It looks like the oldest trick in the book was used to allegedly bilk wealthy investors, banks, charities, endowments, and hedge funds out of their money. How could sophisticated investors have been duped by what could potentially be the largest Ponzi scheme in U.S. history? The answer may center on their due diligence prior to signing up with the investment firm run by Bernard Madoff, accused of masterminding the massive fraud.
Due diligence is the rigorous process undertaken to evaluate the controls, credibility, and capabilities of an investment firm prior to putting money at risk. This process doesn’t stop once a money manager is chosen, but continues over the life of the relationship. The $50 billion in reported losses and the fact that this scheme went undetected for so long are stark reminders that there is no substitute for solid investor due diligence and ongoing monitoring. Unfortunately, it has taken a down market to expose such fraud.
The following are 10 steps to help to reduce the chance of fraud. (Note: Until a human fraud meter is perfected, such risk can never be completely eliminated.)
1. Find a great money manager not a great friend.
Make sure the candidate pool is based on professional reputation, capabilities, investment track record, size of audit firm, and level of overall risk controls. Deciding on the right money manager should be a pure business decision. Confusing this business relationship with friendship or a person’s golfing handicap can cloud sound judgment.