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Trust But Verify

By: Frank Armstrong

By: Frank Armstrong, CFP, AIFA

For those of you who dont remember Ronald Reagan, this was one of his favorite themes while negotiating the IMF Treaty finally concluded with the Soviet Union in 1987. He mentioned it so many times that Mikhail Gorbachev complained, “You repeat this phrase every time we meet,” to which Reagan answered “I like it.” A few years later, Soviet Colonels in full uniform watched as B-52s and ICBMs were chopped into little pieces, while American Colonels watched the same procedures on Russian Bear Bombers and their ICBMs. It is one thing to have the Soviets say they destroyed a nuclear capable weapons system, and entirely another to actually see it happen.

Investors should adopt the same standard. Trust is important when dealing with a financial advisor, but blind trust can be abused. A prudent verification process is essential. Investors ignore that at their peril.

The Greatest Con Man of All Time

Bernie Madoff, the man has rocketed from relative obscurity to worldwide recognition. He has gotten more press than Madonna and Paris Hilton combined. Suddenly Madoff is the face of the catastrophic failure of the regulatory system, and the personification of the rot on Wall Street.

How could he have pulled this scam off? We are all fascinated with the question. We must say that he is one clever devil. But, he never could have succeeded had not investors ignored normal business checks and balances. Madoff did it all. He was the investment advisor, broker-dealer, custodian, and claimed to execute the trades at an overseas brokerage. None of this was verifiable by an outside party. He simply printed up phony statements supposedly audited by a one man accounting firm operating out of a strip mall. This incredible charade went on for more than a full generation.

Unfortunately, Madoff tainted the atmosphere in an already poisonous environment. At this point, many investors are so badly burned that they wouldnt believe their own mothers. Re-establishing trust may be difficult in the post Madoff world. But verification should be simple.

Checks and Balances

How can investors prevent themselves from being taken by another Ponzi scheme? How can they prevent their advisors from simply stealing their money? After all, Madoff wasnt the first, and I can promise you he wont be the last.

Investor Solutions has adopted a very straight forward business model that facilitates prudent checks and balances to protect investors. We appreciate their trust, but provide for simple and full verification.

The structure includes fire-walls between the advisor and the funds because all assets are held by independent third party custodians. We never keep a single penny of client assets. The client owns the investment account at one of several of Americas premier custodians. Investor Solutions simply manages the account under a limited power of attorney granted by the client. That limited power of attorney allows Investor Solutions to execute trades on behalf of the client. But the custodian will never disburse funds to any party other than the client in an identically titled account without the clients written permission. So, with the exception of debiting fees if you give us permission, we cant access the funds in your account.

The custodian reports directly to the client in a statement at least monthly. This statement includes opening and closing balances, all positions, all transactions, closing share prices and all fees paid from the account. These reports should reconcile to the penny with reports prepared by Investor Solutions. Additionally, each custodian maintains a web site with password protected access which allows for 24/7 access to all account details.

The custodians are all regulated by the SEC and FINRA, audited by a nationally recognized accounting firm, and each account is protected for loss of securities by a combination of SIPC insurance and commercial excess Securities Investor Protection Corporation (SIPC).

Note: SIPC does not protect against market value changes. For a complete description of their coverage, see their site, www.sipc.org. For a complete description of the custodians excess coverage, see their individual sites.

The custodians in turn open accounts with and purchase shares of the mutual fund families we select, or purchase shares of Exchange Traded Funds (ETFs) on the open market.

The assets of those funds in turn are held by a custodian / trust company which hold them in separate accounts. They are not assets of the fund manager, nor of the custodian. Additionally, they execute trades, compute Net Asset Values (NAV), calculate distributions and perform other administrative duties for the funds. They are regulated by the SEC and bank authorities and audited by major national accounting firms.

Because all funds are held in separate accounts and segregated from the various managers control, a business failure of the Investment Advisor, Custodian, Bank Trust Company, Mutual Fund Manager, or ETF issuer should have no material effect on the account values for the client.

Additionally, clients should take comfort that our investment policy restricts our investments to fully liquid, SEC registered, widely quoted, funds that are marked to market every day. We are unaware of any more transparent investment strategy.

Summary

Post Madoff, clients should take comfort that their accounts at Investor Solutions are held by independent third party custodians, properly regulated and audited. Firewalls prevent the transfer of these funds away from the custodian.

Now more than ever clients must trust but verify. We appreciate your trust, but facilitate your verification. As always, call us with your questions, comments, or concerns. We are here for you.