Protecting Yourself from Financial Fraud
by Richard
Enough ranting about the stimulus bill…for now…
So…what do all these outrageous financial scandals have in common?
More than anything else, I’d have to say it was their clients.
Seriously.
There seems to be some resolute determination among many clients to resist learning even the basics of managed money.
Let’s review the basics.
1. Every managed account, whether the broker/adviser has discretion (i.e. the ability to trade funds without prior notification to the client) or not….every single such account must be domiciled at a major third party trustee.
It could be Fidelity, Schwab, Scottrade….any of the well known firms on the street.
You will know your account is domiciled at such a firm, as you receive monthly, quarterly and annual statements listing your holdings and their current valuation.
It seems as if everyone who has been ripped off was content to receive bogus statements from the advisers themselves, thereby shredding the protection that would be offered by having a neutral, responsible third party serving as custodian.
Adherence to this strict rule would have eliminated the majority of the fraud.
2. Then there is the matter of the private, limited partnership structure.
Since these involve illiquid and non-listed holdings, they will not have a major firm serving as custodian.
Expect a continuing cascade of promoter fraud in this culture. Check out the Wall Street Journal Article, “Oil-Boom Fraud Hits Investors” (January 15, 2009, D-1) for an in-depth look.
As far as that goes, check out the classic 1968 film “The Producers“, which was not improved in the newer version, for a variation on this scam.
What made the hilarious movie scam work was Zero Mostel and Gene Wilder selling percentages in a Broadway show destined to flop.
In fact, it had to fail to avoid detection.
Basically, when you sell 5000% of a venture, there is no way to pay off the investors even if you make money. Too many investors…too little money.
The very likelihood of a hit….a successful venture, spells doom for the crooked promoter/producer.
But you can sell shares just short of infinity, provided it is guaranteed to fail and there is no profit to distribute. The investors can’t reasonably expect a share of the profits…when there is no profit.
You can see how this would work in the energy patch. By selling shares in a dry hole well, the promoter can smoothly pocket the investors money and go on to the next pool of suckers.
Better yet, by not even drilling, they avoid the risk of actually finding oil, and all the messy accounting that would involve.
It made for a classic comedy…but nobody’s laughing at the real world parody.
3. At the root of all such frauds is the linkage of affinity fraud.
I covered affinity fraud in a prior post. If you seek to be under the same tent with all your family/friends/colleagues, than you will surely all be swept away when the tide goes out.
The one sure way to avoid being bamboozled is to be your own adviser.
Learn the basics of investing. Open your own accounts. Protect your passwords. Invest in your employer sponsored plan.
If you had never been such a passive and trusting client, you would never have inadvertently invited the serpents into your garden.
These bad boys are always going to be targeting easy marks.
It’s their basic work ethic. They make money the old fashioned way…they steal it.
