Avoiding malfeasances requires work

By DAVID MOON, Moon Capital Management, LLC
January 22, 2012

Jon Corzine has been a US Senator, member of the Senate banking committee and governor of New Jersey. He was CEO of Goldman Sachs and is said to have made $400 million when the company came public in 1999.

And now his company is accused of misusing, misappropriating or losing $1.2 billion of client money.

If you can’t trust a governor, senator and head of Goldman, whom can you trust?

Well, don’t answer that.

The National Association of Securities Dealers (the predecessor organization to the Financial Industry Regulatory Authority) was the group charged with regulating stockbrokers and brokerage firms. The Chairman of the group that regulates brokers should be trustworthy, shouldn’t he?

That was Bernie Madoff.

Former Georgia football coach Jim Donnan convinced his friends to invest into what now seems to have been a Ponzi scheme that netted Donnan millions. Coach Donnan abandoned a proposed settlement with creditors and investors after filing for personal bankruptcy.

It’s easy to assume that everyone associated with the investment industry is a crook. Wrong. That is a simple conclusion about a not-so-simple issue. Very few situations are as clear as Madoff’s. Seldom does $1.2 trillion seem to disappear into thin air.

Most malfeasances in our industry are marginal. They are small and seemingly benign. They aren’t noticed for years, if at all. And often the perpetrator is peddling something so complex and magnificently marketed that even he may not understand how wrong it is.

A gentleman asked me to review a fairly common type of packaged investment product that a friend from his church was selling. The gentleman thought this annuity would provide him a guaranteed eight percent income for life.

Sounded pretty darn good. The materials were certainly pretty.

Pay little attention to colorful pictures and graphs printed on the expensive paper. Read the little bitty words printed on onion paper.

The fine print about this product revealed it wasn’t an eight percent annual income; it was an eight percent annual increase in income. And the income wasn’t even based on the original investment amount; it was based on some contrived number that required a rocket scientist to calculate. The footnotes to these documents detailed that over the previous 20 years the underlying investments in this product earned almost six percent annually, while the net return to the investor would have been negative 0.17 percent.

There are thousands more situations like this than there are Bernie Madoff’s. Madoff was an off-course airplane that flew directly into the side of a mountain. This kind of annuity is more like an off-course airplane that flies in circles burning fuel for decades, eventually landing safely – but at the wrong destination.

Avoiding these more common malfeasances is simple, but requires work. Read the fine print of any investment you consider. Go to www.sec.gov and check the background of any firm or advisor you are considering hiring. One friend, about to recently make a significant investment with a large, out-of-state advisory firm, went to the SEC website and found a lengthy history of criminal and civil wrongdoings at the firm.

But their sales brochures were pretty.

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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