What investment scams are made of

This post is from staff writer Jeffrey Steele.

I’ve had Brian Ross’s 2009 book “The Madoff Chronicles” in my sights for several years, and I finally got around to plucking the tome about the 2008 collapse of the House of Madoff from my local library. Having devoured about three-quarters of this Greek tragedy of a tale, I can report the book has not disappointed.

I’m not trumpeting this slim volume as one of the best written or edited books of all time. It’s neither. But a work of non-fiction doesn’t have to be penned by a giant like Halberstam, Caro or McCullough to be a page turner. Not when it zeroes in on one of the classic sociopathic con artists in history, a skunk so unfeeling that when one of his victims killed himself after losing everything, his response was to cavalierly dismiss the man as a very poor stock picker.

In short chapters, Ross lays out Bernie Madoff’s background, tracks his firm’s history, and offers insights into the people surrounding Madoff. He outlines instances in which the Securities and Exchange Commission came close to exposing Madoff (but let him off the hook), identifies some of the outsiders who should have known Bernie was up to no good but did next to nothing. Ross also relates the woeful stories of victims, who included Hollywood gentry and the owner of the New York Mets, as well as wealthy unknowns reduced from mansions to tiny apartments when their life savings were erased in Bernie’s scam.

With 20-20 hindsight, we can all look back on events and claim we saw them coming. But in the case of Bernard L. Madoff Investment Securities LLC, signs of impending doom littered the landscape. These bright red flags pointing to financial chicanery were largely ignored by investors, business partners, Madoff family members, the financial press and even the SEC.

The only good to come from such a story are the terrific lessons that can be learned — or reinforced. You likely had the good fortune of never hearing of Bernie Madoff until his exposure as the biggest fraudster in Wall Street history on December 11, 2008. The money you might have lost remained your own. But that doesn’t mean you won’t sooner or later encounter other land sharks hungering to take an enormous chomp out of your assets.

Let’s explore some of the warning signs ignored by Madoff’s victims and others, so you won’t become a patsy of the seeming endless supply of fraud-meisters looking to separate you from your gainful earnings.

Returns too good to be true.

Madoff didn’t have to advertise for investors. When word got around that he regularly earned 12 to 20 percent for his clients, they came running after him. And those 12 to 20 percent returns weren’t just realized in the good times. They were generated in the good times as well as the times when everyone else was losing his or her shirt. Of course, Bernie wasn’t earning those returns, he merely claimed them. In reality, he was creating fictional statements itemizing trades he never consummated and paying off current investors with money arriving from new ones — the very definition of a classic Ponzi Scheme.

If a money manager claims double digit returns when others are struggling to earn low single digits, your olfactory sense is not errant. You’ve smelled a rat.

Lack of transparency

Madoff’s “technique” for accumulating investment returns was shrouded in secrecy. When those who funneled their own investors’ money to Madoff tried to pin him down on his methods, or his largely European “counterparties, ” Bernie inevitably asserted this information represented deep secrets to which only he had access, secrets that couldn’t be revealed without jeopardizing his firm. There was good reason for him to favor this strategy. Had he divulged information, it could have easily been checked and exposed as false.

If an investment guru isn’t answering questions to your satisfaction, take a walk.

Questionable credentials

Bernard Madoff surrounded himself with lackeys and yes-men who weren’t exactly London School of Economics honors grads. One of his highest-ranking employees had neither a college education nor a background in finance; another started with the firm as a secretary. “Most of the people hired to work on the seventeenth floor had a connection to someone already employed by Madoff, ” Ross writes. “It was a corporate organizational chart that read more like a family tree of wives, cousins, brothers-in-law, fiancés, lesbian lovers, neighbors and ex-girlfriends. There were virtually no outside professionals.”

The reason for this approach is simplicity itself. Had he invited in top financial talents to work alongside him, they’d have seen through his fraud in seconds.

If the new financial advisory employee on your investment account appears to be the same person you saw piloting a Good Humor truck last week, or taking your order at Denny’s last month, run for the hills.

These are just the start of the sagacious insights that flow from a reading of The Madoff Chronicles. From Bernie’s ultra-opulent lifestyle, which would have made William Randolph Hearst envious, to the willingness of many investors to bank not some, not part, not half, not most, but all their money on Bernie, this is a primer on everyone and everything to avoid at all costs when investing.

I recommend “The Madoff Chronicles.” Maybe someday you’ll be able to say its wisdom helped ensure no one ever Madoff with your hard-earned savings.

One Response to “What investment scams are made of”

Leave a Reply