The recently announced discovery of perhaps the largest investment fraud in U.S. history has prompted many investors to inquire about their own exposure to this fraud or to a fraud of a similar nature.  We would like to begin this discussion with one clear message:  Heritage Investment Group has no exposure to Bernard Madoff Investment Securities and we have never done business with Mr. Madoff or any of the companies that bear his name. 

With that said, we would like to briefly discuss the details of the Madoff affair.  Late last week, a long list of wealthy investors both in the U.S. and abroad were shocked to learn that Bernard L. Madoff, a prominent and well-respected broker and money manager, has been accused of orchestrating one of the most extensive investment frauds in US history.  A complaint filed by the Securities and Exchange Commission asserts that Madoff "admitted to one or more employees of Bernard L. Madoff Investment Securities that for many years he has been conducting a Ponzi scheme through the investment adviser activities of BMIS and that BMIS has liabilities of approximately $50 billion." In other words, the client assets invested into BMIS no longer exist, and these clients now face the possibility of losing their entire investment portfolio.

The press has quoted several sources who argue that the Madoff fraud was impossible to identify from the outside.  Yet a large majority of investment professionals (including Heritage) chose not to invest with Madoff despite the claims of stellar returns.  The first reason Madoff should have been avoided is the simple fact that there is no free lunch.  Madoff claimed to provide steady, above-market gains with low-risk.  Unfortunately, there is no such thing.  When pressed on this point, Madoff was often vague regarding the source of the impressive results, and one satisfied investor told Barron's "Even knowledgeable people can't really tell you what he's doing." In this industry, opacity often breeds skepticism, as it should.

The second unnerving aspect of Madoff’s operation was the fact that his firm was serving his clients as advisor, broker and custodian.  We at Heritage have always believed that one of the cardinal rules of investing is to separate the advisory and brokerage/custodial capacities.  There is an inherent conflict of interest between these functions, and for this reason we have never served as custodian or broker for our clients.  All of our client assets are held at independent custodians such as Charles Schwab, Fidelity, Pershing and TD Ameritrade.  These custodians provide the client with independent verification of account balances, securities held in the account and transactions directed by the advisor, which allows the client to be assured that the claims made by the advisor are valid.

Many aspects of the Madoff affair are depressingly familiar:  the lure of high returns with little risk, glowing testimonials from prominent investors, the sense of membership in a special club for those fortunate enough to be "in the know," the vague documentation of investment strategy, the skimpy accounting, and the speed of the ultimate collapse.  However, this unfortunate tale offers a bitter lesson to investors: claims of high returns with low risk and access to the “inside deal” are no substitute for clarity, transparency and independent oversight.

We hope everyone is enjoying the holiday season, and we are available to answer any questions that you may have.
 

Archives