Don’t Get Ripped Off: How to Avoid Financial Scams

It’s easy for investors to become a con artist’s mark, according to financial advisors. Many of the victims scammed in Bernie Madoff’s $65 billion Ponzi scheme were sophisticated at investing. Very sophisticated. One such person – a former trader – invested because he played basketball with Madoff’s accountant.

If successful people are prone to invest in fraudulent private companies, what is the common investor to do? Is there any hope for the average person to invest in private companies and not be ripped off? Here are some tips and red flags to look for before investing.

“There is a lot of hope [for the average investor]” to avoid getting taken, said Tom Orecchio, principal and wealth manager of Modera Wealth Management.

The panel, on “Avoiding Financial Scams,” was held recently as part of National Financial Advisor Week in New York’s Times Square. This event, which attracted hundreds of onlookers, featured financial advisors giving tips on personal finance, ranging from retirement saving to college funding. The panels also focused on how people can get the most out of advisors. At the event, Jennifer Rufener of Dover, Ohio, won a sweepstakes for a free college education.

There is no foolproof system to avoid being ripped off, but there is one major no-no that can help. “Don’t invest purely on trust, or on a friend’s experience without doing any due diligence first,” Orecchio said. He advised against investing with neighbors, or a parent whose child goes to your kid’s school just because you like them. “That’s the biggest red flag I see,” he said.

A cautionary note: Don’t put too much money with one manager. Orecchio had a client who played basketball with Madoff’s accountant. He consequently invested in Madoff’s fund and lost a substantial sum. Fortunately, his client, a former trader on the New York Mercantile Exchange, had the financial savvy to cap his investment to 5 percent of his net worth.

That’s another rule: Limit your speculative investments to no more than 5 percent of your net worth; that way your other investments can, over time, regain the amount you lost, Orecchio said.

Another way to avoid scams is by using the “keep it simple principle,” said Steve Giulietti, senior vice president at Morgan Stanley Wealth Management. “Too often the simple becomes complex for no reason.” If you can’t comprehend how an investment stratagem works or explain it to your spouse, or understand the fee structure, avoid it. He added that too often people invest on the “hope-it-works-out principle.”

Be skeptical of past performance, especially if the investment professional prepared the profit and loss statement itself. Numbers can be manipulated. Only invest with firms that are audited by a reputable accounting firm.

After all, “Everything on paper looks great,” said Orecchio, so one should visit the firm personally – look around, ask questions. And be sure a reputable third-party has custody of the assets in your investment account. Madoff’s firm was the custodian for his investors’ asset.

One more tip: A neighbor might say how great his returns are, the word gets around and an air of exclusivity intrigues people. “It’s who you know and not what you know … That’s how people get burned,” Orecchio said.

When choosing a financial advisor, the panel recommended using BrokerCheck, which is run by the Financial Industry Regulatory Authority, an industry regulatory body. BrokerCheck, on the Web, is a broker’s permanent record. Ask to speak to a client the advisor lost and one he recently gained. Advisor firms regulated by the Securities and Exchange Commission must file a Form ADV, disclosing strategy, the names of the principles and lots of other minutiae.

Giulietti advised asking, “Is this too good to be true? Is there any chance that my objectives cannot be reached?” In the end, one has to go with his “gut” feeling, he said.

Honest advisors, of course, are the rule and the bad guys a small minority. Example: What moderator Paul Sullivan, New York Times Wealth Matters columnist, heard when asked the panel what was their biggest career mistake.

Giulietti, told how he blundered on a trade for a client due to a miscommunication; it turned out his client did not want the stock. Giulietti sold the shares, losing the firm $14,000. Giulietti told his management that they were going to have to “eat” the loss. “I never told the client, until one night the client was feeding me drinks,” the advisor said. The client was amazed. “He bought the dinner,” Giulietti said.

Sullivan responded, “So you bought a $14,000 dinner?”

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