Investors Burned

Investors Burned

July 08, 2009

Ken Silverstein
EnergyBiz Insider
Editor-in-Chief

On Bernard Madoff's day of reckoning, he apologized to those he hurt. But he has yet to cooperate with federal authorities or to tell his victims where the billions he stole went.

Throughout history, scandals have been commonplace. This one is estimated to be at least $13 billion and has entrapped individual investors, banks and charities, all of whom placed their trust in a man with "impeccable credentials." Madoff's penalty, 150 years in a federal penitentiary, is meant to be a warning to future hucksters to back off. The sad reality, though, is that such a Ponzi scheme will invariably occur again and again and that investors must do more of the due diligence up front to avoid getting burned.

"Here the message must be sent that Mr. Madoff's crimes were extraordinarily evil and that this kind of manipulation of the system is not just a bloodless crime that takes place on paper, but one instead that takes a staggering toll," says Judge Denny Chin, who earlier ordered the fraud to forfeit $171 billion in various assets. Still, he was compassionate and left Madoff's wife with $2.5 million.

Because Madoff has not cooperated with federal authorities, they have been left to try to put together the pieces of the puzzle. Their general feeling is that the scam originated in the 1980s and ended in December 2008. In the intervening years, his firm sent bogus statements to its clients that all was well -- too well in fact -- and that his funds were always outperforming the market.

The reality is that Madoff was paying off older investors with new money coming in the door. The government estimates that 1,341 entities have been affected by this scandal.

In March, Madoff, the one-time head of NASDAQ, pleaded guilty to 11 criminal counts that include fraud, perjury, money laundering and lying to federal regulators. Investors, who continue to make their claims against Madoff, have said that if the U.S. Securities and Exchange Commission had investigated assertions made against Madoff's firm, then this whole mess would have been minimized.

Indeed, as early as 1999, the agency had been warned that Madoff's operations could be delusional. But it generally dismissed the allegations, noting that they came from one of Madoff's competitors. Besides Madoff, his accounting firm is alleged to have been complicit in the scandal while the feds are said to looking closely at seven others.

"We implore you to give the maximum sentence at a maximum prison for this deplorable low life," said one of the victims who spoke at the sentencing hearing. "This is a violent crime without a tangible weapon."

Just Desserts

A core issue surrounding the scam is whether the victims should have been suspicious that the returns they had been getting were exaggerated. It's not just a question of due diligence. It's also a legal matter. Investigators are now looking at those investors who cashed out during the last six years and hence avoided the bloodbath. But authorities want to retrieve some of those winnings so as to compensate others who have endured irreparable harm.

Madoff ran a hedge fund, which is an unregulated private investment fund. Hedge funds are comprised of sophisticated financiers that range from wealthy individuals to institutional investors such as pension funds. Investment banks oft-times finance them. Unlike mutual funds that undergo lots of public scrutiny, such accounts lack that relative transparency. The rationale is that the investors know what they are doing and that they are willing to assume the added risks in exchange for potentially higher returns.

The thinking then continues that the lucrative profits that Madoff had provided his clients were too good to be true. In other words, they had been making as much as 10 percent on their investments at a time when others were losing money. They were then given opaque explanations as to how the results were achieved, which few seemed to scrutinize.

"Investors have to do their own due diligence," says Gregory Hays, managing principal of Atlanta-based Hays Financial Consulting, in a BusinessWeek story. "They need to make sure what they're investing in is accurate."

But Madoff banked on his stature within the financial community and was thereby able to deceive authorities. If his operations had been good enough for the SEC, well, it's good enough for those who put their blind faith in the guy. Most people want to believe in and to trust others -- especially the former head of the NASDAQ.

Without a doubt, the overwhelming majority of those who manage wealth have the best of intentions. They play by and live by the rules -- and encourage the national regulators to maintain order in the marketplace. Nevertheless, investors must also do their homework before entrusting others.

Bernie Madoff is an aberration. But the con was caught and now his reputation lives in ruins. Along the way, he has destroyed some faith in the American way. While he will get his just desserts, his innocent victims will also suffer an uncertain fate.