Bernie Madoff may not have been a New York Mets fan; but the Mets owners’ were huge fans of his. So much so that they had 483 accounts with him. The problem was Bernie Madoff ran the biggest Ponzi scheme in history, with $65 billion in investments. And the Mets’ owners may have to give up the team—not because they lost money, but because they unfairly benefited at the expense of others. Now they’re being asked to pay back.
As an entrepreneur, you’ve achieved success through hard work, savvy investments in your business, and a devoted customer base. So did many of Madoff’s investors. In fact, the very qualities that make business owners successful may make them vulnerable when it comes to financial investments.
It’s easy to get scammed. But if you watch for these eight telltale signs and put in the legwork, you can protect yourself from the Bernie Madoffs of the world.
Step 1: Admit you don’t know everything
Entrepreneurs know the numbers needed to make the business math work and they expect the same of their financial counterparts. While you may know your business—and those of your competitors—don’t assume you know how a completely different line of business works.
Here’s an example from the 1990s. A mutual fund salesperson in Ontario used high-powered seminar speakers to attract investors to his events where he also offered a private placement, a security not listed on the stock exchange, in a business venture called a “bovine limited partnership.” The partnership itself offered favourable tax terms, but to maximize tax advantages and returns, investors were advised to borrow from a bank to increase their investment leverage. The partnership went bust and, in the end, investors lost their capital as well as the tax advantage they’d been counting on to justify the borrowing.
LESSON: You probably don’t know an investment venture inside and out. Before sitting through a seminar, check whether the principals holding them are registered with a regulatory body, and see if they’ve ever been subject to any regulatory actions. To check for registration, go to your provincial securities commission’s website. You can also perform a search for regulatory actions. (See “Do your Homework,”) Always seek further advice from a trusted professional before handing over your money.
Step 2: Work with money managers who understand private investments
Fraud can occur in publicly regulated investments—consider YBM-Magnex, a Russian magnets producer listed on the Toronto Stock Exchange whose board of directors included a former Ontario premier. YBM had failed to disclose that the company’s founder had links to Russian organized crime and was intentionally bilking investors out of $150 million.
Such public frauds are infrequent. They’re much more common in the private investment market.
Private investments come in many forms: hedge funds, real estate limited partnerships, and private equity vehicles. Most are aimed at the institutional market (i.e., pension funds), and some at high-net-worth individuals. They generally depend on a small investor base requiring high minimums to opt in. What’s called the limited or exempt market allows accredited investors to participate in non-advertised ventures, providing they have above average incomes ($200,000 a year) or financial assets of $1 million.
Read: 7 tips to fight fraud
But unlike a mutual fund, which has to go through the costly and rigorous process of filing a prospectus, these investments file only their offering documents, which aren’t required to be exhaustive. And, clients signing up for an exempt offering are required to acknowledge they could lose all of their money—which puts considerable onus on the investor.
LESSON: Private offerings are very intricately structured, so make sure the person handling your financial affairs is familiar with them. Determine if the person you’re dealing with is registered to sell securities, and if he or she has the necessary licensing and experience to handle private investments. Insist he or she informs you about the performance of the investment. If you’re really interested in exempt market investments, most brokerages and mutual fund dealerships have a subsidiary that deals with them. They sell off an approved list of products deemed appropriate for clients. If a product has been offered to you that’s not on the list, that’s a sign the rep you’re dealing with is not on the up and up.