Former NASDAQ Chairman Bernard Madoff was known on Wall Street as a big-time investment manager with a “golden touch.” But the giant Ponzi scheme* that Madoff was running came crashing down last week, as Mr. Madoff was arrested and charged with massive fraud, allegedly bilking thousands of investors out of over $50 billion. The scheme had been running since at least 1999. The alleged $50 billion Ponzi scheme operated by Madoff from his investment advisory business may have cost some of the largest financial firms in the world – Britain’s HSBC Holdings PLC, Royal Bank of Scotland Group PLC and Man Group PLC, Spain’s Grupo Santander SA, France’s BNP Paribas and Japan’s Nomura Holdings - hundreds of millions of dollars apiece. Thousands of individuals as well as charitable foundations have also been affected and some even totally wiped out by the scam.
If sophisticated investors can be duped and for such a long period of time, what can the rest of us do to safeguard against being taken by the next scam artist that comes along?
Fortune magazine managing editor Andy Serwer offers advice on what to look for in managing your portfolio to make it “crook-proof.” Here are five simple steps he recommends:
- Don’t invest in something you don’t understand. The attraction of Madoff’s investing philosophy was that he employed what is known as a “split-conversion” strategy. Don’t know what that is? Neither does anyone else. If you don’t understand what the investor is doing with your money, avoid it like the plague.
- There is no such thing as a free lunch. The beauty of Madoff funds is that they supposedly returned 1 percent a month, every month. Like clockwork. They consistently provided above-market returns with no volatility. This is almost impossible to do with a legitimate investment plan. If something looks too good to be true, it probably is.
- Diversify. Probably the most astonishing thing to me in reading about this scam is the number of people and institutions who had all of their money in Madoff’s funds. The first thing you learn in Investment 101 is “DIVERSIFY.”
- Don’t stand for no or low disclosure. Apparently the statements sent to investors from Madoff included only a beginning and ending dollar balance – no detail of where the funds were invested or how those underlying companies were performing – of course, there were no companies involved – only the funds pouring in from more and more investors. Be sure your statement has a detailed disclosure of what the investor is doing with your money.
- Be wary of no-name operations. Stick with well-known funds. You might lose money, but it will likely be because of market fluctuations instead of intentional fraud. Be wary of someone who “knows a guy who knows a guy who is a really great investor.” Yeah, right.
Perhaps one one of the biggest questions in this mess is, “Where in the heck was the SEC?” They are supposed to regulate these guys, right? Right. In fact, the SEC was alerted to possible fraud at Mr. Madoff’s firm as early as 1999 but never acted on the allegations. Just this week, Christopher Cox, chairman of the US Securities and Exchange Commission (SEC), said on Tuesday night that the regulator had been made aware of “credible and specific allegations” regarding Mr Madoff and that he is ”gravely concerned by the apparent multiple failures over at least a decade to thoroughly investigate these allegations or at any point to seek formal authority to pursue them.” Further, Mr. Cox also admitted that SEC investigators did not subpoena any information when looking at these allegations in the past, and instead relied on information voluntarily produced by Mr. Madoff. Are you kidding me? Thousands of people and institutions have been ruined by one man’s greed and the ineptitude of one of our most trusted regulatory commissions. Saying, “Gee, I don’t know how that happened” is unacceptable. I hope they are held accountable, one and all.
* A Ponzi scheme is a fraudulent investment operation that involves paying abnormally high returns to investors out of the money paid in by subsequent investors. There is no existing underlying business from which to generate profits – only the revenue stream from more and more investors. It is named after Charles Ponzi, who became notorious for using the technique after emigrating from Italy to the United States in 1903.