Nooruladha’s Weblog


Investment scam (VC Gold) part 2
July 7, 2009, 11:44 pm
Filed under: Investment Story, Thoughts

I digress a bit, to bring you this expert opinion on Bernie Madoff investment USD65 billion scams. This letter is a part of a mailing list for “Investment U”.

Dear Investment U Reader,

Last week I caused a bit of a controversy on Fox News when I suggested that Bernie Madoff might do more good than harm in the long run.

Don’t get me wrong. Madoff himself was a despicable person. Over a twenty-year period, he created the world’s biggest Ponzi scheme worth an estimated $65 billion. Hundreds of individuals, retirees, and charities were hurt or destroyed by Madoff’s deception.

He deserved to get the maximum penalty (150 years).

Nevertheless, I look at all the positive side effects of the Madoff scandal. Here are the three most valuable lessons we can learn from the biggest crime on Wall Street in a hundred years.

Investigate before you invest

Millions of investors have now learned a powerful lesson. Don’t blindly turn your hard-earned funds over to a money manager just because he promises great returns year in and year out. Be a skeptic about money managers who insist they can beat the market all the time. Make sure the manager has an independent and reliable auditor. Check the monthly statements to make sure there’s no funny business going on.

“Due diligence” finally means something again when it comes to investing.

A corollary is: Manage your own money as much as possible. Use a discount broker and select your own stocks to buy and sell. Get educated by reading books, attending seminars, subscribing to independent newsletters, and asking a lot of questions.

Take responsibility for your actions; don’t blame others for your mistakes.

If you are still uncomfortable managing your own funds, consider investing in publicly traded mutual funds with good track records that you can value daily in the newspaper or online.

Diversify, Diversify, Diversify

I really have little sympathy with individuals or charities that were wiped out by Madoff’s shenanigans. Only the greedy or stupid would invest their entire fortune or foundation’s whole endowment in a single investment.

It’s time to return to fundamentals, specifically, the “prudent man” rule that used to carry some weight on Wall Street and the New York media.

Always diversify so that no single investment can destroy your financial independence.

There is a great deal of virtue in the old proverb, “Don’t put all your eggs in one basket.” From time to time, you hear some guru suggest a modern alternative: “Put all your eggs in one basket –and watch that basket!”

In most cases, it’s a recipe for disaster.

Sure, most entrepreneurs have made it big by concentrating in one particular business, and when they get rich, the wise ones always diversify their surplus wealth – stocks, bonds, real estate, gold, and collectibles. To invest all their wealth with one money manager or in one brokerage account, that is pure foolishness.

Don’t depend on the government to protect you

Government lawyers at the Securities and Exchange Commission (SEC) were hopelessly outwitted by Madoff’s firm. Private financial investigator Harry Markopolos warned the SEC three times about Madoff’s fraudulent activities, but Madoff got a clean bill of health from SEC investigators.

Why?

Because the SEC has a penchant to go after the little guys, such as brokers promoting penny stocks, who are usually willing to settle with a small fine, even when they are innocent. SEC agents are judged primarily by “quantitative metrics” – the number of actions it brings and cases it settles.

Last month the New York Times highlighted the incredible story of a small-time California stockbroker who was investigated by the SEC for promoting a small cap stock.

The broker refused to settle because he knew he had acted ethically within the rules, and didn’t want his good name destroyed with a “consent degree.” Even though he was repeatedly exonerated by the courts, he was left a bitter 72-year old man with $1 million in debt defending himself. “They chose me instead of Bernie Madoff,” he said, and it cost him dearly. (See the June 27, New York Times cover story, “Chasing Small Fry, SEC Let Madoff Get Away.”

On a broader more philosophical basis, the existence of the SEC creates a false sense of security, giving the illusion that somehow the public is protected by the government from frauds, deception and scandal. Now we know better.

Investors must live by the rule, “Caveat emptor.” Let the buyer beware.

Good investing, AEIOU,

Mark

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