How could savvy investors have been fooled by Madoff? Easy


I have a confession to make:

I would have been fleeced by Bernie Madoff.

Filled to the brim with years of prudent advice to know my broker, diversify my investments and perform my own due diligence, I would have placed my portfolio in his hands without a second thought.

Like most of his investors, I would have made a rigorous investigation of his background, amounting to accepting the word of a friend who had his own money with Bernie. He would have attested to Bernie’s record of nearly uninterrupted investment gains averaging 12% a year.

My friend would have pointed to Bernie’s confidence-inspiring client list. Steven (Spielberg). Jeff (Katzenberg). The board of trustees of Yeshiva (University). Pension funds. Charity boards. The kind of people who have people to check these things out.


I would have been reassured by the clean bill of health Bernie had gotten from the regulators. The Securities and Exchange Commission even put him under oath in 2006. It must have investigated him thoroughly -- this is the SEC, after all, experts at sniffing out crooks. They waved Bernie through.

And of course I would have understood Madoff’s “split-strike option conversion” trading strategy, which had just that hint of incomprehensibility you want in an investment methodology. If you had asked, I would have explained that the idea was to buy a few dozen blue-chip stocks and hedge them by selling out-of-the-money call options and buying out-of-the-money put options. . . . But look, if you have to ask, you shouldn’t be investing in the first place.

I would have felt lucky, even proud, to do business with Bernie. No fly-by-night operator on the periphery of Wall Street, he was a former chairman of the Nasdaq stock market and a pillar of the Jewish community. He didn’t let just anyone into the circle. You had to know somebody, and even then you had to be allowed to invest with Bernie.

That accounts for the stories we’ve heard of the Madoff elect strutting around their country clubs in New York and Palm Beach while their excluded fellow members chafed in dark corners. Now, of course, the shoe is on the other foot.

When the story of Madoff’s Ponzi scheme first broke in December I wondered, rather superciliously, how could these people have been so stupid? How could they have failed to perform even elementary due diligence? Didn’t they know the cardinal rule that if it sounds too good to be true -- it is?

But as a veteran of the investment business explained to me, this is how most folks perform due diligence. They ask people they know and trust. They network. They collect references. They don’t bother with things like prospectuses.


You read the fine print of every mutual fund you invest in, don’t you?

Me neither.

A lifetime on Wall Street endowed Madoff with the knowledge that even “sophisticated” investors take short cuts, and that a personal reference will trump painstaking quantitative analysis every time. Even some hedge funds that invested with him didn’t question his magic. (“Madoff’s investors rave about his performance -- even though they don’t understand how he does it,” Barron’s wrote in 2001.)

And the longer the scheme continued without exposure, the more trustworthy it appeared. Had the financial markets not plunged in unison last year, it might have gone on forever. Even so, when the crash came, many of his investors in need of cash probably liquidated some of their stocks and bonds but didn’t dare touch their Madoff holdings, snowed by his claims of continuing profits.

“Madoff interestingly went down rather late in the financial collapse,” Kip Dellinger, a Westside accountant who is working with some of the victims, told me last week. “That’s because people stayed in as long as they could since Madoff was the only ‘performing’ asset in the portfolio.”

Many investment managers who placed their clients’ funds with Madoff -- often without informing them -- say Madoff was such a determined con man that no one could have known what he was up to. But surely many in the investment community knew.

Considerable press has been devoted to the efforts of Harry Markopolos, a Boston money manager, to goad the SEC into investigating Madoff as early as 1999. Some of his insights were blazingly simple: In mathematical terms, the split-strike strategy could not have produced the returns Madoff claimed, and in any event would have required option trades amounting to many times the documented trading volume on option markets.

Markopolos pleaded with the SEC simply to check his math, to no avail. The agency did place Madoff under oath in 2006, only to blindly accept his brazen lies and forged documents as the truth. (So he disclosed, rather embarrassingly, in his guilty plea last week.)


What hasn’t been widely reported is that Markopolos also pointed the finger at numerous eminent financial institutions, including Goldman Sachs Group Inc., Morgan Stanley and JPMorgan Chase & Co., suggesting that their option-trading bosses almost certainly knew that Madoff’s strategy was a sham. Morgan Stanley and Merrill Lynch reportedly warned some clients not to invest with Madoff. Yet none alerted the SEC or warned the investing public, at least not forcefully enough to get Madoff shut down before his scheme buckled under its own weight.

JPMorgan Chase Chairman James Dimon groused in a speech last week that bankers were being unfairly “vilified” for the financial crisis. Let’s hear him defend his firm’s silence in this case.

Certainly those whose money was invested with Madoff have suffered the most grievous losses. But the rest of us have suffered too, by having our faith in the system shattered.

The regulators and the industry now promise us that things will be better in the future. But why should we believe that, when the next Bernie Madoff hangs a bronze nameplate on the door of a fancy office and starts collecting money, we won’t be fleeced again?


Michael Hiltzik’s column appears every Monday and Thursday. Reach him at and read his previous columns at