As a young sporting-goods executive, Larry Leif first became acquainted with Bernard Madoff in the late 1970s, when his boss invested his company's pension with the now-notorious money manager. After Leif left the company, he rolled a pension distribution into an IRA with Madoff.
Then, after coming into some money in the late 1980s, Leif opened a personal account with the New York City adviser. In all, Leif, 58, says he entrusted $8 million to Bernard L. Madoff Investment Securities. Now, with Madoff accused of defrauding investors of billions of dollars, Leif says he has only $100,000 left to his name. "I used to think Bernie Madoff was the smartest man on Wall Street," says Leif, who is retired and living in Palm Beach Gardens, Fla.
Leif thought he had followed all the rules of smart investing. He handed over his money to a highly recommended adviser who was also managing the portfolio of someone Leif trusted. He checked the transactions on his statements. Yet Leif was still ensnared in the alleged scheme because he, like others, missed some red flags. Here's what Leif could have done to avoid being taken for a ride -- and what you should do to ensure that your financial adviser is on the up and up.
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Make sure there's a third-party custodian. When you hand your money over to a financial adviser, the check should go to an independent custodial institution, typically a brokerage firm, such as Morgan Stanley or Charles Schwab. Get the name of the firm and its contact information. Instead of relying on your adviser's word, call the custodian to verify that it is indeed serving the money manager. Leif and apparently other investors got their statements from Bernard L. Madoff Securities, which should have raised suspicion. "The presence of a custodian ensures that money from new investors can't be used to pay off longtime investors," says John Coffee, a professor at Columbia Law School.
Vet the accountants. Find out who audits your adviser. Then inquire about the auditor -- particularly if it's a firm you've never heard of (Madoff used a small, no-name accounting firm). Make sure the auditor is licensed in your state. Each state has its own database -- for instance, New York's database is maintained by the Office of the Professions. Independent auditors are crucial because they verify the existence of the assets in your account and others your adviser manages.
Be particularly careful if your adviser has recently switched accounting firms. If he or she has, find out why. "When an adviser leaves an accounting firm, it might be because the accountants didn't feel comfortable with the adviser's financials," says Ken Springer, a former FBI agent and now president of Corporate Resolutions, which investigates money managers on behalf of hedge funds.
Check up on your adviser. Once the custodian and auditor pass muster, gather information on the advisory firm itself. Of course, as the Madoff case shows, even regulators can be fooled.
Nevertheless, it pays to tap the resources of the Financial Industry Regulatory Authority, the industry's self-regulatory body. Finra has an easy-to-use broker check in the "Investors" section of its Web site. Run the names of advisers through the system. You can get an employment history and records of exams passed -- and see whether there have been any customer disputes or regulatory actions. The National Futures Association has a similar tool on its site.
Verify your adviser's academic credentials and professional certifications. For instance, if the adviser claims to be a certified financial planner, check with the Certified Financial Planner Board of Standards.
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You should also make sure your adviser is registered with the right regulator. Advisers who manage more than $25 million must register with the Securities and Exchange Commission. Those who oversee less have to register with their state. You can get a list of state regulators at the Web site of the North American Securities Administrators Association. "You want to make sure your adviser is complying with regulations and putting your interests first," says Diahann Lassus, national chairwoman of the National Association of Personal Financial Advisors, a trade group.
Beware of group connections. That many of Madoff's investors were Jewish individuals and organizations indicates that unsavory money managers may find it easy to victimize people with whom they have religious or ethnic ties. In 2006, the SEC issued a warning to watch out for affinity fraud, which occurs when an adviser targets members of a specific ethnic or religious group.
You can begin your search for an adviser by getting recommendations from friends or associates you trust. But do your own due diligence. Madoff's clients -- always wealthy, often famous and sometimes financially savvy -- ignored that lesson, and it cost them dearly.
Once you've vetted an adviser, consider asking him or her to sign a fiduciary oath, which requires the adviser to put your interests first. It also prevents the adviser from taking a referral fee for buying or selling an investment for you. You can download a fiduciary oath at NAPFA's Web site.
Before you make a final decision, make sure you understand the manager's strategy and any products that he or she is recommending. Once you've given the nod, touch base on a regular basis and read your statements. If your returns seem too good to be true, they probably are. Madoff investors say they saw steady returns year after year, even when the stock market dropped, which should have been a tip that something was amiss.
It's tough to get an independent assessment of your adviser's performance. But you can compare your returns with an appropriate benchmark, such as Standard & Poor's 500-stock index for stocks of big U.S. companies, or MSCI EAFE for shares of developed foreign nations. "Don't leave your common sense at the door," says Tim Kochis, chief executive of Aspiriant, a financial-planning firm.
Finally, if you try to take out your money and you're told you can't, it may be too late. Nadia Papagiannis, a hedge-fund analyst at Morningstar, says Ponzi schemes always unravel when investors try to withdraw. According to the criminal complaint against Madoff, it was the lack of money to return to investors that ultimately blew the lid off the alleged racket.