Over a decade ago, the most significant financial fraud in history was revealed: a $65 billion Ponzi scheme orchestrated over two decades by New York financier Bernie Madoff. Just under 5,000 clients – institutions and wealthy individuals – lost between $10 and $15 billion.

Madoff’s scam was unusally large, but sadly, not that unusual

The Financial Times reported recently that, in the US, 65 Ponzi schemes were uncovered annually over the last few years in the U.S. There’s even a website dedicated to tracking them. To avoid being a victim of the next one, below are a few simple steps you should take.

But first, a reminder of what happened

In late 2008, Bernie Madoff admitted to having run the largest-ever Ponzi scheme. For 15+ years, he claimed to have a unique strategy that generated consistent and out-sized stock returns. In reality, he deposited clients’ money in a bank account and created fictional brokerage statements that portrayed regular, strong gains. Then, Madoff paid off exiting investors using fabricated profits – the money other investors were putting in. When too many investors headed for the exit simultaneously, the fraud was revealed. That’s the classic Ponzi scheme, named after Charles Ponzi (pictured above), a con artist convicted of multiple fraud indictments in the 1920s. 

There were three essential elements to Madoff’s scheme

1. First, he had a unique personality that gained people’s trust.
2. Second, he claimed to use a “black box” investing strategy — impossible to monitor from the outside.
3. And third, his organization had no outsiders to audit its true activities. Family members had all the management roles. And the outside auditor? A tiny CPA firm with precisely one qualified accountant that operated out of the owner’s home through most of the scandal.

Here’s what could have saved people a lot of money — and what can save you from fraud in the future:

• Be skeptical. If you see something that looks too good to be true, assume it is too good to be true. You cannot generate predictable returns that always beat the stock market – which Madoff claimed. If you are taking a risk (e.g. buying stocks), expect some quarters or years to produce losses, sometimes significant.

The security of working with Old Peak Finance is the checks and balances in our operation.

There will always be fraudsters, because there is always someone willing to believe the impossible is possible. Before you invest, ask a lot of questions, get expert opinions, and ask yourself, “does this make sense?“

Rick Waechter, Founder, CFP®

• Demand checks and balances. A beauty of working with Old Peak is the checks and balances in our operation. Our clients hold their accounts at Charles Schwab, which reports independently from us. So, every day, you can check your account balances at Schwab. Our clients primarily own mutual funds managed by large, third-party firms.
• Use simple, transparent investments. If you buy a small number of diversified mutual funds, you’ll know what returns to expect by what you’ve heard in the news. For example, in Q4 2018, the US stock market was down 14%. If someone tried to claim your account was up 14%, you would know better. But if you owned opaque hedge funds or other “managed” products — the kinds Madoff claimed to use — you would have no idea what to expect.

Trust is the lifeblood of a financial advisor’s business. If you don’t trust a firm, you should never hire them. But trust isn’t enough. Demand that your advisor has checks and balances. Demand that they use transparent investments. And expect them to be available whenever you want to poke or prod.

As the Russian proverb goes: Trust, but verify.