eggs in one basket.
Ask about fees. Does your advisor or fund just take a percentage of the funds invested or does it also get a percentage of your profits? If a percentage of profits is included, find out whether your advisor or fund manager has any of his/her own money in these investments, and if so, how much? In theory, an advisor/fund manager with his own money at stake will have more incentive to conduct thorough due diligence to avoid Madoff-like frauds.
Ask for specific details about the level of due diligence conducted prior to making investments.Have thorough background investigations been conducted on the principals of the funds under consideration? (Cosmo, for example, previously served 21 months in jail for misappropriation of funds. ) Has all litigation concerning the fund and its principals been reviewed for possible red flags (e.g., litigation involving other investors)? Does the due diligence include a review of the auditors used by the fund to establish their bona fides (in the case of Madoff, his use of shopping mall-based accounting "firm" was a glaring red flag)?
Ask about records. Will investors receive periodic reports or will they have real time access to their accounts?
Do your own independent research.Contact the Securities and Exchange Commission (SEC), the Financial Industry Regulatory Authority(FINRA) and the National Futures Association(NFA) for any available records concerning your adviser or fund, including, inter alia, records of registrations and disciplinary actions.
Also, at the very least, do your own Google search on your adviser or fund and the funds (and the principals of those funds) under consideration for investment.-- While such a search is far from complete, there is a chance that you might identify a red flag that has been missed, or ignored, by others. Additionally, if your investment is significant, you may want to consider using a professional investigation firm to conduct due diligence on your behalf. The right firm will have extensive experience in these types of investigations and will know how to spot both the obvious, and more obscure, warning signs.
In simple terms, do your homework and do not be afraid to ask questions. There are never any guarantees but by asking the right questions, you may help to minimize your investing risks.
Dan Nardello, a former federal prosecutor, is the founder of Nardello Co., an international consulting firm specializing in investigations, due diligence and litigation support.