Ask Money

Avoiding a "Madoff"

Chris Farrell Dec 16, 2008

Question: I have Roth IRA accounts with Vanguard and T. Rowe Price. I get transaction confirmations and quarterly statements from each. From what I understand, the people who invested their money with Madoff got the same thing, plus checks that cleared the bank. My question is: How do I know I can trust Vanguard and T. Rowe Price? What prevents those companies from doing what Madoff did? Thanks for your time. Callie, Miami, FL

Answer: It’s a chilling thought, isn’t it? Scam artists thrive during boom times when caution is tossed aside. For instance, in the 1920s the stock market boomed, and the bust caught many wealthy investors by surprise. Comedian and singer Eddie Cantor supposedly lost a million dollars. Songwriter Irving Berlin didn’t heed the advice of Charlie Chaplin to get out and lost a bundle. Irving Fisher, widely ranked among America’s greatest economists, damaged his reputation by loftily predicting shortly before the 1929 crash that stock prices had reached “a permanently high plateau.” Worse, a large part of his wealth disappeared in the crash.

The reputations of Wall Street’s leading lights were also tattered in the aftermath of the crash. For instance, Richard Whitney, acting president of the New York Stock Exchange during the crash and a famous broker with the prestigious firm J.P. Morgan as his client, grandly lived well above his means. When insolvency loomed, he defrauded customers, his wife’s trust fund, and the New York Yacht Club. He was caught, convicted, and sentenced to Sing-Sing prison. Charles Mitchell, known as “Sunshine Charley” and head of National City Bank, relentlessly pushed the salesmen in his financial supermarket with branches in more than 50 cities to peddle junk bonds and junk stocks on to an unsuspecting public. He was forced to resign in 1933, and indicted for income tax evasion the following year, although acquitted.

Now, most money managers run legal operations and, largely thanks to the scandals of the ’30s, there are checks and balances to the system that work most of the time. The most important is that the money managed by broker-dealers and mutual fund companies is kept in separate accounts, custodial accounts, monitored by the Financial Industry Regulatory Authority or FINRA. These account offer fraud and malfeasance protection up to $500,000 through the Securities Investors Protection Corp. In other words, if you’ve invested your money in mutual funds managed by Vanguard or T. Rowe Price (to use your examples) or if you trade securities through their broker-dealer operations, you’re safe from the kind of Ponzi scheme run by Madoff.

In today’s Wall Street Journal a story on how to avoid doing business with future Madoff’s highlights the red flag this way: “The key one: Look out for an investment manager who wants complete control of your money, and asks for checks to be made out to him or a company he controls.” If someone did that to you, run–don’t walk.

Another well known red flag that gets revealed over time: If returns are too smooth and good to be true year in and year out–well, something fishy is going on.

So, all of us need to get familiar with the protections and information offered through the Financial Industry Regulatory Authority at www. The Securities & Exchange Commission offers some good consumer protection information at its website, But that agency hasn’t distinguished itself at all since this financial crisis began, well over a year ago.

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