Victims of Bernard Madoff’s Ponzi scheme finally had one of their wishes come true. After a judge denied bail, Madoff is going directly to jail, and he isn’t passing "go." But Madoff’s victims still want answers.
They want to know where the money went. They want to know who else was involved. And they want to know how they got scammed.
At the courthouse, many victims said there were no warning signs and Madoff himself, in his courtroom statement, backed them up on at least one count. "The clients receiving trade confirmations and account statements had no way of knowing by reviewing these documents that I had never engaged in the transactions," Madoff said during his guilty plea.
Maybe not. But to Harry Markopolos, the risk manager who alerted the SEC to Madoff’s fraud in 1999 to no avail, the foul play seemed obvious. Madoff was supposedly using a complex trading system to generate returns, a strategy he dubbed the "split-strike conversion strategy." He would buy stocks in the Standard & Poor’s 100 and sell options to reduce volatility. But Markopolos’ firm was running a similar strategy and couldn’t match the returns. A look at the returns was all it took for Markopolos to know something was up.
Preying on a Community
Markopolos had plenty of incentive to doubt Madoff; he was a competitor irked by Madoff’s claims of too-good-to-be-true returns. For most of Madoff’s clients, the math that Markopolos employed would have been out of their league. Some Madoff investors were sophisticated enough that they might have dug deeper into their statements and trade confirmations. A quick comparison of their returns with those of the actual markets might have been enough to tip them off that at least some of the trades were phony. Some of them might have realized that the average returns were too high and too constant, based on the mathematical probabilities. "If the standard deviation is too low and the mean too high, something is wrong," says Utpal Bhattacharya, finance professor at the Indiana University Kelley School of Business. Still, "the retail investor would need some help."
Experts say investors can avoid Ponzi schemes and other scams without relying on math. The first step: Take a look around; who are your fellow investors? Often in a scam, a pattern emerges. There’s a reason why many Madoff-like scams are called "affinity crimes." Charles Ponzi, for whom the scam is named, targeted Italians. Joseph Forte ripped off his friends. And before Madoff branched out into Europe in recent years, his clients were primarily Jews and Jewish foundations.
"Ponzis involve preying on people who have some association. The same clubs, religion, geographic location," says Tim Kochis, chief executive of financial advisory firm Aspiriant. "Madoff’s investors all trusted each other. They assumed that was good enough." If investors get a sense that their adviser caters to a very narrow group, they should probably dig a little deeper.
Do Your Own Due Diligence
That starts with doing your own due diligence. Scamsters often make claims to bolster the confidence of investors that they’re dealing with a heavyweight. Allen Stanford built an image of a successful businessman whose family’s financial-services roots went back to 1932. In fact, his banking empire consisted of a Montserrat bank founded in 1986 that had its license revoked by the local government.