Are You Afraid of Being “Madoff’d”?

This is an edited version of an article originally appearing in the August 2009 issue of Southern Neighbor newspaper, Chapel Hill, NC

By Todd Washburn, CFP^©

  The past year has been hard on all of us.  The financial services “industry” has itself been devastatingly affected.  Large, old-time brokerage firms have disappeared or been taken over by rivals, sometimes at the request of regulators.  Other firms have survived only through significant government intervention.  Financial scams, some extremely large and broad in scope have been uncovered.  Many, many individuals, charities and others have been crippled by these scams.  People are understandably nervous about entrusting their hard-earned money to financial advisors, big or small.  Some advisors- Bernie Madoff for instance- knowingly set out to defraud investors.  Others have paid the price for actions their company took, sometimes to their clients’ detriment.  Still others have done nothing wrong but are paying for the sins of the others.

  I’m not going to try to justify the actions of the advisors and companies who didn’t act in their clients’ best interests.  But I do want to try to give you some information that may help you make some sense of what’s happened, what may be happening in the industry, and how you can avoid being hurt in the future.

  When I meet other financial advisors, it’s become a habit to ask them what they’re hearing from their clients and prospective clients about the Madoff scandal. Invariably I hear “Oh yeah”.  They say clients bring it up jokingly- but with a nervous touch to it.  The advisors know they’re wondering, “Could he be ripping me off?”  Perspective clients are a little more direct.  The question is, could you be “Madoff’d” by your advisor?  The answer is, quite honestly, not likely.  The Madoff situation, while not unique, is far different from that of most advisors.  The key is where the money is held (or custodied).  If you work with a representative of a large brokerage firm, the firm itself will typically be the custodian.  Your advisor can make trades, etc., but the firm holds the money.  If you work with an independent advisor (not associated with a brokerage firm), it’s a little different, but equally secure in my opinion.  When you turn over your money to your advisor, he doesn’t put it in an account in his firm.  Rather it goes into an account in the client’s name at a custodial firm (Charles Schwab, Fidelity, TD Ameritrade for example).  The custodian will send monthly statements directly to the client regarding the account.  These are separate from the typical quarterly statements the advisor sends.  Two statements from two different sources.  That’s the checks-and-balances that should be in the system.  The Madoff scam survived because his firm took over both functions- advising and custodying the assets.  So he provided both reports.  It’s easy to make sure they match under those circumstances.  It’s pretty much impossible for someone like me to get Fidelity Investments to send a false report to a client in order to make their numbers match mine.  That’s why I don’t believe you’re at much risk of being Madoff’d as long as you watch the statements from your advisor and the custodian.

    A lot has changed in the financial world in a short period of time.  Those changes have affected us all.  More people are starting to look for help in assessing their situation and making plans for their financial future.  But some are understandably hesitant to seek help for fear of being lead astray.  I think you can get good help and with a little diligence you can significantly lessen the chances of being harmed.  I also think it’s worth moving past that fear if it allows you to work with an honest, ethical advisor who helps you work through your problems and plan for a secure financial future.