Many Investors Seemed to Forget About Bernie Madoff
In the midst of the financial crisis in 2008, a story broke that pushed declining stock prices out of the headlines at times.
Bernard Madoff was a respected founder of an investment firm. Madoff founded a penny stock brokerage in 1960 which eventually grew into Bernard L. Madoff Investment Securities. He served as its chairman until December 2008.
The firm was one of the top market maker businesses on Wall Street, which bypassed “specialist” firms by directly executing orders over the counter from retail brokers.
He was the former non-executive chairman of the NASDAQ stock market with an incredible amount of respect in the business.
He also managed money for a number of clients who believed they were enjoying steady gains.
On December 10, 2008, Madoff’s sons told authorities that their father had confessed to them that the asset management unit of his firm was a massive Ponzi scheme, and quoted him as saying that it was “one big lie”.
The following day, FBI agents arrested Madoff and charged him with one count of securities fraud. The U.S. Securities and Exchange Commission (SEC) had previously conducted multiple investigations into his business practices but had not uncovered the massive fraud.
On March 12, 2009, Madoff pled guilty to 11 federal felonies and admitted to turning his wealth management business into a massive Ponzi scheme. In June of that year, Madoff was sentenced to 150 years in prison, the maximum allowed.
Madoff said that he began the Ponzi scheme in the early 1990s, but federal investigators believe that the fraud began as early as the mid-1980s and may have begun as far back as the 1970s. The amount missing from client accounts was almost $65 billion, including fabricated gains, from an estimated 4,800 clients.
From all of the publicity generated by the scheme, it seems investors should have learned important lessons. But recent news indicates that Ponzi schemes still exist.
In December 2018, the SEC announced that they had “charged a former Rockland County, New York-based investment adviser and his daughter with conducting a multi-million dollar Ponzi scheme that defrauded local community members as well as members of their family and close friends.
The SEC alleges that Hector May, an investment adviser representative and the president and chief compliance officer of the now-defunct Executive Compensation Planners Inc. (ECP), and his daughter Vania Bell, who served as ECP’s controller and senior compliance administrator, misappropriated more than $7.9 million in a Ponzi scheme involving bonds.
According to the SEC’s complaint, with Bell’s help, May lied to investors by promising to invest their money in bonds when they actually used the money to pay for personal and business expenses, as well as extravagant items, such as jewelry, furs, vacations, and a limousine driver.
To conceal the fraudulent scheme, they sent bogus account statements to clients referencing the bonds that had never been purchased.”
There are other examples of Ponzi schemes on their web site.
Fortunately, there are steps an investor can take to limit the risk of being victims of one of these schemes.
Understanding the Scheme
A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk.
In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors to create the false appearance that investors are profiting from a legitimate business.
With little or no legitimate earnings, Ponzi schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.
There are generally red flags associated with the scheme:
- High investment returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk. Be highly suspicious of any “guaranteed” investment opportunity.
- Overly consistent returns. Investment values tend to go up and down over time, especially those offering potentially high returns. Be suspect of an investment that continues to generate regular, positive returns regardless of overall market conditions.
- Unregistered investments. Ponzi schemes typically involve investments that have not been registered with the SEC or with state regulators. Registration is important because it provides investors with access to key information about the company’s management, products, services, and finances.
- Unlicensed sellers. Federal and state securities laws require investment professionals and their firms to be licensed or registered. Most Ponzi schemes involve unlicensed individuals or unregistered firms.
- Secretive and/or complex strategies. Avoiding investments you do not understand, or for which you cannot get complete information, is a good rule of thumb.
- Issues with paperwork. Do not accept excuses regarding why you cannot review information about an investment in writing. Also, account statement errors and inconsistencies may be signs that funds are not being invested as promised.
- Difficulty receiving payments. Be suspicious if you do not receive a payment or have difficulty cashing out your investment. Keep in mind that Ponzi scheme promoters routinely encourage participants to “roll over” investments and sometimes promise returns offering even higher returns on the amount rolled over.
To limit risks, consider searching for your investment advisor in BrokerCheck, a free tool to research the background and experience of financial brokers, advisers and firms.
This is a website sponsored by FINRA, the Financial Industry Regulatory Authority, Inc.
“FINRA is an independent, non-governmental regulator for all securities firms doing business with the public in the United States. We are authorized by Congress to protect America’s investors by making sure the securities industry operates fairly and honestly.”
Watching for red flags and using BrokerCheck could be small steps towards avoiding becoming a victim. Finding that there are complaints against a broker does not mean the broker should be avoided. It does mean you should consider talking to the broker to understand why the complaint was made.
Also, always be sure you understand where your money goes. It could be best to deposit funds into brokerage accounts rather than with individuals.
Working only with registered individuals in good standing with regulators will not avoid all frauds, but it will go a long way to avoiding losses.