How Madoff Did It

Letter from RESOURCE PLANNING GROUP, LTD.

In the most recent bad news from Wall Street, Bernard Madoff, former NASDAQ Stock Market chairman and founder of Bernard L. Madoff Investment Securities LLC, was arrested and charged with securities fraud. What did he do? He allegedly collected money to invest from clients, made up false statements to show that they were doing well, and used new clients' money to pay interest and withdrawals to existing clients. This is known as a Ponzi scheme and is estimated to involve more than a $50 billion loss for his investors.

His clients didn't see this coming. Could they have? Let's look at some safeguards that could have prevented this from happening.

1. Create accountability. All RPG clients utilize either Schwab, Fidelity or TD Ameritrade as an independent third party custodian of their funds. Madoff held his client assets, managed them, and priced them as well. There was no oversight whatsoever. Investment performance can look very good if prices can be manipulated, which is allegedly how he showed such consistently good returns. RPG clients receive independent trade confirmations and a monthly investment statement directly from the third party custodian. They can also access their accounts directly over the internet. Our custodians monitor the payment of our fees, review our SEC filings and some even look at our errors and omissions coverage and confirm our professional certifications.
2. Verify what is reported to you. At RPG, our core investment strategy utilizes stocks, bonds, ETFs, and mutual funds that are publicly traded and listed on major exchanges such as the New York and American Stock Exchange. They are priced independently at least daily by our third party custodians. RPG clients can verify publicly their reported returns against the quarterly performance statements prepared by us. The SEC audit function that we are subject to also tests the accuracy of what we report to our clients. Additionally, there are hundreds of analysts that track and report on our investments and those investments are also subject to a high degree of government regulatory oversight.
3. Insist on transparency. No investor should blindly trust any manager. If you cannot understand the investment strategy being employed on your behalf, hire someone who does or do not make the investment. The principles of transparency and accountability should never be compromised. The Madoff fund was not registered with the SEC and did not conduct an annual audit by a reputable CPA firm. Furthermore, it purportedly employed an undisclosed (and thereby unverifiable) “black box” investment strategy. Good stewardship is not practiced by investors who place their money in the hands of such managers. We are SEC registered as an investment advisor and our investment methodology is transparent.
4. Common sense should be applied. If an investment sounds too good to be true, it probably is. Reportedly Madoff claimed consistent annual returns in the range of 15% to 22% with little volatility and no monthly or annual losses. Can you name any legitimate investor who can make that claim? Additionally, RPG client assets are held by custodians that do not engage in high risk investment activities. If you compare the recent stock performance of Schwab or TDA to that of Merrill Lynch, Lehman, or AIG, even a casual observation will reveal that our custodians employ a much lower risk business model than the “full service” brokers. One principal difference is our custodians low debt to equity ratios.
   

As a final note, our custodians maintain fraud insurance. The first tier is provided by Securities Investor Protection Corporation (SIPC) which covers $500,000 per account. Then, at Schwab for example, there is an additional $149.5 million per account from London insurers. Fidelity and TDA have similar private insurance arrangements. Fraud insurance does not protect against market declines; but it does protect clients against the theft of securities and/or related fraudulent transactions.

We appreciate the confidence that you continue to show in us during these difficult times.

Kindest regards,

John Howard, CPA, JD, CFP