Bad-Report-Card Fraudster: Avoiding an Investment Scam

Video Transcript

Kelly Kesner: I’m Kelly Kesner and I’m here with another episode of Investor’s Watchdog University. I’m here with Pat Huddleston, the founder of Investor’s Watchdog. And here we’re going to talk about a particular kind of scam artist called “the bad report card fraudster”. Pat, what exactly is that?
Pat Huddleston: Well, it’s something we can all relate to Kelly. I don’t know. You and I are both lawyers by trade and so we did pretty well in school.

Kelly Kesner: Speak for yourself Pat [laughter].
Pat Huddleston: Yeah, I know. Well, I guess maybe like you. My path to academic success was not smooth. There were a lot of bumps and hurdles, and I remember specifically in middle school I had a couple semesters where, man, there were some bad grades on that report card. Everybody out there has a similar experience whether it was grades for you or something else you remember growing up or even in your adult life when you had bad consequences. You didn’t do very well and you didn’t want anybody to know about it.

If you’re a kid, you don’t want your parents to know because you know the mom bomb is going to go off and you’re going to be grounded for three months and that’s the best case scenario, right? And so I used to come home with those report cards and I would think, “God, there must be another way. It can’t be necessary for me to go through the pain I know I’m going to go through.” And lots of kids do. And some kids decide they’re going to take that D on their report card and they’re going to turn it into a B with a little stroke of a pen.

And so this happens with investment advisors every time they have to send out a disappointing quarterly report or any report to their clients that show they haven’t done very well. Those monthly statements, those quarterly statements for an investment advisor, those are the report cards.
Kelly Kesner: So, the advisor thinks he’s telling a little bit of a fib, but then it tends to go a little bit longer or continues on because that one fib could lead down an entire line.
Pat Huddleston: That’s exactly right. What he thinks is that he’s just going to cross over this ethical line then he’s going to hop right back. That he’s going to say the account is bigger than what it is, even though it isn’t and next quarter of the market is going to go great. He’s going to be able to straighten out all the accounting and then from then on-all the accountings going to be completely accurate. Everything’s going to be great. But, what happens is they find out there’s a steep slope on the other side of that ethical line, and that first little crossing of the line leads to a downward trajectory that just starts to snowball and they start picking up other people’s accounts and pretty soon they can’t even rationalize it anymore.
Kelly Kesner: Didn’t Bernie Madoff start out that way or Ponzi schemes in general? Isn’t that usually how they start?
Pat Huddleston: I would say more than half of them. From my experience I would say more than half of them start that way and according to the book – Wizard of Lies by Diane Henriques, which is a terrific book, I recommend that you get it – Bernie Madoff claims that he did start that way. That the whole thing, the thing that wound up being the biggest investment fraud in history started with his not wanting to send out a bad report card.
Kelly Kesner: So, they suddenly just didn’t turn criminal, decide to become a criminal. It started with one little fib and they started going down this long road.
Pat Huddleston: Well, that’s exactly right. The point that we’re trying to make with that is that this is not some extraordinary brand of evil. It’s easy to think that it is especially if you’re a victim of ones of these characters. But, what I try to get across with calling it “bad report card fraud” is to get across this is just mundane, ordinary, everyday human temptation these guys are giving in to. So, do you know how common that is in the world in general and in the investment world specifically? Happens every day. That’s why so many of these things crank up and why it’s so easy for them to begin.
Kelly Kesner: And so the next Bernie Madoff could be around the corner. He hasn’t crossed an ethical line yet, but it may just be something that too much bad news, one more bad line and they decide to cross that line?
Pat Huddleston: Yeah, that’s exactly right, especially these days and times when commission income has been down because people have been afraid of volatility. The mortgage payment hasn’t gone down for the broker. The car payment hasn’t gone down. And the kids, the cost of raising them hasn’t’ gone down. And so a lot of them are under stress. And so this is a time even more so before Bernie Madoff where these things could crank up. So, there’s a lot more to know, a lot more that we’re going to teach you at Investor’s Watchdog University.
Kelly Kesner: In the future we’ll get into some of the ways an investor can spot these and how to possibly protect yourself against them, but until now that’s it for this week. Class Dismissed.
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