Michael J. Chapman, CFP®, CIO

It’s been several years since investors lost billions in the Bernie Madoff Ponzi scheme. Despite historical increases in industry regulation and oversight, we continue to read and hear of new scams and lost fortunes, proving no government agency can foolproof your investments against fraud. Fortunately, there is one important thing all investors can do to minimize potential exposure and protect themselves: Separate who’s managing your money from the custodian holding your money.

Having been in the financial industry for over 30 years, I am certain that adding an experienced and competent financial advisor to your team is well worth the incremental cost by allowing you to avoid the many pitfalls inherent in investing. Having said that, I am equally certain your advisor should have limited authority over your assets. These authorized activities should be restricted to:

The buying and selling of securities on your behalf and transferring your funds, but only into an account with the same title and ownership.  These permissions and restrictions can be accommodated by signing a limited power of attorney.  Ensure the investment account your advisor manages is not held at the advisor’s company. Said a different way, the company you write your checks to and that custodies your assets should not be the same company that is managing your money.

The custodian will provide a monthly or quarterly statement showing all of the activity in your account. A good money manager will provide you with performance statements, usually on a quarterly basis, which gives you two different statements from two different sources to compare. You now have a system of checks and balances to ensure your funds are exactly where you believe them to be, in the amount you believe there to be.

Let the Investor Beware.

In the case of Madoff and so many like him, the manager was furnishing fabricated statements and it was not until it was too late that the investors discovered their money was long gone. This would not have been possible if their funds had been deposited at a separate custodian, whereas Madoff was simply given the power to invest those funds.  He could not have used the funds to pay off other investors in his Ponzi scheme if a separate custodian had been used. Additionally, the custodian’s monthly statements would have reflected his true dismal performance.

Most registered investment advisors (RIAs) do not hold or custody client funds. Instead, they have a contract that allows them to buy and sell securities on their clients’ behalf and to move funds from one account to another, as long as they are titled in the same name.  Keep these things in mind:

Some RIAs will act as the money manager for your accounts, but again, your accounts are held at a different custodian.

My firm, Provident Capital Management, Inc. (PCM) uses discount brokerage firms such as TD Ameritrade and Charles Schwab to hold client assets.  Each month you receive a statement from the discount broker and each quarter a performance statement from PCM.  It is in your best interest to compare the ending balances on these two statements. If the balances don’t match, then you know further research is needed.  An additional benefit of this type of arrangement is the custodians mentioned above offer 24/7 viewing of your accounts online, which means you could monitor your funds daily.  As a registered investment advisor, we operate this way to add an additional check and balance to protect you as the consumer.

Greed, fear, fraud and deceit have been around throughout our history. Human nature has not varied much over the ages. Despite modern advances in finance, monetary policies and investment options, we still continue to see asset bubbles and watch investors chase too-good-to-be-true investment returns, only to lose a great deal of money. However, risk of losing money extends beyond the gains or losses in stocks or bonds. The first step to take in protecting yourself from fraud is to separate who’s holding and reporting your money from who is managing it.

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