Personal Investing - Ponzi schemer

June 10, 2021

Bernie Madoff died in prison April 14, 2021. He had served about 11 years of his 150-year sentence. 

Madoff was the mastermind behind the largest Ponzi scheme created to date. In a Ponzi scheme investors are promised outsized returns to attract money into a pool. Early investors are paid their returns from the contributions of the latecomers, because there are no underlying investment assets earning anything. Madoff’s genius, and one reason his scam lasted so long, is that the returns he promised were not remarkably high. Rather, they were remarkably steady, and so seemed safe to prospective investors. 

The seeds of Madoff’s fraud apparently were planted after the 1987 market crash, when some of his investors demanded cash. But the scheme really got going, according to Madoff himself, in the early 1990s. As his reputation grew, more and more investors wanted in on his “split-strike conversion” strategy for beating both bull and bear markets. Eventually clients placed some $16 billion with Madoff for investing. Some $14 billion in principal was eventually recovered, but the estimated $50 billion of phantom earnings just evaporated. 

A wide range of investors were duped by Madoff, reportedly including Hollywood stars such as Kevin Bacon, Kyra Sedgwick, Jeffrey Katzenberg, John Malkovich, and Larry King. The fact that Madoff had been the chairman of the board of directors of the National Association of Securities Dealers probably aided in his credibility. 

The SEC also was tarnished by its failure to detect the massive Madoff fraud earlier. A 500-page report by the agency’s Inspector General in 2009 noted that there had been red flags for at least 16 years, but through three examinations and two investigations the SEC never detected the swindle. Madoff was undone by the Great Recession, when too many of his clients demanded cash as the value of their other assets shrank. He confessed his crime to his sons, and they notified the government. 

The first line of defense against investment cons needs to be educated and skeptical investors. Investors need to be aggressive in investigating those to whom they plan to entrust their money.
For example: 

• Don’t take promises of extraordinary investment returns at face value. If the promoters knew an easy way to make a fortune, why would they share the secret?
  
• Don’t be hustled by high-pressure tactics. The investment world is not going to run out of good opportunities in the next 20 minutes. 
• Beware of those who claim that they’re doing you a favor because you’re a member of a certain organization, church, or professional group. 

Trite but true. 

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