Crooks Send Out Monthly Statements, Too

Steven Thel in New York Times, February 25, 2009

Media Source

By DAVID CAY JOHNSTON

During three decades of marketing employee benefit plans in Southern California, Nancy Weil Brown slowly but steadily built up her nest egg. Then she lost a third of it when an investment she made turned out to be something she had not anticipated.

The financial disaster that wrecked her retirement plans could easily happen to anyone, even those, like Ms. Brown, who had tried to understand the fundamentals of investing.

How this middle-class businesswoman, now a career coach, lost more than a decade’s worth of savings to a man she had never heard of is a cautionary tale for all investors. Ms. Brown’s experience shows that getting a statement every month means nothing more than that you own a piece of paper with numbers on it, even if you think you have invested your money with a regulated investment firm.

More broadly, her tale illuminates how, over three decades, spending on the white-collar police — securities, banking and tax investigators — has not kept pace with the rapidly expanding financial sector, leaving a cost borne by all investors. Regulatory agencies now operate under tightened rules that restrict their ability to act, budgets that have shrunk their capacity to investigate, and revisions to regulatory laws that have unraveled parts of the fabric of investor protection.

Because of those frayed threads, billions of dollars have been diverted. And the reduced regulation enables con artists to operate for decades, creating the appearance of stability for their flimsy empires.

The confessed Ponzi schemer Bernard L. Madoff took Ms. Brown’s money. He is just the currently best-known example of what securities monitors say has been a growing problem with con artists, as the nation’s traditional pension plans, which were invested by fund managers and guaranteed a specific benefit, gave way to individual retirement plans that empower people to make their own investment decisions, but also require them to bear all the risk of those choices.

“I know about spending less than you make, diversifying your investments and knowing where you are investing,” Ms. Brown said.

So she sent her money to Jameson Securities, thinking it was part of a registered investment partnership in California, on the recommendation of a certified public accountant known to her family. Jameson, though, turned out to be just a name used by Stanley Chais, of Beverly Hills, Calif., for some of the bundles of money he had sent to Mr. Madoff. Mr. Chais has said that he, too, is a Madoff victim, and no charges have been brought against him.

And while Jameson is not a registered firm, Bernard L. Madoff Investment Securities is. Every quarter Ms. Brown received statements showing her investment and her returns, which were modest when the market was down and significant when the market was up. Only a few weeks ago, she learned that Jameson, which has collapsed, had placed her money, through an intermediary, with Mr. Madoff.

“I don’t think it matters if you do know your statement is legitimate, because with an operation like Madoff it would have made no difference,” said Lauren E. Willis, who teaches consumer law at Loyola Law School in Los Angeles, adding, “How can Ms. Brown or anyone possibly know” that their money is invested as it says on the statement?

Some steps that Ms. Brown followed reflect the advice of experts. For starters, she sent her money to an institution, not to an individual, or at least so she thought. Investors “should never make checks payable to an adviser; always make them payable to the custodian,” said Larry Hughes, executive director of BNY Mellon Wealth Management in Boston. If an adviser asks that a check be made out to him personally, Mr. Hughes said, walk away immediately.

Steven Thel, who teaches securities law at Fordham University, recommends going one step further. Many smaller brokerage firms do not clear their own trading accounts, but use a larger firm for that work. “Always make a check out to the clearing firm; that one does the actual trades,” he said.

This is a caution that Ms. Brown — like a great many other investors — did not take; she sent her money electronically to Jameson. Investors should also make sure that their monthly statements come directly from the investment firm, not from their advisers. Among the red flags: statements on personal stationery, statements that list offshore banks as the repository of funds or, as happened to Ms. Brown, statements that come from an accounting firm.

“I had no idea I should question why a statement came from a certified public accounting firm, and why would I — or anyone else?” Ms. Brown said. More broadly, no statement should be trusted at face value, said Thomas W. Joo, a professor of securities law at the University of California, Davis, who has written about the adequacy of investor safeguards.

“There is no way to know a statement is not fraudulent,” Professor Joo said. He said investors should check their statements immediately and closely, just as they should check each item on credit card and checking account statements. Any item that looks out of place or that the investor does not recall should prompt a call to the institution, he said.

“If you do not act as soon as you get such a statement, the courts will ask, Why were you dumb enough to believe that was a legitimate statement of your account?” Professor Joo said. Failure to act swiftly could wipe out any chance of recovery in litigation.

The safest way to check statements received electronically is to type the Web address of the firm into your browser and think about whether it makes sense (for instance, does it originate abroad?), rather than copying what may be a fraudulent address from an e-mail message.

Calling the firm to inquire about the Web addresses it uses is also a good idea. And the number called should be obtained independently, not from the statement itself. An Internet search or a call to directory information should yield the number.

Tamar Frankel, who teaches securities law at Boston University School of Law, suggested two basic steps to reduce the risk of being taken in an investment scam.

You should be asking yourself, “Is my money with a registered investment company or mutual fund?” she said, because if it is, the risk of being scammed is very small, and “if employees are pilfering, the firm will have insurance.”

Her second point: “Because we have such a mishmash of regulation, unless you are dealing with a big-name mutual fund you should ask for a statement from the bank that is the custodian” of the securities.

Adding to Ms. Brown’s injury was her tax situation. When she realized she was a victim of fraud and tried to determine the tax consequences, she found that the Internal Revenue Service offered virtually no guidance on how to treat such situations.

What about the taxes you paid on what you thought were capital gains and dividends? And when can you take your losses, and how, on your tax return?

Howard Bartnof, a lawyer in Tarzana, Calif., to whom Ms. Brown turned for help — and who represents other Madoff victims — said it was not even clear that Madoff investors had, for tax purposes, lost money. The authorities have not declared accounts with Madoff to be worthless.

“When do you recognize a loss?” he asked. If your investment turns out to be fraudulent, it poses a series of subtle and complicated tax questions about what kind of loss it is and when you can declare it on your tax return. The authorities typically are of little help.

Without I.R.S. guidance, Mr. Bartnof said, different people will end up with different results because of differing advice, and the I.R.S. will waste audit resources to pursue people trying to comply with uncertain tax laws.

The I.R.S. has not issued any guidance to Madoff investors and none is planned, said a spokesman, Bruce I. Friedland. He said they should consult their tax advisers.

I.R.S. Publication 547 explains how to report fraud losses and Publication 550 deals with investment losses.

Essentially, while understanding financial principles is useful, it is far from adequate to protect investors.

“The overwhelming evidence is that most people make serious investment mistakes, which is why they should put their money into index funds and bond funds with low costs,” said Professor Thel, “and not spend too much of their time trying to become financially literate.”