Be Vigilant Against Financial Fraud

Financial fraud seems to hit the news headlines on a regular basis these days. By fraud, I am referring to Ponzi schemes or other illegal activity designed to steal your money. So, how can you protect yourself against financial fraud? Here are some practical steps:

  1. “Trust, but verify.” If you initiate a money transfer from one account to another, check both accounts to ensure that the transfer occurred properly. Reconcile your bank, credit card, and investment account statements against your own transaction registers. If you pay a vendor through direct debit of your bank account, then call the intended recipient of the money to confirm that the appropriate funds were received. Check your account activity online on a regular basis. Review your credit reports on a regular basis. Be suspicious of anyone who you do not know that calls you on the telephone and asks you for personal or financial information.
  2. Know where your money is located. If you deposit money at a bank, your money is held at the bank. If you deposit money into an investment account, is your money held at the investment firm that issues the account statements? It depends. Say you purchase shares in the Vanguard 500 Index mutual fund. Does Vanguard hold your shares? Surprisingly, no. Mutual fund managers are required to hold fund assets at an outside custodian. The assets of the Vanguard 500 Index fund are held at Brown Brothers Harriman & Co. You can find this information in the mutual fund’s “Statement of Additional Information” document, which is available on Vanguard’s website. Also, be aware that some smaller brokerage firms hold their customer accounts at a third-party brokerage firm, which is known as the “clearing” broker. The largest clearing broker in the U.S. is Pershing LLC, a subsidiary of The Bank of New York Mellon Corporation.
  3. Separate investment management and asset custody. This is just a fancy way of saying that the person or firm that manages your investments should not also hold your account assets. If you hire an investment advisory firm to manage your investment portfolio, then your account should be held at a third-party brokerage firm that issues statements and trade confirmations directly to you. Review those statements and confirmations on a regular basis. This was one of the fundamental flaws in the Bernie Madoff fraud. The client funds that Madoff “managed” were held at his own firm. If someone comes to you with an investment opportunity and asks you to write a check payable to him or his firm, politely decline.
  4. Be suspicious of exotic or exclusive investments. If someone pitches a complicated investment to you, then consider a more straightforward investment instead. Words such as “exotic, exclusive, private, etc.” that are used to describe an investment opportunity should raise immediate red flags.
  5. Be wary of claims that sound too good to be true. If someone promises an attractive investment return with little or no risk, then assume that the investment is fraudulent unless you can prove otherwise beyond any doubt. Legitimate investments that have the potential for attractive returns have risk.