The Adviser with Other People’s Money

A Sicilian businessman told Gambetta a story he himself found hilarious. A big firm from the north of Italy won a large contract in Sicily, and its management had no doubt that sooner or later the Mafia would come and demand money for protection. And one day a man did come and made the vague hints mafiosi are famous for. The northerners were so firmly expecting exactly this that they took him for the real thing and started paying.

They paid for about two years. Regularly. Then they found out their “mafioso” was an impostor.

Gambetta tells this story to show that the protection market, like any other, has its swindlers selling fake goods. Protection is hard to check until you need it. You pay for years, and you only find out what your protector is worth on the day someone really does come for you.

It’s exactly the same with a financial adviser.

Goods You Can’t Check

Buy a washing machine, and within a week you know whether it’s any good. Hire someone to manage your money, and you won’t know for years. A good year? Maybe luck. A bad one? Maybe bad luck. The real exam, a crisis, comes rarely, and by then you’ve been paying the adviser his fees for years.

Choosing an adviser by last year is much like choosing a protector by how confidently he drops hints. The northern firm’s mistake wasn’t that it paid, but that it didn’t check who it was dealing with. It was enough for them that the man behaved the way, in their idea of things, a mafioso behaves.

The Man Selling His Own Goods

The main question to ask any adviser: who pays him?

Is he paid by the company whose products he’s selling you? Then he isn’t an adviser. He’s a salesman. Maybe an honest one, but he needs you to buy more, and buy dearer. Does he take a commission on every trade you make? Then it suits him for you to trade often. Does he take a percentage of the sum he manages? Then it suits him for you never to take your money out.

The best-known example of where this leads is IOS, Investors Overseas Service, the firm the American Bernard Cornfeld founded in Geneva in 1955. His salesmen went all over Europe selling people shares in funds, and in a little over ten years the firm raised, by some estimates, two and a half billion dollars. Its pride was a “fund of funds”, which invested clients’ money in other funds of the same firm. The client paid fees on top of fees. And the money never left Cornfeld’s house.

In the spring of 1970 the shares of IOS itself started sliding, and the financier Robert Vesco came to the rescue. The American Securities and Exchange Commission accused him of misappropriating more than two hundred million dollars from the IOS funds. When it came out, Vesco fled to Costa Rica, then to Cuba, and he was never extradited. Thousands of people trusted their money to charming salesmen in good suits. And lost everything.

A Lawyer with a Briefcase

In Mario Puzo’s novel The Godfather—fiction, but very observant fiction—Don Corleone says that a lawyer with his briefcase can steal more than a hundred men with guns. He knew what he was talking about. A man you’ve trusted with your money and your papers can do you more harm than any robber: you can see the robber; the adviser you can’t.

Over a lifetime I’ve drawn a few rules from this.

Find out how he’s paid. The best adviser is one you pay yourself, by the hour or a fixed sum. Not one who’s paid for what he’s sold you.

Find out where the money is. It should be held not by the adviser but by an independent bank or custodian, and that custodian should be checked by an independent auditor. If the adviser manages the money, holds it and writes your statements himself, you’ve already read how that ended with Madoff.

Don’t pay for polish. A good suit, an expensive office, a confident voice, acquaintances in high places—that is precisely what the northern firm was paying the impostor for. Check the papers, not the manners.

And the simplest one: if you don’t understand what you’re being sold, don’t buy it. Fees love to hide in complexity.

The Don’s Adviser

All his life Don Vincenzo kept one lawyer. One. A dry old man who never smiled and charged only for the hours he worked. Once I suggested another to the Don, young and energetic, who promised to work “for a percentage of what we win”. Sounds like a good deal: no win, no fee.

The Don refused. “A man who gets a percentage of the winnings,” he said, “will advise me to go to court even when it’s better to settle. I need a man who doesn’t care whether we go to court or not. Then he’ll tell me the truth.” In forty years the old lawyer talked the Don out of a good dozen lawsuits, and every time, as it turned out later, he was right. The Don paid him for the hours he spent talking him out of them.