Did Madoff investors overlook the obvious?

Signs point to safeguards being ignored - and safeguards prevent pyramid schemes, advisers say

The list of victims who lost money in Bernard L. Madoff's alleged $50 billion Ponzi scheme reads like a who's who of the financially savvy. As people study the names, however, many are asking a basic question: If all those supposedly sophisticated investors got so badly fleeced, how can I possibly protect myself against such scams?

"Some people got fooled who shouldn't have gotten fooled," says fee-only investment adviser Rick Miller of Sensible Financial Planning in Cambridge. Given a list of victims that includes banks, insurance companies, pension funds, and investment firms, there's a strong indication that many investors weren't doing enough due diligence, he says.

The full details of Madoff's operations aren't yet known. By his own admission, Madoff produced his consistently good returns by paying existing clients with money deposited by newer investors. He allegedly kept multiple sets of books, generated his own statements, and hid his activities from regulators for decades.

So how can investors avoid being conned? In vestment advisers say it's all about following the basic rules of investing.

"There should be no secrets to this business," says Michael Kozak, director of wealth management at Cabot Money Management Inc., in Salem. "It should all be very transparent."

Financial advisers say that if you can't figure out how your money is invested or why your investments are producing the returns they're getting, it's time to ask questions. Remember, it's important to build safeguards into any investing relationship. Investors, however, must be willing to do their homework and take responsibility for monitoring their portfolios. Those who take the time to get answers to the following questions will be less likely to get taken.

Legitimate money managers and investment advisers never want to actually handle your money. They simply want to have the authority to trade your accounts. To protect themselves and their investors, they use banks, mutual funds, or brokerage firms as independent custodians. That means your initial check should not be made out to your manager, but rather to an account in your name at the custodial firm where your funds are being deposited.

"That way, the adviser can't walk off with the money," says fee-only adviser Thomas McFarland, of Darrow Co. in Concord.

Investors who ignore the protections offered by independent custodial accounts do so at their peril.

Anyone with a computer can print an account statement, so make sure your custodian is a well-known and respected firm. Boston-area advisers commonly use Schwab, Fidelity, or TD Ameritrade. If you've never heard of the custodian used by your adviser or money manager, check it out before you write the check. One resource is the Financial Industry Regulatory Authority, which provides a BrokerCheck tool at www.finra.org/Investors/index.htm, its website.

Since Madoff didn't use custodial accounts, investors had no way to independently verify that the numbers on Madoff's statements reflected actual performance. If you are getting statements from both your manager and your custodian, it's easy to compare the activity on both sets of reports, says Cheryl Costa, managing director at AFW Wealth Advisers in Natick. If you find any discrepancies, don't hesitate to contact the custodian directly.

Your money manager will need a limited power of attorney in order to trade in your custodial account, says McFarland. That authority shouldn't allow the adviser to take money out of your account, except to cover fees. "If we authorize a check, it would have to go to your home," he explains.

If you can't get an appointment to sit down with your adviser, there's cause to worry, says Costa, noting that reports indicate many of Madoff's clients never actually got such sit-downs. "You should be meeting with someone from the firm, asking, 'What is it that I am invested in?' " she says. "Then, in your own mind, just make sure that it makes sense."

Madoff allegedly attracted clients by offering steady returns of about 10 to 14 percent, regardless of market conditions. "But if someone is telling you you're making 10 percent and everyone else is down 40 percent, that is really a red flag," says Cabot's Kozak. "You can't turn a blind eye to unrealistic returns."

Madoff registered as an investment adviser with the Securities and Exchange Commission in 2006. Checking out his SEC registration after that date might have done little to alert investors of potential problems. Nonetheless, it's a good idea to get as much information as possible about any firm that is going to manage your money.

Get recommendations from friends and colleagues, but don't stop there. Check out the firm using fraud-protection guidelines such as those provided by FINRA. Review SEC and other regulatory filings. Take advantage of tools offered by the National Association of Personal Financial Advisers; there's a seven-page questionnaire on the NAPFA.org website you can use when interviewing prospective advisers.

Using the checks and balances outlined above will make it tougher for investment advisers to help themselves to your money, but it won't do anything to protect you from the damage done by bad financial advice. Still, says Kozak, going through the process is a good first step.

"If an adviser is organized from a compliance standpoint, there's a good chance that he or she will be able to develop an organized and systematic approach for managing your money," he says.