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Investors in Bernard Madoff’s Ponzi Scheme

This article was written by in Investing. 57 comments.


Bernard Madoff is on his way to jail, having plead guilty to defrauding investors in a massive Ponzi scheme. While his victims thought they were investing with a legitimate manager, Madoff simply deposited clients’ money in a Chase Manhattan bank account and paid “returns” to earlier investors from the contributions of newer investors. The bulk of investors directly damaged by the failure of the scheme were banks, foundations, endowments, and trusts. Other investors include Kevin Bacon and Zsa Zsa Gabor.

Most investors didn’t invest with Bernie Madoff directly; usually, funds were invested through at least an additional layer, such as a wealth manager or two. The further someone is separated from their money, the harder it is to understand the investments. For example, Jeffrey Katzenberg and Steven Spielberg relied upon a financial adviser named Gerald Breslauer, who invested his own money with Madoff in addition to his investors’.

Even though investors and their asset managers who decided to invest with Madoff are due some blame for investing without requiring concrete details of their investment, I do feel bad about their situation. Madoff was obviously a professional; he was able to convince otherwise smart people that he was running a legitimate operation. I’m confident that many of the middle-men who had access to Madoff and were investing on behalf of wealthy clients didn’t care about the existence of underlying investments as long as the quarterly statements showed growth, even if this growth was merely a work of fiction.

I feel bad for investors who found themselves as victims of this Ponzi scheme. In their position, I can understand putting faith in highly recommended money managers which reportedly search for the best investments balancing risk and reward for wealthy clients. Someone should have made sure there was an understanding of the underlying investments, but in theory, that is why wealthy clients pay asset managers.

Even early investors who managed to withdraw more than they invested, the only investors other than Bernard Madoff who made money in this Ponzi scheme, might deserve some pity if they weren’t complicit. But I do not believe any investor who withdrew more than they contributed should deserve any more restitution. The most judicial way to resolve the issue should be for every investor to receive back only their contribution, and to do so, anyone who withdrew more than they invested should be ordered to return their false profits back to others who were not able to withdraw as much as they invested.

This will reset the clock, providing no advantage for anyone. I would imagine that most of that money is gone, spent by Madoff, so I’m not sure how viable this plan would be.

What are your thoughts on Bernard Madoff’s Ponzi scheme?

Published or updated March 13, 2009. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 22 comments… read them below or add one }

avatar Brandon Barkley

My only thought is that I wonder how he did not think he would get caught. It just does not seem like it is worth it to run such a scheme in such a high profile way where you are surely going to get jail time if caught. I would rather live a middle class life all my life than a high class life followed by jail.

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avatar KC

I feel bad for them, too, even those who did invest directly with him and didn’t diversify – as stupid as that may be. I feel bad for anyone who loses their entire savings. That’s why its even more important, regardless of how well-off you are, to live debt free, keep a percentage of your wealth in cash, and diversify. If you take these steps the only thing that can take you down is the collapse of the government.

I live a very comfortable lifestyle and I live like I’ve described above – low debt, respectable cash reserves, and a fairly diverse portfolio. I really believe that is why we’ve survived (even thrived) during this recession. Even if we had to we could endure a job loss because of our cash reserves.

Regardless of how wealthy you may be, if your home and cars are paid for, you keep about 20% (more if you have less job security) of your wealth in cash reserves, and you diversify, you should be safe – safe even from Bernie Madoff. But, then again, hindsight is 20/20.

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avatar Kyle

I feel bad and I blame the investors at the same time. You need to understand what you are investing in, even if you think you trust the person doing the investing.

Like grandma says, if it seems to good to be true, it probably is. These people were blinded by returns that didn’t seem possible. Because they weren’t.

I feel horrible for those people who lost everything and I hope they get something out of it, if nothing else none of them will ever blindly hand over their money again.

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avatar Apex

I have to say I can’t see any fair way to go back on investors who withdrew their money years ago and ask them to give back their witdrawal to spread it around. Why? Because there was fraud? How about the investors who got out of the Enron Ponzi scheme. You can say Enron is not a Ponzi scheme in the classical sense but there was no real investment there. The company was making up bogus financial numbers, creating bogus off shore companies to buy and sell bogus product to and from themselves giving the illusion of a growing revenue stream with falsified underlying profits and accounting fraud to make it appear the company had tons of revenue/growth and profit when it had none of any of it. The fact that there was a legitimate underlying business is hardly important when 95% of the value of the stock was based on corruption and false information.

So on what grounds is this corruption different than that corruption?

How about all the stock analysts who hyped all the internet bubble stocks and now we know that off the record they were talking about what a bunch of idiots we all were to buy this stuff, but they were getting paid to hype it and so they did. Pets.com, and all the stocks like them that went from 2 to 200 to 2 and often to 0, what do we do with the investors who got out of those early and made huge profits on business models that were never viable, never made anything close to a profit and never had or had any hope of achieving real growth, and were clearly pumped by fraudulent analysts. Huge deceptions occurred here. And people who you are supposed to be able to trust are the ones who propagated the deceptions.

So again, when does the fraud become such that those who got out lucky have to share their money with those who didn’t?

How about a stock which trades with small float and is manipulated by speculators. I have an example (TravelZoo TZOO). Look their stock trades up for around 2004-2005. The stock only had 13% of total shares on float and was originally worth only 140 million. That means stock available for trade totalled about 18 million. Very easy to manipulate. They went from 8 – 110 in less than a year. Guess how much their revenue changed in that time period, probably grew about 50%. Once it got that high the company sold tons more stock, put cash in the bank, the CEO cashed some of his out and then the manipulators stocpped driving it up. The stock quickly crashed back down to 50 then to 25, then to 15, it did bump back up to 50 again but then crashed down again and now it trades at 6 and has a market cap of less than when that whole thing started. And you know what, its revenue now is higher than it was at any time when it was trading between 8 and 110. So what was that? That was all maniuplation and anyone who bought in above 50 had literally zero chance of expecting any long term gains out of the stock because it was trading at valuations that made no sense based on the business model. But plenty of people got in at 50 and out at 100 or in at 20 and out at 80. What do you do with them? Plenty of them were completely unaware that there was a total stock cornering maniuplation going on but they saw something making huge returns every week and they hoped on board and then got off. They were attracted to the big returns and they got lucky. Thats the breaks. Most people got left holding the bag.

For Madoff people were attracted to the large stable returns as well. Some got lucky, most got left holding the bag. It’s what happens when you take a huge risk on something that sounds too good to be true. It is too good to be true and a few get lucky and most get burned eventually.

What if you were the one who had made a contribution of 50K and 6 years later drew out 100K (12% returns). Then you took that 100K added it to another 100K you have a put it into a house that cost 600K. That house is now worth 400K and you have a 350K mortgage on it. So they ask you for the 100K back or atleast the 50K profit. Where are you supposed to get it? Try to sell your house in a down market, sell off your stuff, move into an appt and give them back the money even though it is going to cause you to lose all the extra 150K you have put into your house through the extra downpayment and extra mortgage principle paydown?

The whole thing definately sucks but if you got lucky you got lucky. People are destroyed here and if you force people to give back previous withdrawals you are going to destroy some more people and for what? How much are you going to get? All so that you can spread around a few more pennies to the people who are destroyed by destroying a few more?

I keep hearing about this deal of making people pay back the money and as far as I can figure it is merely compounding a fraud and a travesty of justice to do such a thing.

So honestly I can’t figure how this would be a fair thing to do. Can you please explain how this is different than getting taken in some other manner by fraud and con men who manipulate market systems to defraud “investors”?

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avatar Diane

Apex! Thanks for making this plan for lay people like myselft to understand. I began to dapple in the stock market late in my career. I am an educator and now I have lost 50% of my investment. I trust my mattress better than I do “so called good investments.” I doubt that I will ever get back in the game because I now know that it was a game and the rules changed daily without any prior notice. Thanks for taking the time to explain just how corrupt even legal businesses can become.

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avatar redski

Apex, you have made very good points and most of what your saying has been bought up. Appearently the Feds are looking into the ones who recieved gains and will be “requesting” that these investors pay back their gains. Well, that I am sure will never happen.

You can certainly bet the investors who cashed out most likely spent their money already. As far as Mrs. Madof and sons and uncle, I say their assetts frozen and leins placed on everything they own until their fate is resolved. In the meantime they can eat welfare cheese like their investors.

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avatar SJ

Great post! Isn’t every bubble like that =)?
Actually I was wondering what he was thinking and why he didn’t choose to run away and hide. After a certain point don’t you have enough?

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avatar redski
avatar redski

Hello Bernie, hows the powdered eggs? Toaste a little dry? No more “Chock Full O Nuts”, its “Chicory” from here on.
Kinda worries me when I think about how someone might spit or urinate in your food taking into concideration that you might have ripped off someones grandmother thats an inmate? (it happens).
Oh, the things at lunch time that look like ribs and taste like ribs?, They’re not ribs. Those are “RIBLETS”, a Hormell product constructed of scrapings off the floor during manufacturing of SPAM.
Mmmmmm, just a little barbeque sauce and some intestine and whatever, all you need m8.
Hey, dont worry about Bubba, (respectfully), he’s not in the jail where you are, hes at the prison.
Did you think getting to sleep wouldnt be a problem taking into concideration that you live in NYC? hehehe, ‘BIG” problem dude, you never get used to it.
Every nite its the same old thing. Drunks getting locked up, screaming and yelling all hours of the day.
Guess you wont be reading the “Wall Street Journal” anymore. Even in prison I would want to know how my investments are doing? Oh yeh, I forgot, people were your investments.
You dont have to worry about being lonely for too long though because the way I hear it, your sons and uncle, will be joining you soon.
I think your wife will be the lonliest though since you have no other women folk involved with your Ponzi to keep her company in prison.
I’ll write her if you want, I think I can help her keep her spirits up with some kind words like I am doing for you?
Keep a smile on your face.

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avatar redski

I forgot to mention, (and this is to the people), do not be surprised if Madoff and his Wife do Federal time together in some community prison in some desert somewhere?

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avatar Praveen

Can we ask the CEOs who minted millions and billions of dollars to return those monies??

Try that first than the hapless and innocent investors who made money!

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avatar Bud

I find it very difficult to have sympathy for investors that should have known on some level that the returns on their investments (on paper at least), were just too good to be true. Madoff’s phony returns were outperforming Warren Buffet and all of the other brightest financial minds in America, year after year.

Discussing his discovery of Madoff’s Ponzi scheme on “60 Minutes”, Harry Markopolos said, “It took me five minutes to know that it was a fraud. It took me another almost four hours of mathematical modeling to prove that it was a fraud.”

Investors (and regulators), that didn’t know Madoff was a fraud didn’t want to know the truth.

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avatar redski

Hey Bud, you said it yourself, “outperforming Warren Buffet and all of the other brightest financial minds in America, year after year”.
Those investors had put all their faith in the regulators to make those investments.
You have no right to blame them.
I certainly hope you invest and lose money yourself someday and have some dipsh*t tell you it was your own fault.
Pretty much every one of them investors was under some advisement to “invest”.
So, for Harry Markopolos’s input which came after Madoffs indictment dont mean sh*t.
It means just about as much as me saying George Bush wont win the election right now.
Get an education before posting here.

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avatar Bud

redski:

I’ve lost money on investments the last few months as many others have, and the investment choices I made and the money I lost are indeed my responsibility.

And Harry Markopolos’ input did not come, “…after Madoffs indictment…”.

Mr. Markopolos contacted the SEC about Madoff in May 2000, October 2001, three times in 2005, June 2007, and April 2008.

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avatar redski

Sorry Bud for insulting you.
But, if this was the case then even still it is not entirely the investors fault for being ignorant because we were supposed to be “under the watchfull eye” of our regulators that this sort of thing wouldnt happen again as it did with Enron and Tyco.
Once again Bud, I did get unruely because both me and my wife lost most of our 401k’s because of the economy the way it is and I dont blame Madoff entirely for it as much as I blame our government.
Accept my appology

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avatar Bud

Redski:

Apology accepted, no problem. And I am sorry for your family’s financial losses.

I agree completely that the government failed miserably in this instance. As much as I want to see Madoff and company held accountable, I want to see thorough investigations of the SEC and others responsible for discovering frauds such as this. If that leads to prosecutions of those in government who failed the investors, so be it; put ‘em in a cell right next to Bernie.

avatar redski

rgr that

avatar redski

forgot to add, I agree with you, our government needs to investigate the SEC and incarcerate the head turners.
Under no turn or twist whatsoever should Madoff family and friends be allowed any breaks.
With the exception of Ken Lay who dide of Enron, Joseph Hirko only got 16 months and had to forfiet $7mil (whoopy freeking do). Jeff Skilling is appealing his case and some judge recently allowed a re-sentencing.
People who ruin other peoples lives just plain and simple, should not have one for the rest of theirs and our government officails need to step in and enforce their positions without the “lets make a deal” attitudes.

avatar James Raider

The Judicial system is missing the boat on this one. There is a deal that should be made with Madoff.

http://pacificgatepost.blogspot.com/2009/03/deal-to-make-with-madoff.html

The objective is NOT revenge, but Restitution and Reconstruction.

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avatar Tony

Alongside the earlier investors who got out before the scheme unraveled, the US Treasury also benefited quite handsomely. Every investor in the scheme had to pay taxes on the steady stream of dividends that Madoff was paying year after year. Which means we all as americans benefited from Madoff’s scheme (except for those who were invested in it till the end).

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avatar Ishan

This is really a very sad episode. This guy had been indulged in this fraud scheme since such a long time, and no one cared to audit his reports. Its really surprising that he was able to hide this for so many years.

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avatar AnnJo

Investors in Madoff’s scheme violated (at least) three basic rules of investing:

1. Diversify. “Don’t put all your eggs in one basket.”

2. Understand what/who you are investing in. “Look before you leap.”

3. Expect risks to correlate with rewards. High returns = high risk. “There’s no such thing as a free lunch.”

This doesn’t make their behavior criminal or make them complicit in his crimes, but it also means that, aside from whatever restitution may be available from him, they are not entitled to government aid in recouping their losses from earlier investors who just happened to be lucky enough to get out in time.

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