After Bernie Madoff, knowing who to trust with your investment funds

When the Bernie Madoff affair shocked the nation, investors began wondering who they can trust. What matters more in an investment manager: the quality of an individual or the institution? How the pros pick who to trust with their investment funds.

Louis Lanzano/AP/File
Bernie Madoff arrives at Manhattan Federal Court March 10, 2009. He would plead guilty to charges of securities fraud and other crimes. Investment funds have since faced more scrutiny.

Rusty Leonard and Mark Regier have a lot in common. Both are investment industry professionals, evangelical Christians, and believers in working only with trustworthy business partners.

They differ, however, in one area: how to figure out who can be trusted with their investment funds – and who can't – a talent that could have been put to great use before the Bernie Madoff affair. The question seems to grow more critical with every scandal, fraud, and high-profile disappointment from a CEO.

In today's business world, investment managers say, skill in discerning character is every bit as important as being able to decipher a balance sheet or earnings report.

But how does one do it?

Mr. Leonard relies in part on indicators of executives' character to judge whether a company is in good hands. Portfolio managers at his money-management firm have sold stock on at least two occasions because the CEOs were leading flashy lives, cavorting with multiple women, and demonstrating an apparent lack of moral values.

"If you know that a guy is divorced three times, so on and so forth, then you see how he acts," says Leonard, founder of Stewardship Partners in Matthews, N.C. "Parties that cost $2 million and that sort of thing – if you knew about that stuff, then obviously you [as an investor] would run for the hills.... The Lord says, 'He who exalts himself will be humbled.' And if [a CEO] gets humbled, I don't want to be part of that process."

'What do you value?'

Mr. Regier takes a more open-ended approach. As director of stewardship investing at Mennonite Mutual Aid (MMA), he asks what a company professes to value besides profits, then looks for evidence and expects proof to get stronger over time.

"We are very cautious about the practice ... of using executives' character as a driver for investment decisions," he says. "We've learned [that] good people, whether through their own devices or systems that they're caught in, can end up doing ... some very bad things. We want to see systems [of accountability to ethical standards] embedded in the company."

As Congress considers how regulators might protect consumers of financial products, some in the industry are getting out front by emphasizing their own wolf-spotting credentials.

"Even if you're referred to [an adviser or money manager] who's supposed to be a person of character, you still have to check them out," says Bonnie Kirchner, a financial planner in Marion, Mass., and author of "Who Can You Trust With Your Money? Get the Help You Need Now and Avoid Dishonest Advisors."

Formerly married to Ponzi scheme operator Brad Bleidt, Ms. Kirchner says clients should be suspicious whenever they get vague answers about how their money is invested or how their investment team is compensated. Character is revealed in part, she adds, when professionals own up to their mistakes.

In quests to discern character, approaches vary widely. Some professionals trust intuition while others look for measurable, objective cues. In the end, the question is not only whom to trust, it's also what to trust in making that determination.

Picking up on signals

Benjamin Bingham swears by in-person meetings with public company managers as a means to discern whether managers are as solid as their corporate social responsibility reports suggest.

"Tone of voice that conveys defensiveness or natural humility ... may be the only signals that can be picked up beyond what is easily found on the Internet," Mr. Bingham, managing director at Philadelphia-based Benchmark Asset Management, writes in an e-mail.

Even in a data-driven age, some in high-finance still rely on low-tech networks to reveal what they really want to know about company leaders when they're making investment decisions. Ed Easterling, who picks which hedge funds to include in his fund of funds based in Corvallis, Ore., primarily considers funds based in Texas, where he lived for years. The reason: If one manager has a history of treating business partners badly, Mr. Easterling is apt to find out with a few calls to fellow Texans in the industry.

"Let's say, hypothetically, you found out that somebody cheats on his wife," says Easterling, president of Crestmont Holdings, an investment management firm. "When data points like that sufficiently accumulate – sometimes it takes just one, [such as a fraud case], sometimes it takes five or 10 – you begin to say, 'Wait a minute. This person may not have as strict a threshold on integrity as I'm looking for.' "

Is character discernment enough to avoid the Enrons, AIGs, and Bernie Madoffs of the business world?

"Someone can be a completely moral person, but when you go into a corporate context, what you measure is what people are going to give you," says John Camillus, professor of strategic management at the University of Pittsburgh's Katz Graduate School of Business. "In that kind of situation, you have to look at: What are the control systems that are in place? What are the measures of success in the organization? And how are people compensated?"

Feeling vindicated

While investors may forever debate discernment methods, some feel vindicated by their experiences. Easterling, for example, tends to trust a few select fund managers whom he believes to be deeply knowledgeable about every company they bankroll. Thus he felt he'd made a good choice one day when colleagues complained about how one of his fund managers plays golf.

"They said, 'The worst part about playing golf with him is he always wants to talk about his ideas, and he always knows so much about the companies he invests in,' " Easterling says. "They would have no incentive to tell me that kind of a story. [But] that's the kind of comment that tells you whether this person really is as diligent as he says he is."

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