Ponzi Scheme Roulette

In a world where investor confidence has been shattered by massive mismanagement by top executives in the banking, insurance, mortgage lending, stock brokerage and auto industry fields, now comes the greatest Ponzi scheme in history. Bernard Madoff has reportedly admitted and is accused of bilking experienced investors worldwide out of an estimated $50 billion. There are many aspects of this case that are simply astounding. First is the sheer amount of money involved…$50 billion. Next is the number of years Madoff was able to keep the scheme going without getting caught. Finally, it’s amazing the number of so-called sophisticated investors that were caught in his web of deceit. As a former chairman of the NASDAQ Stock Exchange, investors and regulators alike viewed his credentials and reputation as impeccable. 

The scope of the fraud is so widespread that virtually everyone is familiar with at least a few of the names of some of the victims. Notable examples of sophisticated investors include: Spain’s international banking group BBVA ($400 million in losses) which bought Compass Bank; Royal Bank of Canada ($40 million in losses) which acquired, through its American subsidiary RBC Bank, the long-time Birmingham financial institution First American Bank (formerly National Bank of Commerce); Mass Mutual Life Insurance Company subsidiary Tremont Group Holdings Inc. ($3.1 billion in losses); Steven Spielberg’s Wunderkinder Foundation; and GMAC Chairman J. Ezra Merkin’s Ascot Partners LLC ($1.8 billion in losses).
If these so-called sophisticated investors can be fooled to the tune of millions or billions of dollars, what chance does the typical investor have of avoiding a similar fate? By following a few simple rules, you can protect yourself:
  • The single biggest safety guard for protecting yourself is to make certain that your custodian, the company where your money is held, is separate from your investment advisor. In the Madoff case, his company served as investment advisor and also held the client assets. Client statements were controlled, and falsified, by Madoff. The key here is to make sure your statements are being produced by a third-party custodian such as Charles Schwab, Fidelity, or Vanguard.
  • Be sure to review your statements. Too often, people ignore their statements assuming all the details are being taken care of by their investment advisor. When reviewing your statements, look for security purchases or sales that appear contrary to your agreed-upon investment strategy. If you find anything unusual, contact your advisor immediately for an explanation. If you do not receive a satisfactory answer, speak with your investment advisor’s supervisor or, if necessary, a securities regulator or simply move the account to another advisor. In Madoff’s case, his returns were too ‘steady’ showing earnings of approximately 1% per month for years. In the stock market world, that should have raised many red flags.
  • Understand the relationship with your advisor. Many advisors have a fiduciary responsibility to their employer, not you. One group, Certified Financial Planners (www.cfp-board.org), are required to have a fiduciary relationship with you, the client. While this direct fiduciary link is not a guarantee against fraud or a guarantee of competence, it is a giant leap in the right direction. 
Ultimately, you are responsible for monitoring your investments and this case puts an exclamation point on why that responsibility should be taken seriously.