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Thoughts from the Curb

By: Thomas M. Lewry, CFP

In the face of a struggling economy, a banking crisis, confidence levels not seen since the 1930s, and unsettling volatility in the stock and commodity markets, another negative surprise hit the investing public in the disclosure, by the culprit himself, that Bernard Madoff had succeeded in evaporating approximately $50 billion in client assets, the result of a Ponzi-type scam in which he promised modest, reliable rates of returns to his investors. The scale of his alleged $50 billion Ponzi scheme is hard to comprehend. Madoff had once served as the Chairman of NASDAQ, and was a respected individual on Wall Street….perhaps the reason he had successfully avoided the regulators for all these years. From all reports, he was an engaging, charming individual who created the illusion of exclusivity in his managed accounts, duping professionals, advisers, and clients alike.

The question we all should be asking is the same question that is being asked by Congress, the regulators, and particularly those duped, many who were “sophisticated” investors. About a decade ago, I served as Chairman of the Business Conduct Committee for the New England Region of the National Association of Securities Dealers (NASD). During a recent holiday gathering of those regulators, the topic of the day was the Madoff scandal. The retiring Director of the Boston office had served on several committees with Madoff’s children, and found them to be bright, engaged, contributing members of those committees. One of my former committee members, a seasoned industry professional, told me that he knew Madoff personally, and was “totally shocked that this was even a possibility”, perhaps another reason Madoff was able to succeed for so long.

To me, having served in a regulatory capacity during my career, there were red flags all over the place…the very reason we structured our firm as we did. Others saw the same warning signals. Madoff apparently blended the roles of adviser, broker and custodian through his various business entities. Bear Stearns and other reputable firms distrusted his structure and refused to do business with him. Several market analysts actually computed the reality that the returns Madoff was posting were impossible, given the trades that were supposedly made. One analyst figured out that the entire open interest in some of the markets he was trading was insufficient to handle his supposed dollar volume. Regulators were warned, cursory reviews conducted, but apparently Madoff’s charms won the day. And clients, blindly impressed with his consistent returns, accepted the fact that information relative to their account holdings was almost impossible to secure.

Should investors in our managed accounts be concerned as a result of this scandal? Investors should always be diligent and exercise appropriate due diligence relative to their financial holdings. Investors may also derive comfort from the following realities relative to their accounts:

1) This firm does not hold a single dollar of client assets. All client funds are held by completely independent outside custodians (Charles Schwab Institutional, TD Banknorth Trust, or Wells Fargo Trust).
2) No funds can ever leave those custodial accounts, other than to the account of record, without the express written consent of the client.
3) The custodian provides our clients with a monthly, independent audit trail (statement), detailing all money flow, purchases and sales within the accounts. We as advisor have absolutely nothing to do with the generation of those reports.
4) Clients receive our quarterly performance report, which must reconcile to the independent custodial report.
5) Executed trades are settled through the independent custodian, not through Curbstone. Curbstone simply has your authority to enter the trades thought to be prudent by the adviser.
6) Our custodians carry significant third party insurance to cover any potential malfeasance on the part of their employees.

We have the Madoff case as a current example of a systems and regulatory breakdown. Some years ago, New Hampshire residents will recall the Judge in Exeter who walked off with millions in client assets, before terminating his own life in a Las Vegas motel. Both of these horrific situations arose from situations where the advisor had custody and control of the assets, and was thus able to generate fictitious statements showing assets that no longer existed. Although we are saddened by the losses experienced by this community of investors, and angered by the inept performance of the regulators, the red flags should have been apparent to any investor performing even a modicum of thoughtful due diligence. We tend to push off responsibility in this country, but there is no bailout coming for those who ignore the basic tenets of due diligence.