Much has been written about how and why Bernie Madoff was so successful in fooling so many people for so long. Unfortunately, Madoff wasn’t the only one preying on trusting individuals, as Allen Stanford has notoriously demonstrated. Beyond those high profile examples lie some much more pedestrian cases that are no less devastating to their clients. Today many of my neighbors learned about one that hit closer to home.
A quick search of Google on the name James J. Buchanan will turn up many reports from early in 2008 – months before the Madoff scandal broke – as well as numerous websites of attorneys angling to assist investors in claiming damages against Buchanan and LPL Financial, the broker who employed him and was charged with overseeing his conduct. Yesterday Buchanan, a resident of Ahwatukee, was sentenced to serve 20 years in jail after pleading guilty to 15 counts of theft that totaled over $10 million.
Although the scale of their crimes was much different, Buchanan and Madoff operated in similar ways. They both employed affinity fraud to build their Ponzi schemes. In the case of Buchanan, it is said that he preyed on members of his Church as well as friends he met through his affiliation with Little League.
The number of victims of these Ponzi schemes and similar scams is still a small percentage of all investors, although the volume of cases over the past couple of years has shown that it may be bigger than many of us thought. I remain much more concerned about the stockbroker who is legally funneling customer dollars into ill-advised investments that generate high commissions than I am about large-scale fraudulent activity. Nonetheless, I think it pays to revisit some of the actions investors can take to protect themselves against predatory individuals who call themselves advisors.
Look for an independent custodian
One act that Buchanan and Madoff shared was to manufacture trade confirmations and monthly statements that purported to show the performance of investors’ assets. As the sole conduits between investors and their money, this was reasonably easy for them to do. Madoff owned his own brokerage firm, whereas Buchanan was affiliated with Ameriprise and ultimately LPL Financial (who, incidentally, took him on after ignoring red flags on his record dating from his time with Ameriprise). Investors should at all times maintain the ability to view their assets online via a site maintained by an independent custodian, preferably one that does not employ their advisor. They should also receive statements that are generated by that custodian. They may receive statements from their advisor as well, but these should sync with what the custodian provides. This is probably the single most important thing that an investor can do to ensure that what their advisor is telling them is actually true.
One of the most remarkable things coming out of the Madoff scandal was the reported returns investors were seeing. Apparently every year they would “gain” 10%-11% on “100% safe” investments. For one thing, that kind of return in most years implies a significant risk premium that would contradict the 100% safe idea. More obvious, though, is the lack of volatility year-to-year. These were risky assets in which the funds were supposedly invested. As such, they were likely to have some big years and some down years. If they were invested in the stock market, an average 10-11% return over a number of years would not be outrageous, although it would have been pretty solid over the last decade. It definitely would not have been consistent, though. This isn’t the first time I’m saying this, but “if it seems too good to be true, it probably is” is never more true than in the world of financial services.
Seek a fiduciary relationship
Disclaimer 1: my firm is a Registered Investment Advisor and as such I act in a fiduciary capacity in all of my relations with clients. So I may be biased toward the fiduciary way of doing things.
What’s a fiduciary? Simply put, as a Fiduciary, the financial advisor is required to act with undivided loyalty to the client. That means the clients’ interests come before those of the advisor, legally and ethically.
Disclaimer 2: just because an advisor signed up to be a fiduciary doesn’t mean that he or she isn’t a crook. I’d like to say otherwise, but that would be nonsensical. Criminals come in all shapes and sizes.
However, depending on whose research you believe, somewhere north of 90% of all people who call themselves financial advisors are NOT required to act in a fiduciary capacity all of the time. The 5%-10% who are have generally chosen that path because they think that is the most appropriate way to serve their clients. It certainly is not the easiest way to make money in this business. It stands to reason that those who’ve chosen a fiduciary role would be less likely to fabricate an investing record on a massive scale, at least to my way of thinking.
Regardless, if you’re looking for an advisor, seek one who has chosen to be legally bound to act in your best interests. They’re relatively scarce, but worth the effort. Just because an advisor claims to be independent, it doesn’t mean they’re not beholden to a brokerage firm. If their marketing materials say “…securities offered through…”, you can bet that they’re being paid to sell products. Certainly, many good advisors operate under the commission-based model, but so do a lot of pure salespeople who are easily confused with fiduciary advisors.