Lessons to be learnt from Madoff fiasco
Last month marked the end of another human tragedy of epic proportions. A tragedy so similar to Shakespearean elements of deception, lies, obfuscation, greed, herd mentality, the overwhelming need to be aligned with the “popular” group, religious community grooming, power, lax oversight, a finality of suicides in the face of financial ruin and a lonely incarcerated cancerous demise.
The whole scenario, a fraud in excess of $60 billion, evolving in financial circles over more than 30 years was perpetrated by a highly respected member of the finance industry, a prominent philanthropist, serving on various boards, e.g. cofounder of the Nasdaq Stock Exchange and its chairman, while his firm was a broker-dealer, a pioneer in electronic trading, and one of the largest market makers on Wall Street.
Even when it was unquestionably fact-proven that what was supposed to be a unique investment policy position was actually a total scam, few in financial circles initially paid more than cursory attention.
We now know that Bernard Madoff, who died last month, founder of Madoff Investment Securities LLC, was running a Ponzi scheme, pure and simple.
How could this have happened right in the investment environment of some of the smartest finance people in the world?
Madoff had the reputational credibility, financial influence, power, social standing, secrecy, discretion and the offer of exclusivity. Not everyone who wanted to invest with Madoff was accepted. Those that did were advised of discretion. It appeared that those who did ask too many questions did not become a “member” of the club.
In the foreward to Harry Markopolos’ book No One Would Listen, David Einhorn, an American hedge fund manager, founder and president of Greenlight Capital, stated “Harry Markopolos is a hero. But not for anything he meant to do. He did not stop Bernie Madoff from creating the largest Ponzi scheme of all time; nor did he save Madoff’s investors any money. What he did do was create a clearly documented record of his warnings so that when Madoff’s scheme eventually toppled under its own weight, the Securities and Exchange Commission (SEC), which was charged with stopping fraud and protecting investors, could not assume an ostrich defence.”
The discovery process all started because a Madoff fund was returning a steady 11 to 12 per cent a year, deviating only slightly over time, with only three minor down loss years. Markopolos, an experienced forensic accountant, a CFA and CFE and quantitative mathematician, was asked by his boss to deconstruct Madoff’s investment strategy – in order to offer a competitive alternative.
Over the next nine years, Markopolos and a team of like-minded dedicated colleagues attempted to document and build an equivalent fund. They failed, but all arrived at the same conclusion.
There was no fund.
Why? Because in researching the Madoff “split-strike conversions strategies”, there were no securities purchased, no trade tickets placed, no block option strategies, no rebalancing, no credible investment policy. There were no mathematical algorithms that made sense.
Yet, there had to be significant paper trails just due to the high volume of purported trade strategies. There was no back-up documentation.
The whole purported portfolio did not exist, yet millions, billions were being invested by high-income clients, including nobility, charitable foundations, financial institutions, feeder funds, and the like. What was considered a stellar performing fund, an honour and a privilege to be invested in, did not exist.
Five times, Markopolos (with his team’s assistance) reported his findings with factual detailed evidence to security authorities – receiving little to no response. Several times, too, he submitted verifiable proof to prominent financial newspapers. He not only put his own reputation on the line, but the stress of significant safety concerns for his family and himself.
Markopolos’s (and team) discovery did not topple the Madoff finance empire. The 2008 US capital market crash did the ultimate damage.
A Ponzi scheme works simply and well as long as the money pipeline is in place. Old investor money is siphoned off; new investor money is used to pay old investor gains, dividends, etc. When investor redemptions accelerated, and the new money spout dried up, it was all over – except for the grief, remorse, and staggering personal losses.
We can only speculate why an individual could act supposedly with an impeccable reputation of integrity while his entire life was a lie: friends, acquaintances, clients, family, investment colleagues, and more, all deceived – for money.
Finally, where did all the money contributed in a 30-year fraud go? Amazingly over 12 years to April 23, 2021, the US Securities Investor Protection Act (SIPA) Trustee with the extraordinary efforts of Irving Picard, recovery trustee, and his team has recovered approximately 80 per cent of clients’ principal monies under the Madoff Recovery Initiative.
This feat of rigorous dedication is an absolutely stellar success, as Ponzi scheme recoveries in the past have generally resulted in collection of only a few cents on the dollar, a mere 3 to 5 per cent of the initial client contributions.
Ponzi schemes are illegal, period.
We all know just how overt peer pressure can be subliminally exerted. We see it every day. We may have even succumbed from time to time: going along to get along; wanting to be included in the popular, “with-it” group; not being perceived as a loser; having the feeling of a special, exclusive camaraderie such as wearing/owning/driving the latest consumer tastes, the more perceived valuable the better, being acknowledged and included with politically-connected persons, and on.
Nothing in life has really changed since high school, has it? Except that those adult stakes can be astronomically higher. Whether you are in finance, religion, politics, trade/business, environmental change actions, professions, education, or any other involvement, everyone wants to feel that they belong, that they are part of a special community that relies on trust, integrity and respect. Nothing wrong with any of these aspirations.
Sometimes, however, an individual veers off the track, punitively to those around him or her. We will never really know why.
Finally, what can we ordinary folk take away from such horrific financial tragedies.
When considering investing, there is much persuasion to use common sense and as in court testimony – to seek the truth tellers.
• The truth, the whole truth and nothing but the truth
• Trust, but always, always verify information independently
• Trust your own your intuition. If it doesn’t feel right, it probably isn’t.
Recovery of funds from the Madoff investment scandal, https://www.madofftrustee.com/recoveries-25.html
• Martha Harris Myron CPA JSM is a native Bermudian Pondstraddler, author of The Bermuda Islander Financial Planning Primers now hosted on The Royal Gazette website, and financial journalist to The Royal Gazette since 2000. All proceeds from these articles are donated to the Salvation Army, Bermuda. Contact: email@example.com