Experts Give Warning Signs Of Shady Investors

Powerhouse investor Bernard Madoff allegedly swindled clients to the tune of billions of dollars. As the case unfolds, many wonder how Madoff was able to garner such an elite reputation of trust in the financial world. Money coach Alvin hall and personal finance expert Louis Barajas offer tips on how to avoid scams and discuss potential pitfalls of investing.

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MICHEL MARTIN, host:

Now, we're going to talk about another kind of crime, financial fraud. When Wall Street investor Bernard Madoff was arrested earlier this month and charged with cheating investors out of some $50 billion, the ripple effects went far and wide - from retirees to celebrities to charities and other public institutions. But nowhere was the damage greater, both financial and emotional, than among affluent, community-minded Jewish New Yorkers who trusted Madoff, in part because he was one of their own. We wanted to talk about how otherwise-sophisticated people may have been taken in on a scheme like this, if indeed that's what it was. So, we wanted to talk with our regular contributor on matters of personal finance, Alvin Hall. We're also joined by financial expert Louis Barajas. Welcome to you both. Thanks so much for speaking with us.

Mr. LOUIS BARAJAS (Financial Planner; Author, "The Latino Journey to Financial Greatness"): Thank you.

ALVIN HALL: Very glad to be here.

MARTIN: So, Alvin, and Louis, I wanted to ask you this also. Do you think that - and I don't know if there's any data on this point - that people are perhaps more likely to be swindled, if indeed that's what occurred, by someone who's of their own ethnic background?

HALL: Yes. Because there's the feel that this person is like me; he knows how I feel; he knows my ambitions. Therefore, if he can introduce me to somebody or help me become more successful, he'll be prouder of having helped me. And that's what I think a lot of people believed with Madoff. And also, he was really smart; he belonged to the right synagogue; he belonged to the right country club; he was introduced to people who were smooth and sophisticated. Success attracts other successful people, and he used that tool quite expertly.

MARTIN: But, Louis, I mean, is it necessarily wrong to seek out someone who, for financial advice, who is of your background, who you might think might understand you better? Who - for example, there are many people who consider tithing very, very important, and they would want to work with someone who understood why tithing is important. Some people might think, well, that's ridiculous. You know, devoting 10 percent of your income to a religious institution, that's crazy. It - you know, that needs to go to your retirement first. Is it necessarily wrong to look at it that way?

Mr. BARAJAS: No, it's not. Yeah, it's not. But what happens is that, in certain communities - for example, I tend to work more with the underserved and overlooked communities, for example, in the Hispanic and ghetto areas - they want to work with someone who is either African-American or Hispanic. They want to give them their business. But it's unfortunate that in the poor neighborhoods, they usually get taken by people who look just like them.

MARTIN: Well, obviously, there's a fine line between seeking people who are compatible with you in terms of understanding your worldview and perhaps some of the pressures on you. For example, in some communities it's considered particularly important to offer financial support to relatives, and other people might not understand that. So, there's a line, I think, between maybe being discriminatory and then just feeling a comfort level. But this leads to the question of, how do you go about making good decisions while still respecting the kinds of relationships that do allow you to feel comfortable?

HALL: First, you have to understand the product that you're buying, or the scheme, if you will, that you're getting involved in. Often people who sell these types of pyramids, or Ponzi schemes, are very skillful at making something sound like it should be a necessity and that if you miss out, you're missing out on a once in a lifetime opportunity. But when you start to ask them questions about it, often they can't explain it in a way that you can understand. So, you need to understand the product. And the other thing is that old adage: If it sounds too good to be true, it is. No one can deliver those high gains without taking incredibly high risks.

MARTIN: Well, Louis, this raises the question I think that many people have. If people who are already successful and presumably well-educated and have access to all kinds of financial advice can be taken in, what chance does a regular person have?

Mr. BARAJAS: You know, I totally agree with you. There's an endemic problem with all of this, though. The problem is that, you know, there's a huge group of people that lack education. There's also - we have language barriers, right? And then we don't have specialists to guide them in a lot of the communities who don't have access to all those successful people. And it becomes something very traumatic, and it's very heartbreaking, because I work in communities that struggle every day, and it's just amazing how many stories you hear about them just taken advantage of. They're very vulnerable. They're like prey out there, and it's just heartbreaking.

MARTIN: Alvin, can you tell us, what's the definition of a Ponzi scheme? That's something that we keep hearing a lot in connection with this Madoff scam. I mean, I do have to emphasize the man has been charged, but he has not been convicted of a crime. So, in this country, you're still innocent until proven guilty. I still think that's important to establish.

HALL: Exactly. A Ponzi scheme, also known as a pyramid scheme in the rest of the world, starts out when somebody creates a fake business. And a person will go out and - I'll go to you, I'll go to Louis, and I'll say, if you give me $100,000 to put in this, I'll guarantee you a fairly stable rate of return. In most Ponzi schemes, the rate of return is very high, but since there's no real business, then I have to go out and find four people to get another $100,000 from each to pay you the dividends I promised. Then, with those four people, I have to go out and get 16 people to pay me $100,000 each. That money filters down in the form of dividends to all of those people. So, what you're literally doing, starting out with a business idea, and every time you bring in more and more people, an exponential amount, so the pyramid scheme has to get bigger and bigger and bigger to bring in more money.

MARTIN: But what's the difference between that and, say, a network marketing, or - an organization or company that relies on network marketing, like Avon or Amway or Mary Kay?

Mr. BARAJAS: Michel, the difference...

MARTIN: Louis?

Mr. BARAJAS: Is the intent. The intent is that they're trying to make money in a legal way, in a way that works in a business format. The other way the intent is to defraud somebody, and actually there is no business out of it. They're just scamming or conning the people that they're bringing in.

MARTIN: Louis, Alvin was saying, look, if you don't understand how the money is made, then walk away, if it's so complicated that you're going, huh? Do you think that's a good rule of thumb?

Mr. BARAJAS: It can be, but the problem is it depends on the level of sophistication. For example, there are a lot of people out there who are very unsophisticated with investments and they don't understand how, let's say, mutual funds work. That doesn't mean they shouldn't walk away from them. That means that they should get more education.

MARTIN: Do you think that people, then, if they don't trust their understanding of these issues, should stick to large institutions, for example?

Mr. BARAJAS: Large institutions sometimes can be the whole cause of the problem, especially, for example, in my neighborhood and community. Sometimes the large institutions are the ones that are causing most of the problems. Unfortunately, there's no compliance or no one's checking up on people working in the same community. And so, again, I go back to, buyer beware, always take a look at who you're dealing with, ask a lot of people, and don't go in there blindly. I would say, you know, be careful about doing business on a handshake.

MARTIN: But Louis...

Mr. BARAJAS: The (unintelligible) informality can really cause a lot of problems.

MARTIN: But Louis, I've got to tell you that with this Mr. Madoff, who again, is innocent until proven guilty, but if the facts as they have been laid out are true - a lot of these people did that. I mean, he did have the right connections. He did have licenses. What should they have done? Is it that...

Mr. BARAJAS: You know, this guy was the top, you know, con artist of his generation, you know, of this generation. And maybe, you know, he took advantage - he knew how to work those type of people.

HALL: It doesn't take...

MARTIN: Alvin, what about you? What are the red flags that you saw? I mean, it was interesting. There was a columnist in the New York Times over the weekend who said that he had been pitched by Madoff and that - by representatives of Madoff, Ben Stein. And he just said, look, the returns were too good to be true.

HALL: Yes.

MARTIN: And when he pressed the point with the sales people, saying, exactly how are you achieving these returns, it didn't make sense to him. And the final point is the fees were too high. The fees were so large, his attitude is, I could go into the Wall Street Journal, pick a fund out of the, you know, the tables there, and do better than I'm doing by paying these high fees. I'm not doing that.

HALL: Exactly.

MARTIN: But what do you think?

HALL: For me, it's a matter of transparency, and transparency means you have to understand what this person is doing. Very few people have any secrets - secret formulas, secret strategies, or what they referred to in Madoff's case as black-box strategies - that can really go out in the market and essentially front-run the market or find a gap in the market. So, if somebody can't explain this in a way, in a simple way that you can't understand, walk away. If investment results are that consistent over the years, then something is very, very wrong.

I've been investing in the market for over 20 years. I've made money, lost money, had good years, bad years, like everybody else. Even the famous Fidelity Magellan Fund has had horrible periods. How can anybody like Bernard Madoff have achieved that? And the third point is, why would you ever put all of your money with one person? Granted, it was the long, slow seduction that he worked on, but diversification is always key. If you can afford to lose five percent of your money, put five percent of your money with something like that, but don't put all your money in one scheme like that.

MARTIN: In the spirit of full disclosure, I wanted to ask each of you, neither of you earns your income from selling financial instruments; that's not how either of you gets paid.

HALL: No, I do not.

MARTIN: So, is that a final point? Is that something to be wary of? Because on the one hand, sometimes people get paid as a percentage of assets under management. Sometimes people get paid a commission on a transaction. Should you inherently be suspicious of commissions on transactions, Louis?

Mr. BARAJAS: Yeah, I don't think so. I really don't. You know, I don't do any commission work whatsoever, but there are a lot of great people out there doing great work in the financial planning industry who're getting paid on a commission. The problem is it goes back to, you know, that fear, the greed, not checking up, being lazy, not reading the contracts and that, you know, that sense of illusion that everything is going to be OK. We just can't let somebody else take control of our money. We have to be in charge of it as well.

MARTIN: All right, we're going to have to leave it there. Financial adviser, Louis Barajas, he's also an author and writes about financial matters, joined us at NPR West. Alvin Hall is our regular contributor on matters of personal finance. He joined us from our New York bureau. Gentlemen, thank you both so much, and Happy New Year to you.

Mr. BARAJAS: Happy New Year, Michel.

HALL: Happy New Year, Michel.

(Soundbite of music)

MARTIN: Still to come, it's almost time to toast to the New Year. You might be having a little sip of something, but what about your teenager?

ARACELY PANAMENO: I want you to have fun, but I want you to be safe.

MARTIN: Our moms share their thoughts on helping teens bring in the New Year. That's next on Tell Me More from NPR News. I'm Michel Martin.

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