Top Ten Ways to Spot Financial Fraud

06/06/2009 05:12 am ET | Updated May 25, 2011

I just re-read Harry Markopolis' 2005 submission to the SEC. With a fisherman's precision, he guts Bernie Madoff. He slits the Ponzi scheme down the center and lays bare the innards.


His language is crisp. The numbers are easy to follow. And as Markopolis fillets "split-strike conversion" strategies, there are no metaphorical references to scales, roe, or other kinds of fish gak. There's only the damning evidence of his exposé.

Few of us share Markopolis' expertise. With his special skills--an insider's knowledge of puts, calls, and OTC derivatives--he first smelled the Madoff rot in 1999. It makes me wonder:

How can the rest of us avoid con artists?

With this question in mind, I offer the "Top Ten Ways to Spot Financial Fraud." The list won't make Letterman. But the purpose isn't to be funny. It's to help you identify the bad guys through "touch and feel" rather than in-depth knowledge of the capital markets.

These observations stem from my career in wealth management. I also conducted extensive research while writing my novel, Top Producer. The ten are by no means a fail-safe mechanism for detecting fraud. But review the list, and you'll ask the right questions.

1. Absolute Control Over Financial Statements

Con artists must control the flow of financial information. Otherwise, Madoff and his ilk could never lure victims with the promise of 12 percent returns, year in, year out. They could never hide accounts, empty of all value.

Custodial banks--State Street or The Bank of New York Mellon--make it possible to separate the reporting function from money management. As a wealth adviser, I arranged for clients to receive monthly statements from custodians. These reports served as a check and balance to the financial statements sent by money managers.

Two sets of financial statements are atypical. You'll encounter resistance from legitimate money managers, particularly those who commingle assets like hedge funds. But ask anyway. Your bargaining position is strong. Money managers are fighting to keep their clients. See my post, Beating Bernie, for more details.

2. "Black Box" Money Management

"It's proprietary."

"It's complicated."

Those two responses are siren calls to grab your wallet and run. If you can't explain a money manager's strategy--in simple, jargon-free language--don't make the investment.

3. Uniformly Happy Clients


Where there's money, there's conflict. I founded to pose solutions to the inevitable friction that accompanies wealth management. Not everybody is a happy camper.

The reason is simple. Investment returns are erratic. Volatility leads to angst, which leads to conflict between adviser and client. Prior to Thursday, December 11, 2008, Bernie Madoff's clients were all happy.

No wonder. Madoff seldom showed monthly losses. There were only seven, for example, in the 14.5 years leading up to Markopolis' 2005 testimony.

4. Philanthropic Largesse

There's nothing like large donations to buy respectability. Crooks find prospects on the rubber chicken circuit. Did you meet your money manager at a charity function?

5. Studio 54 Sales Pitch

There's an air of exclusivity to financial frauds. Ponzi artists are masters of the anti-pitch. They understand our aversion to the word, "No." They understand the humiliation of waiting in line while others enter the club.

"We don't accept just anybody's money."

6. Big Lifestyles

Need I say more?

What is it about yachts? Madoff and alleged Ponzi artist, Allen Stanford, owned huge luxury yachts. Even Charles Ponzi, the crown prince of fraud, fantasized about ships. His dream was to buy a destroyer out of retirement from the US Navy and turn it into a floating mall--complete with banking services.

7. Presence of Legitimate People

Given the trappings of success, it's no surprise fraudsters mingle with legitimate people. Nor am I the first to notice. J.K. Galbraith, according to The Economist, observed a "disastrous interdependence between man and crook" back in 1961.

8. Lies About Background

Con men often exaggerate their education or work experience. See the attached story about alleged fraudster, Danny Pang.

Insist on background checks. They're simple, easy, and relatively inexpensive. They will expose a surprising number of would-be crooks.

9. Style Drift

In the first half of this decade, a Greenwich hedge fund blew up amid allegations of fraud. The manager purported to focus on value stocks. Court records show, however, he also produced and financed a full-length motion picture.

No surprise, his movie bombed at the box office.

Fraudsters make risky bets, I believe, to buy their way out of trouble. When long-shots hit, they can return capital to investors and get going again.

10. Neat Freaks

Everything in its place.

Madoff's sense of order was legendary. He probably arrived at the office early just to run the vacuum cleaner. Other cons are similarly fastidious. The reason, I think, is a function of lies. If you're telling different things to different people, it helps to limit other complexities. You need to reserve your mental energy to remember who's who.

When it comes to fraud, there's nothing sacred about the number ten. This is Acrimoney, not Letterman. Can you think of other techniques?

Comment, and please share your thoughts.

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