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To paraphrase our next Secretary of State, it takes a village to keep an investment scam going. It takes an entrepreneur who's hungry, amoral, and clever; investors eager to believe that what's too good to be true is real; auditors who get paid not to audit; politicians who take money to keep regulation away; and regulators who do what the politicians tell them to do. All these factors were in play with the $50 billion Madoff Securities scandal. As I posted, Bernie Madoff was able to scam investors by creating false financial statements and using a tiny, unknown auditor to persuade investors hungry for membership in his club that they could get regular 10% annual returns in any market.
But Madoff's scam also benefited from a hands-off policy towards Wall Street thanks to help from politicians such as Chuck Schumer (D-NY) who raised millions from Wall Street to do its bidding. As head of the Democratic Senatorial Campaign Committee between 2004 and 2008, he raised $240 million while increasing donations from Wall Street by 50%. In return Wall Street got free-market, deregulatory policies that helped them cook up the scandals that have helped wipe out $30 trillion in global stock market value in the last year.
And the SEC, which could have audited Madoff in September 2006 when it registered there, complied with Wall Street's wishes. Its defense is that it lacked the people to do the job -- claiming its investigations staff has dropped from 880 in fiscal 2006 to 796 in the fiscal year ending in September 2009.
The SEC could have nailed Madoff in 1992 when he was named in an SEC lawsuit brought against two Florida accountants, whom it accused of raising $441 million while selling unregistered securities -- money that Madoff managed. But Madoff claimed he did not know the money was illegally raised.
People forget about such scandals in a bull market -- but in the past eight years, that bull was a mirage floating on a sea of debt. In order to get investors back into the market, the next president will need to restore confidence in the system. And to do that he'll need to run the village differently. How so? Now we have a system where the politicians need money from the industry to get elected so they do the bidding of their paymasters -- so do regulators and auditors.
To fix this, the president will need to devise a way to pay the people who protect the public from scams that is independent of the industry they are supposed to regulate. The solution is to use money raised from many taxpayers so that no organized group -- such as industry lobbyists -- can exercise the power of its cash to dominate a politician's agenda.
But as I posted, the key to protecting the public is to create an independent group that produces the financial statements of all organizations that seek money from the public. As long as investment managers and companies produce their own report cards, we'll have investment scams.
Changing that one part of the system could create a village that would squelch any investment scam before it got off the ground.
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)
12-14-2008 @ 10:03AM
williambanzai7 said...
MADOFF THE WALL STREET FAKIR
(Rudolph the Red Nosed Reindeer)
WilliamBanzai7
You know Vesco and Boesky, and Keating and Milken,
Leeson and Mozer, and Ponzi and Wiggen,
But do you recall, the most famous securities fraudster of all?
Madoff the WALL STREET FAKIR
Had a GIANT PONZI SCHEME,
And if you ever saw it,
You could say it was Wall Street's own worst dream.
All of the other Wall Street fraudsters
Used to laugh and call him names;
They never believed poor Madoff
Made a legitimate Alpha trade,
Then one shady Wall Street trading eve,
Madoff spilt his own beans to the SEC
"Madoff oh your scheme's so bright,
Won't you go to jail tonight?"
Then how the Wall Street fraudsters loved him
As they shouted out with glee,
"Madoff the WALL STREET FAKIR,
You’ll go down in securities fraud infamy."
Q: Whats the difference between Bernie Madoff and the CEO of a bulge bracket Wall Street investment bank?
A: Madoff is not asking for a bailout.
12-14-2008 @ 10:18AM
william lindblad said...
Well, well! I am happy to see that you finally realized that what is economically present is the work of both parties.
Fraud, scams, rip-offs and everything else that fits this bill have been part of the human environment back as far as time can tell. Back in ancient Babylon it carried the death penalty.
Actually, there will be plenty more but it will not impact the larger picture in any real degree. What is really at stake is confidence - confidence in leadership. So far, this is on the wane and all indications point to it getting worse. I still find it impossible to believe that we have hundreds of representatives sitting in Congress and ALL missed the warning signs. These are supposed to be bright people? As you imply, the only reasonable explanation is that they all knew, but chose to ignore. That being the case it does not take too much thought to deduce that the public interest is not being represented.
As Thomas Paine once said - this will be a time that tries men's souls. It will be a winter of dissent.
12-14-2008 @ 10:28AM
bruce wills said...
This was NOT a Ponzi scheme.
This massive scam did what it was supposed to do- lay in waiting...being funded by those who paid for it to stay alive...until the day it was needed to destroy the further investment across a broad class of investors world-wide.....
so as to acheive the descent into monetary chaos that now has been engineered by the Central and local banks worldwide ...to acheive their goal of enough unemployed manpower to force into the U.S. and British Armies so as to attack Iran.
12-14-2008 @ 10:46AM
jake23 said...
The United States economy is in a contraction brought on by a spike in imported energy costs. The whole concept of long term interest on debt in such an environment is open to question. How much different are the actions of this one individual and our own government?
12-14-2008 @ 11:06AM
Stephen M Smith said...
What is happening now, which is exemplified by the Madoff scandal, is already written in history books including the most ancient scriptures. People are hesitant to call their leaders to account for their actions because it is more likely they will be punished for speaking than that their complaint will be helpful. Our leaders are failing us for the usual reasons; greed and lust for power.
12-14-2008 @ 11:26PM
Jan said...
Any group requesting public funds should be required to supply 3 yrs of tax returns and in the case of non profits From 990 and the current balance of their endowment funds. If the fund is $1 billion or more, no public funds will be granted to do their chairty work, education or research. They have the ability to raise tax free dollars, they need to use them as the donor intended.