Madoff’s Investors Needed a Blagojevich Moment: Ann Woolner

Dec. 16 (Bloomberg) -- Kind to employees, generous to charities, devoted to regulation of the financial services industry, Bernard Madoff was a much-admired man whose oldest, dearest friends are among his biggest victims.

Now it seems those fine attributes cultivated over a lifetime were nothing more than a con, a cover for one of the more blatant ways to steal money without gun or mask.

He told his sons last week he had been running a “giant Ponzi scheme,” precipitating his arrest.

A former chairman of the Nasdaq Stock Market, Madoff was so smooth, so reassuring, so sophisticated, and such a stalwart on Wall Street, that few suspected. If he had been as profane and as blatant about helping himself as Illinois Governor Rod Blagojevich was, the feds would have been on him years ago.

But Madoff’s joyride lasted for decades, judging from the aging red flags now being reported. He made suckers out of some of the most sophisticated investors in the world.

Investment management firms Fairfield Greenwich Advisors, Kingate Management Ltd., Tremont Capital Management and banks in Spain, France and Switzerland are counting up their losses.

In Ponzi schemes, new investors unwittingly supply cash for what passes for dividends to earlier investors, but the securities don’t exist. The operator pockets the rest. And as long as new investors keep showing up and few folks demand their capital back, it all works just fine.

Scam With Longevity

This scam’s longevity helps explain why so many financial sophisticates went for it. Ponzis tend not to last long, and Madoff had been in business since 1960. Their involvement reassured others like them to invest, thus keeping it going.

“Who could ever fathom that an individual who had achieved such a lofty reputation of legitimacy and propriety could ever be capable -- in operation or in mentality -- of betraying the trust of so many people in so elaborate a manner?” asks Stephen Weiss, a lawyer with Seeger Weiss, who is preparing a lawsuit for Madoff victims.

The question explains how Madoff got away with it. Hardly anyone did fathom it. And those who did, who tried to warn, were waved off.

Like so many Ponzi operators, Madoff seems to have preyed on people much like him. This happens so frequently that it has a name: affinity fraud.

Developing Trust

“A lot of Ponzi schemes involve members of a church or a particular nationality who invest in part because they trust the people who are already investing,” says Carl Loewenson, former federal prosecutor and co-chairman of Morrison & Foerster’s securities litigation and white-collar group. He has no connection to the Madoff matter.

There have been Ponzi schemes targeting Mormons, Orthodox Jews and evangelical Christians. Another targeted Haitian immigrants in Miami.

Madoff’s customers were much like himself, financially sophisticated and wealthy. Many, like him, are Jewish, and a hub of activity was the Palm Beach Country Club, where Madoff had long been a member.

He plied his trade within his social community, his philanthropic network, his professional peers. Many of his victims had been intimate friends for generations.

“When people get investment advice from people who are part of their group, they tend to rely on it,” Loewenson says.

And when they rely on it, so do others in their group. When this group includes the most sophisticated investors around, then why not credit their judgment. Trusting that someone else did the due diligence relieves you of the chore, right?

Great Record

Besides, Madoff produced consistently solid returns that weren’t so outrageous as to look Ponzi-like. “It was not something that sprung up six months ago and paid 60 percent returns,” Loewenson says. “He had a great track record.”

This helps explain the international banks, money managers and institutional investors who flocked to his funds.

OK, but surely somebody, somewhere actually paid attention to where they were sinking millions of dollars. Where was the paperwork? Who was producing it?

When Aksia LLC, a hedge fund investment adviser, noticed that a three-person accounting firm was auditing Madoff’s massive assets, which NASD puts at $17.1 billion, it warned clients to stay away.

And now the auditor, Friehling & Horowitz, finds itself under investigation by a suburban New York district attorney.

It took 70-year-old Madoff’s confession to his sons and employees to finally put an end to all this. His reputation had kept him under the radar and silenced whatever alarms might have otherwise alerted authorities.

With more bravado, he might have been a Blagojevich and the feds would have taken notice. For investors, a crack in the Madoff façade could have saved a lot of heartbreak and many billions of dollars.