How To Protect Yourself Against Investment Fraud

Economic pressures and tax laws continue to fuel generational changes in retirement planning from defined benefits (where an employer takes charge of providing for and investing employee retirement funds) to defined contribution plans like the 401(k), where the employee takes responsibility for his or her own retirement funding and investments. One side effect of this change in responsibility is greater opportunity for abuse.

In 2008, some of the world’s most sophisticated investors were duped by Bernie Madoff, the New York City investment adviser accused of running a decades-long $50 billion classic Ponzi scheme.

More recently, local investors have accused Cincinnati-based money manager Glen Galemmo of running an elaborate scheme that could see investment losses of hundreds of millions of dollars. Because Ponzi schemes are not the only danger facing investors as they take greater responsibility of their own portfolios, here are some tips to help you avoid becoming a victim of any investment scam.

Check The Record

An investment adviser gives advice about what securities to buy and sell. A broker is an intermediary who executes customer trades. These distinctions are important because professionals have different responsibilities under various federal and state regulations and industry guidelines. Start by asking for referrals from people you know and trust. This is your first, but not the last step. You must do some homework.

The Financial Industry Regulatory Authority (FINRA) has an easy website that you can use to check the history of registered brokers and investment advisers. Most states, including Ohio, will provide a complete written background report, including registrations, customer complaints and any disciplinary action.

Ask for a complete CRD (Central Registration Depository) report in Ohio by following these instructions. The report will be sent to you by mail or e-mail. The main document in the registration of an investment adviser is a Form ADV that can be obtained from a state’s securities regulator (e.g., Ohio Division of Securities) or by linking to the broker and adviser check page using the U.S. Securities and Exchange Commission or the North American Securities Administrators Association. The Form ADV should clearly spell out the details of the relationship, and the adviser is required to give this form to customers before entering into any contract.

If your adviser does not give you this document, or hesitates in any fashion when requested, investigate further. You might also ask if your adviser is a member of the National Association of Personal Financial Advisers, which is a trade organization of fee-only registered financial advisers who sign an oath to maintain the highest levels of competency and to put their fiduciary obligation to their client above all others.

Independent, Regulated Financial Custodian And Credible Accountants Are A Must

Whoever manages your portfolio should be using an independent financial institution, known as a custodian, to hold the assets. When a company such as Fidelity or Schwab is your custodian, you will receive written transaction statements directly from them, and typically you will have online computer access to track and verify the activity in your account. If your assets are held by a reputable custodian, it becomes extremely difficult — though not impossible — for a manager to run a Ponzi or other investment scheme. Also, research the auditor or the accountant your adviser uses. This is particularly important if the auditor works for a firm you don’t recognize. Each state has a database you can check to make sure the auditor is licensed (e.g. Ohio’s is The Accountancy Board of Ohio).

Make Deposits And Withdrawals Directly With Your Custodian

A giant red flag is an investment manager who wants complete control of your money, by requiring that checks for deposits be made out to him or to his company, rather than in the name of the financial custodian. The same principle applies to withdrawals. If the checks come to you from an account in the name of the manager or his company, rather than from an account in your name at a regulated custodian, get out now! Similarly, you should be able to request prompt redemptions and withdrawals. If your adviser tells you that you have to wait for some event to happen before you can have access to your own funds, you should be on high alert and investigate further.

Know Your Investment
If You Don’t Recognize Or Understand It, Get Out Now

Stocks, corporate and municipal bonds, and mutual funds are easily researched on the internet. If you have money invested in anything that doesn’t show up on the monthly statement that comes directly from the custodian, or something that you cannot find on the net (for example, by going to the stock exchange web sites, using Yahoo Finance or Google Finance, or visiting Morningstar), then you likely are invested in a privately-issued investment. Oftentimes, they will show up on a monthly statement from the custodian as “reported at original cost” or “value not available.” You should immediately ask your adviser to give you a complete explanation in terms you can understand, and if possible, look for a way out of the investment. Even if the investment is legitimate, many times funds are locked-up, and getting out will trigger substantial penalties.

When To Run Away Fast?
If You Only Get Statements From Your Adviser 

Alarm bells should sound if the only written statements you receive are created by your adviser, especially if they don’t itemize transactions, or show only total account value, or just gains and losses. Most good advisers will prepare monthly or quarterly summaries of the assets and the activity in your account. But, be aware. If you can’t back up those summaries with statements directly from the financial custodian (e.g., Schwab or Fidelity), or if your adviser says anything to suggest to you that statements from the custodian are not necessary, then you should take immediate action to recover your assets and find a new adviser.

If It Sounds Too Good To Be True…Don’t Do It

Finally, be particularly suspicious of family and friends who are bragging about the success of any particular security sales person, investment product or investment adviser. The best advisers in the world still lose money at times.

  • Be very skeptical of any investment adviser who “guarantees” any investment performance, boasts of a track record that looks too good to be true, or consistently outperforms the market.
  • Stay away from any investment adviser who pressures you in any way, or who suggests that you must act within a limited period of time.
  • Importantly, you should listen to your inner voice. Do not accept anything less from your adviser than a complete and understandable explanation of all investment activity.

If you are uncomfortable with your adviser in any respect whatsoever, move on — now. Your retirement security is more important than an adviser’s hurt feelings. If you suspect you have been the victim of investment fraud, you need to investigate it now or you will have no chance of recovering any of your losses. Speak with a credible adviser or good attorney, soon.

Five Common Investment Scams

Although certainly not inclusive, the following are five of the more common schemes targeted at individual investors:

  1. Schemes targeting seniors
    Many scam artists prey on seniors, who have had a lifetime to work and save money. If you receive an unsolicited offer, end the discussion immediately, shred the mailing or delete the e-mail.
  1. Promissory notes secured by real estate
    Promissory notes are short-term debt instruments that often promise high returns from little-known companies. A relatively new variation includes notes that are advertised as “super safe investments” backed by a lien on a mortgage, which might not exist.
  1. Unregistered sale of securities
    Ohio law requires that investment products to be sold in Ohio must be properly registered or be exempt. Check with your state’s Division of Securities to see if the investment is registered.
  1. Affinity fraud
    Investment promoters often use something they have in common with a potential investor — such as attending the same place of worship, being of the same race or ethnic group, or sharing common friends or hobbies.
  1. Non-disclosure of risk
    A common misrepresentation is to mislead the investor to believe it is a low-risk or “guaranteed” investment, when it is actually high-risk.
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