Spotting Fraud

“One due diligence test, which requires little technical skill, is to consider the basic premise that if this money manager was so truly exceptional, why aren’t they already extremely wealthy?”


The famous criminal, Willie Sutton, was once asked why he robbed banks, and his response was simple and humorous: “Because that’s where the money is!” It should be no surprise that the money management business has its fair share of Willie Suttons seeking to take advantage of unsuspecting investors. There are, however, some common features of corrupt investment schemes that can serve as a warning of possible fraud.

First, and perhaps most obvious, is that any scheme which involves placing money in a money manager’s personal account is likely fraudulent. A good rule is to only invest money through the account of an independent custodian, such as Schwab or another institutional broker or bank. Reserve your investing dollars for programs where the value of your assets is calculated and reported to you directly and not by the investment manager.

In a similar vein, all investment products should be audited, either by a reputable auditing firm or by the independent custodian. Transparency and neutral oversight should be mandatory to ensure asset accounting is done correctly. Solo, unregistered money managers should be avoided.

The Willie Suttons of money management are often charismatic, personable characters who seek wealthy social networks and enjoy referrals from friends or acquaintances unknowingly caught up in
the fraudulent program. Endorsements from friends who lack technical financial skills should be appreciated, but not necessarily heeded.

Counterfeit schemes typically have spectacular performance, with “guaranteed” returns that appear to generate month-over-month appreciation and income without any material losses. The deceptive pitch probably includes the promise of monthly liquidity, no leverage, and frequent small distributions with no estimate for return of capital.

The “too good to be true” program often involves a unique strategy that the money manager has

“Too Good to be True” Numbers

JanFebMarAprMayJunJulAugSeptOctNovDecYTD
Year 10.91.11.20.81.00.91.11.30.70.80.91.212.2%
Year 21.21.30.50.90.71.31.21.10.90.60.50.911.5%
Year 30.60.90.91.21.01.00.81.31.40.80.70.610.9%
Year 41.31.20.71.01.10.90.91.11.31.00.80.812.8%

discovered and that they alone know how to execute. When questioned, they explain that the investment program is too complex and proprietary for a layperson to understand. The operator is seldom registered with the Securities and Exchange Commission and usually fails to disclose any past regulatory or criminal infractions. Unsuspecting investors often don’t know how to conduct proper due diligence, which involves an understanding of the industry and methods to check the validity of investment proposals.

One due diligence test, which requires little technical skill, is to consider the basic premise that if this money manager was so truly exceptional, why aren’t they already extremely wealthy? There is an enormous amount of private and institutional money in search of great money management. When any individual or money management firm demonstrates superior returns, the world quickly beats a path to their door. The very best money managers are difficult to access, as any excess capital they can’t deploy profitably dilutes their performance. They have their own money at work and have little need for your investment dragging down their performance. They are besieged with requests from investors.

The Willie Suttons, Martin Shkrelis, and Bernie Madoffs of the investment industry will never go away—this is where the money is. While we spend considerable effort trying to identify and gain access to the best active money managers throughout the world, our due diligence efforts are extensive. We look beyond investment performance and risk metrics to include business practices, personnel qualifications, tenure, regulatory history, and audit reviews. We have identified substandard money managers and strive to avoid suspicious track records. We are happy to assist clients in reviewing any manager that they suspect could be questionable. There are many good active money managers and a plethora of passive index funds that offer investors access to the returns from the capital markets. There is no sense in risking assets with unproven, questionable managers, no matter how charming they might be or how enticing their numbers. 


Disclosures

This material is solely for informational purposes and shall not constitute a recommendation or offer to sell or a solicitation to buy securities. The opinions expressed herein represent the current, good faith views of the author at the time of publication and are provided for limited purposes, are not definitive investment advice, and should not be relied on as such. The information presented herein has been developed internally and/or obtained from sources believed to be reliable; however, neither the author nor Manchester Capital Management guarantee the accuracy, adequacy or completeness of such information.

Predictions, opinions, and other information contained in this article are subject to change continually and without notice of any kind and may no longer be true after any date indicated. Any forward-looking predictions or statements speak only as of the date they are made, and the author and Manchester Capital assume no duty to and do not undertake to update forward-looking predictions or statements. Forward-looking predictions or statements are subject to numerous assumptions, risks and uncertainties, which change over time. Actual results could differ materially from those anticipated in forward-looking predictions or statements. As with any investment, there is the risk of loss.

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