In the span of just a few days, cryptocurrency exchange FTX, the world’s third largest cryptocurrency exchange with more than 1 million users, filed for Chapter 11 bankruptcy. A few days later, cryptocurrency lender BlockFi announced that it was “not able to do business as usual” and paused client withdrawals as a result of FTX’s implosion. Then the lending arm of crypto investment bank Genesis Global Trading announced it was pausing new loan originations and redemptions.
The FTX fiasco is reminiscent of Bernie Madoff, the mastermind of the biggest investment fraud in history after he defrauded more than 40,000 people of over $65 billion. Considered by many to be the archfiend of the financial world, his Ponzi scheme will haunt the financial industry for years and the FTX debacle is resurrecting some of the same fears in the minds of investors and regulators.
The epic Ponzi scheme Madoff ran and the spectacular collapse of FTX both underscore a harsh reality:
Many folks don’t understand how investment firms operate, what they are invested in, and not sure what to look out for.
It’s important for investors to understand:
- Madoff was custodian for his clients’ assets, which means there was no separation between church and state, a big red flag.
- Madoff also generated his own statements for clients, which were major works of fiction. Clients need to have their money at a third-party custodian, which generates independent statements.
- And it is vital for investors to understand what a custodian does and assure clients that we don’t hold or take custody of their money.
So how do you make sure you don’t run into the next Bernie Madoff or FTX?
One way is to assure that your advisor does not oversee every part of your investing.
Here are four questions to ask your advisor:
- Who is selecting my securities and who is executing my trades?
- Who is keeping custody of my assets?
- Who is generating and providing monthly statements?
- Who is verifying my performance?
Madoff controlled the first 3 exclusively. And for the 4th, he was able to find a small outside auditor to help him with his scam and sign off on the phony returns. Your advisor might be selecting securities for you but listen carefully to how they answer the next three questions.
Do Your Homework
Investors need to ask lots of questions and if anything doesn’t feel right, or your advisor balks at your 4 questions, or doesn’t want to provide you with their Form ADV…don’t walk away. Run.
-Paul R. Rossi, CFA