Jones, Madoff & other knock-offs: 5 ways to avoid an investment scam
It seems news headlines are rife these days with stories of fraudulent activities, “Ponzi”-like schemes committed by trusted investment advisors such as U.S. money manager, Bernard Madoff and now, closer to home, a Montreal-based advisor, Earl Jones has allegedly committed a $50 million fraud against his clients.
Many people are asking how could that happen to those people? How could so many be duped, for so long? Could it happen to me?
Here are 5 tips that can help you avoid phony investment schemes:
1. Keep the money away from the manager.
The single most important protective measure you can take to prevent fraud is to ensure the roles of money manager (who provides advice and executes investment transactions) and the custodian (who holds the cash and securities and provides accounting for the transactions) are performed by separate, unrelated companies. For example, at Newport Investment Counsel Inc., we act as money managers but the custodian for client accounts is the subsidiary of a major Canadian bank which holds all of our clients’ assets. No one at our firm has access to client cash or securities.
Having a separate custodial arrangement is a ‘best practice’ within the industry. It helps to prevent fraud because the custodian sends account statements directly to the client; the investment manager is unable to intervene or change client reports from the custodian. Reports from the custodian should be reviewed and compared against what your investment manager is reporting to you.
Fraudulent activity most often occurs when the role of advisor and custodian are handled by the same firm regardless of size or reputation – as was, it appears the case with both Madoff and Jones for example and this should have been a red flag. Wherever you have investment accounts you may wish to confirm the arrangements.
2. Hire credentialed, licensed professionals.
In the world of investment advice, there is a veritable alphabet soup of professional accreditations – CFP, PFP, CFA, CSC, CIM, etc. with the premium standard being the CFA. Serious financial advisors have at least one and often multiple designations. These educational and licensing bodies require members to adhere to an ethical code. Many also require their members to complete annual continuing education courses. Violation can result in the member being stripped of his or her right to use the designation. Confirming credentials and licensing should be part of standard due diligence with any investment advisor.
Ask the questions directly: ‘What qualifies you to do what you do?’; ‘When did you obtain your accreditation and how long have you been in the business?’ If you have any reason to doubt, or if the advisor’s firm is not an established name, you may wish to take the extra step of contacting the professional association to confirm the advisor’s credentials.
At Newport Investment Counsel Inc., all of our investment professionals are licensed across Canada as is our firm, Newport Investment Counsel Inc. and the primary regulator is the Ontario Securities Commission (OSC), an independent government body that administers and enforces securities legislation in the province of Ontario.
In the absence of accreditation and/or licensing, there is a higher risk of fraudulent activity. Using the example of Jones, neither he nor his firm were registered with Quebec’s investment regulatory body, L’Autorité des marchés financiers or with the Investment Industry Regulatory Organization of Canada as they should have been.
3. Know who is auditing the firm.
By contrast, a small accounting business was reportedly the main auditor for Madoff’s multi-billion dollar operation. The accountant, who has also been charged in the case, allegedly “rubber-stamped Madoff’s books for 17 years without confirming their accuracy,” said prosecutors.
4. Know what is insured.
In the unlikely event a breach of trust should occur, what is the level of protection you are provided as an investor? Does the advisor’s firm carry insurance? In what amounts? Investment counseling firms such as Newport Investment Counsel Inc. that are licensed and regulated by the OSC are required to hold a Financial Institution Bond that provides insurance against fraud or employee theft. This is another area to probe in your due diligence.
5. If it doesn’t make sense, don’t invest.
Finally, if the investment returns seem to good to be true; or too easy or “too complicated to explain”, these should be warnings to you. Anybody who doesn’t take the time to educate you or explain their investment process is not doing a good job, or worse may be hiding something -- possibly their own lack of understanding or something more underhanded. Ask questions until you are satisfied with the answers.
