Madoff Mess Nothing New :The big lesson in the Madoff scandal? How little financial scams change over time

/Home/Notorious Frauds and Tips on Avoiding them/How to Avoid Common Fraud Schemes

Madoff Mess Is Nothing New
William P. Barrett, 12.18.08, 06:00 PM EST
Forbes Magazine dated January 12, 2009
The big lesson in the Madoff scandal? How little financial scams change over time

Bernard Madoff
The scope of the unfolding Bernard L. Madoff scandal-- $50 billion and counting--is breathtaking. But aside from the extra zeros, little about it is new. In fact, the ploys and plays on human nature that Madoff used to pull off his brash heist have a long, infamous history.

The Reputation Ruse
Madoff was the former chairman of Nasdaq and thus a trusted Wall Street wheel. Investors counted on his reputation, rather than on diligent inspection of his audits, to safeguard their money.

Hardly an original mistake. Former New York Stock Exchange president Richard Whitney went off to prison in 1938 for embezzling funds entrusted to him.

Affinity Quagmire
Madoff moved in upper-crust Jewish society. Hard questions apparently were anathema inside the inner circle.

Such affinity frauds have long been plied among people grouped by race, religion or nationality. One of the largest involved the 1999 collapse of the Baptist Foundation of Arizona, which nicked Southern Baptists for $500 million. Several leaders went to prison.

Like many affinity fraudsters, Madoff appears to have duped a respected member of the community into vouching for him. In Madoff's case it was philanthropist Carl Shapiro, whose family Madoff seems to have smoked for a half-billion dollars.

Falling For A Free Lunch
The most obvious red flags often are claims that, in hindsight, are too good to be true. In Madoff's case that involved consistent 10% to 12% annual returns in good markets and bad.

In 1920 Charles Ponzi promised investors he would earn them 50% in 45 days by arbitraging international postal reply coupons. He was actually paying early investors with money raised from newer ones. The scheme collapsed after investors realized there weren't enough postal coupons in the world to account for Ponzi's claimed volume.

In Regulators They Trust
Chairman Christopher Cox recently said he was "gravely concerned" by the Securities & Exchange Commission's "apparent multiple failures" in the Madoff case. That makes him look as gullible as Madoff's marks.

Truth is, regulators have never been a reliable defense against fraud. In the past decade they have been caught snoozing on illegal mutual fund trading, stock options backdating, bogus stock analysis and mortgage fraud, among other sins.

Eggs In One Basket
Diversifying is Investing 101, but amazingly many of Madoff's clients trusted his unregulated investment firm with virtually their entire wealth. In such a blunder, they've got ample company.

Phoenix con man Charles H. Keating Jr. managed to take scores of retirees for their life's savings when his American Continental Corp. (other-otc: AMKKQ.PK - news - people ) collapsed in 1989 and rendered its uninsured bonds worthless. Similarly, New Jersey financier Robert E. Brennan wiped out thousands of investors when his bucket shop, First Jersey Securities, foisted crummy stocks on them. Keating and Brennan both did time.

Magic Black Box
Madoff told clients he produced steady returns with a "split-strike conversion" options strategy (see "Options Boom"). When pushed for details, he brushed off queries by labeling his methods "proprietary." Enron became the nation's seventh-biggest company with a convoluted business and a penchant for disparaging and shunning analysts who questioned it.

Fox Guarding Henhouse
Madoff's was a closed shop. It was housed with its own brokerage, used close affiliates to lure money and was audited by an unknown three- person accounting firm.

After creating a fictitious accounting firm from scratch, Samuel Israel's Bayou Group hedge fund collapsed just four years ago and cost investors $400 million. That was considered a massive fraud at the time, but Madoff may surpass it 125-fold. Israel is serving 20 years in federal prison for fraud.