How to Avoid the Next Bernie Madoff

The following is an edited excerpt from the new book, 5 Steps for Selecting the Best Financial Advisor: How the Internet Has Changed the Game for Investors and Financial Advisors by Jack Waymire and Jonathan Dash.

When Bernie Madoff was arrested in December 2008, he instantly became the face of the greed and corruption that has permeated Wall Street for decades.

It is common knowledge that he bilked 11,000 investors out of $65 billion in the largest and most damaging Ponzi scheme in history. Madoff pleaded guilty to multiple counts of fraud, theft, and money laundering and was sentenced to 150 years in prison.

How bad were the consequences of his criminal enterprise?

There were thousands of victims, suicides, and multiple bankruptcies. Less than $12 billion has been recovered for Madoff victims, many of whom lost all or a significant portion of their wealth.

We say “wealth” because it was not as if Madoff’s victims were unsophisticated people who invested small amounts of money in his scheme. Most of Madoff’s victims were wealthy people and institutions — millionaires, celebrities, executives, banks, European royalty, pension funds, university endowments, charitable foundations, and hedge fund managers — all of whom felt privileged to have their assets invested by a “Wall Street Wizard” who had the Midas touch.

It Can Happen Again

Why talk about Bernie Madoff? After all, this happened years ago and is old news. We hope his story is an attention-getter for the following reasons:

• History can repeat itself, even if it is not as dramatic
• Bad financial advice is still bad advice
• There are very few Madoffs, but there are thousands of bad advisors
• He had current industry licenses while he stole from his clients
• His victims could have avoided him with a few minutes of online research

The Allure of Bernie Madoff

Madoff managed to engineer an “Oz” persona — he was the evil genius behind the curtain who rarely met face-to-face with his clients. But that didn’t matter as long as he delivered the consistent 10 to 12 percent returns that he promised them.

The lie he inserted into his sales pitch was that he could deliver good (not great) returns regardless of market conditions. It turned out the claim was too good to be true.

No one dared question his methods or results because they were afraid he would drop them from his list of wealthy clientele. He even turned away some investors to create a sense of exclusivity, which made him even more alluring to the rich and famous. Although he guaranteed easy access to their funds, his clients were afraid to withdraw their money for fear of not being able to get back in.

His clients were not stupid people. They had to accumulate a lot of assets just to afford his investment services. Plus, they were surrounded by tax, legal, and financial specialists who were supposed to protect their interests.

The Madoff story was a finely honed blend of fact and fiction. He founded one of the largest market makers on Wall Street. He served as the Chairman of the Board of Directors for the National Association of Securities Dealers (NASD), the then self-regulatory body for the securities industry. He was a member of the Board of Directors of the Securities Industry Association, which wielded a substantial amount of political power in Washington, D.C. Obviously, he was a man who could be trusted by virtue of his industry visibility, past accomplishments, and sterling credentials.

He was also very charming. Like many of the best con artists, he was an exceptional schmoozer, with an uncanny ability to convince wealthy individuals that he had a unique process for investing their assets. Not only was he able to convince people he could produce positive returns in all market conditions, he made them feel exceptionally lucky to be investing with him.

One of the most frequent laments from his victims was: “I thought he was my friend.”

The goal of our work, and our book, is to teach investors how to choose a financial advisor objectively, to avoid the risk of history repeating itself.

For more strategies on picking the financial advisor that’s right for you, check out Jack and Jonathan’s book, 5 Steps for Selecting the Best Financial Advisor.