Wednesday, December 17, 2008

The Oldest Trick in the Book

Palm Beach Country Club Has at Least One Member Who Hasn't Paid His Dues

By Henry J. Stern
December 16, 2008

The massive fraud perpetrated by community pilar Bernard Madoff has supposedly consumed the life savings of thousands of people. The money would otherwise have gone to maintain their comfortable lifestyles, pay for their eventual nursing home care, help their children, put their grandchildren through college, or supported charities and other worthy causes.

We know that there will always be swindlers in the world, particularly when money is at stake. What is surprising in the Madoff case is the magnitude and durability of the confidence game and the wealth and importance of many of the investors who went along for the ride, based largely on personal trust. In fact, the Madoff fund was a very good ride, with consistent double digit returns, until withdrawals began to exceed deposits as people with little faith brought down the house of cards. One wonders what would have happened if the fund had survived its 70-year-old impresario, although we know that 70 is not that old at the Palm Beach Country Club.

The issue arises as to whether investors in such a fund should be insured in any way, not against losses resulting from market activity (those are business risks), but from losses through embezzlement, for example, if someone stealing the corpus of their fund, or if there is no fund.

If this were to be done, the premiums for theft insurance coverage would have to be paid by the trust funds, and those payments should be disclosed to depositors, along with a statement as to the policy limits, if any. The insurance might be capped at two to five million dollars, to keep the premiums more reasonable and allow the rich to pay some share of their losses.

Investors should place their money in accounts insured by the Federal Deposit Insurance Corporation (which covers bank deposits up to a newly increased $250,000) and you can create joint accounts to expand those limits substantially, or covered by the Securities Investor Protection Act of 1970, which provides maximum coverage of $500,000 before the authorities start dividing the brokerage firm’s remaining assets pro rata. The investors are now out of luck because they must bear the risk of their broker’s defalcation, not something they anticipated, unless they have previously purchased insurance to offset such losses..

The big banks and insurance companies have received federal bailouts in these parlous times, but not the investors who chose Maddof to handle their money. The fact that some of these gulled investors were rich and famous, and therefore presumably sophisticated, makes this case much more interesting than it would have been it the victims had turned out to be just ordinary people, like you and us. Well, maybe not you. You’re special.

If the Madoff fund had been required to purchase insurance against fraud, government inspectors would presumably have looked into their books sufficiently to know that something was amiss. The reliance by Bernard Madoff on a tiny CPA office in Rockland County to certify his financial reports over billions of dollars entrusted to his care should have been seen as vividly as a flashing, illuminated billboard, indicating that something was rotten in the County of Rockland, which is on the far side of the Hudson River, sandwiched between Orange County and New Jersey. We are not certain at this time whether the SEC lapses were due to corruption, incompetence or sloth.

The failure of the Securities and Exchange Commission to investigate Madoff in the face of a
number of situations which should have alerted them to the existence of a problem is described in today’s Times in an article by Stephen Labaton on pA6. S.E.C. IMAGE SUFFERS IN A STRING OF SETBACKS; Missed Warnings in the Madoff Case. Labaton’s biting lede:

“The Securities and Exchange Commission, a once-proud agency with an impressive history as Wall Street’s top cop finds itself increasingly conducting autopsies of leading financial institutions after failing, in the first instance, to perform adequate biopsies.

“The latest black eye for the commission came when inspectors and agency lawyers missed a series of red flags at Bernard L. Madoff Investment Securities. If it had checked out the warnings, the commission might well have discovered years ago that the firm was concealing its losses by using billions of dollars from some investors to pay others.”

The case is of journalistic interest because of the high profile victims, and the dexterity with which this mild-looking fatherly man, a trustee of numerous charities, a generous donor in his own right, looted more recent accounts to pay off earlier investors. Madoff showed ability in keeping the scheme going as long as he did, aided by the bull market. He showed guile by making the fund difficult to invest in; people thought it was an investment which it was a privilege to be allowed to make.

Abraham Madoff will go down in history along with Charles Ponzi, who gave his name to these pyramid schemes in the 1920’s. Ponzi may have been the first , but Madoff was the biggest. Look up Charles Ponzi in Wikipedia. In the “See Also” section, there is a link to Reed Slatkin, founder of Earthlink. Slatkin was also an ordained minister of Scientology, to which he funneled millions in his salad days.

The Ponzi article features a brand new link, to Bernard Lawrence Madoff.

3 comments:

  1. Anonymous1:58 PM

    Henry,

    To quote Paul Krugman in his NY Times op-ed of December 19, "How different, really, is Mr. Madoff’s tale from the story of the investment industry as a whole?"

    Not very, I would suggest. Just look at what was alleged to have gone in AIG's London office...

    The fine line between legal and illegal in this case will be grist for the mill of hundreds of delighted lawyers.

    Unfortunately, charities are the big losers, and I doubt that there will be any bailouts for them or for the people and causes that they serve.

    Arthur

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  2. bird of paradise12:35 AM

    Hello Starquest
    Take a look at the Made Off series @Poignant Frog

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  3. Mister Stern: What about the fraud being perpetuated between the Aspalt Green and the current NYC Park Department? The public basketball courts were oddly removed four years ago and an outdoor, above-ground pool was installed, open to members and $25.00 paying non-members, with access for only three months a year! The pool was not very popular and after much pressure from the community, the Asphalt Green is rebuilding only one basketball court and allowing public access 16 to 20 hours a week! With the Park Commisioner's Blessing! Last year the community board 8 voted unamomously to remove the pool immediately and to rebuild the courts! Instead the pool was allowed to re-opened and to date, no courts were rebuilt! Something Stinks here and this never would have occurred under your administration!!! See NY Times: http://www.nytimes.com/2008/04/06/nyregion/thecity/06pool.html?_r=2&scp=1&sq=asphalt%20green%20april%202008&st=cse&oref=slogin

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