Table of Contents Fisher Investments Press Title Page Copyright Page Acknowledgements Introduction Don’t Let Your Money Get “Madoff ” With Just One Thing Big or Small—a Con Wants ’em All Bear Markets Don’t Cause Scams Normal Market Volatility Is Just that—Normal Chapter - Good Fences Make Good Neighbors Sign #1 Your Adviser Also Has Custody of Your Assets Chapter - Too Good to Be True Usually Is Sign #2 Returns Are Consistently Great! Almost Too Good to Be True Chapter - Don’t Be Blinded by Flashy Tactics Sign #3 The Investing Strategy Isn’t Understandable—Is Murky, Flashy, or “Too Chapter - Exclusivity, Marble, and Other Things That Don’t Matter Sign #4 Your Adviser Promotes Benefits, Like Exclusivity, That Don’t Impact Results Chapter - Due Diligence Is Your Job, No One Else’s Sign #5 You Didn’t Do Your Own Due Diligence, But a Trusted Intermediary Did Chapter - A Financial Fraud-Free Future Takes a Pirate to Catch a Pirate Due Diligence Checklist Hiring the Right Adviser Further Reading Appendix A - Asset Allocation—Risk & Reward Appendix B - Same But Different—Accounting Fraud Appendix C - Minds That Made the Market Notes Index About the Authors Fisher Investments Press Fisher Investments Press brings the research, analysis, and market intelligence of Fisher Investments’ research team, headed by CEO and New York Times best-selling author Ken Fisher, to all investors The Press covers a range of investing and market-related topics for a wide audience—from novices to enthusiasts to professionals Books by Ken Fisher How to Smell a Rat The Ten Roads to Riches The Only Three Questions That Count 100 Minds That Made the Market The Wall Street Waltz Super Stocks Fisher Investments Series Own the World Aaron Anderson 20/20 Money Michael Hanson Fisher Investments On Series Fisher Investments on Energy Fisher Investments on Materials Fisher Investments on Consumer Staples Fisher Investments on Industrials FISHER INVESTMENTS PRESS Copyright © 2009 by Fisher Investments Press All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written 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situation You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products, visit our web site at www.wiley.com Library of Congress Cataloging-in-Publication Data: Fisher, Kenneth L How to smell a rat : the five signs of financial fraud / Ken Fisher with Lara W Hoffmans p cm.—(Fisher investments series) Includes bibliographical references and index eISBN : 978-0-470-55272-8 Fraud—Prevention Commercial crimes Investments Swindlers and swindling I Hoffmans, Lara II Title HV6691.F57 2009 364.16’3—dc22 2009021631 Chapter 4: Exclusivity, Marble, and Other Things That Don’t Matter Brian Ross and Vic Walter, “Tearful Allen Stanford Expects Indictment in Two Weeks,” ABC News (April 6, 2009) http://abcnews.go.com/Blotter/WallStreet/story?id=7270405&page=1 (accessed April 20, 2009) Erin E Arvedlund, “Don’t Ask, Don’t Tell,” Barron’s (May 7, 2001), http://online.barrons.com/article/SB989019667829349012.html (accessed March 31, 2009) Mark Seal, “Madoff’s World,” Vanity Fair (April 2009), http://www.vanityfair.com/politics/features/2009/04/madoff200904 (accessed March 31, 2009) Gary Dymski and Thomas Maier, “LI Victims of Madoff: ‘He Has No Conscience,’” Newsday (March 12, 2009), http://www.newsday.com/services/newspaper/printedition/thursday/business/nybzside0313,0,5048879.story (accessed March 31, 2009) Jesse Westbrook, David Scheer, and Mark Pittman, “Madoff Tipster Markopolos Cites SEC’s ‘Ineptitude,’ ” Bloomberg (February 4, 2009), http://www.bloomberg.com/apps/news? pid=newsarchive&sid=a_UBDG13Gld0 (accessed March 31, 2009) Bob Clark, “The Perfect Ponzi,” Investment Advisor (February 1, 2009), http://www.investmentadvisor.com/Issues/2009/February%202009/Pages/The-Perfect-Ponzi.aspx (accessed March 31, 2009) James B Stewart, “The Opera Lover,” New Yorker (February 13, 2006) Tom Leonard, “Opera Patron Alberto Vilar Convicted of Fraud and Money Laundering,” The Telegraph (November 21, 2008), http://www.telegraph.co.uk/news/worldnews/northamerica/usa/3493101/Opera-patron-AlbertoVilar-convicted-of-fraud-and-money-laundering.html (accessed March 31, 2009) Lawrence Delevingne, “Stanford Financial: How To Buy A Reputation,” CNN Money (March 4, 2009), http://money.cnn.com/2009/03/04/news/newsmakers/stanford_influence.fortune/index.htm? postversion=2009030412 (accessed March 31, 2009) 10 Eugenia Levenson, “One Madoff Charity Goes Unscathed,” CNN Money (December 17,2008), http://money.cnn.com/2008/12/17/news/companies/madoff_lymphoma.fortune/index.htm (accessed March 31, 2009) 11 “Madoff’s Victims,” Wall Street Journal (March 6, 2009), http://s.wsj.net/public/resources/documents/st_madoff_victims_20081215.html (accessed April 20, 2009) 12 Amanda Carpenter, “Madoff Spent Nearly $1 Million Lobbying and on Democratic Causes,” Washington Times (March 13, 2009), http://washingtontimes.com/weblogs/backstory/2009/Mar/13/madoff-spent-nearly-1-million-lobbying-and-democra/ (accessed March 31, 2009) 13 See note 14 Robert L Fitzpatrick, “Utah Legislature Passes Pyramid Scheme ‘Safe Harbor’ Amendments,” MLM Watch (March 1, 2006), http://www.mlmwatch.org/11Legal/utahbill.html (accessed March 31, 2009) 15 See note 16 Monee Fields-White, “Kirk Wright’s Razzle-Dazzle Play,” Bloomberg Markets (October 2006), http://www.bloomberg.com/news/marketsmag/wright.pdf (accessed April 20, 2009) 17 FT Reporters,“Stanford’s Sugar-Crusted Show,” Financial Times (March 3, 2009), http://www.ft.com/cms/s/0/be1a1c12-0825-11de-8a33-0000779fd2ac, dwp_uuid=d7b5a5de-07de11de-8a33-0000779fd2ac.html?nclick_check=1 (accessed March 31, 2009) 18 “Stanford Eagle 2008,” Stanford Financial, http://www.stanfordfinancial.com/Magazine/Stanford_Eagle.pdf (accessed March 31, 2009) 19 Matthew Goldstein, “Stanford’s Rocky Start,” BusinessWeek (March 4, 2009), http://www.businessweek.com/bwdaily/dnflash/content/mar2009/db2009033_601499.htm? chan=top+news_top+news+index+-+temp_top+story (accessed March 31, 2009) 20 James B Stewart, “The Opera Lover,” New Yorker (February 13, 2006) 21 See note 17 Chapter 5: Due Diligence Is Your Job, No One Else’s US Securities and Exchange Commission, “SEC Files Complaint Against Daren L Palmer and Trigon Group for Operating a $40 million Ponzil Scehem and Obtains Orders Freezing Assets, and Appointing a Reciever,” (February 27, 2009), http://www.sec.gov/litigation/litreleases/2009/lr20918.htm (accessed April 24, 2009) Clifford Krauss, “Stanford Points Fingers in Fraud Case,” New York Times (April 20, 2009), http://www.nytimes.com/2009/04/21/business/21stanford.html?em (accessed April 24, 2009) Matthew Goldstein, “Stanford’s Rocky Start,” Business Week (March 4, 2009), http://www.businessweek.com/bwdaily/dnflash/content/mar2009/db2009033_601499.htm? chan=top+news_top (accessed March 31, 2009) Stanford Eagle 2008, Stanford Financial, http://www.stanfordfinancial.com/Magazine/Stanford_Eagle.pdf (accessed March 31, 2009) See note Zachary A Goldfarb, “Probe of Stanford Began at Least Years Ago,” Washington Post (February 21, 2009), http://www.washingtonpost.com/wpdyn/content/article/2009/02/20/AR2009022003420.html (accessed March 31, 2009) Sue Asci and Jed Horowitz, “RIAs Angry Over SEC Move to Contact Clients Directly,” Investment News (March 12, 2009), http://www.investment-news.com/apps/pbcs.dll/article? AID=/20090312/REG/903129989/1032 (accessed April 21, 2009) Ross Kerber, “The Whistleblower,” Boston Globe (January 8, 2009), http://www.boston.com/business/articles/2009/01/08/the_whistleblower/?page=1 (accessed March 31, 2009) Bob Clark, “The Perfect Ponzi,” Investment Advisor (February 1, 2009), http://www.investmentadvisor.com/Issues/2009/February%202009/Pages/The-Perfect-Ponzi.aspx (accessed March 29, 2009) 10 Robert Chew, “Bernie Madoff’s Victims: Why Some Have No Recourse,” Time (January 12, 2009), http://www.time.com/time/business/article/0,8599,1871173,00.html (accessed March 31, 2009) 11 “Madoff’s Victims,” Wall Street Journal (March 6, 2009), http://s.wsj.net/public/resources/documents/st_madoff_victims_20081215.html (accessed March 31, 2009) 12 Ibid 13 Dunstant Prial,“Madoff Feeder Fund Charged with Fraud in Mass,” FoxBusiness (April 1, 2009), http://www.foxbusiness.com/story/markets/market-overview/madoff-feeder-fund-charged-fraudmass/ (accessed April 21, 2009) 14 Robert Frank and Peter Lattman, “Cohmad Securities Subpoenaed Over Relationship With Firm,” Wall Street Journal (December 17, 2008), http://online.wsj.com/article/SB122948051697212935.html (accessed April 24, 2008) 15 See note 11 16 Jane Musgrave, “Scandal Sullies Robert Jaffe as Feds Probe Ties to Bernard Madoff,” Palm Beach Post (December 20, 2008), http://www.palmbeachpost.com/localnews/content/local_news/epaper/2008/12/20/a1a_jaffe_1221.htm (accessed March 31, 2009) 17 Monée Fields-White, “Kirk Wright’s Razzle-Dazzle Play,” Bloomberg Markets (October 2006), http://www.bloomberg.com/news/marketsmag/wright.pdf (accessed April 21, 2009) 18 “Madoff Auditor Charged With Securities Fraud,” Journal of Accountancy (March 19, 2009), http://www.journalofaccountancy.com/Web/20091553 (accessed May 5, 2009) 19 Stephanie Bodoni, “UBS, Accounting Firm Sued Over Fund Linked to Madoff,” Bloomberg (March 19, 2009), http://www.bloomberg.com/apps/news? pid=20601087&sid=a6Gvh2RgyMFU&dbk (accessed March 31, 2009) 20 Ron Chernow, “Madoff and His Models,” New Yorker (March 23, 2009), http://www.newyorker.com/reporting/2009/03/23/090323fa_fact_chernow (accessed April 21, 2009) 21 James Quinn, “ ‘Generous’ Bernard Madoff Was Obsessed With Cleaning, Recalls Employee,” Telegraph (March 24, 2009), http://www.telegraph.co.uk/finance/financetopics/bernardmadoff/5039591/Generous-Bernard-Madoff-was-obsessed-with-cleaning-recalls-employee.html (accessed March 31, 2009) Chapter 6: A Financial Fraud-Free Future Robert Cookson, Michael Peel, and Joanna Chung, “SEC Alerted About Stanford in 2003,” Financial Times (February 27, 2009), http://www.ft.com/cms/s/0/148817be-043b-11de-845b000077b07658.html?nclick_check=1 (accessed April 20, 2009) Index A Abuse on Wall Street: Conflicts of Interest in the Securities Markets (Twentieth Century Fund Steering Committee) Access International Advisor Accounting fraud See also Financial fraud Accredited investors AIG Ameritrade Arthur Andersen The Art of the Steal: How to Protect Yourself and Your Business from Fraud, America’s #1 Crime (Abagnale) Ascot Partners B Barron’s The Big Board: A History of the New York Stock Market (Sobel) The Big Con:The Story of the Confidence Man (Maurer) Blinder, Meyer Boogie’s Aspen Boston Post Brennan, Robert Brown, Robert Buffet,Warren C Capitalism and Freedom (Friedman) Chanos, Jim “Claw backs” Common Stocks and Uncommon Profits (Fisher) Cosmo, Nicholas Credit Suisse Crimes of Persuasion: Schemes, Scams, Frauds (Henderson) D Dalbar Associates Davis, Jim Derivatives See also Financial fraud, and flashy tactics Developing an Investment Philosophy (Fisher) Distilled Liquors Corporation See also Whitney, Richard Dominelli, David Dow, Herbert H E Electric Bond and Share Company Elie Wiesel Foundation for Humanity See also Wiesel, Elie The Embezzler (Auchincloss) Enron Ernst & Ernst Ernst & Young Extraordinary Popular Delusions and the Madness of Crowds (McKay) F Fairfield Greenwich Advisors Feeder funds Financial fraud: and advisor as broker/dealer and commingling assets finding an honest adviser and large firms overview questions to ask about custody and alternate investments and asset allocation and bankrupt firms and bear markets and consistently great returns due diligence fraudulent conveyance little variance overview the SEC third-party custodians and due diligence checklist feeder funds intermediaries overview professional audits referrals the SEC transparency and exclusivity affinity groups charitable donations client minimums false lineage hobnobbing overview political pandering reputation showy displays and flashy tactics building a good strategy collars derivatives murky strategy odd fee arrangement options overview penny stocks persuasive talk shorting -free future (see Financial fraud-free future) and gender and market volatility and newsletters signs of and small investments victims See also Ponzi scheme; Pyramid scheme Financial fraud-free future: due diligence checklist finding the right adviser overview See also Financial fraud; Securities and Exchange Commission Flores, Clelia Forte, Joseph S The Founding Finaglers (Miller) Frankel, Martin Franklin, Ben Fratis, Lynda Fraudulent conveyance “Fund of funds.” See Feeder funds G Getting Started in Options (Thomsett) Global Investment Performance Standards (GIPS®) The Global Securities Market: A History (Michie) Grant, Ulysses S Green, Hetty Green, Ned See also Green, Hetty Grübel, Oswald Gruttadauria, Frank H Hanover Trust Company Hedgecock, Roger Hedges, James A History of the Global Stock Market: From Ancient Rome to Silicon Valley (Smith) How to Become a Professional Con Artist (Marlock) How to Cheat at Everything: A Con Man Reveals the Secrets of the Esoteric Trade of Cheating, Scams, and Hustles (Lovell) How to Lie With Statistics (Huff) Howe, Sarah I The Intelligent Investor (Graham) Investment Performance Measurement (Feibel) J Jaffe, Robert J David Company JEHT foundation Jewish Community Foundation of Los Angeles JP Morgan & Co K Kennedy, Joseph P Kreuger and Toll See also Kreuger, Ivar Kreuger, Ivar Kreuger’s Billion Dollar Bubble (Sparling) Kynikos Associates L Lamont,Thomas Landis, James MacCauley Lehman Brothers LuxAlpha M Madoff, Bernard Madoff Investment Securities Mania, Panics, and Crashes:A History of Financial Crises (Kindleberger) Markets, Mobs & Mayhem: How to Profit from the Madness of Crowds (Menschel) Markowitz, Harry Marx, Groucho The Match King: Ivar Kreuger,The Financial Genius Behind a Century of Wall Street Scandals (Partnoy) Meehan, Michael Miller, Bill The Monetary History of the United States, 1867-1960 (Friedman, Schwartz) N Nadel, Arthur New York Stock Gratuity Fund New York Yacht Club O Once in Golconda:A True Drama of Wall Street 1920-1938 (Brooks) 100 Minds That Made the Market (Fisher) 100 Years of Wall Street (Geisst) The Only Three Questions That Count (Fisher) Option Volatility & Pricing (Natenberg) Options See also Financial fraud, and flashy tactics Own the World (Anderson) P Palmer, Darren Pendergast-Holt, Laura Penny stocks See also Financial fraud, and flashy tactics Players: Con Men, Hustlers, Gamblers, and Scam Artists (Zanetti) Ponzi scheme See also Financial fraud, and advisor as broker/dealer; Madoff, Bernard; Ponzi, Charles; Pyramid scheme; Vesco, Robert Ponzi, Charles Ponzi:The Incredible True Story of the King of Financial Cons (Dunn) Ponzi’s Scheme: The True Story of a Financial Legend (Zuckoff) Portfolio theory The Pretender: How Marlin Frankel Fooled the Financial World and Led the Feds on One of the Most Publicized Manhunts in History (Pollock) Public Utility Holding Act of 1935 Pyramid scheme See also Madoff, Bernard; Ponzi, Charles; Ponzi scheme R Reminiscences of a Stock Operator (Lefevere) Richard Whitney & Co See also Whitney, Richard Robinson, Edward “Black Hawk” See also Green, Hetty Robinson, Henrietta Howland See Green, Hetty S Schrenker, Marcus Securities Act of 1933 See also Landis, James MacCauley Securities Analysis (Graham) Securities Exchange Commission (SEC) Shakespeare Shapiro, Carl Shorting See also Financial fraud, and flashy tactics Singh,Vijay Split-strike conversions Spring, Richard Stanford International Bank Stanford, R Allen T Tellier,Walter Templeton, John The Ten Roads to Riches (Fisher) Texas Midland road See also Green, Hetty The Transformation of Wall Street: A History of the Securities and Exchange Commission and Modern Corporate Finance (Seligman) Tremont Group Holdings Twain, Mark V Vanderbilt, William Vesco: From Wall Street to Castro’s Cuba—The Rise, Fall, and Exile of the King of White Collar Crime (Herzog) Vesco, Robert Vilar, Alberto W The Wall Street Waltz: 90 Visual Perspectives, Illustrated Lessons from Financial Cycles and Trends (Fisher) Ward, Ferdinand The Watchdogs of Wall Street The Way the World Works (Wanniski) Whitney, Richard Wiesel, Elie Wright, Kirk Y Yellow Cab About the Authors Ken Fisher is best known for his prestigious “Portfolio Strategy” column in Forbes magazine, where his twenty-five-year tenure of high-profile calls makes him the fourth longest-running columnist in Forbes’ 90-plus-year history Ken is the founder, Chairman, and CEO of Fisher Investments, an independent global money management firm He is on Investment Advisor magazine’s prestigious IA25 list of the industry’s most influential people; is the award-winning author of numerous scholarly articles; and has published five previous books, including the New York Times bestsellers The Only Three Questions That Count and The Ten Roads to Riches —both of which are published by Wiley Ken has been published, interviewed, and/or appeared in most major American, British, and German finance or business periodicals He has a weekly column in Focus Money, Germany’s leading weekly finance magazine Lara Hoffmans graduated from the University of Notre Dame with a BA in theatre She is a content manager at Fisher Investments and contributing editor of MarketMinder.com She also coauthored with Ken Fisher the bestsellers The Only Three Questions That Count and The Ten Roads to Riches a The Fisher Investments Private Client Group (FI PCG) Global Total Return (GTR) strategy was incepted on January 1, 1995 and is managed against the Morgan Stanley Capital International (MSCI) World Index For the period from inception through December 31, 2008, performance returns (net of advisory fees, commissions and other expenses, and reflecting the reinvestment of dividends and other earnings) of the FI PCG GTR composite have exceeded total returns of the MSCI World Index as well as the S&P 500 Index Past performance is no guarantee of future returns Investing in stock markets involves the risk of loss ... manager also had custody of the assets In other words, the money manager or financial adviser also acts as the bank or broker/dealer— holding and supposedly safekeeping the assets he/she/it manages... stars and athletes can be very isolated Movie stars in particular are sheltered from the real world and most of their financial decisions are made by their managers They feel isolated and unable... changed Their long-term goals certainly haven’t But what they say they want has The bull market made them confident, but the bear market made them daunted And that’s when a artist strikes The