I have to take exception to the notion that every victim was complicit or simply greedy. Buying into funds is reasonable as a way to get decent returns; further, it is true that some funds do better than others because the fund manager is better at it, has a strategy that works at the time, etc. This is not to be confused with a "get rich quick" scam (where the economics are clearly not possible, and there is no government oversight) and certainly not in line with credit card fraud.
The problem here for the victims is that they followed reasonable precautions: the books were audited, the SEC was checking the funds/company, people had been getting returns for many years. All of those are how you are supposed to verify validity of an investment. What else is there?
So, it does not always take two any more than identity theft or being car jacked or robbed takes two. Some scams are such that the victims are not taking unreasonable risks or complicit in the fraud. This kind of fraud has relied on broken oversight systems, just as Enron and Worldcom did. Were the children in China who died from Melamine poisoning at fault? No, the oversight system was. And so it was in this case - there is in fact no real way that the investor could have investigated this themselves. Short of putting your money under the mattress, anywhere you put it is at risk if the oversight system is broken.

pkimelman,

I see your point, but I recall once when I lived in Manhattan and was walking out of the office to get some cash - I had just fallen in love and was buoyant - that a drunk bum approached me with some coins he "found". There was a telephone number on their case, which he got me to call - the guy said, "oh my God, thanks. I will give you a reward of $4000 if you bring them to me." Then the bum said, give me $200 and you can take it. I was feeling good and went to the cash machine, but then I got scared, aided by the time I was given as the machine was out of cash. I said, knowing my date was expecting me at the office, "let's go together". Later that week, I learned that my boss had given the same bum $200, and then couldn't find the address given. This was very frightening to me, in that I was almost taken.

Regardless of one's good intentions, when something is too good to be true - $200 for 4000 to help a smelly drunk and enrich yourself in the process - the victim IS complicit, as a sucker. If that machine had not been out of cash, I might have given him that money, then been shattered to have been such a fool. That is, I think, the way the victims and perhaps you actually feel. The writer is correct about complicity.

rjcrawford33, note my statement "where the economics are clearly not possible, and there is no government oversight". Your example covers both aspects. That person was offering you something where the economics were not possible (when the ratios are that off, illegality can be the only explanation) and there clearly was no oversight since it was outside of regulation. Your example is like buying a "real" Rolex on the street corner for $50 - it is not possible that a many thousands of dollars watch could be $50 and clearly the seller is not an authorized or regulated vendor.
The point I am making is that buying into funds, like buying stock or bonds, is through a government regulated system.
To explain my point vs. yours: if you put your money in a bank with a 2% interest account, you expect to get it back from the bank with the 2% (or the FDIC if the bank fails). If you give that money to some guy on the street who promises you 200% and you do not get your money back, you are a fool. The fact that the guy offered over any reasonable return should have been your 2nd clue - the fact that he is not a regulated bank or institution should have been your 1st.
The Madoff funds were not earning wildly unreasonable amounts, and they were a regulated and licensed securities company. So, people were trusting the system as much as the company behind it.

pkimelman, you clearly have not been following the story much. Plenty of smart managers and banks (including SocGen) did their due dilligence and said "wait, this can't be right, and he can't explain how it works -- best just to avoid it."

The fact is, Madoffs clients had to engage in willful blindness. They didn't ask the questions that you HAVE to ask if you're being responsible with large portions of your wealth. Those who avoided Madoff's scam were largely those who DID ask the questions, those who said "whoa... how is he making such consistent returns even across wildly varying market conditions and events?" So please stop comparing the returns Madoff offered to those of a federally insured savings account.

No, instead they took faith in their friends, Madoff's status in the community, and yes, the imprimatur of the SEC and FINRA. It's stupid (yes, I mean stupid) to think that you can abdicate personal responsibility on those grounds. Plenty of drugs get approved by the FDA -- doesn't mean they won't turn out to have nasty side effects far down the road. Plenty of doctors and pharmacists are licensed -- and only lose those licenses after they get caught in malpractice.

If your pharmacist was able to consistently charge you less than anyone else around... wouldn't you want to know how? If your oncologist said he his patients had a 50% better survival rate than anyone elses', wouldn't you want to understand his technique and get a second opinion?

Maybe it's just the way I was raised, but I've always understood that we are, each of us, the first line of defense against fraud and lies. SOMEONE has to be the first to blow the whistle. If we're lucky, it'll be the cops... but usually, we're the ones who have to call them!

Madoff's victims were victims of a supreme con artist. In case you don't remember, "con" is short for "confidence" the phrase. No one, not even Bernie Madoff can steal confidence -- confidence is always given, willingly.

idiotking, I disagree. A competitor had been trying to get the SEC to look at his funds given that the returns seemed too good to be true, especially as they were using the same methodology. The SEC claimed to check and found nothing. Competitors often try to get each other in trouble in that business, but usually they are just sore losers.
Madoff did explain how his system worked, using a reasonable approach, but he was just lying. He was claiming to be using a kind of collaring model. That method does work, but is not completely immune to downturns. Madoff claimed that he anticipated downturns well enough, which is possible. Some very savvy people have managed to make money in stock market swings, so it is not impossible. Some funds have done much better than others over the same 5 years - it is not a problem as long as it is valid.
I would not question why my pharmacist was charging less than anyone else if it was Walmart (think $3 generics) or Costco or any large chain (loss leaders pull in shoppers). Some surgeons have far better survival rates than others - usually using the exact same technique. Skills are just that. Some are better at some things and they do better as a result. Janus funds used to be consistently better than most and they were fully legit.
Of course we all have to blow the whistle if we know there is something wrong. If you bought google and it increased in value by 4x (which it did), did you blow the whistle? I doubt it, because there was nothing wrong; the market simply chose to value it higher based on its ad revenues at that time.
The problem for all of us consumers is that the vast majority of things we entrust with companies are such that we have to rely on regulation systems to protect us. I do not have the lab equipment to test the milk I buy at the supermarket - I have to trust local authorities to monitor milk production. I do not have the tools nor access to inspect the commercial jet I am boarding, so I have to rely on the FAA to make sure it is maintained. Of course hindsight is 20-20, we all know to avoid buying Enron now, but when they were doing well, few of us had the tools to inspect their books to know they were crooks. Likewise with Madoff. You can only be a 1st line of defense if you have the tools to defend yourself. In the world of investment, your main line of defense is government oversight and time - both failed in this case.

Great article. Thanks for the insights. Call me dumb, but I have never thought of the criminal mind in this way. I always felt the criminal mind was somehow 'evil' but it sounds more like it's just 'weak and deluded'.

There is no crime for which blaming a victim is acceptable.

Mansfield, I really enjoyed your column. Great job!

Madoff may be the new King of Scammers, but the investment -con industry rakes in $40 billion a year. Even the Nigerian 419 scam still takes in some $2 billion a year despite being well publicized. The thing about scammers like Bernie is that they are magicians. No matter how hard you look, the smoke and mirrors look real. In fact, the smarter you are, the deeper you investigate and the more homework you do -- the better the prospect looks.

Take this about Enron from an series about Bernie and other scammers going on at www.media-watchdog.com:

"Here's one take on the company's version of instant profits attributed to a Colorado Aggie professor who came up with something that his students could easily understand.

Enron Capitalism.

You have two cows.

You sell three of them to your publically listed company, using letters of credit opened by your brother-in-law at the bank, then execute a debt/equity swap with an associated general offer so that you get all four cows back, with a tax exemption for five cows. The milk rights of the six cows are transferred via an intermediary to a Cayman Island company owned by your CFO who sells the rights to all seven cows back to your listed company. The annual report says the company owns eight cows when in fact there are seven listed, with an option on six more.

While this sounds a bit tongue in cheek, the reality is more bizarre. Enron owned some 2,832 subsidiaries with 874 of those registered in off-shore tax havens creating a haze of obscure financial transactions that will take years to uncover."

Like the Enron operators before him, Bernie made people beg to get in on the action - which is standard operating procedure.The scary thing is that there are over two-thousand hedge funds across the world wielding some $2-trillion. A lot of this money belongs to charities, retirement funds, government funds from cities and states across the country and sovereign funds across the world. There are definitely more Bernies out there.And even the honest funds are going to get hit with redemptions, which will cause them to sell more stock, which, in turn will cause more companies to collapse.

The Saudi's can obviously take the hit, but look at California, they're going to be broke in 70 days.How many cities there are invested in some supposedly "absolutely solid" funds? How many emerging market countries that can't afford the hit?

ScottRose wrote: "There is no crime for which blaming the victim is acceptable."

Nonsense! To abdicate personal responsibility in crimes in which greed or negligence result in "getting taken" is to deny personal responsibility for our lives and decisions. Scams and con games are a good example of a victim's complicity in their own exploitation.

That humans are susceptible to psychological coercion is not new...(see P.T. Barnum). What fascinates me is how seemingly educated and ostensibly sophisticated people are so easily taken in by schemes that involve subtle psychological manipulations.

In the Bernie Madoff scam, the exclusivity of the investment appealed to the victims' need to belong, the urgency of their making a quick decision on investing was reinforcement of their feeling of being "special" or in being smarter than others in their "risk-taking equals rewards" justification, and the promise of consistent and unrealistic profits appealed to their greed. These manipulations are all classic con red flags. Yet otherwise rational people chose to ignore them.

I find the anger of investors interesting. Not one of them was complaining when Madoff was making money for them. What is clearly evident is that they were complicit in their own fleecing. That it's human nature to blame others for our own failings is understandable, but individuals do not learn unless we own our mistakes or the mistakes of others.

BTW, I see Madoff and other con artists as microcosms of the larger scheme perpetrated by Wall Street and our government. That the international banking community, millions of individual and corporate investors and our government (both legislators and regulators) bought into the myriad of legal ponzi schemes is just a further confirmation that most individuals (and institutions) think that they will be the exception to the rule. That rule is consistent, predictable and reliable: almost all ponzi players are ultimately bilked.

baptox, I agree with you that many fraud crimes are as much the fault of the victim, but your extrapolation to investment funds is not valid.
First of all, exclusivity is common in popular funds because if the fund gets too large, then the market swings it creates will stop it from being effective (especially with computerized trading systems tracking trends). People want in on a good fund for the same reason they want want to buy a good stock. Wanting to increase your money validly is not greed or being special. Risk is a necessary component of most investments (including buying a house). Obviously, most people are looking for the lowest risk and the highest gain. Again, that is not greed, it is common sense.
Saying "Not one of them was complaining when Madoff was making money for them" is like saying that no one was complaining about their new car until it blew up. Of course no one was complaining - they invested in his funds to make money, just like anyone invests in something. Similarly, no one was complaining about their 401K making money until it was losing money; "um, duh" as they say.
The Madoff scheme is not part of the normal rule. Normally, you know approximately how much risk you are taking. Hedge funds are not really regulated and have high risk with high potential rewards (and losses). Likewise, "junk bonds". Mutual funds have lower risk and moderate returns. Some funds have historically very low risk with decent returns. Madoff was not one of those cases because he was lying about what he was doing and so the risk was absolute, but stated to be within normal distributed investments.
I have no idea what these other ponzi schemes you are referring to. Other than social security, I am not aware of government sanctioned ponzi schemes. A ponzi scheme means that you are taking money from a newer group to give to an older group. By nature it must fail as you cannot get new groups to give their money after a while. The only reason Madoff pulled it off as long as he did is that his returns were not that large (around 11% or so) and most kept their money in the system (if not redeemed, he did not have to actually pay them).

Mr. Frazier
Insightful, thought-provoking, well-written and an absolute pleasure to read.
Thanks.

Interesting piece. I agree with some of your points, like the fact that Madoff will never see himself as a common criminal; however, I don't think he was trying to please all his client-friends. There were plenty of times his wrath came through, especially when people asked what he thought were too many questions. And even if he started out "honest," that was a long time ago. It takes years to lose fifty billion, even twenty billion, so he had to have known, over and over, that he was taking money under false pretenses. Claiming he thought it would all come out in the wash is washing away his guilt. He knew, and an honest person would have come in clean with a confession.

PKMelman, your ideas about Wall St. investing seem rather dated given what has occurred in the last six months to two years. You state, for example: "The Madoff scheme is not part of the normal rule." I imagine that having firms that rate funds assign absurdly high ratings to garbage funds is not part of the normal rule either, but in our unregulated stock market, that is what occurred.

"Exclusivity" is a psychological manipulation tool used to sell everything from cars to bars. "Exclusivity" combined with pressure to close a deal quickly is a formula for disastrous decision-making.

My point about investors not complaining when Mr. Madoff was making money for them was to reiterate the greed component of this scam. Even though Mr. Madoff's investments made unusually high returns on an unusually consistent basis, very few (if any) of those scammed questioned how that could be. (And yes, 11% returns on a consistent basis are anomalous and lead many more objective advisers to steer their clients away from Madoff.) Common sense alone, not clouded by greed, would lead one to question how one could (legally) beat the market so consistently. Many of the people and institutions scammed were well-versed in investing and most probably knew that Bernie's house of cards would fall. My guess is that they were just hoping to get out before the cards fell. Some did, apparently, and made a good profit.

Interesting that you would site Social Security as an example of a ponzi scheme. Had Bush and other psycho-market rah-rahs had their way and allowed people to invest their social security deductions, their social security credits would be about as beneficial to them as their 401k plans are now. You are correct in noting that our Social Security is financed by current earner deductions.So what? Our entire government is financed by current workers and businesses whose tax contributions give us some confidence (oops, there's that con reference again) to print the vast amounts of paper we refer to as money.

BTW, I don't think every victim of Mr. Madoff's scam was complicit or simply greedy. I think many people were overly trusting of both this man, their sources of referral and the regulatory system. Again, I see this scam as a reflection of our misplaced societal trust in unregulated markets. Mr. Madoff like many others on Wall Street, simply "made-off" because of a dangerous combination of other people's misplaced,unquestioning trust and disinterested regulatory agencies. We will all paying for this larger scam for a long time to come.

Thanks, Mr. Frazier on your insights.

Sir,
You are a splendid writer (and thinker!) I very much enjoyed reading this piece and I do hope we'll see you again here on TDB.

This is an excellent piece Mr Frazier and enunciates what I was thinking. I've got sympathy for Madoff's victims but I also feel they had a hand in their own fate-many must have felt the deal was too good but greed took over. The court case will be fascinating to watch unfold.

Greed, one of the 7deadly sins almost always wreaks havoc & obliterates it's followers.

Greed,it's a guaranteed death spiral sooner or later.

"If men (and women) do not choose to learn from history, they are condemned to repeat it."

baptox, I agree that Wall St was broken under the bubble, especially the securitized mortgages. However, what I am not saying is dated. The exceptions prove the rule. Many normal stock funds that were reasonable in nature were taken down when the bubble burst, even if nowhere near a securitized mortgage or CDS. That happens in the cyclical nature of the stock market. Those will recover their value (some more than others since redemption runs means they are having to sell when low). The highly risky hedge funds and mortgage tranches will be wiped out, but that is their nature (high risk in exchange for massive upside potential). Diversified funds will have taken a hit with some defaults, some failed companies, etc, but will retain most value. Madoff's scheme was all a fiction, so there is no intrinsic value to recover - it was worthless paper full of lies. That is why it is an exception.
Even funds based on mortgages are not worthless since many will not default (depending on your tranche, you may do just fine).
The problem in rating securities based on collateral, is that you have to know how solid the collateral is. Rating mortgages is based on historical default rates (just as any credit risk is) and we all know that they got caught with their pants down on that one. But, much of the problems have been 3-fold: mark-to-market accounting was supposed to force honesty but has created massive instability (and wiped out companies quickly), way too much paper has been leveraged so heavily that it really was like a house of cards, too many people were buying securities without even looking at the risk profile. The former meant that banks/ibanks were forced to be technically bankrupt even if their assets were likely fine for the most part (and runs on those banks ensured they failed). The overly leveraged nature meant that every model failed instantly due to the interconnects (and laws requiring unwinding leverage on even a hint of change). So, you have to separate those that were wiped out by taking high risk paper (even if they claim to not understood what a CDS or CMO was) from those that were wiped out by someone lying about what the fund was based on. If you bought mortgage backed securities directly or via a fund, you knew there was risk regardless of rating. Sure it was worse than historicals, but you knew what it was based on. If Madoff had been telling the truth about what the funds invested in, the fund would be way down (just as your 401K for example) but able to recover. In this case, since it was a fraud, it is worth nothing. People were not investing in something that was supposed to be high risk with high reward such as hedge fund, but something with moderate risk and moderate reward using a diversified set of industries. Hopefully you see the difference.
The main question is why so many customers had so much of their investments (or all) in one fund - that is just stupid.

I totally enjoyed this article. I also think the trial will be fascinating. Thank you for your insight.

pkimelman - I apologize if I lack your flair for analogies, but perhaps my working in the securities industry (compliance, natch) for most of my career has stripped me of creativity.

If it has, it has also taught me that investing is no different from any other kind of business or transaction -- if it looks to good to be true, it is. If you flatter someone's intelligence, they're more likely to do something stupid. And ALWAYS be suspicious when the party responsible for checking on another is dependent on the success of the first... if it looks like they're in cahoots, they probably are.

You're quite right that Madoff "explained" his supposed technique -- I don't argue with that. When I say it lacked transparency, I mean what happened if you tried to delve beyond chatting him up about it on the golf course. While there is nothing inherently wrong with winning out in down markets, or consistently beating other funds over a period of time, the *consistency* and relatively flat rate of return for Madoff's funds *WERE* rather bizzare and seemingly outside the realm of likelyhood.

So what happened if you did ask? I mean, if you weren't feeling pressured to make the move RIGHT NOW because this was a VERY EXCLUSIVE offer that you have to jump on! ("we don't have time to do full due dilligence!" is always a huge red flag) Well, you'd find that all of the transactions and holdings for funds Madoff was managing were with.... Madoff's securities company. Now, the only possible check on whether the transactions being reported to clients were actual or not would be an outside auditor... and Madoff's auditing firm was a small, virtually unknown operation dependent on Madoff for almost all of their income.

Really? That wouldn't raise eyebrows for you?

It's simple really -- like so much else in life, the world of investing is based on trust and confidence. If you trusted your financial advisor, and they trusted Madoff -- well, yes, I'd say the failing was your advisor's more than your own. For those people who invested directly, there's no such convenient excuse. They were duped by their own trust and greed, manipulated by Madoff.

Also, I'm not sure what you're talking about in terms of firms "trying to get each other in trouble." Trust me, I don't think any reputable firm files SAR-SFs for s**ts and giggles, much less to cause problems for a rival. Going to the regulators and saying "this does not add up -- it needs to be checked out" is something that's done only when there's a high level of certainty. Crying wolf too often would bring a great deal of suspicion on your firm.

idiotking, I think we agree a lot more than you realize.
I agree that time pressure and exclusivity cause people to make poor decisions - exactly why that is used all the time, especially when the market is doing well. But, as to due diligence, most investors (including those managing money for others) rely on filings (auditor signoffs, clean SEC record, etc), 3 mon, 1 year, and 5 years return data, and what others are doing. Stupid perhaps, but few investors are savvy enough to do detailed DD, and most funds do not give you their precise model anyway, since that is their value-add (if it works anyway). This was not some scheme claiming 50% or 100% or more return such as most scams promise, and since most people do not look at month by month data, but only annualized returns, people assume 11% average and not consistency. Whether many investors would realize that consistent data in spite of the larger trends is a big red flag or not is unclear, but most did not see that level of detail. In fact, a common technique in this type of fund is to claim lower risk in exchange for lower but more consistent return (as happens with collars and hedges and balanced portfolios); what was wrong here was that it was just too consistent to be plausible. Which leads to the next part: most investors were relying on advisers and others who claimed to monitoring the fund. Think how people will buy what Warren Buffet buys.
As to FinCEN 101 filings, the SEC gets a lot of these. My point is that when one fund seems to be doing too well, SAR-SFs (101s) do get filed. None of the competitors want to look bad, so if they think there is a chance that the other fund will at least get a slap on the wrist (for some simple compliance issue even), that helps them. You must know that, given your role. Many of the funds will use deferring techniques and other simple gray areas to make the quarter or year-end results look better.
I do agree that investing in any form is about trust (confidence is based on trust). Most of the trust is earned based on historical data and indirect (e.g. auditors, regulators, etc). That is, it is not Madoff saying trust me and that is all. It is an auditor saying you can trust him. It is the SEC saying you can trust him. It is historical data saying you can trust his past performance. And, it is others trusting him that tells you that you can trust him.
As to the auditor issue: I question how many people checked who the auditor was and what size. I agree that it not being a top 10 auditing company raises a lot of flags; I suspect most investors will be looking at the auditing company name from now on!

A brilliant piece, although I am unable to find the Wilde quote you referenced, perhaps yours is a combination of Samuel Johnson and Mark Twain's? Judas was indeed an historical scoundrel.
"Every great man has his disciples, and it is always Judas who writes the biography." Oscar Wilde

I read TDB almost everyday, though somtimes I wonder why I bother. This article reminded me. Great writing, keep up the good work.

Dear pkimelman--
It is precisely within those "other simple gray areas" you've referred to where the devil resides. Sweetie--the Devil Wears Gray!! And those are the places where trust can be bankrupted.
Please tell me you don't realize this.

spinozareader, gray areas are areas where regulation is unclear or not specific enough, even if the spirit of the regulation is. Madoff was not in a gray area, that was outright calculated fraud. Trying to use settlement time to hide less optimal numbers, or using international transactions to shuffle losses or gains (usually to control commissions) is not nice stuff, but that is just short term; trust continues because that kind of gray area is not sustainable and so people can judge a normal fund by its past behavior. Outright lies are so totally in a different camp. Madoff used the guarded trust investors have in other funds to hide the fact that his was not an investment fund at all (he was not investing the money).
Another way of thinking about this is that although many of us exceed the posted speed limit and do rolling stops (gray areas), we are not compared with the maniac that intentionally plows through a crowd of pedestrians. The pedestrians trusted that maniac because they are used to the rest of us who would not run them down. Should pedestrians now assume all drivers are maniacs? Should the fact that many drivers exceed the speed limit mean that we are all as bad as the maniac?