How to Stop Future Fraudsters

Bernie Madoff’s multibillion-dollar Ponzi scheme had been exposed to the Securities and Exchange Commission numerous times by diligent whistleblowers, only to be roundly ignored.

And it was reported this week that R. Allen Stanford’s Stanford Financial, now charged by the SEC as being a $7 billion Ponzi scheme, had had just such suspicions raised by a whistleblower as early as 2003. The SEC was tipped off…but didn’t get around to actually pressing charges for six years.

The net result of both deceptions will undoubtedly be yet more regulation on all financial institutions, ranging from banks to advisers to hedge funds. Yet as many Stanford victims tell it, it was the company’s regulatory affiliations that solidified their confidence to invest in the first place. 

Both Madoff Investment Securities and Stanford Financial were registered and regulated by government supervisory bodies, namely the SEC and Securities Investor Protection Corporation (SIPC). Stanford was an active SIPC member, with its logo on company marketing materials, business cards and affixed to its physical locations, all overseen by regulators.

As we wrote last year, government regulation doesn’t eliminate fraud, it just makes it easier to commit. Any nefarious operator can easily meet arbitrary government requirements, giving a fraudulent firm the instant aura of credibility. In effect, we now tend to rely on regulators to think on our behalf. Why bother asking questions when a company bears the seal of approval from Uncle Sam?

Sarbanes-Oxley, the last major regulatory burden passed back in 2002, included detailed protections for whistleblowers that identified financial fraud. Seven years later, it turns out that we’ve got plenty of whistleblowers, as both the Madoff and Stanford cases illustrate. What’s needed isn’t more draconian regulation -- but simply an effective and diligent cop to heed existing whistleblowers’ calls.

A new Merrill Lynch study indicates investors have again embraced their taste for risk, with optimism among portfolio managers at a six-year high and cash holdings among portfolio managers now at a two-year low. Thirty-four percent of respondents are now overweight stocks, up from 7% in July.

Not that bullish? An investor interested in a truly conservative portfolio but pressed on time to actually assemble it might consider the S&P Conservative Allocation Fund (AOK), which combines eight ETFs into diversified portfolio focused on preservation of principal and modest capital appreciation.

Source: iShares

Seventy-six percent of the portfolio is allocated to fixed income, with 50% specifically in Treasurys. Stocks account for roughly 20% of the fund, with about 6% to international stocks and a modest 3% to real estate that presumably boosts income. The fund currently yields 2.4%.

Safety First

S&P Conservative Allocation Fund (AOK) – 6 months

Earlier this year we wrote about the “Rule of 100,” a basic template for asset allocation: You take your age and subtract it from 100 to arrive at the approximate percentage of your portfolio that should be held in stocks.

Given the fund’s 20% exposure to equities, this isn’t the fund for recent college grads, rather an ideal choice for retired or risk-averse, income-oriented investors looking for a simple but diversified choice.