The Madoff Scams: The SEC Report Lets Us Blame the Victims

Dare we say it? Are the victims of Madoff at fault, at least partially, for the pain they are suffering? Were those who gave Ponzi schemer Bernard Madoff their money (and faith) acting irresponsibly and were their wounds self-inflicted? Dare we blame the victims?

We typically recoil from doing so. Blaming the victim is the sleaziest courtroom ploy used by defense attorneys to deflect attention from every miscreant client. We find such attorneys repugnant. Yet, on occasion, though to say it pains us greatly, the victim shares the blame. The Madoff case is such an occasion.

This is clear from the recently-submitted 457-page Securities and Exchange Commission’s Inspector General’s Report on how the SEC failed to protect investors from Madoff. One striking fact leaping from the Report: Those investors who took even modest effort to look at what Madoff was offering turned heel and fled. Those who performed even modest “due diligence” (a lovely term of art, conveying precisely what responsible investors do) did not invest. But those who, uncomfortable as it is to say, were too lazy or too naive to protect their own interests, became Madoff victims. They relied on a tip from a friend, on advice from a broker, on a gut feeling or even on the purported clearance that SEC investigations might have given Madoff. They did not rely on themselves and their own judgment. To put the matter crassly, they probably spent more time and probed more deeply in deciding what auto or laptop computer to buy or what new restaurant to try than they did in deciding how to invest their money.

Suspicious activity & red flags.
If one big lesson from the SEC Inspector General’s Report is that federal bureaucrats are incompetent serial bunglers (see my September 8th blog posting), a second big lesson is that individual investors must take responsibility for where they place their money.

Descriptions of responsible investing fill the 14 pages of Section VIII of the Inspector General’s Report. The Section’s very title powerfully makes the point: “PRIVATE ENTITIES’ DUE DILIGENCE EFFFORTS REVEALED SUSPICIOUS ACTIVITY AND RED FLAGS ABOUT MADOFF’S OPERATIONS.” The Report emphasizes that firms “using ordinary due diligence methods, such as voluntarily requesting basic documents like financial statements and asking pointed questions of Madoff or Madoff feeder funds,…determined that an investment would be unwise.” The Report is chocked full of the rewards of due dilligence.

When one fund, for instance, was asked by clients to invest their money with Madoff, the fund only had to check the periodic statements received by those already investing with Madoff to find what the fund CEO called a “pattern which really seemed weird.” Madoff consistently was buying stocks at their lows and selling them at their highs. “Of course, nobody can do that,” the CEO told the Inspector General. As a result of his cursory investigation, the CEO said that he “certainly wouldn’t touch [Madoff] with a 10-foot pole.” Others across Wall Street similarly were puzzled by Madoff’s astonishing ability, year after year, in down markets and up, to post consistent returns. They concluded, after just a peek at Madoff’s purported investment strategy, that Madoff was a fraud, that there was no way such consistent returns could be booked. As one research firm CEO told the Inspector General: Madoff’s “returns were impossible. Absolutely impossible in my opinion. No financial strategy could produce those sort of returns.”

“Simply by inquiring.”
Several investment professionals, astounded by Madoff’s alleged huge trading volume, had to do little more than check with the various exchanges to learn that trades in such volume were never executed. Puzzling other investment bankers was the apparent obscurity of Madoff’s auditors. One suspicious research firm, after finding almost nothing about the auditors on the Internet, hired an investigator who discovered that Madoff’s multi-billion dollar operation was being audited by a strip-mall accounting firm with just three employees, one of whom was a 78-year-old living in Florida.

The examples of due diligence scaring away investors march on and on. With palpable amazement and respect, the Report stresses that none of these due diligence efforts had any “authority that a regulator like the SEC has to compel” Madoff and his accomplices to submit information. Yet, simply by inquiring, by checking public records, by asking for voluntary disclosure, they learned enough to decide not to invest.

Core conservative maxim.
None of this, of course, makes Madoff less guilty nor less deserving of his 150-year prison sentence. But it does demonstrate that the most basic and simple practices of responsible investing would have kept financial advisers, brokers and individual investors away from Madoff. And while Main Street investors may lack the resources or confidence to perform the due diligence documented by the Inspector General, it would have been enough for them to spread their risk by not placing large portions of their assets with Madoff. The technical term for this is “diversification” – and long has been urged on investors by every article, every commentator, every analyst. And there is nothing new or sophisticated about this. It’s based on the eons’ old quaint folk wisdom of not putting too many eggs in one basket. How clever. How shrewd. It would have spared thousands of investors their Madoff agony and it demonstrates the core conservative maxim, that we can’t abdicate our own responsibility.

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