From the November 01, 2012 issue of Futures Magazine • Subscribe!

Spotting broker red flags

Anecdotal red flags

Another red flag perhaps should focus not on the brokerage firm, but on introspection. Boston University Professor Tamar Frankel has studied hundreds of frauds and schemes. Her research has concentrated not just on the scheme and schemer, but also on the gullibility of the victims. She says, “Many con artists make it seem that they are limiting access to their investments, making them available only to a select few. Now, rationally, why would a money manager do that?” 

Good question, but Madoff, in particular, used this approach. 

We now know that balance sheet and bank balance fraud can be hidden from the self-regulatory organizations (SROs). So with the benefit of hindsight, perhaps we need to be on the watch for grandiose actions of the CEO or chairman. New expensive headquarters can be a red flag as well, particularly when they can’t be justified by growth in business and or profits, as was the case with PFG’s fancy green Iowa headquarters. This bit of conventional wisdom extends to the castles the CEO may be building in his or her mind. Jon Corzine seemed set on recreating Goldman Sachs at MF Global and publicized those plans widely, including here in Futures

Some internet-sleuthing on PFG’s Russell Wasendorf Sr. would have revealed his firm defaulted on the terms of state loans used to build PFG’s new $18 million headquarters in Cedar Falls. Here was a man who owned a private jet, opened restaurants and engaged in activities to portray himself as a grand philanthropist, yet couldn’t pay his rent. 

A web search on Corzine would have revealed a man whose ego and hubris were perhaps a bit too over the top. 

Bernie Madoff was a quiet man but he was the exception. SEC and CFTC records are filled with investment advisors who seemingly came up from nowhere, suddenly driving the most expensive cars, buying the most expensive homes and contributing the most to high society charity events. Eventually their Ponzi schemes fall apart and their wealth is discovered to come, not from trading, but from the funds handed over to them by unsuspecting investors. A lavish and flashy lifestyle can be another subjective red flag. If a Google search of your advisor comes up with more hits on society pages than financial articles, it should raise suspicion. A hubris test could be used as a subjective counterbalance to more traditional financial ratio tests.

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About the Author
Larry Schneider

Larry Schneider has worked in the futures industry for 40 years. He is now a consultant on education, ethics and training matters, and teaches courses for the New York Institute of Finance in Chicago.

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