Bernie Madoff pled guilty this morning to all charges against him. Bail was revoked and he now faces a maximum 150-year sentence.
Fortunately, the market seems to be enjoying the news and we’re holding on to a nice gain. The Dow is back over 7000 and this could be our first three-day rally for the Dow since the final three days of the year.
Since news of the Madoff Scandal broke, I’ve discussed it several times. In December, I had some initial reflections. Later I discussed a few important lessons from the scam. I also gave investors seven red flags on how to spot a scam.
* Red Flag #1: It’s Too Good to Be True: Be very wary of unusually steady returns. Remember that the people behind Ponzi schemes are masters of human conditioning. If the returns are consistently strong and there’s little or no volatility, you can probably be sure that the returns are truly “too good to be true.”
* Red Flag #2: Your Manager Wants Your Money: Never, never, never give money directly to an investment manager! In the securities businesses, manager’s never take custody. Instead, they use independent banks or brokers. These are the folks who provide monthly statements and transparency, as well as gobs of account insurance. Technically, Madoff operated as his own broker-dealer and faked his account statements. Most banks and brokerages carry supplemental insurance, often $20 million to $100 million per account upon request. The bottom line is, never be afraid to ask.
* Red Flag #3: Questions Are Discouraged: That brings me to my next point: If anyone asked Bernie too many questions, he’d give them their money back. Talk about alarm bells! Never be shy about asking questions. Managers should be transparent, not secretive or mysterious.
* Red Flag #4: Selling While Socializing: Hedge fund managers are famous for throwing great parties, sometimes on big, fancy yachts. In South Florida, they try to sell hedge funds through social channels. The hedge funds often have very attractive young women selling to older guys. (Personally, I’m banned from these parties since my wife doesn’t like me hanging out at these scenes!) You should be suspicious of any investment sold through social networks or the party circuit.
* Red Flag #5: Lack of Licenses: Never get investing advice from unlicensed experts. The Madoff scheme was distributed through intermediaries-like real estate brokers, attorneys, accountants and especially other country club members-who weren’t always licensed in the securities business. In the Madoff case, referring brokers often got trades in exchange for pushing business Bernie’s way. In the securities business, any fee must be disclosed.
* Red Flag #6: Unknown Auditors: If you invest in a hedge fund, absolutely make sure that it has a reputable auditor from a Big Four accounting firm with lots of insurance. Madoff used an unknown auditor who worked out of a 13-by-18-foot office. Needless to say, that’s not a good sign.
* Red Flag #7: Your Sole Resource: And finally, diversify! Too many folks gave Bernie Madoff all their money. Never put all your eggs in one basket.