If you are serious about growing your wealth, you had better be just as serious about protecting it. It is an unfortunate fact that there is a dark side to the investment business—sleazeballs who spend their days trying to figure out how to rip you off. They carefully lull their victims into a sense of complacency. Too often, victims wake up to the awful reality of their situation only after significant damage has been done.
Bernie Madoff is the poster child for this kind of crook. Madoff estimated that his scheme cost investors more than $50 billion over the course of nearly 50 years. He was the quintessential wolf in sheep’s clothing. Before his fraud came to light, Madoff was well-respected. He played a leading role in the development of electronic stock trading and had even served as the chairman of the NASDAQ stock exchange from 1990 to 1993—all while he was engaged in the largest Ponzi scheme in U.S. history.
The Madoff case is instructive for a couple of reasons. First, like Madoff, many investment fraudsters use variations of the old-fashioned Ponzi scheme to suck in new investors. Ponzi schemes usually promise high returns—much higher than the market can actually deliver. However, the money isn’t really invested. Instead, the “returns” paid to investors come from money invested by others. As the inflated returns attract more and more money, the pyramid grows until it eventually implodes—it always implodes—and the losses become apparent.
Second, Madoff engaged in what is known as affinity fraud. Affinity fraud is a type of investment fraud that targets people who share a common identity or affiliation such as religious, ethnic, or professional associations. Perpetrators of affinity fraud exploit the trust and relationships within the targeted group to gain credibility and manipulate individuals into investing in fraudulent schemes.
Madoff cynically used his Jewish heritage to target prominent members of the Jewish community, including many Jewish philanthropic organizations. To be sure, Madoff’s victims were not just Jewish, but he mercilessly exploited his Jewish ties. Victims included savvy investors like Carl Icahn, Carl Shapiro, and Mortimer Zuckerman as well as other prominent people like New York Mets owner Fred Wilpon, holocaust survivor and Nobel laureate Elie Wiesel, film director Steven Spielberg, and baseball legend Sandy Koufax.
Investment fraud is not something that happens only to people living in faraway places. In 2007, a similar scheme unraveled right here on the Monterey Peninsula. William “Jay” Zubick, who seven years earlier had been fired from Merrill Lynch and who had been barred for life from associating with any National Association of Securities Dealer firm, was convicted of defrauding 29 local investors of $16 million.
Many of Zubick’s victims were close friends who invested with him because he promised them access to an “exclusive limited partnership.” However, instead of investing the money, Zubick spent it on a lavish lifestyle. He duped investors with phony account statements and K-1s that made it look like they were making solid profits. About $1 million was paid out as “returns” to investors, but most of the money went into Zubick’s pocket. The fraud came to light while Zubick was hospitalized for a near-fatal heart condition and he could no longer maintain the charade. He eventually accepted a plea agreement and was sentenced to 10 to 25 years in prison.
You can protect your wealth from the dark side by following three simple rules.
First, make sure your assets are always held by an independent custodian, like Charles Schwab or Fidelity. The custodian’s primary job is to safeguard your assets. A reputable advisor will never take custody of your assets. This financial control protects both you and your advisor.
Second, “trust but verify.” It is important to have an advisor you can trust, but you also need to verify that your advisor is trustworthy. The easiest way to do this is to compare the statements you receive from your independent custodian with the information provided by your advisor. If things don’t add up, ask your advisor for an explanation. If you are still uncomfortable, ask your CPA or an attorney for a second opinion.
Third, beware of special deals or investment returns that are too good to be true. Remember, if something is too good to be true, it usually is. And those special deals? Well, that’s just a sales pitch playing to someone’s ego.
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Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to email@example.com.