This may be a post-Madoff world, but Ponzi schemes are still with us.

Ponzi schemes are investment frauds involving the “payment of purported returns to existing investors from funds contributed by new investors.” The perpetrators of these schemes typically don’t invest the funds entrusted to them. Instead, they use it to fund a lavish lifestyle.

You can find a list of “red flags” on the SEC’s website. The most common one is the promise of huge returns with little risk. Greed is a powerful motivator.

You can find a depressingly long list of post-Madoff SEC enforcement actions against Ponzi schemes here.

What can you do?

Minimize your risk by not doing business with unlicensed sellers. Don’t purchase investments that aren’t registered with the SEC. Avoid investments that promise unrealistic returns with minimal risk.

Using a registered investment advisor will further reduce your risk. You can verify whether your advisor is registered with the SEC, or has a disciplinary record, by going to this web page. Once you have confirmed your advisor has a current registration, you need to be sure that your investments will be held at an independent custodian, unaffiliated with your advisor. You should be able to access your account on the web site of your custodian at any time.

You will want to be sure the custodian used by your advisor is one of the largest and most established. Schwab Advisor Services, TD Ameritrade Institutional and Fidelity Institutional Wealth Services are three of the most prominent ones. You can find a list of others here.

Following these guidelines will go a long way to protect you, but there’s still a danger lurking. And it comes from a very unexpected place.

Your advisory agreement

The vast majority of advisors are honest and trustworthy. Nevertheless, you need to protect yourself from the small minority that aren’t. That protection starts with an understanding of your advisory agreement.

There are two kinds of accounts you can open with your advisor or broker. A non-discretionary account requires authorization from you before making any investment decision. A discretionary account permits transactions without your approval.

I strongly advise you opt for a non-discretionary account. Make sure the agreement provides your approval must be in writing before any transactions are made. This may be redundant if you follow my recommendation below and insist that you are the only one who can give trading instructions to your custodian.

In addition to the advisory agreement, you will also be asked to sign an agreement with the custodian of your assets. Here’s where it gets tricky. Advisors typically want to be able to deduct their fees directly from your account. They can only do this if you give them permission to access your funds at your custodian for this purpose. However, the authorization set forth in the custodial agreement is often much broader, giving them authority to engage in a range of transactions, and possibly even providing they have the right to change custodians.

This is the chink in the armor

A dishonest advisor can misuse this authority to move your assets to an affiliated custodian or to make transactions you never would have approved. Here’s how to protect yourself.


Take these steps to avoid becoming a victim of dishonest conduct:

  1. Insist on a non-discretionary agreement.
  2. In your agreement with the independent custodian, don’t give the advisor any authority to give the custodian direction or to engage in any transaction. Instead, ask your advisor to bill you quarterly for fees. You can implement your advisor’s trading instructions directly with the custodian.

If you don’t want this level of involvement, follow these steps:

  1. Insist on a non-discretionary agreement. Be sure the agreement requires your consent in writing before your advisor can make any transaction. Don’t agree to any language giving your advisor “power of attorney” over your account.
  2. Limit the authority of your advisor to make transactions with your custodian to only those transactions approved by you in writing. Call the custodian to be sure the custodial agreement requires it to comply with this restriction.

While this process may involve more effort, it’s well worth it to avoid becoming the victim of a scam.

A Chink In Your Ponzi Armor blog was originally posted on The Huffington Post website.


The Smartest Investment Book You'll Ever Read Dan Solin is a New York Times bestselling author of the Smartest series of books, including The Smartest Investment Book You’ll Ever ReadThe Smartest Retirement Book You’ll Ever ReadThe Smartest 401(k) Book You’ll Ever Readand his latest, The Smartest Sales Book You’ll Ever Read. He is a wealth advisor with Buckingham and Director of Investor Advocacy for The BAM ALLIANCE.The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.