Meltdown 101: Steering clear of investment fraud

[December 13, 2008]  NEW YORK (AP) -- A $50 billion swindling of investors -- allegedly perpetrated by former Nasdaq Chairman Bernard L. Madoff -- throws up a new warning sign for consumers already on their heels after a horrific year in the markets.

If a business run by such a well-known Wall Street figure could purportedly bilk investors for years before getting caught, is there anything other investors can do to avoid falling into a similar trap?

Madoff founded and owns Bernard L. Madoff Investment Securities LLC and separately oversaw an investment advisory business that managed money for high-net-worth individuals and hedge funds. He was charged with securities fraud Thursday after federal investigators said he caused investors to lose billions of dollars in what was labeled "a giant Ponzi scheme."

Here are some questions and answers about protecting yourself against fraud by an investment adviser.

Q: What is a Ponzi scheme and how does it work?

A: It's a fraudulent investing scam that promises high rates of return at little risk to investors. The scheme generates "returns" for investors by paying them with money taken from newer investors -- a fraud that perpetuates itself as long as there is a continuing flow of new investors. When that flow stops, the scheme collapses, leaving investors with big losses.

It derives its name from Charles Ponzi, a clerk in Boston who first orchestrated such a scheme in 1919.

Q: Let's say I'm looking for help investing my money. What's the difference between a financial adviser, financial planner, investment adviser and broker?

A: Anyone can hang up a shingle saying they are a financial adviser or a financial planner and give advice to people about money; those broad titles by themselves do not indicate any type of certification. Investment advisers and securities brokers are required to be registered.

Someone accepting money for investment advice must register as an investment adviser with the state(s) where he does business, or the Securities and Exchange Commission if he manages more than $25 million in assets.

A securities broker, who acts as an intermediary between buyer and seller and charges commissions, must be registered with the Financial Industry Regulatory Authority (FINRA).

Q: What credentials should I look for in an investment adviser?

A: Two of the most reliable credentials are CFP, for certified financial planner, and CFA, for chartered financial analyst. Both require rigorous training, passing exams and continuing education to keep skills up to date.

Whatever the credentials, make sure they signify accreditation by a reputable industry association. Jack Mitchell, chief of investigations for the Senate Committee on Aging, says some of the less reputable designations they examined were obtained in a couple of hours in a class at a hotel. One investigator passed an exam in less than an hour with a grade of 94 even though he had no financial background whatsoever.

Q: How can I get information about advisers?

A: Information about brokerage firms and individual brokers is available online through FINRA's Broker Check program or by calling 800-289-9999. Information about certain investment adviser firms is available through the SEC's Investment Adviser Public Disclosure Program site at http://www.adviserinfo.sec.gov/. This will also steer you to your state securities regulator.

Q: What questions should I ask before selecting an investment adviser?

A: Try these: What experience do you have? What are your qualifications? What services do you offer? What is your approach to financial planning? Have you ever been publicly disciplined for any unlawful or unethical actions your professional career? Can I have it in writing?

Also ask to see their registration forms, called the Form ADV, and carefully read it in its entirety. It comes in two parts: The first has information about the adviser's business and whether he or she has had problems with regulators or clients; the second outlines the adviser's services, fees and investment strategies.

Q: What are the warning signs that something might be amiss with my money?

A: Not getting regular account statements or confirmations of transactions would be something to follow up on. Statements can be as frequent as monthly but usually are quarterly. And any activity that takes place should have first been authorized by the investor and should be confirmed in writing.

"If there are any unauthorized transactions, that's definitely a red flag," says Gregory Anderson, founder and CEO of Denver-based GRAnderson Wealth Management.

Q: What should I do if I suspect I've been caught up in something, both to notify authorities and to safeguard my money?

A: Consider transferring the money out of the firm immediately, if it can be done. Second, contact the Securities and Exchange Commission.

"The SEC can act very quickly by going to court and getting a judge to freeze all of the firm's assets if fraudulent activity is suspected," said Andrew Stoltmann, a securities attorney and investment adviser in Chicago.

Q: What regulations exist to protect investors?

A: Securities laws guard against anyone making false representations to investors in connection with a stock sale. Criminal laws prohibit fraud. Investors also can file civil suits. Once an investor gets to this point, though, the battle may already have been lost.

"Ultimately the best protection is to scrutinize any (investment) offer, because if it seems to be too good to be true it usually is," said Michael Budwick, an attorney with Meland Russin & Budwick in Miami. "Most of the protections come in after the investor has lost all his money."

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On the Net:

SEC tips for checking on investment advisers: http://www.sec.gov/investor/brokers.htm

Financial Industry Regulatory Authority: http://www.finra.org/

[Associated Press; By DAVE CARPENTER]

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