This week a little story about a $50 billion investment fraud has metastasized. Madoff Securities, a brokerage firm that ran a secretive investment fund on the side, has closed down -- revealing that its steady 10% annual returns was a result of a Ponzi scheme. For some who trusted Madoff a week ago, they are today coming to grips with life without money. Is Madoff the only one out there? I doubt it. So you need to protect yourself.
How did Madoff accomplish this? That story has yet to be revealed. But founder Bernie Madoff revealed that he was using money from his most recent investors to pay off the earlier ones who requested their money. And a letter from hedge fund research and advisory firm, Aksia -- which steered its clients away from Madoff -- reveals five useful clues:
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Unknown accounting firm. Madoff used an accounting firm Friehling & Horowitz that employed three people -- one was a 78 year old living in Florida.
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Incomprehensible investment strategy too good to be true. Madoff employed a "split conversion strategy" which was never clearly defined and whose returns other traders could not duplicate.
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Deception about technology. Madoff claimed it was technologically sophisticated but a visitor to its offices found paper tickets sent through the mail.
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Family control of key jobs. Madoff staffed key control jobs with family members and it was extremely secretive.
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Violation of segregation of control principles. Madoff failed to separate the jobs of initiating trades, holding assets, and reporting on their condition.
To this list, I'd add that Madoff was quite effective at marketing his fund by creating the perception that giving his firm money was a rite of passage for those aspiring to wealth and prestige -- many people tried to get admitted to wealthy Palm Beach, FL country clubs -- in part -- so they could boast about how Madoff managed their money.
Are there others out there? Not that I know of. However, there are certainly hedge funds -- 10,000 lightly regulated investment pools for the ultra rich managing $1.72 trillion -- whose returns are incomprehensible. For example, Renaissance Technologies earns extremely high returns -- its Medallion Fund gained 58% in the first nine months of 2008 -- and its CEO, James Simons, makes billions each year.
But his strategy -- using complex computer-driven mathematical models -- defies explanation. I am not saying that Renaissance is the next Madoff -- but its steady high performance would make me eager to know how a firm like Aksia would assess it.
What should you do? Make sure that you trust no more than 5% of your money to any financial advisor. Even if that advisor loses your money legitimately -- after all $30 trillion in global market wealth has evaporated over the last year -- you won't suddenly lose all your wealth if it's spread around. Some Madoff investors went from thinking they were multimillionaires to paupers in a week.
And for those to whom you do entrust your money -- take a look at whether they have any or all of the red flags that Aksia identified at Madoff.
Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.
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Reader Comments (Page 1 of 1)
12-13-2008 @ 9:36AM
nick said...
I took a bath in the market, my broker was suprised when called and said sell it all.... He said but I think rpt I think it will come back. I told him you been watching too much of MSNBC. I told him most of us don't have 20 years for a turn around. The CD and money markets and savings accounts are the only hope. Take this crook that just ripped off big shots who should know what is going on for 50 billion. And you want us to trust these slime balls on Crammer and MSNBC.
12-13-2008 @ 10:50AM
john said...
people laughed when I opened a 4.75 cd with over 25,000. They are not laughing today.
12-13-2008 @ 11:04AM
bill said...
It`s hard to loose if you don`t have anything invested with those outfits that promise you the world in one hand and golden goose in the other.
I had all my extra $ in hard metal, on hand, not on paper. Wise move and I had preached it long ago to all my close friends to do the same. Some listened and some didn`t. Some made it bigtime some lost lots of their $ in the false markets.
I haven`t lost a dime in all this but I do really feel bad for those that have been taken to the cleaners by those slimeballs.
My investments are still sound and worth lots more than when all this mess started. I can sell all or a little as needed in an eager buyers market at a huge profit. I prefer to mover it as needed to lower any tax liability though.
I`ve been retired for near 30 years and learned before then that the money investment markets were a place for fools to gather.
Bill
12-13-2008 @ 11:26AM
Sports Fan said...
My coworkers were extremely upset with the market. I stayed away from any stocks. Its too risky if you don't have the income to chance it.
12-14-2008 @ 11:38PM
Jane MacT. said...
We have been in the biggest, badest, bank heist of all time. Deregulation is a conjob that allows deep insiders to game the system to near-death — which they like to call 'creative destruction.' Wake up, America: You have been royally fooled, again. The next swindle is well under way. ... Oh, and Mr. 'Made-off,' was a Ponzi by way of affinity fraud to the point of cult religion. Criminals gather were the money is. ... Follow the $$$$$, including taxes. Always question assumptions.
12-16-2008 @ 10:12AM
Steven in Colombia said...
Hmmm...now let me get this straight...a "ponzi scheme" consists of using new investors' money to pay off old investors until the scheme inevitably collapses and is revealed for what it really is...a scheme!!! Ah ok...so that's why Social "Security" in the US is in such dire straits.
I'm down here in Colombia surrounding by "victims" of the very same pyramid scheme (DMG-created by a 28-y.o. con-man, David Murcia who was paying 150% returns on money invested) quietly laughing my arse off. Their greed continues to supercede their common sense as they protest the abrupt closure of the 30 offices throughout South America, and even want to this Ponzi apprentice President of Colombia
12-21-2008 @ 7:54PM
pat said...
Have any of you heard about microfinance? Its about giving loans to people in poverty and they will repay you with interest. Default rate is less than 1% - and you are investing in real value - not the black hole of the stock market. We have a fund invested in South and East Asia and the returns are still chugging away. Most Americans are too focused on the big money to understand that there is value at the bottom of the pyramid