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NEW YORK — The suicides of two foreign tycoons, the loss of at least $50 billion in assets and a regulator catching heat for failing to follow through on several red flags waved over a 10-year span. These are just a few of the outcomes involving the largest Ponzi scheme on record allegedly perpetrated by Bernard Madoff and his firm, Bernard L. Madoff Investment Securities LLC. As of Jan. 5, more than 120 charities, hedge funds, European and Asian banks and individual investors are among the victims, according to The Wall Street Journal, which has been tracking the losses of Madoff’s former clients. The aftermath has been grim. German billionaire Adolf Merckle, whose conglomerate of companies brought in more than $40 billion last year, was hit by a train on Jan. 5. His family members later found a suicide note. The family of Rene-Thierry Magon de la Villehuchet said the French investor killed himself on Dec. 23 by slashing his wrists and taking pills after losing $1.4 billion through Madoff. Congressional leaders held a hearing on Jan. 5 with the Securities and Exchange Commission, and they questioned why the regulator failed to stop Madoff’s Ponzi scheme sooner than it did. SEC Chairman Christopher Cox had previously said the agency learned of past “credible and specific allegations” going back at least a decade involving Madoff. A former National Association of Securities Dealers (now called the Financial Industry Regulatory Authority) vice chairman, Madoff remains out on bail even though prosecutors want to send him to jail for allegedly violating bail conditions. He is currently under house arrest. The trustee overseeing Madoff’s asset liquidation recently mailed out more than 8,000 claim forms to former clients. While several nonprofits and everyday investors are still reeling from their losses, credit unions have been immune to Madoff’s investment pyramid. The hypothetical question is what would happen if credit unions and members had investments through Madoff. Like his clients, they would naturally have to stand in line to recover any of their losses. Experts say it helps that the NCUA has guidelines in place to restrict the type of instruments credit unions can invest in. “Credit unions are independent cooperatives that serve their members, and as such have essentially the same legal rights against a third party as any other corporation,” said John McKechnie, NCUA director of public and congressional affairs. NCUA regulations allow FCUs to use a third-party entity to purchase or sell investments, including certificates of deposit only if the third party is registered with the SEC or is a depository institution whose broker-dealer activities are regulated by another federal agency. As a result, guidelines are in place to essentially protect credit unions from themselves. It may sound like operations 101, but credit unions must “take the time and the money to do on-site due diligence,” said Scott Powell, managing director of common stock and managed accounts at MEMBERS Capital Advisers, the registered investment adviser affiliate of CUNA Mutual Group. “Don’t delegate the due diligence. Even if it costs more money on the front end, it will be worth it on the back end.” Powell said the Madoff case is a “great showcase” of why regulations are in place to make sure something like this does not happen within the credit union industry. That’s not to say widespread fraud can’t happen. In 2001, it was discovered that a number of credit unions lost millions of dollars through the defunct Bentley Financial Services, which sold bogus securities as insured certificate of deposits. The firm served as a CD broker and Entrust Group acted as the custodian for the instruments. In all, investors, including CUs and banks, lost, but later recovered, nearly $340 million. The bulk of Madoff’s clients were considered “accredited investors”-those ultra-high net worth people with $5 million or more in assets, Powell said. While some members may not meet that criterion, it really doesn’t matter because regardless of net worth, credit unions have prided themselves on looking at each person’s unique needs rather than pushing unnecessary products, Powell said. “We’re trying to serve each individual member, not just take their business. The concept of how credit unions separate themselves [from how other financial institutions operate] coupled with proactive and constructive regulations helps members feel good about their money.” Credit unions also tout their methods in educating members on everything from creating a budget to saving for retirement. This may be an ideal time to offer refresher seminars on the difference between private and public offerings, suggested Pete Snyder, principal and founder of Snyder Consulting Solutions, an investment and insurance program integration firm. “The reality is you buy a mutual fund, stock or bond and that is probably the epitome of what people think is risk, but it’s not fraud,” Snyder explained. “Whereas with a Ponzi scheme, someone is soliciting money from a little old lady for a deposit so someone can get money from the United Kingdom later. That’s the epitome of a fraudulent scheme.” Snyder said Madoff’s expectations, a lack of a prospectus, what he promised and then the reality along with private offerings were a recipe for disaster. Credit unions can go a long way in helping members understand what is legitimate and illegitimate. “We as an industry hate disclosure because it’s so cumbersome. It’s intended to weed out the bad guys,” Snyder said. “Does an investment require licensing? What should a member’s expectations be when they are solicited to make an investment? If someone is trying to sell you an investment, ask if they are registered, do a search on [Financial Industry Regulatory Authority, which regulates securities firms].” The emphasis on due diligence and constant follow-ups can not be stressed enough, said Brian Hague, president/CEO of CNBS LLC, a broker-dealer and registered investment adviser that serves the credit union industry. The issue of discretionary versus nondiscretionary is a critical layer of protection, he added. The NCUA has limits on discretionary accounts, which allows a broker or adviser to buy and sell securities without the client’s prior knowledge or consent, Hague explained. A nondiscretionary account requires the broker to obtain authorization before it makes any investment decisions. All of CNBS clients have been nondiscretionary, Hague noted. “Obviously, you want an adviser that is registered with the SEC. There’s an advantage if the firm has adopted a code of ethics and you ask to see it,” Hague recommended. “Disclosures and any other information of the firm are major things. You want to know how long they’ve been in business.” Hague said another area to watch for potential conflicts of interest is within an organization’s ownership structure. If an adviser is wholly or partly owned by a single credit union, there can be the tendency to load up on their certificates, for example. “If you see large concentrations, it might raise some eyebrows,” Hague said. “The broader the ownership, the better.” Madoff launched his firm in 1960 and many of his clients had worked with him for more than 20 years. A fact that has puzzled Powell from MEMBERS Capital, who has been involved in outside due diligence management. “I find it hard to believe that something of this magnitude can happen with one person,” Powell said, adding the concern is that Madoff’s aftermath will “domino to other respectable firms” and lead to a mistrust of advisers. There is the potential for credit unions to get swept up in wanting to bring what may look like a believable product to their members. Powell used a quote from former President Ronald Reagan as a word of caution: “Trust but verify.” “Be careful with the ‘wink and nod’ of working with an individual or a small investment boutique. I know in the credit union space, relationships are key drivers, but that’s not always the case in vendor selection.” –[email protected]

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