Survival TipsNormally, I save this section until last, but today it's time for one extended survival tip. It's on how to avoid becoming the victim of an unfathomably large fraud. The reason the question arises? Bernie Madoff, perpetrator of the biggest Ponzi scheme in history and arguably the most notorious financial criminal of all time, is no longer with us. He died in prison Wednesday morning, at the age of 82. You can read my instant analysis, which you might call an "appreciation" for want of a better word, here. Madoff was far from a loved or lovable character, and his success was in large part because he succeeded in avoiding attention. But he has come to symbolize a lot. For some, he can be a convenient symbol of all they hate about Wall Street, which is understandable. I've also had feedback from people who feel that he was a scapegoat for the global financial crisis of 2008, which in my opinion is simply untrue. Madoff's crimes were clear, premeditated and monstrous. They far predated the crisis. Indeed, without the crisis he might quite possibly have escaped undetected until he died. Rather, Madoff became a significant cultural figure for two reasons, in my view. First, the sheer scale of the crime is breathtaking. The original Ponzi scheme, involving airmail stamps, collapsed in a matter of months. Madoff's lasted for decades, and by the time it ended his clients thought he was looking after $65 billion of their money. Second, the utter cynicism and lack of any empathy that Madoff needed in order to commit his crimes surpasses normal understanding. He stole from friends, charities and religious groups. He must have known for many years that he was bringing disgrace and humiliation on himself and his family. But he had the chutzpah to carry on. My argument is that he got away with his crimes for such a long time because he showed an acute understanding of what might pass without raising alarm. People know that if something seems too good to be true it probably is, but Madoff's funds made a virtue of modest consistency. Year after year, they claimed to have earned about 10%. Over the fullness of time, this compounded into fabulous sums, and was plainly too good to be true; but each individual year seemed plausible, and the consistency of the returns lent the funds an aura of conservatism and common sense. This was another critical element of Madoff's success as a fraudster. His statements were provided regularly and appeared to be detailed and professional. Those who asked to withdraw cash received it promptly. Even though it was a thoroughly criminal enterprise, he ran it as though it was a real business, with customer service to match. To a reasonable and intelligent person, everything seemed legit. My colleague Joe Nocera wrote this moving piece on the damage that Madoff left in his wake. Many victims were middle-class, and their life plans were ruined when the scheme collapsed. They weren't greedy, so much as sincere in the belief that they were acting prudently to safeguard their families. In the months after Madoff's arrest, I was pretty unsympathetic to the plight of those who had lost money with Madoff. I thought they should have realized that it's implausible for a money manager to generate the kind of steady returns that Madoff did. But then someone showed me a statement from Bernard L. Madoff Investment Securities LLC. I was astonished. It was extremely detailed, with a long list of securities that the client supposedly owned, along with monthly gains or losses. It must have been arduous for those helping Madoff commit the fraud to compile — and have it add up to a small gain each month. But if you were a relatively unsophisticated investor, could you truly be expected to even suspect that the statement was fraudulent? Unlikely.
Madoff also had the ability to bring exclusivity to his side. He didn't advertise. When people asked to place money with him, he would first demur. Getting into his funds, often at the recommendation of friends, seemed to be a great privilege. Anything will seem better if you think you have been granted admission to something others cannot have. Ponzi schemes haven't gone away, and others will try to do what Madoff did. So how do you stop yourself from becoming a victim of such a man? Any time you are told you have the chance to get something exclusive, or to take advantage of an offer that will soon be taken away, it is a good idea to run away. There were plenty of whistle-blowers who spotted that something was amiss. Harry Markopolos, whose book can be found here, famously told the Securities and Exchange Commission that there weren't enough options in existence for Madoff to be performing the strategy he said he was doing. The reporter Erin Arvedlund, then of Barron's and now of the Philadelphia Enquirer, had written at length on the anomalies surrounding the Madoff fund in 2001 — her book can be found here. While many banks wittingly or unwittingly enabled him, some asked the right questions and didn't. Richard Butler, who ran the U.S. financial business of ING during the last years of the Madoff scheme, sent me this: For years we looked at Madoff's record and marveled at his low vol strategy. Great Sharpe and Sortino Ratios using liquid stocks easy to margin. On several occasions my Asset Management team was queried as to why we didn't have Madoff as a client (we were a leading firm providing leverage to managers running non-public illiquid portfolios). You were spot on in his apparent diffidence to new business. He worked hard to portray himself as a manager who picked his investors from an exclusive list and really wasn't interested in your money. However, he was very interested in adding leverage to his portfolios towards the end. We had always insisted on requiring the assets and record keeping to be at a third party custodian - pretty normal stuff. He always was very polite in throwing us out of his office when we wouldn't budge from that. About six months before it all blew up he actually called us and wondered if we could work on a $500mm leverage facility and that he would consider putting a third party custodian in place within a month or two of closing. We said we would be glad to work with him as long as the custodian was in place. Of course that was it. It was interesting that my team never got kudos for avoiding Bernie from the folks that gave us a hard time for "missing out on all that revenue".
He concluded by saying: "Stick to your principles — in the long run it works out." As the fraud grew larger, and Madoff paid fees to more Wall Street firms, it became harder to stick to the principles. But with hindsight, all you needed to do to avoid being swindled was ask the most basic questions about the professional and technical infrastructure on which Madoff's investments were based. Another reader, veteran of a different Wall Street bank, said: Our compliance group asked him 3 questions: 1. Who is your law firm (2 man shop)? 2. Who is your accounting firm (2 man shop)? 3. Where are the assets held ("we hold them")? In 5 minutes they figured him out....and the U.S. Government could not. Simple. Tragic.
It was that simple. If Madoff had had credible lawyers and accountants, and an independent custodian, he couldn't possibly have done what he did. For those on Wall Street, it was straightforward to say no to him, and many did. The fact that it was that obvious to so many in the financial world that Madoff was up to something only makes it more scandalous that he was allowed to keep plying to his trade to the public. That leads to the question: should we feel sorry for the victims? Many don't. This was perhaps the harshest comment I received, but others felt the same way: Do they bear no responsibility? Could you be that dumb and feed yourself ? Did they see what stocks were long and who the custodian was? Advisors often send out statement but the positions must be housed somewhere. They deserved to lose their money. Especially the ones that gave him 100% of what they had. Who does that ? I wouldn't give my mother that.
I still pity them. My time as a personal finance journalist interviewing victims of financial scams taught me that you can be very intelligent and very successful in a non-financial profession, and be clueless about finance. People saw an investment that seemed conservative, that wasn't being overtly advertised, and that came recommended by many friends and people they respected, fronted by a man who had risen to be the chairman of Nasdaq. Was it really incumbent on them to have the same grasp as a professional Wall Streeter, and ask questions about the custodian, or check each line of a long and internally consistent financial statement? If we require the customers themselves to ask such questions, we are leaving far too much to the last line of defense. They should be able to assume that anyone allowed to ply their wares must have satisfactory answers to such questions. But as regulators, in the U.S. and elsewhere, cannot be trusted to thwart a Madoff, the moral of the tale is clear. Ask the usual questions about an investment; and then don't be embarrassed to ask about accountants, lawyers and custodians. It can often seem almost rude to question trusted friend about such things (which was part of Madoff's genius). But financial survival depends on it. Like Bloomberg's Points of Return? Subscribe for unlimited access to trusted, data-based journalism in 120 countries around the world and gain expert analysis from exclusive daily newsletters, The Bloomberg Open and The Bloomberg Close. | 
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