The sentencing of Bernard Madoff brings the Securities and Exchange Commission one step closer to closing the book on one of the largest Ponzi schemes ever perpetrated. While Madoff has garnered most of the headlines, numerous other fraudulent schemes of various magnitudes have come to light over the past six months.

The common thread between many of these schemes is quite simple. The criminal serves dual roles as investment manger and qualified custodian of the same assets. As investment manager, funds are accumulated, often under the guise of guaranteed high investment returns. Once in possession of the money, funds are transferred between accounts in order to meet withdrawal requirements. As custodian, fake account statements with bogus information are provided in order to create the illusion of a legitimate operation. If the money inflow from new clients offsets the outflow from withdrawals, the fraud may be perpetrated for a long time.

Hardesty Capital does not take custody of client assets. Independent third-party qualified custodians, such as banks and broker-dealers, are utilized for the vital function. Qualified custodians are subject to extensive regulation and oversight. Included in the oversight is a daily reconciliation conducted by our firm to assure the accuracy of custodial records.

In response to the financial schemes, the SEC has modified their registered investment adviser examination process. They will now perform a valid verification of assets by requesting independent confirmation of investor assets from various third parties, including custodians and advised clients. The SEC exam staff may ask clients to confirm that their account balances as of a specific date were consistent with their own records and that the contribution and withdrawals from their account were authorized.

—Eric Schopf