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Madoff 101: Fraud Lesson Still Difficult

Now that Bernard Madoff just got 150 years in prison, what have we learned from his sensational investment fraud?

Probably not enough.

While Madoff's scheme was spectacular in size, scope and hubris, it also shared many elements with other swindles.

That such scams continue to recur means potential victims aren't spotting the red flags.

Here are lessons from this latest, but certainly not last, scandal:

- Know what you're getting into.

Madoff claimed to be running a stock-option hedging operation but mostly hid behind a veil of secrecy, citing competitive reasons for refusing to divulge details.

People who sign up for an investment without knowing much about it can't assess its riskiness or suitability for them.

Scam artists often don't even register with state or federal regulators and may lack legitimate financial statements, yet victims fail to check these basics, said Terry Goddard, Arizona's attorney general.

A lot of Madoff's victims probably didn't care what he was doing, as long as he seemed to generate profits for them. Still, ignorance usually isn't bliss.

- Resist peer pressure.

Madoff's victims spanned the globe but were concentrated around New York, South Florida and a few other places (Arizona had a couple of dozen victims). Many were Jewish and belonged to the same country clubs. With affinity scams, crooks often find it easy to gain referrals, once they're part of the group.

"A common denominator is that word-of-mouth referrals become the most persuasive sales (tactic)," Goddard said.

There's a natural desire to trust others who are like you and share your values. Crooks count on people letting down their guards in certain social circles.

- Don't assume the government will protect you.

When you venture from Treasury bills or FDIC-insured bank accounts, you're taking risk. Government watchdogs are spread too thinly to prevent every crime, assuming they recognize a problem.

The Securities and Exchange Commission checked into Madoff in 2006 but gave him only a slap on the wrist. The scam didn't end until Madoff confessed.

Regulators play an important role, especially in compiling disciplinary records about crooks, but they often don't react until after damage has been done. For that first line of defense, look in the mirror.

- Check the auditors and custodians.

Madoff didn't have an acceptable accounting firm audit his books, and he didn't hold client assets at banks or with other third-party custodians.

Verify that audits have been performed by a recognizable accounting firm, and make sure the custodian is a bank, brokerage or other firm with which you're familiar or can verify as authentic.

Beware custodians affiliated with the investment company because they can generate false reports, said Carleen Shilling, a partner in the Phoenix office of accounting firm Eide Bailly LLP.

She also suggests verifying the audit firm is in good standing with the state accounting board.

- Use advisers but think for yourself.

Certified public accountants, certified financial planners, attorneys and other advisers can help analyze and monitor investments, and they can serve as sounding boards on costs, risks and more.

But advisers don't always sound alarms and, even worse, can contribute to the problem.

Madoff, for example, recruited many of his clients through middlemen.

If an adviser pitches an investment, find out about his or her connection to it, and how much pay he or she stands to earn from it.

- Diversify your assets.

The same caveats for reducing risk also apply to fraud mitigation: Lower your vulnerability by spreading your money around. If possible, split your portfolio among investment firms dealing with separate custodians.

Diversification won't immunize you from fraud, but it will boost your chances of surviving one.

- Beware outlandish promises.

Maybe the biggest red flag about Madoff was his ability to show investment gains (for a while) that were not only high but remarkably consistent - 10 percent to 12 percent a year, in good stock markets or bad.

But low risk goes hand in hand with low returns, while the pursuit of high returns requires that you accept big uncertainties.

Anyone who touts high gains with minimal risk is stretching the truth.

"The broad theme (in avoiding scams) is to use common sense," Shilling said. "And don't do something you're not comfortable doing."

If you take the plunge, continue to monitor things afterward, especially because the promoter might hit you up for more cash.

"Don't stick your head in the sand," Shilling said. "Open up and review account statements."

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