Financial Opinion and Insights

Avoiding The Crooks

Jim Lorenzen, CFP®, AIF®

Jim Lorenzen, CFP®, AIF®

Protecting Yourself Isn’t That Hard

First, some background:

Remember Allen Stanford?  Maybe you don’t; but a lot of people do.  He was convicted last week of running a $7 billion Ponzi scheme.  So what else is new? 

He was found guilty on 13 counts of a 14-count criminal indictment, including fraud, conspiracy and obstructing an investigation by the U.S. Securities and Exchange Commission.   According to a Reuters report. “The Stanford case was the biggest investment fraud since Bernard Madoff’s.”

Stanford, who was head of the now defunct Stanford Financial Group, based in Houston, was charged on Feb. 17, 2009, by the SEC with fraud and other violations of U.S. securities laws for his $7 billion Ponzi scheme that involved supposedly “safe” certificates of deposit. His personal fortune was once valued at $2.2 billion.

Besides Allen Stanford and Bernie Madoff, there have been lots of others – all you have to do is turn on the tv and watch American Greed to see the laundry list – people who make it pretty difficult for those who try to do things the right way.

So, how do investors protect themselves?  Here are a few short, simple rules that would have saved a bunch of investors had they followed them:

  1. ‘Too good to be true’.  You know this one – who doesn’t?  Just remember this:  Everyone who invests in registered securities is investing in the same marketplace.  No one has a special ‘in’ or ‘deal’ that no one else has.  If the investment is unregistered, i.e., a private transaction, then independent due diligence is crucial.   Remember, there’s swamp land everywhere. 
  2. No independent custodian.  A custodian is the firm or institution that actually holds your money, i.e., they have custody of your assets.   If you’re working with an advisor from a major Wall Street firm, the firm will likely be the custodian and that shouldn’t be a problem.  However, if you’re dealing with an independent advisor or advisory firm, which more and more people are opting to do, `Who has custody of my money?’ becomes a relevant question.  For example, my firm is an independent Registered Investment Advisor; but, we don’t take custody of client assets.  While we can use any number of custodians, we generally use Pershing, which is owned by Bank of New York-Mellon (BNY-Mellon).  It’s an arms-length relationship and we receive no compensation from them; nor do we have access to client money.  Our clients’ money is in their own accounts in their own names.   One thing Bernie Madoff, Allen Stanford, and others all have in common:  They had custody of client assets.  Checks were made out to their firm.  They were able to put their hands in the cookie jar.
  3. Internal money managers.  This isn’t necessarily bad; but if your independent advisor has custody of your money and is providing the management, too, it’s worth asking more questions.  For example,  in my practice we use no-load mutual funds, ETFs, and, where ongoing management is required, we use independent third-party managers.  The managers are paid a fee directly from client assets on a fully disclosed basis.  We do not share in the managers’ fees, nor does any other service provider.
  4. Lack of independent reporting.  Again, if your working with a major Wall Street firm, this shouldn’t be a problem; but if you’re working with an independent advisor, you should ask, “Who generates my reporting and what kind of reporting to I receive?”  This doesn’t mean that firms providing their own reporting should be considered suspect, but it should be viewed in light of the other answers.  For example, our client’s assets are held at Pershing, but the reporting is handled by an independent third party who is paid directly from client assets on a fully-disclosed basis.  We do not share in their fees and they do not receive compensation from the managers they cover or any other service provider.    The crooks we all hear about seem to custody the assets, manage the money, and create their own reports.   And, finally….
  5. Independent due diligence.  Is due-diligence provided by the firm selling the investment?  This process should not only be independent, it should be provided by a firm without a stake in the outcome and provided by an advisor in a non-sales environment.  For example, manager due-diligence is provided by an independent third-party for our clients.  The third party is not compensated by the managers they cover and all of our work is done in a fee environment, i.e., compensation does not vary based on investment selection.  Guess what our crooks did?  Yes, they provided the due-diligence to go along with the reporting, custody, and management.

How convenient for the crooks!  I’m sure I left a few things out; but, this short 5-point list should be a good starting point for anyone worried about getting taken.  Again, remember that no single answer should be determinative; but, all the answers taken together should form a picture.



Jim Lorenzen is a Certified Financial Planner® and an Accredited Investment Fiduciary® in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.   IFG provides investment and fiduciary consulting to retirement plan sponsors and selected individual investors. Plan sponsors can sign-up for Retirement Plan Insights here.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained in this material is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader.  The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Written by Jim Lorenzen, CFP®, AIF®

March 13, 2012 at 8:00 am