Money Rehab with Nicole Lapin - #TBT: How Did Bernie Madoff Scam Thousands of People out of Billions?

Episode Date: January 4, 2022

On Nicole’s second #TBT episode, she unpacks the Bernie Madoff scandal and answers questions like: how did Bernie Madoff pull off the biggest Ponzi Scheme on record? And how can we protect ourselves from the next big scam? As promised, here are: Investment Adviser Public Disclosure: https://adviserinfo.sec.gov/  Financial Industry Regulatory Authority’s(FINRA’s) BrokerCheck database: https://brokercheck.finra.org/

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Well, it doesn't. Charge for wasting our time. I will take a check. Like an old school check. You recognize her from anchoring on CNN, CNBC, and Bloomberg. The only financial expert you don't need a dictionary to understand. Nicole Lappin. Today we have our second Hashtag TBT episode.

Our first was an episode on the 2008 subprime mortgage crisis that we aired a few weeks ago. As I mentioned in that episode, one of the goals of this show is to break down the headlines. And yes, we do unpack headlines that are in the current news cycle, but I also think it's really important to dissect the hot-button topics from our past, especially when those hot-button topics are historical moments that financially crushed innocent people like you and me. It is true that the only way to protect yourself from repeating history is to understand it so that you can make different choices in the future. So today we're going to be focusing on Bernie Madoff. His story is worth knowing because

it's the biggest investing horror story in history. And because I'm encouraging you to do more investing, I want to make sure you do it the right way with your wits about you. As you probably know, Madoff is responsible for running the largest Ponzi scheme in history, with an estimated $65 billion worth of fraud. That is a massive number. For context, there are 118 countries who calculate a national gross domestic product of less than $65 billion. The obvious question is, how the hell did this guy pull it off? Madoff operated a hugely popular and famous investment company, Madoff Investment Securities, LLC, that owned and operated investment funds. Madoff told his clients that he was investing their money. But the shocking truth is that no securities were bought or sold. It was a textbook Ponzi scheme.

When his clients wanted to take their returns out of their accounts, Madoff and his team would give the clients money. And the clients thought the money was profit from their investments, but it was not. The money that Madoff gave clients was just cash that newer clients had put into the fund to be invested. In other words, clients were getting paid only in money that came from newer clients' contributions to the fund. Again, textbook Ponzi scheme. In the Madoff mess, there was one man, Harry Markopoulos, who was the main whistleblower. He submitted a research brief to the SEC where he outlined 29 red flags he had identified with Madoff's company. In the brief, he said that he was

worried that sharing his research would put the safety of himself and his family at risk, but that alerting the SEC was, quote, the right thing to do. One of the biggest red flags was that the ROIs Madoff was reporting were straight up impossible. For example, Madoff would say things like he was investing in one particular industry and that he got large returns. But Markopoulos crunched the numbers and found that the industry Madoff had claimed to invest in hadn't actually yielded strong returns. It just didn't add up. Another red flag Markopoulos raised was that there was a lot of secrecy around how Madoff was investing. Markopoulos made the connection that Madoff was touting a track record that would make him a better stock picker than the MVP

himself, Warren Buffett. Markopoulos was suspicious of the fact that Madoff was extremely tight-lipped about who exactly was making the investments for clients and what the strategy was. Markopoulos thought if Madoff really is better than Buffett, wouldn't he want the credit? When the SEC finally got around to investigating and Madoff was arrested, it was then Madoff, not Markopoulos, who feared for his life. In fact, Madoff wore a bulletproof vest to court. For his actions, Madoff was sentenced to 150 years in prison and was ordered to forfeit $171 billion, including all of his personal property and assets like real estate, investments, and boats. Getting into Madoff's psychology is complicated, to say the least. It's hard to

understand why he would orchestrate this fraud because, frankly, it doesn't seem that Madoff needed to fool anyone. By all accounts, Madoff was a very smart, successful, and well-respected investor. He accomplished many legitimate, important contributions to the investing world. He was one of the first people to create a computerized program for investing. He was an early developer in NASDAQ and later even became the chairman of NASDAQ. In my mind, it seems that Madoff had all the tools and capability to run a successful, legitimate fund. And yet, he turned into a complete fraud. But why? Was it all motivated by greed? We'll never really know for sure. Madoff passed away in jail just last year. Throughout the course

of his investigation, more than 15,400 claims against Madoff were filed. When reporters talk about how much money investors lost to Madoff, the figure $65 billion gets brought up a lot. While it's not not true, it's a bit misleading. Madoff did not take $65 billion from clients. Investors gave Madoff a total of $17.5 billion of their own funds. But by the time Madoff was arrested, Madoff was telling clients that their accounts were part of a $65 billion fund, which, as we now know, was all smoke and mirrors. Since Madoff pled guilty in 2009, of the estimated $17.5 billion that investors gave to Madoff, $14 billion has been returned. Although the distinction between the amount of money investors gave and the amount of money they thought they'd earn is an important one. Make no mistake, just because the $65 billion wasn't given directly from

investors' pockets doesn't make the loss any less real. Clients thought they had this stellar nest egg growing and likely made decisions based around how much money they thought they were earning. I mean, if you thought you had access to a million dollars that you could withdraw any time, wouldn't you be living your life differently than if you, well, didn't? Again, the people who got scammed by Madoff only got back what they invested, not what Madoff told them they had earned. If they had adjusted their spending plan, as big as that may be for these folks, to align with the money they thought they had made from Madoff, they were SOL. Madoff did invest for celebrities like Steven Spielberg and Kevin Bacon, but he also invested for people who

did not have money to lose. People who were investing their life savings, people who were investing so that they could provide for sick family members. Madoff did ultimately plead guilty and apologized publicly for his crimes. During Madoff's trial, CNBC reported that Madoff said, quote, I cannot offer an excuse for my behavior. How do you excuse deceiving investors and 200 employees? How do you excuse lying to my sons and two brothers? How do you excuse lying to a wife who stood by me for 50 years and still stands by me? There is no excuse for that. I made a terrible mistake. End quote. So what's keeping history from repeating itself? Well, new legislation followed the Madoff scandal with the goal of protecting investors. But hedge funds

are still largely unregulated. That leaves a lot of responsibility with investors to vet hedge funds thoroughly before investing. As you can tell from this story, vetting hedge funds is not an easy task. On paper, Madoff seemed like he was very trustworthy. He had been in the finance industry for a super long time. He was a fiduciary, for crying out loud. He had the responsibility to act in the best interest of his clients on paper. And yet, he didn't. So how can we protect ourselves from con artists? Not every scammer will tip us off with the name as on the nose as made off. Markopoulos is certainly the hero of this story, but my god, did he have a lot of time on his hands. We probably don't have the bandwidth to crunch the numbers

for each hedge fund in the same way that Markopoulos did during the Madoff scandal. But there are a few red flags that you should be able to pick up on with an investment fund without needing to get too deep into your calculator. Number one, secrecy is a bad sign. Madoff kept his investment strategy close to the vest because there was no investment strategy or investments at all. If you're looking into a hedge fund, the more questions you can ask about the way it works, the better. Number two, if it's too good to be true, it probably is. While I don't think that you need to check the math on every earnings report for your

investments, you should keep a watchful eye for any patterns that just don't add up. Remember, Markopoulos was very suspicious of the fact that Madoff was showing gains in investments within industries that weren't performing particularly well. This can be a tricky element to fact check because the whole edge of hedge funds is that they claim they can beat the market. However, there's a big difference between outperforming the market and outperforming an industry. If a hedge fund shows gains when the market is down, that's not necessarily a red flag. In fact, that could be a sign of an effective hedge fund. But if a hedge fund tells you that they're investing in commodities and you've read that commodities are plummeting,

but your brokerage account keeps going up and up, well, there's something fishy there. This brings me to my last red flag. Number three, don't automatically trust whoever is telling you what you want to hear. And yet, that's exactly the kind of people we want to get involved with. The issue is if someone's telling you good news, you are less likely to question it, right? If you meet with a hedge fund manager and they tell you they beat the market 100% of the time, you may think, sweet, how do I give you my money? But you should be extremely skeptical of someone who promises you the moon. No one, and I mean no one, beats the market 100% of the time. The market is influenced

by too many unpredictable factors for anyone to get it right 24-7, 365. A good hedge fund manager will present you a clear plan for riding out market dips unscathed. For today's tip, you can take straight to the bank. Here are some questions you should ask any hedge fund manager. How will I be getting my investment back and when? How will my money be invested? Who is making the investments in the fund and how are they qualified? Does your fund have any disciplinary history?

how are they qualified? Does your fund have any disciplinary history? The last three questions should be easily answerable by looking up the fund's information in the SEC Investment Advisor Public Disclosure, IAPD, database, or the Financial Industry Regulatory Authority's, FINRA's, broker check database. I know that's a mouthful. I have linked both of those sites in the show notes so that you can always double check the work of so called investment experts who tell you they know better. Because fuck them. Remember, no one knows what's better for your financial life than you do. what's better for your financial life than you do. Money Rehab is a production of iHeartRadio. I'm your host, Nicole Lappin. Our producers are Morgan Lavoie and Mike Coscarelli. Executive producers are Nikki Etor and Will Pearson. Our mascots are Penny and Mimsy. Huge thanks to OG

Money Rehab team Michelle Lanz for her development work, Catherine Law for her production and writing magic, and Brandon Dickert for his editing, engineering, and sound design. And as always, thanks to you for finally investing in yourself so that you can get it together and get it all.