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28 December, 2008

Beware of Madoffs of the world


Bernard Madoff was not a household name until his arrest by police in Canada in connection with a massive investor fraud case. Later Madoff was rearrested in New York when his two sons reported his fraudulent investment methods to the police. After preliminary investigation, authorities have concluded investors lost about $50 billion. As the details of the fraud became known hundreds of investors were bilked by Madoff whom they trusted as Uncle Bernie. He is charged with one count of securities fraud.

Madoff ran a giant Ponzi scheme which lasted more than two decades. Ponzi scheme is nothing new to Americans. Ponzi is an Italian who first devised the scheme. In a ponzi scheme returns for the existing investors are paid by new investors like robbing Peter to pay Paul. Madoff was able to consistently generate 12 to 14 % returns year after year on the investment. As the word passed around about Madoff’s financial genius, more and more investors vied to participate in his “safe” investment. Madoff created an aura of invincibility around him. Madoff carefully chose his clients. He would reject potential investors without assigning any reason.

How Madoff was able to pull off such a huge fraud without eliciting suspicion from his faithful clients for many years has befuddled the investors. Madoff was a reserved and elusive person. Brought up in Queens, New York, Madoff did not finish law school. He made his fortune as a stock trader in the early seventies. Whenever an investor suspected Madoff operation could be a Ponzi scheme, he would return the money as soon as requested. What is remarkable is the investigative agency Security and Exchange Commission had looked into his books over the years and found nothing unusual. Madoff was one step ahead of the sleuths.

The investor community had nothing to worry about the Madoff investment strategy. His credentials were impeccable. Madoff was the Chairman of the famous NASDAQ stock exchange in 1990, 91 and 93 and held a seat on a government advisory panel on stock market regulations. He cultivated a large circle of wealthy friends through his business and country club affiliations. Those who were wealthy knew who Madoff was. His clients included rich individuals, small investors (minimum required was $100,000), Yeshiva University, New York Law School, International Olympic Committee, Tufts University and many Jewish charities.

A disproportionate number of Madoff clients turned out to be from the Jewish community. Well known names like movie director Stephen Spielberg, Frank Lautenberg and Elie Wiesel have lost heavily. So many Jewish charities which helped wide ranging causes have lost most of the money invested. Many organization throughout the country depended on the annual donations from these Jewish charities. Some had to close down. Then there were individual investors who put in from half a million to 5 million dollars with Madoff. The last group has lost all their hard earned money and retirement savings and now faces the prospects of starting all over again.

Madoff’s financial operations were not limited to the United States of America. Banks in U.K, France, Spain, Switzerland, Italy, Austria, Japan and Singapore were affected. French financier Villehuchet, 65 years old, committed suicide in New York on Dec 3rd. His firm Access International Advisors had lost 1.5 billion dollars. Some will go into depression while others will have sleepless nights and nightmares. All the Madoff investors will need psychiatric counseling to help them cope with the financial crisis. Some people were wise enough not to invest all their savings with Madoff. They are the only winners in this unfolding tragic saga.

Ultimately Madoff’s Ponzi scheme went undetected because of the human tendency to trust a fellow human being. That trust will be further secured when all the people in the group belongs to the same community. The Jewish community is a close knit group. A fellow Jew can well relate to their common ethos. It is that basic trust that Madoff violated and betrayed. Herein lies a cautionary tale of unpredictability in human nature.

If an investment appears too good to be true, it probably is. Return on investment of 12% year after year even in a bear market should raise suspicion. The adage “Do not invest all your eggs in one bssket “especially if you have no other source of income holds true. Retirement savings should always be invested in stable funds. Those who depend on financial planners should know their credentials and investment strategy. In the Madoff case some investors got sucked in, even though their money was placed in other reputable funds. This was done without the investor’s knowledge. As long as there is money to be invested, there will be a crook somewhere waiting to bilk the client. As long as the lure for money remains a flaw in human character, one has to be cognizant of the potential fraud. Often it is the greed and trust that pave the way for fraudulent activities. Treat money always with respect and prudence.

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