The Complexity of Bernie Madoff's Ponzi Operation is Coming to Light

The Wall Street Journal published an article this week with more information about how Bernie Madoff's Ponzi scheme could operate with so few people. I've always been skeptical that anyone could pull off such a massive fraud without a team of people involved. It looks like the government is now putting together a case showing that a team was behind the fraud and it ran for a much longer time than previously estimated: nearly four decades.

Revisiting Allen Stanford's Ponzi Scheme

While Bernie Madoff has claimed the bulk of the spotlight in fraud related news over the past few years, Allan Stanford's fraud isn't just another Ponzi scheme, as highlighted in this interesting article by DailyFinance.  Here are some of the highlights:

Sir Allen Stanford gets life sentence

Well, the US Justice Department comes through on Ponzi schemer, Allen Stanford and sentenced him to 110 years for running his $7 billion Ponzi scheme. 

Unless you follow fraud like I do, you probably have never heard of Stanford. That is one bizarre effect of the Bernie Madoff fraud. If Madoff hadn't come to light about two months before the Stanford fraud came to light, everyone would know Sir Allen since his Ponzi scheme would have been known as the largest in history, by far. If you want to learn more about Sir Allen, including why I refer to him as "Sir" you can read the posts linked here.

Now, I just hope the Justice Department decides to prosecute some of the fraudsters who caused the mortgage meltdown and put the world economy in a the great recession...

Stanford Convicted on 13 of 14 Counts

Allen Stanford has been been convicted of fraud.

Madoff and Watergate

No, Bernie Madoff didn't play a role in the Watergate scandal (at least as far as we know) but it turns out that his Ponzi scheme may have been going way back then. If so, it will go down in history as not only the largest Ponzi scheme we know of but also the longest running scheme too (by far!). This new revelation is according to the guilty plea of 66 year old David L. Kugel who was apparently associated with Madoff even back when Richard Nixon was in the Whitehouse. Here are a few quotes:

Ponzi Schemes and Sophisticated Investors

So when you read about a small, $50 million dollar, Ponzi scheme coming to light, you almost always read about some gullible investors who had no idea they couldn't make 50% returns in a legitimate business deal. The list of victims was recruited from friends or family in an affinity fraud and almost always includes a bunch of doctors and dentists who have too much money and think they need a bunch more but don't understand risk and return. It is very rare that the so-called sophisticated investors who understand risk and return get duped. The following story was sent to me by a former student, Robert Madsen, who pointed out that this is what makes this story incredible...

Bernie Madoff Implicates Banks and Hedge Funds

The Correctional Facility that Houses Bernie Madoff

The NY Times is reporting that Bernie Madoff was interviewed in prison and has said that, at least some of, the banks and feeder funds knew he was operating a Ponzi scheme. This is not going to be well received by JP Morgan Chase who is being sued by the Madoff trustee who asserts the bank should have known or did know that Madoff was operating a Ponzi scheme. Here are some key paragraphs from the article:

Sir Allen Stanford: Prison Beating and Drug Treatment

Allen Stanford--Accused of $7 billion Ponzi Scheme

Although it's been some time since I've posted anything on Sir Allen Stanford and his $7 billion Ponzi scheme investigation (see this link for prior posts mentioning Stanford), I've been following his case and thought I'd share the latest news on the Knight from Antiqua or the Scammer from Texas, depending on who you talk to.

Stanford was supposed to go to trial last month. However, it appears now that his trial will be postponed for several months. The reason is because he's recovering from his cushy life in prison (not). Just yesterday, in my fraud class, I talked about the myth that white collar criminals have a cushy life in prison. I showed my class what Mark Morze, the former ZZZZ Best fraudster, said about white-collar-prison life.

In an interview several years ago, Morze explained his five years in prison in Lompoc, California. Here are some quotes from an article describing Morze's experience:

Bernie Madoff News: NY Mets and JP Morgan Chase

The past week has led to two new stories related to Bernie Madoff's massive Ponzi scheme. I'm going to provide a short blurb and a link to an article in case you want to read more.

Bernie Madoff's Personality Disorder

I read an intriguing article in the International Business Times about Bernie Madoff's personality disorder. According to the article, Madoff and many fraud perpetrators have what is known as "narcissistic personality disorder (NPD), a condition in which the sufferer is absolutely convinced that he or she is better than everyone else." Among other things, the article explains the following:

How Should Madoff's Victims Be Compensated?

The government has an insurance fund that covers broker-dealer accounts known as the Securites Investors Protection Corp. (SIPC). The SIPC generally covers victims' losses up to $500k. As such, victims who had more than $500k invested with Bernie Madoff, will receive $500k from the SIPC plus the law allows for recovered assets to be divided among the victims based on a weighted average of their actual funds over $500k that they had deposited with Madoff.

There are two groups of victims in a Ponzi scheme such as that run by Madoff: net winners and net losers. The net winners took out more money than they put in. Under the current rules, this group gets nothing when a Ponzi scheme collapses and they may be asked to give some of their assets back to the net losers in what is known as a "clawback."As for the net losers, they are covered by SIPC and get a share of the recovered assets.

Some victims of Madoff are saying that they should be entitled to recoup what Bernie's statements showed they had in their account. In other words, suppose they put in $500k and never took any out. If they had the money with Bernie for, say, a dozen years or so, it would have supposedly grown to about $2 million. Now, these victims would love to get the SIPC to give them $500k and then to get some share of the recovered assets based on the additional $1.5 million that Bernie said was in their account. Under the current rules, they will get $500k and nothing else.

The question some lawmakers are asking is whether this is fair? Apparently, a few of our esteemed representatives in Washington don't think so. The WSJ reported recently that Rep. Paulk Kanjorski (D., Pa.) "would pursue changes to require the SIPC to fulfill claims of customers based on the account statements they received from failed broker-dealers." Well, I'm afraid the good Senator is confused about where money comes from. He must think the government can just print some up and give it to these victims without it hurting anyone else. Let's consider the options.

Madoff Net Winners Want More from Net Losers

Today's WSJ is reporting that the 'net winners' in the Madoff scam (i.e. those who withdrew more than they invested) are suing in an effort to collect more money. I find this amazing. First, these people got assets from the net losers already and now they want more. To get more, they will need to take it from someone else: either more from the net losers or from taxpayers. I personally hope they are required to give back through clawbacks any excess that they got above their investment so the losers have more to make them whole. If so, this group would break even which is better than all the others who are net losers. Maybe everyone should end up getting an equal percentage so everyone is an equal net loser. Then, in addition they could recover up to $500k from the government. That sounds fair to me...

In any case, the real losers are taxpayers. They didn't put in anything and have to give up some of their money.

Clawback Lawsuits For Madoff Victims Who Were "Net Winners"

Trying to clean up after a fraud is a messy affair.  Trying to clean up after the world's biggest ponzi scheme collapses is just downright nasty.  The WSJ reports that Madoff trustee Irving Picard is preparing to sue many of the Madoff victims who ended up in the black when all was said and done:

Dodd-Frank and Whistle-blowing to the SEC

I just read an interesting post in the NY Times about how the new Dodd-Frank financial regulations bill will provide an incentive for whistle-blowers to give information about various frauds to the SEC. Apparently, deep in the bowels of the 2,500 page Dodd-Frank bill that overhauls our financial regulatory system is a provision that requires the SEC to award whistle-blowers 10-30% of monetary sanctions collected by the SEC that exceed $1 million.

 The NY Times post also said that while the amount of the award must range from 10-30% of the sanctions, the exact amount awarded is up to the discretion of the SEC. Also, the whistle-blower must meet certain conditions in order to collect under Dodd-Frank.  Here is what the post said about the requirements:

A free lunch without a catch...

I'm a firm believer that there are no free lunches in this world. However, here's one that may be an exception to that rule. The Utah Division of Securities and several other organizations are sponsoring a free conference on how to avoid becoming a victim of fraud. Those who register also get a free lunch!

Topics for the conference include such things as affinity fraud, Ponzi schemes, the psychology of fraud perpetrators and fraud victims, and common markers of fraud. In addition, one of the sessions I'm most interested in is hearing from Carolyn Jessop who escaped with her five children from a polygamous sect. She has written two books documenting her experiences and has been a guest on the Oprah Show and Good Morning America. She will be speaking on "How to say no when everyone around me is saying yes."

The conference is on June 30th from 8:30 am - 4:30 pm. They asked me to be on a panel session from 10-11 am. See you there!

The Madoff trustee has been busy lately...

The WSJ has reported two major lawsuits filed recently by the Madoff trustee. The first was reported yesterday and involves a $7.2 billion claim against Palm Beach, Fla., investor Jeffry Picower. Apparently, Mr. Picower was able to specify the returns he wanted and Bernie gave them to him. The trustee claims that Picower took home profits totaling $7.2 billion! That's not a bad arrangement: I want a 50% return, compounded daily please! Of course, Mr. Picower claims he had no idea Bernie was operating a Ponzi scheme.

Then, today, the WSJ reported that the trustee is suing various Madoff family members for nearly $200 million. While it doesn't sound like a lot any more, this really is an incredible sum of money. Apparently, Bernie paid nearly 75% of these funds to family members in the last six months before the scheme unraveled. Peter and Shana Madoff held the titles of Chief Compliance Officer and Compliance Officer at Madoff's firm. As such, the trustee is saying they were essentially complicit in the fraud because if they would have done their job they would have prevented or detected the scheme.

Some other revelations that are coming out of the trustee's investigation include:

• the trustee believes the total losses by Madoff investors is about $18 billion
• approximately half of the investors took out more money than they put in
• total deposits to Madoff were about $36 billion
• total funds sought by the trustee in lawsuits to this point are $15 billion

This saga will continue for a long time. We do know one winner in it all: the attorneys will undoubtedly come away from it with plenty of money to invest with someone. I wonder who is eying their cash and soliciting their investments...maybe the next huge Ponzi scheme will get their funds!

Fraud and motivated reasoning

Have you ever wondered why some victims of fraud end up believing the fraud perpetrator is innocent long after a loud and clear signal that they have been duped has been revealed?

I observed this behavior in a profound way a few years back when Charis Johnson was accused with strong evidence that her "12 Daily Pro" investment was no more than a Ponzi scheme. Charis was paying 12% interest per day and she had many followers who knew she was a saint because she was paying them this outrageous interest rate which compounds to an absurdly enormous rate of return. I calculated at the time that $1.00 invested in 12 Daily Pro would grow to 9,217 trillion dollars in one short year if interest was compounded daily! That amount was 333,000 times the US federal budget for 2007 when 12 Daily Pro was running strong!

I would think that any reasonable person who had these facts explained to him or her would be outraged at Charis and be thrilled to learn what was necessary to avoid future losses. However, when the Dean of BYU's Marriott School of Management explained that 12 Daily Pro was a scam, he received death threats from investors around the globe. In addition, numerous people ridiculed him for suggesting that this scam could not be based on anything short of a pyramid scheme. Why so?

It turns out that the 12 Daily Pro story above is not unusual. In fact, many people become committed to an idea and then justify the idea both emotionally and cognitively. They end up reasoning in a way that allows them to keep their belief, even when facts suggest otherwise.

A recent article in the NY Times explained how this took place decades ago when two explorers claimed to make it to the North Pole. Both are now believed to be frauds. However, at the time they had many believers who refused to see the facts as they were due to what is known as motivated reasoning. Motivated reasoning can be very costly to victims of fraud schemes. It's likely that many of Bernie Madoff's investors had clear signs that the scam was a fraud, including articles in Barrons and other warning signals. However, they were getting their returns so they found a way to dismiss the warning signals.

It sounds like the Lebanese Madoff studied under Bernie or Charles Ponzi himself when he designed his strategy to scam $1 billion from his fellow countrymen.

Consider a few quotes from a recent NY Times article and you can see the common conditions of successful Ponzi schemes:

First: "He was known as a deeply religious and charitable man, with a gift for winning people’s friendship."

Pyramid schemes often involve "con men" who build confidence by "winning people's friendship" and appearing to be religious. Bernie Madoff also built confidence and many fraudsters appear to be deeply religious.

Next: "But the dollar figures have drawn less attention here than Mr. Ezzedine’s close links with Hezbollah, the militant Shiite movement. Many of the investors — mostly Shiites living in Beirut and southern villages like this one — say those party links were the reason they chose to risk their hard-earned savings with a man who offered 40 and 50 percent profits but never showed any paperwork."

In this quote we see a few more common ingredients including affinity with a group and outrageous returns. Affinity is used since it gives the perpetrator a group of people who trust one another's opinion. Once one person in the group gets excited, the rest follow and seem to turn off any due diligence based on the fact that others in their group are doing it. Bernie's scheme started in among his fellow Jewish friends.

As for the outrageous returns, when will the world learn that "if it seems too good to be true, it is probably a scam!"

A word to Ponzi schemers: Stay away from China!

The WSJ and AP reported that two Chinese individuals were executed for defrauding others in a Ponzi scheme in which they promised 10% returns every month. Now that is some serious punishment!

Apparently not all Madoff victims were victimized equally...

According to a recent article, the trustee in the Madoff case is suing Jeffry M. Picower so as to obtain $5.1 billion that was apparently withdrawn from several accounts from the mid-1990s to 2008. Here is an excerpt:

The trustee says that Mr. Picower made numerous withdrawals from his various Madoff accounts from the mid-1990s to 2008, each time realizing enormous profits that, in several instances, exceeded the returns of other Madoff investors who invested during the same period. Mr. Madoff marketed his investment services as offering consistent annual returns of 10 to 12 percent, but the trustee has identified several people who seemed to have a special deal with Mr. Madoff that ensured them extravagant profits.

Over a dozen times between 1996 and 2007, Mr. Picower’s accounts posted gains of more than 100 percent, the trustee said. One account in 1999 chalked up an annual profit of more than 950 percent. But, Mr. Picower claims the same account records show the account earned a 37.6 percent return in 1999 and none of his accounts ever earned a return of more than 100 percent in any one year.

I'm glad that the trustee seems to be tracking some of the money but I doubt we will ever know where a lot of it ended up..."I'll pay you a 950% return this year but send me 1/2 of it through this Swiss bank account..."