Here's how investors can spot the next Bernie Madoff

Bernie Madoff was perhaps the starkest reminder that financial advisors can go rogue — and, when they do, people stand to lose a lot of money.

Fortunately, there are steps investors can take to limit their risk.

Madoff, who died in prison Wednesday at age 82, was the mastermind of the biggest investment fraud in U.S. history. His Ponzi scheme swindled tens of thousands of people of as much as $65 billion over four decades.

He’d been serving a 150-year prison sentence after pleading guilty in 2009.

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Madoff’s death, reportedly of natural causes, is a sobering reminder of the investor-protection shortfalls that persist more than a decade after his fraud was exposed, according to investor advocates.

“Nobody is immune from fraud,” said Andrew Stoltmann, a Chicago-based attorney who represents consumers in fraud cases. “If Bernie Madoff can do it, anybody can do it.”

There are a few enduring lessons from Madoff’s multibillion-dollar fraud.

Ensuring investor money is being held by a third party and being cautious of consistently stable investment returns are among the two biggest, according to investor advocates.

Ensuring a financial advisor uses a reputable, third-party custodial firm like Fidelity or Charles Schwab to hold investor money is essential, Stoltmann said.

That makes it much harder for an advisor to steal money or take advantage of a client, since the assets aren’t held in-house, he said. Clients write checks to a third party, not the advisory firm.

“Where you custodied your assets simply wasn’t a topic that anyone really considered, until the Madoff bomb hit,” according to Stoltmann. “Had that happened, the scam wouldn’t have been able to proliferate.”

Think of this as a firewall like two-factor authentication — the custodial firm has certain procedures for withdrawing money, which often involve contact with the client, he said.

Customers can check their regular account statements for this information. They can also call the custodian or log on to a custodian’s website for verification.

Investment promises or guarantees are another telltale fraud signal, according to financial experts.

For example, the SEC charged the Woodbridge Group of Companies and owner Robert Shapiro in 2017 for running a “massive” Ponzi scheme. The $1.3 billion fraud bilked more than 7,000 people, mostly seniors, and enticed them with promised returns of 5% to 10% a year on real-estate investments.

Shapiro pled guilty in 2019 and was sentenced to 25 years in prison. The SEC alleged that he’d used at least $21 million for his own benefit, to charter planes, pay country club fees, and buy luxury vehicles and jewelry.

“The promise is the red flag,” Stoltmann said.

Consistently stable returns for investments other than, say, government bonds are also another lesson of the Madoff scandal, he added.

“I don’t care if it’s a 3% return or a 10% return,” Stoltmann said. “The lack of variance is a [big] red flag.”

Regulators have upped their scrutiny of advisors and brokers to identify investment fraud, experts said.

But occasionally a crook slips through the cracks — sometimes in dazzling fashion.

Matthew Piercey, a broker from Palo Cedro, California, who pleaded guilty to co-running a $35 million Ponzi scheme, tried fleeing the FBI in November by using a submersible to hide underwater.

Some have gone so far as trying to fake their own death. About a decade ago, Marcus Schrenker, an Indiana advisor and pilot, did so by crashing a plane in Florida after parachuting to safety and then speeding away on a motorcycle to avoid prosecution for allegedly stealing $1.5 million from clients.

“What [the Madoff scandal] taught us is the limitation of a system that relies on investors to protect themselves,” said Barbara Roper, director of investor protection at the Consumer Federation of America.

The bulk of his investors were institutions and wealthy individuals — clients who, in the eyes of regulators, are thought to be sophisticated, Roper said.

There are some surefire red flags for consumers that their money manager has broken bad.  

Financial regulators have online databases consumers can reference for background information on specific individuals and firms.

The Securities and Exchange Commission has one, the Investment Adviser Public Disclosure website, for financial advisors. The Financial Industry Regulatory Authority’s resource, BrokerCheck, lists brokers. (A person may appear in both.)

First, check to see that the person appears in either system and that they are licensed or registered with a firm. This means they have met a minimum level of credentials and background to work in the industry, Stoltmann said.

“If not, it could be some guy cold-calling from his mom’s basement,” he said.

It also makes sense to Google the advisor or broker’s name to see if any news articles about past indiscretions or lawsuits appear.

The regulatory databases will also list any disclosures, complaints, arbitrations or settlements involving the individual.

“If you have one or two complaints, there are likely dozens of other times the advisor has engaged in chicanery but hasn’t gotten caught,” Stoltmann said.

Check for nefarious financial behavior like sales abuse practices, unsuitable recommendations, and excessive or unauthorized trading, Roper said.

“There are plenty of people out there who don’t have a problem,” she said. “So why not be safe and avoid those who do?”

Finding a fiduciary investment advisor can also help clients who want long-term financial planning to reduce financial conflicts of interest that may be present in the advisor’s business model, she said.

Just because red flags aren’t initially present doesn’t mean consumers should let their guard down.

Madoff is the perfect example.

“With Madoff, you could’ve done all those things and it wouldn’t have protected you,” Roper said of the common warning signs. “He was like the darling of the financial world [before his con was exposed].”

Losing money isn’t necessarily a red flag, in and of itself, especially if it occurs in a down market.

But it might be a bad sign if an investor’s portfolio is tracking well below customary stock and bond benchmarks, according to George Friedman, an adjunct professor at the Fordham University School of Law and a former FINRA official.

“At some point you start asking questions,” he said.

Hyper trading activity, as outlined in an investor statement, is another telltale sign. Such account churning generates fees and commissions for advisors but financially harms the client.

Proprietary investments — for example, owning a mutual fund run by your brokerage firm — aren’t necessarily a fraud signal, but may be a sign that an advisor or firm is making money at your expense, Friedman said.

“I’d review account statements every month,” he said. “If you see something funny or unusual, that’s a flag.”

Of course, investor statements could be doctored to hide such information.

Unsatisfactory or delayed responses to client questions should prompt clients to escalate their case to the firm’s compliance department.

Being asked to communicate outside of an advisory firm’s official channels, like company e-mail, is also a major red flag, Roper said.

And, importantly, understand your investments and only place your money with reputable money managers, she said.

“If you can’t understand it, it’s a bad sign,” Roper said. “If the [investment] prospectus seems designed to confuse rather than clarify, it’s a bad sign.”

“People want to believe there’s some great investment opportunity out there they’ve just lucked into,” she added. “It’s as old as time, the persuasive con artist who can talk someone into buying the cure-all elixir.”