Protect investments from a Ponzi scheme

NEW YORK (7/6/09)--Don't let your guard down. Even though Bernard Madoff received a 150-year sentence for a massive Ponzi scheme that bilked investors out of billions of dollars, other investment fraudsters are on the prowl. Look for warning signs to avoid being caught in a similar scheme (CNNMoney June 29).

In a Ponzi scheme, the operator, acting as a financial planner, promises investors steep returns--generally higher than those available through other investments. Instead of investing the funds, the operator uses money from those entering the scheme later to pay purported dividends to the earlier investors. Once the operator can no longer pay out to all investors, the scheme falls apart and victims are left stripped of their investments (FBI.gov).

In legitimate transactions, financial planners generally do not have access to their client's money directly. Instead, they buy, trade and sell investments on behalf of their client, but the planner never touches the actual funds--those are held in an outside custodial account, such as Charles Schwab, Fidelity Investments or T. Rowe Price. In the Madoff case, however, victims missed this safeguard and dealt directly with Madoff. Victims were unable to detect that he simply was paying them with investments stripped from other victims.

Use caution to avoid falling prey to a Ponzi scheme:

• Always write and receive checks through a third-party custodial account--not your money manager. Ask your planner if he uses a custodian, and who it is. Make sure it is a well-known, independent firm.

• Don't give in to guarantees of big returns on investments--no investment is ever a sure thing. Madoff's scheme claimed an average return of more than 10% a year, which defied market fluctuations (abcnews.com Jan. 4).

• Obtain confirmation of trades and check your mailed account statements against online account balances (Ohio Department of Commerce, June 30).

• Check out financial adviser records with the "BrokerCheck" tool on Finra.org. The site reports adviser qualifications, such as licenses, registrations and employment history for the past 10 years, and includes a disclosure section where you can access complaints and references from past and current clients.

• Find out how is your adviser paid? Some charge a flat fee; others have agreements with mutual fund or insurance companies and receive commission on products they sell. Find a flat-rate adviser to avoid this scenario.

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