Bernie Madoff Revisited

May 5, 2010

About 17 months ago, Bernie Madoff was arrested for perpetrating the grandest Ponzi scheme ever, believed to be in excess of 50 billion dollars. From time to time since then, several of our clients and prospective clients asked us how they can be sure their money is safe. Before we answer that question, here is some history on Mr. Madoff.

Bernard Lawrence Madoff, a law school drop-out, founded his firm back in 1960 with $5,000. Quickly establishing himself as a prominent market-maker and seeking to compete with the bigger firms, Madoff looked toward using technology as his edge over the competition. He joined the National Association of Securities Dealers, serving as its vice chairman, and helped to create the NASDAQ in 1971.

Everyone was shocked that, with such an auspicious background, Madoff perpetuated such an outrageous scheme for so many years on so many people that counted him among their friends.

Everyone who talked with Madoff and his wife had nothing but good things to say about them. Clients told their friends about his consistent returns and pleasant demeanor, piquing their interest. Madoff used this popularity to his advantage, creating exclusivity around himself and his fund. It was a well-known fact that Madoff turned down many investors, and you had to have an “in” to be accepted. He was so nice that his relationship with many people was built on his handshake and smile rather than the proper due diligence which should be associated with a high-level fund manager.

Madoff reported consistent year-over-year returns in his Fairfield Sentry Limited Fund, which, when plotted on a graph, resembles almost a perfectly straight ascending line since its inception in 1990. His “modest” returns, usually in the low double-digit range, kept him under the SEC radar just enough to continue his operation.

When a fund manager “guarantees” positive returns - year in and year out, with no discussion of how he does it - clients should abandon ship immediately. Virtually no one can avoid the inevitable downturns in the market for so long.

An independent custodian, such as Charles Schwab or Fidelity, helps safeguard an advisory firm’s assets and reports major activities performed by the advisory firm, providing an extra layer of security for the clients. Custody of the assets is usually done by a third party custodian, but Madoff did all of this in-house. Without an independent overseer, he was allowed to steal money and easily create false account statements about the “returns” investors were receiving. 

Kohlhepp Investment Advisors, Ltd. is an SEC (Securities and Exchange Commission) Registered Investment Advisor having only limited authority. Kohlhepp Investment Advisors, Ltd does not and never has had direct access to your assets. We are authorized to trade but cannot move your money around without permission.

Madoff was very secretive about the process through which he created his returns. He used his “split-strike conversion” strategy (a sophisticated options trade) as his cover for everything. When people asked too many questions, they were asked to leave. Madoff made it obvious to his investors that he did not like too many questions and that it is not other people’s business what he does with their money.

How ironic it is for the person who fathered the NASDAQ system of computer-based trading to refuse online access to his clients and to send antiquated statements with 10-year old technology to his clients. User-friendly statements and online access is a standard feature among managers and firms across the board. It is obvious in hindsight why Madoff’s technology was so outdated: updating his technology would have meant additional staff was exposed to his charade.


In order to protect your investments, always remember the following:

1. NEVER make investment checks payable to the advisory firm, i.e., “Kohlhepp Investment Advisors, Ltd.” Your checks should be made payable to the custodian who “safeguards” the funds, e.g., Charles Schwab, Fidelity Investments, XYZ Trust Co., etc. The only exception to this would be for hourly and/or financial planning fees.

2. Always make sure you receive separate confirmations/statements for your investments (no less often than quarterly) from the independent custodian, Charles Schwab, Fidelity, etc. If you have multiple strategies you will probably receive multiple statements. These statements, either electronic or paper, will confirm your investments and trades and keep you up to date on your accounts.

3. Above all, your investment advisor should be a fiduciary. He or she should be schooled in the area of fiduciary duties and operate pursuant to a published code of ethics. It is evident that Madoff was unethical and illegal. He stole from his investors and broke the law.

We at Kohlhepp Investment Advisors, Ltd. are fiduciaries, always acting in your best interest. The fiduciary standard is a legal concept, but its core idea is not complicated. To act as a fiduciary means we professionals have to put aside our own financial interests, and also put aside the business/financial interests of any company we work with, and give recommendations that are solely and completely in the best interests of people like you, our clients.

In other words, our recommendations have to be made with only one concern: is this the best thing I (the professional) can do for you (the client), given what I know about who you are and what you want and need?

We encourage questions about your investment strategy. We follow guidelines placed upon us by you and the regulatory agencies. Though almost all registered investment advisors act in the best interests of their clients, the few bad apples taint the credibility of the whole investment industry. Should you have questions or concerns, we encourage you to contact us.

We truly hope this e-letter is helpful. Feel free to pass it on to friends and family. Let’s try to prevent any further Bernie Madoff scams from occurring.

Happy spring!

Best regards,

Edward J. Kohlhepp, CFP®, ChFC, CLU, CPC, MSPA
Edward J. Kohlhepp, Jr., CFP®, MBA

The views expressed are not necessarily the opinion of Cambridge Investment Research and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investing is subject to risks including loss of principal invested. No strategy can assure a profit nor protect against loss.


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Kohlhepp Investment Advisors, Ltd.
3655 Route 202, Suite 100
Doylestown, PA 18902
Phone: 215-340-5777
Fax: 215-340-5788

Securities offered through Cambridge Investment Research, Inc. a Registered Broker/Dealer, Member FINRA/SIPC. Investment Advisory Services offered through Kohlhepp Investment Advisors, Ltd., a Registered Investment Advisor. Kohlhepp Investment Advisors, Ltd. and Cambridge Investment Research Advisors, Inc. are not affiliated.

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