FTX, the third-largest cryptocurrency exchange with more than 1 million users, filed for Chapter 11 bankruptcy.
Later, cryptocurrency lender, BlockFi announced it paused client withdrawals because of FTX’s implosion. Then the lending arm of crypto investment bank Genesis Global Trading announced it was halting new loan originations and redemptions. The FTX fiasco is reminiscent of Bernie Madoff, the mastermind of the largest investment fraud in history. Bernie Madoff defrauded more than 40,000 people of over $65 billion. Considered to be the archfiend of the financial world, his Ponzi scheme will haunt the financial industry for years. The FTX debacle is resurrecting the same fears.
Advisors Regaining Trust
The Ponzi scheme and the collapse of FTX, underscore a harsh reality: many folks don’t understand what advisors do or much about finance. Financial advisors must draw sharp contrasts for clients between how they operate and how FTX and Madoff did. For instance, Madoff was a custodian for his client’s assets, a big red flag.
Madoff also generated statements for clients, which were significant works of fiction. Clients must be told their money is with a third-party custodian who can generate statements independently. And advisors need to explain this contrast to gain client trust. Most importantly, advisors must lay out what a custodian does and assure clients that they do not hold or take custody of their money.
A crucial way to gain trust is to explain everything that is happening. Not every client understands how markets work, with financial matters daunting to some. But advisors must assure clients that investments “won’t go FTX or Madoff” which is hard to do, especially if we’re showing clients that they are giving up liquidity for a better opportunity. But in today’s post-Madoff and current FTX era, advisors who counsel their clients about bad investments are doing both their clients and themselves a favor.
Avoiding Another Madoff/FTX
So how do you ensure you don’t run into the next Bernie Madoff or FTX? One way is to ensure that your advisor does not oversee every part of your investment.
Here are four questions to ask your advisor:
- Who is selecting my securities?
- Who is executing my trades?
- Who is keeping custody of my assets?
- Who is verifying my performance?
Madoff controlled the first three exclusively. And for the 4th, he was able to find a small outside auditor to help him with his scam and sign off on the phony returns. Your advisor might be selecting securities for you but listen carefully to how they answer the following three questions.
Record of Paying Fines
A little research would have told clients that Madoff paid thousands of dollars in fines, stemming from a 2005 violation. Details from the Form ADV on the SEC’s website are sketchy, but it appears that his firm withheld required information from the Nasdaq exchange.
A Madoff client wanting to buy or sell a stock had filed a limit order, which means that the customer wanted a specific price or better. This information is necessary for bidders to see what the market for the stock is like. And the Madoff client who bid had the right to have that order enter the market. Oddly, the SEC still maintained a listing for his firm, Bernard Madoff Investment Securities, even though it is defunct. If you just emerged from a coma after Bernie had been in prison for a few years, you might have thought the Madoff outfit still existed. The reason for the continued listing, according to the SEC, is legalistic. Madoff’s firm needs to be registered with the agency so victims can make claims on its assets.
As a practical matter, you couldn’t invest with the firm if you tried because the firm is out of business and its founder was sent to prison for 150 years. Now, he’s no longer alive.
One More Thing
It has been over 10+ years since Madoff went to prison (he has since died) and the recent FTX debacle will surely resurrect more client concerns concerning their financial advisors. But if any financial advisor balks at your 4 questions or doesn’t want to provide you with their Form ADV, don’t walk away.
Run.
