Avoiding the Bernard L. Madoff Investment Securities LLC debacle

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Avoiding the Bernard L. Madoff Investment Securities LLC debacle

As anyone not locked in a closet is aware, Bernard Madoff was arrested for running a Ponzi scheme that cost investors something on the order of $50 billion. Wall street was stunned, as were the apparently-primarily-Jewish investors, both individual, organizational, and fund-to-fund who had invested in this high-return scheme without bothering to exercise due diligence. After all, why bother to spend a thousand bucks to look at someone of Madoff’s stature. It would be practically insulting to do so!

After the scandal broke we got a thank-you call from a client who habitually has us look at any investment before he makes it. In the case of Bernard L. Madoff Investment Securities LLC, we told our client that as funds get larger the return tends toward the mean of all investment fund payoffs. However, as BMIS got larger, the return was heading away from the mean. While we did not know what was happening inside the fund, this was a very big red flag. Our client prudently decided to put his money elsewhere.

We spend a lot of time looking for concealed assets – something between $600 million and $800 million in an average year – and find a number of common factors in these frauds. First, the participants choose not to exercise due diligence before forking over their money to the fraudster. Second, the participants ignore the fact that the returns are irrationally high, even though they may know intellectually that if it sounds too good to be true it probably is. Third, there is almost always a religious element involved.

This last is an astonishingly good filter. When someone calls us to say that they lost all their money in investment, and wants to know if it was a fraud or a legitimate operating loss, we ask what the people running the fund are like. If the response is that they are wonderful God-fearing folk, and start off each meeting with a prayer, then we know it’s a fraud.

It is as true today as it was when WC Fields movie came out in 1939 that “You Can’t Cheat an Honest Man.” You can, however, cheat someone who is too smart to exercise due diligence, who is willing to take advantage of preternaturally high returns, and who is willing to accept a cloak of religiosity as representing character. We are not attacking religion. What we are doing is letting you know, yet again, that people who regularly make faith-based choices can be convinced to make faith-based choices on investments, when one should use a fact based choice making system.

Many innocent people have been hurt by Madoff, but, sadly, we do not expect that this will lead to an appropriate exercise of due diligence by the next generation of investors, who will be defrauded by the next generation of fraudsters.

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