Bernard Lawrence Madoff, a law school drop-out, founded his firm back in 1960 with $5,000. Quickly establishing himself as a prominent market-maker and seeking to compete with the bigger firms, Madoff looked toward using technology as his edge over the competition. He joined the National Association of Securities Dealers, serving as its vice chairman, and helped to create the NASDAQ in 1971.

Everyone was shocked that, with such an auspicious background, Madoff perpetuated such an outrageous scheme for so many years on so many people that counted him among their friends.

Everyone who talked with Madoff and his wife had nothing but good things to say about them. Clients told their friends about his consistent returns and pleasant demeanor, piquing their interest. Madoff used this popularity to his advantage, creating exclusivity around himself and his fund. It was a well-known fact that Madoff turned down many investors, and you had to have an “in” to be accepted. He was so nice that his relationship with many people was built on his handshake and smile rather than the proper due diligence which should be associated with a high-level fund manager.

Madoff reported consistent year-over-year returns in his Fairfield Sentry Limited Fund, which, when plotted on a graph, resembles almost a perfectly straight ascending line since its inception in 1990. His “modest” returns, usually in the low double-digit range, kept him under the SEC radar just enough to continue his operation.

When a fund manager “guarantees” positive returns - year in and year out, with no discussion of how he does it - clients should abandon ship immediately. Virtually no one can avoid the inevitable downturns in the market for so long.

An independent custodian, such as Charles Schwab or Fidelity, helps safeguard an advisory firm’s assets and reports major activities performed by the advisory firm, providing an extra layer of security for the clients. Custody of the assets is usually done by a third party custodian, but Madoff did all of this in-house. Without an independent overseer, he was allowed to steal money and easily create false account statements about the “returns” investors were receiving. 

Kohlhepp Investment Advisors, Ltd. is an SEC (Securities and Exchange Commission) Registered Investment Advisor having only limited authority. Kohlhepp Investment Advisors, Ltd does not and never has had direct access to your assets. We are authorized to trade but cannot move your money around without permission.

Madoff was very secretive about the process through which he created his returns. He used his “split-strike conversion” strategy (a sophisticated options trade) as his cover for everything. When people asked too many questions, they were asked to leave. Madoff made it obvious to his investors that he did not like too many questions and that it is not other people’s business what he does with their money.

How ironic it is for the person who fathered the NASDAQ system of computer-based trading to refuse online access to his clients and to send antiquated statements with 10-year old technology to his clients. User-friendly statements and online access is a standard feature among managers and firms across the board. It is obvious in hindsight why Madoff’s technology was so outdated: updating his technology would have meant additional staff was exposed to his charade.

Summary

In order to protect your investments, always remember the following:

1. NEVER make investment checks payable to the advisory firm, i.e., “Kohlhepp Investment Advisors, Ltd.” Your checks should be made payable to the custodian who “safeguards” the funds, e.g., Charles Schwab, Fidelity Investments, XYZ Trust Co., etc. The only exception to this would be for hourly and/or financial planning fees.

2. Always make sure you receive separate confirmations/statements for your investments (no less often than quarterly) from the independent custodian, Charles Schwab, Fidelity, etc. If you have multiple strategies you will probably receive multiple statements. These statements, either electronic or paper, will confirm your investments and trades and keep you up to date on your accounts.

3. Above all, your investment advisor should be a fiduciary. He or she should be schooled in the area of fiduciary duties and operate pursuant to a published code of ethics. It is evident that Madoff was unethical and illegal. He stole from his investors and broke the law.

We at Kohlhepp Investment Advisors, Ltd. are fiduciaries, always acting in your best interest. The fiduciary standard is a legal concept, but its core idea is not complicated. To act as a fiduciary means we professionals have to put aside our own financial interests, and also put aside the business/financial interests of any company we work with, and give recommendations that are solely and completely in the best interests of people like you, our clients.

In other words, our recommendations have to be made with only one concern: is this the best thing I (the professional) can do for you (the client), given what I know about who you are and what you want and need?

We encourage questions about your investment strategy. We follow guidelines placed upon us by you and the regulatory agencies. Though almost all registered investment advisors act in the best interests of their clients, the few bad apples taint the credibility of the whole investment industry. Should you have questions or concerns, we encourage you to contact us.

We truly hope this e-letter is helpful. Feel free to pass it on to friends and family. Let’s try to prevent any further Bernie Madoff scams from occurring.

Happy spring!

Source:Horsesmouth.com

The views expressed are not necessarily the opinion of Cambridge Investment Research and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investing is subject to risks including loss of principal invested. No strategy can assure a profit nor protect against loss.

Economic forecasters sometimes describe the investment markets as a leading indicator, which means that they believe returns can anticipate good or bad economic news. Share prices fall when investors expect a recession, and rise when a recovery is expected--and last year's stock market growth seems to fit that pattern. The market rose last year faster than anybody expected, and so too, later, did the U.S. economy. On March 26, the U.S. Bureau of Economic Analysis reported that the U.S. gross domestic product increased at an annual rate of 5.6% in the fourth quarter of 2009, after a 2.2% increase in the third quarter. 

Nobody knows how we, the community of investors, could have known, during the darkest hours of March 2009, that better economic times were around the corner.

The U.S. equity markets were generally higher across the board in the first quarter of 2010, which is a terrific contrast with where we were at this time last year. Indeed, CNNMoney.com reported that the returns for the first three months of this year ranked among the best first quarter performances in more than a decade.

Wilshire Associates reports that the Wilshire 5000 total market index, the broadest indicator of U.S. stocks, was up 6.42% in the first quarter of this year. Most of the action came in March. The Wilshire index was actually slightly down for January and February, but March produced a 6.61% rise in the index. The S&P 500 also rose 4.9% for the quarter.

Wilshire's Mid-Cap index was up 9.11% for the quarter; the Russell Midcap rose 8.67%. Wilshire's Small Cap 250 rose 9.00% in the first three months of the year, and the Russell 2000 returned 8.85% over the same period.

A generally rising tide--and signs of an improving economy--seems to have floated all boats.

The EAFE index, the broadest measure of developing nations, reported a relatively calm-looking year-to-date return of 0.22% on the MSCI/Barra web site, and the Far East index was up a robust 6.29% for the quarter. Emerging markets were up 2.11%. Meanwhile, government deficit troubles in Greece, Spain and Ireland, and to a lesser extent in Italy cast a shadow over the European economies. European stocks in the MSCI index were down 2.33% for the quarter.

Real estate stocks continued a recovery that began in 2009 after two very difficult years. The FTSE NAREIT Index, which is compiled by the National Association of Real Estate Investment Trusts, experienced a total return drop of 17.83% in 2007 and fell another 37.34% the following year. But in 2009, the broad real estate index rose 27.45%, and recorded a 10.60% total return in the first quarter of this year. 

Even bonds offered positive returns. The Lehman U.S. Aggregate Bond index was up 1.64% for the first three months of 2010, and Treasury bonds started the year on a positive note. 

Nobody knows whether this sunny investment climate will continue, or whether the strong market returns over the past 12 months will give way to a new bear market. However, one indicator suggests that we may not be walking blindly into another frightening meltdown like the one we all experienced in 2008 and the first two months of 2009. The Chicago Board of Options Exchange measures volatility in the stock market by its VIX index--which is more precisely an expectation of volatility and risk over the next 30-day period, and is sometimes called Wall Street's "fear gauge." On November 20, 2008, the VIX index hit a ten-year high of 80.86, according to data compiled by the IMCA-RC web site. On March 23, 2010, the VIX index closing price stood at a more historically normal level of 16.35. 

Thanks to a positive uptrend in March, the past quarter's market returns represent one of those unusual periods when just about everything went up. Just a year ago, people were talking about the collapse of civilization, and six months ago there were worries that the economic stimulus package would not be enough to get the U.S. economy moving again--that the country was headed for a double-dip recession.

The economy won't be fully recovered until jobs come back, and the recent stock market rises haven't yet taken us back up to the levels before the Great Recession swept through like a hurricane. But people who were nervously sitting on the sidelines over the past year, and the past quarter, missed out a nice rally. Let's hope it continues.

Enjoy the Spring!

Best Regards,

Edward J. Kohlhepp, CFP^®, ChFC, CLU, CPC, MSPA

Edward J. Kohlhepp, Jr., CFP^®, MBA

Sources:

First quarter returns are higher than most others this decade: http://money.cnn.com/2010/03/31/markets/thebuzz/index.htm

Economic growth rate: http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm

Wilshire Indices: http://www.wilshire.com/Indexes/calculator/

Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp

Bond returns: http://www.lehman.com/indices/dailyreturn.html

International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html

Dollar's rise and fall: http://www.fxstreet.com/rates-charts/

VIX data: http://www.icmarc.org/xp/rc/marketview/chart/2010/

Global Stock Market index returns: http://www.emerginvest.com/WorldStockMarkets/Countries.html

NAREIT (Real Estate) data: http://www.reit.com/IndustryDataPerformance/FTSENAREITUSRealEstateIndexDailyReturn/tabid/77/Default.aspx

Unemployment data: http://money.cnn.com/2010/03/31/news/economy/ADP_private_sector_payrolls/index.htm?postversion=2010033109

The views expressed are not necessarily the opinion of Cambridge Investment Research and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investing is subject to risks including loss of principal invested. No strategy can assure a profit nor protect against loss.

March 29, 2010

Taxes: This bill is an increase in taxes for upper income taxpayers. Starting in 2013, the Medicare tax on households with income over $250,000 will increase to 2.35% from 0% at present. Plus, a new 3.8% Medicare tax will be assessed on investment income for that same group.

In 2011, the tax rates on dividends and long term capital gains are expected to rise to 20% for households earning over $250,000.

Medical Care Industry: This bill will expand demand without much effort to control costs. The pool of insureds will be increased dramatically, possibly by 32 million. While there are many provisions preventing insurance companies from limiting coverage, there are few provisions that limit how much the insurance companies can charge for it, i.e., the insurance premiums.

According to J P Morgan Asset Management, early in the health care debate, the White House cut deals with pharmaceutical, insurance and medical device companies to dissuade them from fighting the reform effort. As a result, the companies appear to retain autonomy on price setting. However, they will pay cumulative taxes of $107 billion between 2011 and 2019. It appears they will be able to pass many of these costs and additional taxes on to consumers.

Federal Deficit: Theoretically, this legislation is supposed to reduce federal deficits by a cumulative $143 billion between now and 2019 and larger amounts later. It is obviously very difficult to estimate what total health care costs will be over the next decade. Certainly nothing suggests there will be reductions in either the quantity or prices of health services. Some observations:

• There is no malpractice reform
• There are no reasons for insurance companies to compete across state lines.
• There are only minimal controls in place to lessen the increase in health insurance premiums. In fact, if insurance companies have to cover tens of millions of additional people, many with pre-existing conditions and health problems, they are likely to increase premiums for healthy people, because they are not likely to accept lower profit margins.
• Should our country mandate that a person must buy health insurance or be penalized?
• Richard Foster, the chief actuary for Medicare, says the planned squeeze in federal payments to hospitals may cause many of these hospitals to drop out of the program.

This bill moves our country further away from the principles of market economics. In 2007, the US devoted 16% of the GDP to health care spending, compared to the second highest country, France (11%). Despite this, the US ranks 38^thin the world in life expectancy at birth. Is this bill likely to change either of these numbers for the better?

Note, there are many, many issues that are not addressed in this commentary. We will have future newsletters as more information and interpretation becomes available. Obviously, we all have concerns about the efficacy of the legislation.

Enjoy your Easter and Passover holidays with family and friends.

Best regards,

Edward J. Kohlhepp, CFP^®, ChFC, CLU

Edward J. Kohlhepp, Jr., CFP^®, MBA

Sources:

J P Morgan Asset Management

HR 3590 – The Patient Protection and Affordable Care Act

HR 4872 – The Reconciliation Act

The views expressed are not necessarily the opinion of Cambridge Investment Research and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Investing is subject to risks including loss of principal invested. No strategy can assure a profit nor protect against loss.

But the fight is not over. The House of Representatives also passed a collection of amendments to the Senate bill by a 220-211 margin, but the Senate must also approve this reconciliation bill – exactly as it is worded. If that doesn’t happen, then guess what … there will be another vote on the Senate version of the bill in the House.^1,2

“If those people think they’re only going to vote on this once, they’re nuts,” Sen. Orrin Hatch (R-UT) said on Bloomberg Television March 20. Hatch claims that Senate Republicans have the votes to force a modification of the bill passed on March 21 and boot it back to the House for a second vote.³

Will the reforms be overturned? Twelve state attorney generals have indicated that they will contest the bill on these grounds the moment President Obama signs it.⁴ What are the odds the Supreme Court will throw the reforms out? Probably pretty slim. Look at the precedents of Medicare and Medicaid. When both those federal programs were enacted, the Court twice upheld a broad federal role in health care.

The big reforms will take effect in 2014. If you are looking forward to health insurance reform, you will have to wait a while before many of the big changes occur.

• Starting in 2014, individuals will be required to have health insurance coverage or pay an annual penalty which could climb to $750 or 2% of their income (alternately $695 or 2.5% of income), whichever is larger. Inmates, Native Americans, and those with religious objections would be exempted.^5,6
  
• In 2014, if you aren’t enrolled in an employer-sponsored health care plan, you will have to buy coverage yourself. You could shop for it through a state insurance exchange. The federal government will offer $500 billion worth of assistance to help insurance shoppers buy coverage through these state exchanges. Undocumented immigrants would not be able to buy coverage.^5,7
  
• After 2014, businesses with more than 50 employees could be fined as much as $2,000 per worker for failing to provide the option of coverage.⁵
  
• In 2014, insurers will be required to provide coverage to all Americans regardless of their health status.⁷
  
• Medicare spending will be cut by about $500 billion over the next decade, mostly in reduced government payments to Medicare Advantage plans. Democrats have claimed this will not shortchange Medicare recipients.⁵
  
• Federal money coming from the bill could not be used for abortions, with exceptions made in cases of rape, incest, or danger to a woman’s life.⁸
  

What changes are about to happen in 2010? These new rules would go into effect presently thanks to the new law.

• Insurers will be barred from revoking existing health insurance coverage on an individual, unless fraud or misrepresentation can be shown.⁶
  
• Insurers will not be able to limit the amount of money that can eventually be paid out on a health care policy, and it will be harder to limit the amount of money that can be paid out annually.⁶
  
• Seniors will get $250 payments to help them out if they face a coverage gap in the middle of the Medicare Part D prescription drug coverage plan.⁶
  
• Children will be able to stay on their parents’ health care policies until age 26, and they won’t be denied coverage because of pre-existing health conditions.⁶
  
• Adults with pre-existing health conditions will get a chance to enroll in a national high-risk insurance plan – albeit a temporary one.⁶
  
• Small businesses that sponsor health care plans for their workers could qualify for tax credits of up to 50% of the cost of the premiums they pay.⁶
  

New taxes? Yes – starting in 2013. Approval of these reforms will also bring a new 3.8% tax on investment income for individuals earning more than $200,000 and households earning more than $250,000, so the effective capital gains rate will be 23.8% for these taxpayers in 2013. Also, these taxpayers will be able to keep 8.8% less of the income resulting from taxable stock investments. The Medicare tax rate on households with income over $250,000 will also rise in 2013, from 1.45% to 2.35%.^5,6,9

A huge savings? Maybe. The non-partisan Congressional Budget Office estimates that the health care reforms will reduce the federal deficit by between $65-118 billion over the next decade and by more than $1 trillion in the decade after that.⁵

We will continue to keep you posted as the details and effects of these healthcare changes unfold.  Until then, Happy Spring!

Best regards,

Edward J. Kohlhepp, CFP^®, ChFC, CLU, CPC, MSPA