From the August 01, 2011 issue of Futures Magazine • Subscribe!

Can you spot a fraud?

Who to turn to?

What could an investor have done to protect himself against Madoff or Heim?

For about 8,000 Madoff investors who invested directly with Madoff Investment Securities, a broker/dealer, they were protected by SIPC (Securities Investor Protection Corporation), "a special reserve fund mandated by Congress to protect the customers of insolvent brokerage firms," for up to $500,000 per account. But 30% to 50% of Madoff investors, the so-called "feeder-accounts," were not covered by SIPC and never knew they had lost money with Madoff until the firm they had originally invested with notified them. One such firm was The Fairfield Greenwich Group, which poured billions into Madoff’s Ponzi scheme. As a consequence of the Madoff failure, Fairfield’s investors suffered huge losses.

With U.S. Gold and Silver, Heim was not required to register with SIPC or any regulatory agency, just the State of Oregon via a standard business license. The only recourse Heim’s investors could have taken was to have insured their hard assets via a private insurance company the same way they might have insured jewelry or valuable paintings. Investors also could have taken possession of the coins early during a period in which Heim was solvent.

Because some of the Heim investors believed their "contracts" with Heim might have been "securitized," because the contracts were issued serially, they filed complaints with the Securities and Exchange Commission (SEC) hoping to open a path to restitution. But the primary responsibility of the SEC is "enforcement," not asset retrieval. In addition, the agency is highly secretive and is not in the information-sharing business. In fact, if a small investor files a complaint with the SEC, the securities "watchdog" will not contact the investor to reveal how an investigation might be progressing.

We similarly were underwhelmed after calls to the Federal Trade Commission (FTC), whose "principal mission is the promotion of consumer protection." We were left with the distinct impression that the FTC was not interested in investigating such acts as the transporting of gold and silver coins across state lines.

Of the federal agencies we contacted, the FBI and the U.S. Attorney’s Office in Portland proved to be the most helpful.

The Financial Industry Regulatory Authority (Finra) has put together a profile of an "average" fraud victim (see "If you can’t spot the sucker…"). It also provided links to white papers on fraud named: "Psychology of a scam" and "How to protect yourself through asking and checking".

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The National Futures Association (NFA) booklet "Scams and swindles," is a guide on avoiding investment fraud. Also, any futures broker commodity trading advisor or commodity pool operator is required (with few exemptions that must be noted) to be registered with the NFA. You can look them up on the NFA’s Background Affiliation Status Information Center (BASIC). BASIC is a web-based system that allows individuals to check the registration status and disciplinary history of every firm and individual registered to conduct futures trading business with the investing public. NFA also puts out "investor alerts" that highlights changes in regulation, potential types of fraud and best practices that your broker/investment advisor should be carrying out. It also provides a list of the resources provided by other regulators (links to these due diligence tools are provided at futuresmag.com/duediligence).

These preventative measures are very important because it is difficult to catch fraudsters and gain restitution once you are separated from your money. In addition, even if an agency provides some help, investor and agency objectives eventually could be in conflict. For example, while it is the objective of the FBI to gain evidence that could result in a criminal indictment via the U.S. Attorney, possible jail time and perhaps a large financial penalty for a defendant, it is not the primary responsibility of the FBI to disburse discovered assets.

In a nutshell, small investors need to do their own due diligence.

Only certain asset classes, like stocks and bonds, offer protection while providing investors some recourse, like arbitration or SIPC. Other classes like physical precious metals have little or no protection.

Also, while a small investor can seek redress through civil action in court, the choice can prove costly, even if assets are discovered and recovered. Federal agencies ultimately took notice of Madoff because his crime was too large to ignore. There also was a very large agency "embarrassment" factor in play that some might say has yet to be erased. For the Heim investors, it remains to be seen what, if any, assets will be discovered during the investigation and if investors ever will recoup lost funds through legal channels.

While there are numerous types of fraud and they continue to grow, there are some best practices that will help you not only avoid fraud, but also the merely unscrupulous or incompetent in the investment world.

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