Lessons from the $50B Bernie Madoff Scam

December 19, 2008

Bernard Madoff, a force on Wall Street for decades and the former chairman of the NASDAQ ,was arrested recently and charged with running a $50 billion scam that could very well be the biggest fraud case in history. In addition to allegedly swindling individual investors, it looks like some institutional investing firms were caught up in the mess. If these charges are true, the scope of this scam is remarkable and could actually be pervasive enough to affect the market. It saddens me to think of how many people lost their savings in this mess, and I want to take some time today to tell you what you can do as an individual investor to prevent this from ever happening to you.

As you may know, I have a home in South Florida and know lots of folks that were invested with the controversial hedge-fund manager Bernie Madoff. On Friday, I called a couple of stockbrokers I know and started to count the local money lost with Bernie. Within minutes, we were up to $2 billion at the Palm Beach Country Club alone, and we feared that the total would be at least $1 billon more at the Boca Rio golf club. Then there were all the Long Island golf clubs where there were likely billions more lost since Bernie's money management services were mostly sold via social contacts. It appears that at least $17 billion was lost in the biggest Ponzi scheme ever seen.

As a former Chairman of NASDAQ and a member at the Palm Beach Country Club, Madoff was an investing legend. That's what makes his Ponzi scheme so sad. I have seen many hedge fund frauds in South Florida, but this is by far the biggest. Since Bernie provided the illusion of being able to buck negative downdrafts in the stock market for decades, he attracted money from many sophisticated "fund of funds" investors. If I can give you any advice on these situations, please don't take hedge fund advice from your real estate brokers, golf clubs or social contacts! More importantly, demand complete transparency (including disclosure of all the securities in your account), with legitimate auditors from big accounting firms, plus liability insurance.

There is one other thing that I must mention. Some of Bernie's investors were bragging to me that Bernie went to cash in mid-September. However, they also told me that Bernie made 2% in November, which is an impossible return if you are 100% in cash, since money markets do not pay 2% per month. Obviously, these newly poor investors could not figure out this obvious anomaly thanks to Bernie's lack of transparency. The lesson here is that if an investment sounds too good to be true, it probably is. Please do not take investment advice from anyone who says they are smarter than everyone else but won't share specific details. The bond and stock markets can be a very humbling place, so good investors will not boast of their investing prowess. Great investors never stop learning, and they continuously adapt to changing market conditions.