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How to Avoid Bernie Madoff Situations Thumbnail

How to Avoid Bernie Madoff Situations

Tim stresses the importance of separating a financial advisor's custodian from their own firm to prevent conflicts of interest and ensure investor protection. See why we feel that smaller, fiduciary firms like Eagle Ridge Wealth Advisors provide better service and improved safety of assets due to the separation.

In a previous video, I explained what a financial custodian is and why we’ve chosen to partner with Altruist.

In this video, I’ll explain why checks and balances between Registered Investment Advisors (RIAs) and custodians are key no matter who you choose to use as an advisor.

A strong argument could be made that it would greatly benefit you to be sure that your custodian is not only separate from the RIA or advisor that you use, but also that the firm you use has no ownership or control over your custodian.  

Bernie Madoff Scandal

Why, you ask? Well, have you ever heard of BERNIE MADOFF? He had the largest Ponzi scheme in history until 2008 and 2009.  

As Warren Buffett likes to say: You never know who’s swimming naked until the tide goes out. Well, the tide went out in 2008 and Madoff went down.

How did he get away with it? Well, his entire scheme appeared legitimate because he controlled the company that served as his custodian. So, he could move money around whenever he wanted, including into his own pocket, and of course, he did. He could also fabricate statements from his custodian which allowed him to fleece some of the wealthiest people on the planet.  

His clients did not have the proper checks and balances that investors should insist on! But how would you know this? Well, now you know because you’ve tuned in here to educate and inform yourself.

Downsides of Large Firms

Now, the large Wall Street firms also serve as their own custodians. And as I mentioned before, a strong argument can be made, that the best way to safeguard your nest egg is to work with a financial planner or investment advisor who has a custodial relationship with a separate, well-established custodian. This way you can usually get better service and enjoy improved safety of your assets.

However, many consumers don’t understand the importance of this separation and prefer to keep their assets at the large Wall Street firms – which notoriously and historically have sales cultures driven by multi-million-dollar bonuses for their brokerage sales agents, which benefit the firms and brokers at the expense of their clients. 

And they are not fiduciaries, so they are not legally bound to put their clients’ interests over their own. And the firm BrokerCheck reports, which are reports of unethical or illegal activity by advisors, read more like rap sheets than profiles. 

If you would like to see for yourself, simply go to the second box on the BrokerCheck website and type any large, old, famous brokerage firm name into the box– and you’ll get hundreds of thousands of listings of specific broker transgressions, fines, and examples where customers received arbitration awards after various kinds of financial abuse.

The reason, of course, is that many people feel safer keeping their assets at a very large firm that they have heard of, rather than a smaller financial planning firm, even if that smaller firm often provides more customized service and has renounced predatory sales activities by being a fiduciary firm, like mine.

The problem is, that the large firms with the stadium naming rights, and fancy ivory towers, and all their grandfathered money, are generally a false comfort. Your funds are probably safer with the smaller planning firm than with the larger multinational firm.

It seems these large Wall Street firms run into trouble about every 10-20 years or so. They lobby to get rules changed, then they incentivize their salespeople to take more risks with clients' money, and the next thing you know, we’re having another 2008 or 2009. Then the politicians crack down with regulations for a while, then down the road a bit, Wall Street lobbies to loosen the rules, and rinse and repeat. 

The collateralized debt obligations (CDOs) and credit default swaps (which are basically highly leveraged tools) are what helped lead to the 2008 and 2009 Great Recession, and they were sold and propagated by the same, old, large, well known, Wall Street branded firms! So, the distrust of the large Wall Street institutions is not without merit.  They pretty much earned it.

Bottom Line

Having custody at an established and insured institution, but also being separate from that institution, is a very strong check and balance that should not be taken lightly. After all, incentives are what drive human behavior.

This setup, the separation of custodian and advisor, means a firm has no direct access to your money, and therefore cannot take it out or otherwise steal or misplace it. As I mentioned before, this is how I want it, as much as you want it, because I don’t want any extra liability.  

A CERTIFIED financial planner™ professional can help you plan for your retirement. Schedule a call today so we can talk about your situation. 

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