Sniff out bad investors with these tools

By DAVID MOON, Moon Capital Management, LLC
January 18, 2009

In October 2007, admitted Ponzi scheme operator Bernard Madoff stated, 'in today's regulatory environment, it is virtually impossible to violate rules.'

You are free to insert your own punch line.

Almost as soon as Madoff's charade fell apart, an east Tennessee self-proclaimed investment guru and philanthropist disappeared, leaving his investors wondering about the prospect of recouping their millions.

The only difference in a big-time and small-time hustler is the wealth or number of people in his circle.

There are enough legitimate risks with any type of investment. How can you know if you are taking unnecessary risks?

The most useful tool is the easiest to use ' and most frequently ignored. Your nose. Does this investment opportunity pass the smell test?

In order to attract increasingly large sums, swindlers promise irrationally large, predictable or risk-free returns. How does that smell? Don't fall for something simply because you want it to be true.

There are some useful objective tools, as well.

Any presumed professional who provides you investment advice should be registered or licensed. He might fall under either federal or state jurisdiction ' but in almost every circumstance he falls under someone's jurisdiction.

Check to see if he's in the system.

Brokers are generally regulated by FINRA, the Financial Industry Regulatory Authority. Registered investment advisors with more than $25 million in assets are regulated by the Securities and Exchange Commission. Investment professionals regularly disagree about which oversight organization and methodology provides greater investor protection.

The Securities and Exchange Commission website ( has an 'Investor Information' area. From there, you can review certain disclosures from both SEC advisors and FINRA brokers. There is also a useful explanation of what to do when hiring an advisor or broker.

SEC regulated advisors must provide a disclosure document, Form ADV Part II, before beginning work for a client. If you don't receive one, ask why not.

This form reveals certain types of legal problems, if there are any in the advisor's background. If your broker falls under FINRA, he has a different form for this purpose.

There is a good chance that the entire face of investment advisor and broker regulation is likely to change under the new SEC Commissioner, expected to be Mary Schapiro who currently oversees FINRA.

An obvious problem is when an individual operates completely outside the system and simply chooses to ignore all registration and licensing requirements. A check at the SEC or FINRA website will let you know if they are in the system.

Of course, a check of registration is merely a tool; it guarantees nothing. Madoff fell under both SEC and FINRA jurisdictions ' and he ran what appears to be the largest Ponzi scheme of all time.

Many potential Madoff victims used their more intuitive tool ' their noses ' and decided that Madoff's purported returns didn't smell right. Those people still have their money.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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