huck Gallagher has a unique perspective on the Madoff scandal. In the mid-1990s,
he served eight months in federal prison for plotting and executing his own Ponzi
scheme. Now a business ethics and fraud prevention consultant, Gallagher says that
any company thinking, "This wouldn’t happen to me" is dead wrong.
"Fraud is like cancer; it needs fuel," he says. "In a down
economy, fraud will be on the rise. [The time is] ripe."
On December 11, Bernard Madoff, a Wall Street trader and former
chairman of Nasdaq, was arrested for running a $50 billion Ponzi scheme. While only
a handful of pension plans had money invested with Madoff directly or through hedge
funds of funds that invested with Madoff, experts say the scandal unveils the need
for greater due diligence by all companies on the investments in their retirement
plans.
"I don’t think that [employers] should be generally distrustful,
but I do think [they] need to have a healthy skepticism," Gallagher says.
News of retirement plans that invested with Madoff surfaced
in the weeks following his arrest. Among them are Sterling Properties, a St. Louis-based
real estate company that had a 401(k) plan that allowed employees to invest with
Madoff. The Fairfield, Connecticut, pension plan also invested $42 million with
Madoff.
But these situations are few and far between, experts say.
"This is going to have virtually no impact on 401(k) plans,"
says Weston Tomkins, a practice leader for Watson Wyatt Worldwide’s investment consulting
branch. "Even its impact on defined-benefit plans is going to be very, very modest."
However, the scandal does shed light on the need for employers
to perform more due diligence of not only how the investments in their plans are
performing, but of the managers of these investments, says Joe Nagenast, researcher
and senior manager of Target Date Analytics and president of Turnstone Advisory
Group, a Marina del Rey, California-based investment advisory firm.
"Just because someone looks impressive, don’t drop the basics,"
he says. "If you can’t understand how a manager is making money and they won’t tell
you, don’t invest with them."
Specifically, the scandal exposes the need for employers to
be diligent in reviewing hedge fund of funds in their retirement plans. Hedge fund
of funds, which are essentially mutual funds that invest in hedge-like fund vehicles,
have lately become more popular in the 401(k) industry. Tremont Group and Fairfield
Greenwich Group, two firms that manage hedge funds of fund investments for institutional
investors, invested with Madoff.
Some experts argue that hedge funds, even through fund of
funds, have no place in 401(k) plans. "It’s just not an appropriate investment,"
Tomkins says.
These vehicles are particularly inappropriate in a 401(k)
plan because the average employee doesn’t have the investment knowledge to understand
these vehicles, Nagenast says.
Also, hedge funds are often not transparent in terms of what
they invest in, says Mike Griffin, hedge fund manager with Spectrum Global Fund
Administration, a privately owned fund administrator based in Chicago. Hedge fund
managers are often wary of sharing what they see as proprietary business tactics,
Griffin says. Still, it’s not enough for employers to be blindly accepting of their
strategies. Spectrum now provides daily return data for clients as part of an effort
to be more transparent.
Even companies that have advisors overseeing their retirement
plans need to be diligent, Nagenast says. "An employer is never fully relieved of
their fiduciary duty," he says.
And if companies do have hedge fund of funds in their plans,
they need to increase investment education for employees to make sure that they
understand exactly how their money is being invested, says Matthew Tuttle, president
of Stamford, Connecticut-based Tuttle Wealth Management.
Companies also really need to make sure their money managers
are doing the right things, he says.
"Fund of funds really dropped the ball," Tuttle says. Clients
were paying for a level of due diligence and institutional oversight that obviously
didn’t take place when examining whether investing with Madoff was a smart decision,
he says.
Jeff Sklar, managing director of Bellmore, New York-based
SHC Consulting Group, predicts that the scandal will cause an increase in government
oversight of investments, particularly among private equity and hedge funds. Still,
he says, "We can put in laws all we want; the problem is in enforcement."
"I think this will cause employers to take a hard look at
their portfolios," Sklar says.
Despite the fact that Madoff’s returns were never truly outstanding,
experts agree that there should have been a bump in the road at some point.
And that in itself should have been a red flag, they say.
After all, the experts say: If it looks too good to be true,
it probably is.
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