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How to hold money managers accountable

Madoff case shows need for custodial accounts when working with advisers.

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In addition, he notes, the financial business is filled with many smart people with good social skills that they use to gain the trust of potential clients. That may be fine, Mr. Martin says, but, quoting former President Ronald Reagan, he adds: "Trust, but verify."

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"Madoff ingratiated him­self to his community," agrees Jeanne Sullivan, a financial planner with Back Bay Financial Group in Boston. She points out that in addition to being a former chairman of Nasdaq, Madoff spent many years cultivating clients in Boston, New York, and Florida. "Many of them were people he had known for 20 or 30 years," Ms. Sullivan says. Also, she notes, Madoff would sometimes refuse to take on new clients the first time they asked, "so it increased their desire to be part of his operation." It's also been reported that if current clients asked Madoff too many questions about how he invested, he kicked them out.

But experts stress that there was no financial or legal reason why even these wealthy people and large institutions could not have insisted on having their money held by an independent custodian – except that Madoff would not have let them into his "club."

As difficult as the Madoff case has been, avoiding this problem isn't difficult. Just ask the money manager or financial planner plenty of questions, Sullivan says. Of course, one of the first should be: Do you use an independent custodian, and do my statements and any checks come from you or the custodian? (They should come from the custodian.) "Make sure that the custodian is a well-known independent firm," such as Fidelity, Schwab, or T.D. Waterhouse, Sullivan adds. Several large banks also provide custodial services.

Other important questions to ask any financial adviser:

•Are you registered with the Securities and Exchange Commission?

•Can I see the ADV (adviser) form that you filed with the SEC? This form is also used for state registration and includes information on the adviser's education, type of business, as well as any disciplinary actions within the past 10 years. It also covers the adviser's services, fees, and investment strategies. (It's not foolproof; Madoff was registered with the SEC and had an ADV form.)

•What kind of investment returns have you provided over the past several years? While many managers do "beat the market," their returns should not be wildly out of line. Some managers have legitimately been able to lose far less than the market this year by constructing portfolios that include a fair amount of bond and money-market investments, as well as stocks. But even some of these portfolios fell 20 percent this year, while the S&P 500 is down about 40 percent.