Christopher A. HopkinsWe all remember the massive fraud perpetrated by Bernard Madoff, which broke all records and eclipsed even the eponymous scheme of Charles Ponzi. But here, closer to home, a $5 million shakedown by a couple of local investment brokers serves once again to remind us just how important it is to observe some basic precautions before entering into any investment relationship.
Ronald Reagan frequently used the phrase "trust, but verify." He was, ironically, quoting an old Russian proverb, but the dictum conveys a useful perspective. We need to trust our financial consultants and advisers, but that trust must be earned. And investors owe it to themselves to verify that the trust is well placed. In the case of the most recent scheme, as well as most of the great cons in history, a little verification up front would have negated the trust and scotched the swindle.
The first step should always be to check out the official record of any broker, financial adviser or sales agent who solicits your business. In the case of the two brokers who most recently took their clients to the cleaners, a simple background check would have triggered a cacophony of alarm bells. Not only had they previously been disciplined for unlawful behavior, they were no longer licensed to sell securities and had effectively been banned from the financial services industry. No one armed with this information would have invested with their firm.
Checking the record of a broker or adviser is actually quite simple and takes about two minutes. Log on to the website of FINRA, the industry self-regulatory agency, at BrokerCheck.FINRA.org. Type in a name and city or ZIP Code, and viola. The entire compliance record of the person in question appears before you. It's free and accurate, and allows you to have confidence that the person in question has a clean record. If the person is not listed in the database, he may not legally sell or advise on investments.
Next, check out the specific securities you are being pitched. Visit the SEC database known as "EDGAR" (Electronic Data Gathering, Analysis and Retrieval system) at SEC.gov/EDGAR. In general, investments sold to the public must be registered with the SEC. In some cases, non-registered securities may be sold, but only to sophisticated investors who attest to their expertise and meet certain wealth thresholds. For most of us, avoiding unregistered securities is a sound practice to minimize the chances of fraud.
It is essential to safeguard your assets by entrusting their custody to an independent third party firm. Almost invariably, Ponzi schemes involve investors sending funds directly to the investment firm promising the spectacular returns. Instead, make sure your account resides at a recognized brokerage or custody firm like Schwab, TD, UBS, Merrill Lynch and so forth. Reputable custodians display the SIPC logo assuring that your assets are federally insured against the custodian's financial insolvency. Your broker or adviser may direct transactions in your account but generally cannot withdraw funds except to cover agreed-upon fees.
Finally, apply the smell test. There is much wisdom in the adage about something seeming too good to be true. Almost all successful investment cons begin with a promise of returns that exceed reasonable expectations with unreasonably low risk. In the real world, there is no secret sauce and successful investors still make money the old fashioned way: with patience, due diligence, and time.
No doubt next year will bring another story of an unscrupulous con artist preying upon unsuspecting clients. We need not fall victim, but we must take responsibility to verify before trusting.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.