Heeding The Lessons of The Bernie Madoff Scandal

by Jacob Zamansky on December 15th, 2008 at 2:15 pm : Comments 000

My office’s client investigation of the scope and fallout of Bernie Madoff’s mind-boggling Ponzi scheme is well underway, but already valuable lessons have emerged that individual investors must immediately heed to ensure the safety and soundness of their financial assets:

A Financial Manager’s Business and Social Prominence Doesn’t Ensure Safety and Soundness

Bernie Madoff had impeccable credentials.  He served as chairman of the NASDAQ, was on the board of Yeshiva University, was revered by fellow members of the Palm Beach Country Club, and was extremely generous with his charitable contributions.  Investors in his funds mistakenly believed that Madoff’s prominence in of itself served as effective due diligence.

The sad truth is that individuals who aggressively court business and social prominence can be especially vulnerable to wrongdoing if their identities ultimately become bound to the reverence they successfully court.  My guess is that Madoff didn’t set out to perpetrate a major scam, but took measures to protect his vaulted reputation when the market turned against him.  Like most Ponzi schemes he probably started on a very small scale, masking losses by using new cash inflows to pay off losses with the intent of quickly replacing the money when the markets recovered.

Investors would be wise to be leery of money managers with a so-called affinity base tied almost exclusively to social, cultural and religious institutions.   To wit: The managers of the failed Bayou and WexTrust hedge funds also were prominent members of their communities.

If It Seems Too Good To Be True, It Probably Is

Investors must take time to understand the statements they receive from their financial managers.  All funds should be benchmarked against an appropriate index and if a fund significantly outperforms its yardstick investors must take the time to understand why.   Although significantly outperforming a benchmark isn’t necessarily indicative of fraud or wrongdoing, it often is a sign that a manager has deviated from his investment parameters.  Equally important, investors who don’t understand the investment strategies of the funds they have invested in, shouldn’t be in those funds.

Wall’s Street Appalling Lack of Due Diligence

There were countless warning signs to raise suspicions about Madoff’s purported returns and yet supposedly sophisticated “fund-of-funds,” hedge funds, and their “expert” advisors either didn’t notice or care about them.  At the end of the day, money management isn’t a meritocracy but rather an ol’ boys network.  It is probably the only recourse Madoff investors have to recover any losses is suing the advisors and funds who invested their money with him.

Individual Investors Are Afforded Virtually No Regulatory Protection

The SEC has come under widespread condemnation for its failure to uncover the Madoff fraud, but this outrage reflects a certain naiveté.  As readers of this blog know all too well, I have long argued that the SEC long ago abandoned its mandate to aggressively protect the rights of individual investors.  The Madoff debacle is just the latest example.  The SEC needs to focus on the entire investment advisory service whether clients are “accredited” or not.

Filed under Bernard Madoff, Investment Fraud, Securities Arbitration, Wall Street
and Bernie Madoff, madoff fraud, madoff investors, Ponzi Scheme, Securities Arbitration