Not Glamourous, But Important

A few months ago, I was watching Netflix and came across a series on the Madoff scandal, which happened in 2008. It included several episodes related to one of the most elaborate financial scams in the history of our country. I must admit, I was amazed by the complexity of what was done and how they were able to continue it for so long. The scandal involved investors worldwide, trading at the most intimate levels of our securities network on the “legitimate” side of their business, as well as regulators being notified over a long period of time. Yet, it proceeded for many years. After watching it, I remember thinking that as someone who understands the system, abides by the rules, and has dedicated their life to trusting what is supposed to work on behalf of the individual investor, I had been let down. However, somewhere into the final episodes, I was given a nugget of information that allowed me to see the key to just how it happened, as well as comfort in how we manage money for our clients that prevents this from ever occurring.

Almost in passing, it was mentioned in the episode that the way things were built was that there was one account set up by the Madoff family that was held at an investment firm. So, let’s say they had one billion dollars held at XYZ firm. It was all lumped together, and then Madoff “falsely” segregated the accounts on their side. This allowed them the opportunity to make statements on their client’s behalf, send out information with whatever they wanted, etc. No one knew what was going on at the holding firm because it was just one large account. The thing is, this is a common way to custody funds in our industry. One piece of info I found interesting is that Madoff never invested one penny of their investor’s assets. All of the trades on statements were manufactured, and the cash was simply used at their discretion all along the way.

Here’s the important part. The way we work with the custodian that we entrust to our clients’ money operates in a much different manner. First, they maintain custody of all clients’ assets, not any other outside firm. Also, they do not commingle the client’s assets in a pooled account but hold them individually in specific client names. In addition, our custodian cannot pledge, lend, or margin client assets held in its custody. In addition, they hold Errors and Omissions professional liability policies as well as a fidelity bond which ensures against things like forgery, counterfeit currency, etc. I remember a story they told years ago when we started working with them that they had actually looked into Madoff and their company. They said they would not open their books and show them what they required as part of their due diligence process, so they passed.

It’s a complex world out there. Much of what we do is centered on developing relationships with people, helping them determine their financial path, and building a plan for it. However, eventually, the money must go somewhere and be a central part of an integrated plan. We are happy to report that the custodian we have chosen to partner with has built a strong foundation in client custody, and we wanted to share this. Not super glamorous, but extremely important.

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