Beyond Madoff madness: What advisors need to do

By Don Wilkinson

DFW & Associates


Bernie Madoff, the swindler with the Cheshire Cat face who made off with billions of investor dollars, will shortly make a transition from his $7 million Park Avenue apartment to a jail cell.

Orchestrated by one man, the largest ever "Ponzi scheme" has disgruntled investors putting the financial advisor community on the same popularity playing field as politicians. The term "lost confidence" has taken on new meaning.

The infamous case has most Americans believing that investment fraud like Madoff's is a common occurrence on Wall Street, according to a recent CNN/Opinion Research Poll. More than 74 percent of those surveyed believe the motives of Madoff are the usual order of business among financial institutions and financial advisors.

Such news has reputable financial advisors looking to organizations to bolster their image, according to Investment News, a leading news source for financial advisors.

Supporting organizations like the Financial Planning Association and the National Association of Personal Financial Advisors are normally geared up to present the financial services industry in a favorable light. Nevertheless, as the focus on Madoff continues to intensify, investor confidence in the advisor community will be a deteriorating moving target.

Amplifying the vote of no confidence towards advisors is the extreme volatility that occurred in the markets in 2008. The S&P 500 index lost 38 percent and has lost 30 percent since the credit crisis hit on Sept 15.

In this kind of environment, what can advisors do to begin the rebuilding process among their clients and convince prospects of the value of their services in the midst of the worst scandal in the history of the financial industry? Is this the greatest opportunity to capture new assets? You bet!

One lesson learned from the Madoff scandal is that Bernie seemed to have 100 percent control of his fund (if he actually had one). No independent CPA custodian or separate reporting company authenticated his trades and there was no arms-length trading company. His firm had all these functions under one roof, which, as you know, is a violation of asset management and due diligence principals.

Because of Madoff's escapades and the resulting firestorm for the SEC, I would recommend that the following should be instituted by all investors:
    A. Audited annual returns by independent CPA firm -- preferably one that specializes in fund of funds.


    B. Disclosure of all separate custodians for trading.


    C. Independent law firm that specializes only in hedge or fund to funds.


    D. Independent general partner to oversee the trading company.


    E. Independent trading company with at least an eight- to10-year track record that is audited.


    F. Most importantly, an independent reporting company that validates all the trades from the managers and provides monthly statements that go directly to the clients, not the general partner.
On a personal level, it goes without saying that one of the easiest and most necessary solutions is to stay in contact with your clients and prospects. At this time, they need reassurance -- even if they haven't experienced severe losses during last year's market collapse. Every advisor should be aware that poor communication between client and advisor gives the client a reason to pull their assets.

On the asset management side, every advisor should probe his or her clients' investment strategy to determine if it's stable, secure and provides worthwhile returns. If your client is heavily into mutual funds, there's a red flag waving. Even without a Madoff hanging around, according to Morningstar, Inc, "Out of almost 2,100 diversified U.S. mutual funds open to new investors, just 17 generated positive returns during the past 12 months."

In addition, mutual funds are plummeting each year with capital gains taxes shrinking their return on investment (ROI). Since substandard performance is presently the norm in the market, it would be prudent for advisors to take taxable mutual fund investors out of funds and recommend more practical investment strategies such as cash, CDs, ETFs, index funds and the new bright star on the investment horizon, the unified managed account (UMA). In my opinion, you need to tell your prospects to get out of mutual funds.

As with other managed account strategies, like the separately managed account (SMA), the UMA rewards the knowledgeable investor with asset customization, professional money management and, most importantly, transparency.

Begin to promote areas like transparency in your practice, showing clients and prospects how the money flows on their managed assets within the firm. Use a chart to show them the independent firms that are watching and checking the assets, show the law firm, CPA company, custodian, etc.

If, as an advisor, your practice does not currently host the SMA and UMA options, perhaps you would like to read more. Contact me using the forum below for more information. You can also find more in-depth information on the subject by reading my other articles on ProducersWEB.

Advisors need to learn more about SMAs, educate their clients by indentifying the problems associated with mutual funds and offer a better wealth- building solution for their clients that alternative investment strategies like the SMA offer. An example would be a setup managed account with access to down market alternatives like inverse ETFs and non-correlated assets found in alternative assets classes such as senior debt lending and commodity assets.

If you're a wealth manager with high-net-worth clients, the negative feelings are not any different from investors on Main Street.

In fact, in another recent study conducted by Prince & Associates, 81 percent of investors with $1 million or more in investible assets plan to take money away from their current advisor. Get this: Even a larger number (86%) plan to tell other investors to avoid their advisor. Since the wealthy often take advice from one another, the fact that only 2 percent plan to recommend their advisor firm to other investors is a gut-wrenching statistic for wealth managers. Taking the biggest hit are the "brand-name" firms like Merrill and Lehman. In fact, as the money moves, the survey says the wealthy are expected to shift more assets to smaller shops with fewer conflicts like independents.

So what does this mean for wealth management firms? First, get over being defensive. Most wealth managers and financial advisors were victims of extreme market conditions that wrecked the decisions of even the most sophisticated of managers. Forget that. This is the opportunity to provide a positive relationship with your new client because you have the solutions that the previous broker did not.

In addition, you might want to consider advancing to a higher plateau with ultra-high-net-worth clients with investible assets in the $5 million to $25 million range. You could open a family office, a concept not universally known by most affluent families. Family offices are private wealth management advisory firms that serve ultra-high-net-worth investors. Family offices are different from traditional wealth management shops in that they offer a total outsourced solution to managing the financial and investment side of an affluent individual or family. For more information on family offices, contact me using the forum below.

Finally, it's OK to talk about trust but now it's also necessary to show clients and prospects the facts with the use of chart statements and organization and flow charts of their assets and the use of references.