Ponzi Schemes, Bernie Madoff and How to make sure it won't happen to you.

Bernie Madoff was one of the most notorious investment fraudsters in history. He ran a massive Ponzi scheme that lasted for decades and resulted in billions of dollars in losses for thousands of investors. In this article, we will explore how Madoff was able to carry out his scheme and how investors can protect themselves from similar scams.

First, it is essential to understand how Madoff’s scheme worked. A Ponzi scheme is a type of investment fraud that relies on new investors’ money to pay returns to earlier investors. The scheme typically promises high returns with little or no risk, which can attract a large number of investors. The fraudster uses the money from new investors to pay returns to earlier investors, creating the illusion of a successful investment. In reality, there is no legitimate investment, and the scheme eventually collapses when there are no new investors to provide funds to pay returns.

Madoff’s scheme was one of the largest Ponzi schemes in history, lasting for over 20 years and resulting in an estimated $65 billion in losses. Madoff ran his scheme through his investment firm, Bernard L. Madoff Investment Securities LLC, which he founded in 1960. The firm initially operated as a legitimate market-making business, which involves buying and selling securities to provide liquidity to the market.

However, in the 1980s, Madoff began using the firm to carry out his Ponzi scheme. He convinced investors to invest in a “split-strike conversion” strategy, which he claimed involved buying stocks and selling call options to generate steady returns with little risk. In reality, there was no legitimate investment strategy, and Madoff simply used new investor funds to pay returns to earlier investors.

To make the scheme appear legitimate, Madoff created false account statements and tax documents that showed steady returns. He also used his reputation and connections in the financial industry to attract new investors, including wealthy individuals, charities, and hedge funds. Many of these investors were referred to Madoff by friends or family members who had already invested with him.

Madoff’s scheme began to unravel in 2008 during the global financial crisis, when investors began to withdraw their funds en masse. Madoff was unable to pay the requested withdrawals, and the scheme collapsed. In 2009, Madoff was sentenced to 150 years in prison for his crimes.

So how can investors protect themselves from similar investment scams? The first step is to be skeptical of any investment opportunity that promises high returns with little or no risk. This is a classic red flag of a Ponzi scheme or other investment fraud. Legitimate investments always carry some level of risk, and investors should carefully consider the risks before investing.

Investors should also do their due diligence before investing in any opportunity. This includes researching the investment, the investment firm, and the individuals promoting the investment. Investors should ask for detailed information about the investment strategy, including the risks and the historical performance. They should also research the investment firm and its track record, including any disciplinary actions or legal issues.

Investors should be wary of any investment opportunity that is not registered with the Securities and Exchange Commission (SEC). The SEC regulates most investment opportunities, and unregistered investments are often a sign of fraud. Investors can check the SEC’s website to see if an investment is registered and to review any filings or disclosures.

Another way to protect against investment scams is to work with a trusted financial advisor. A reputable advisor can provide guidance on investment opportunities and help investors avoid scams. However, it is important to research any advisor before working with them, including checking their credentials and background.

One of the checklists I have developed that will prevent you from falling victim to most investment schemes is as follows:

1. Who is the custodian of the assets? Who has the actual money? In the case of Madoff, he acted as the custodian.  Never invest with someone unless you know who has custody and are comfortable with the custodian.  In the case of Alpha Wealth Funds, we don’t custody any assets and use well known and reputable custodians.
2. Who is creating the statements you receive? Again in the case of Madoff he was generating statements.  We use a 3rd party independent fund administrator who generates the statements and sends them directly to you.
3. Who is the auditor. We use a PCOAB member accounting that is held to the highest standards  to do all of our independent audits.  Madoff was using an unrecognized firm down the street to audit one of the largest hedge funds in the world.
4. Check results over multiple time periods and market cycles. Anyone can get lucky once in a while, including us.  This one would not have helped you though as Madoff faked the statements and return.
5. Last but not least, you should understand the investment strategy.  That doesn’t mean you need to implement it yourself, but if you were smart enough to earn and save your fortune, you’re smart enough to determine if your manager’s strategy makes sense.

Please feel free to reach out for help with any of your investment, insurance, or financial planning needs.  Harvey Sax hsax@alphawealthfunds.com