The richest con

The Baltimore Sun

How might investment adviser Bernard L. Madoff have stolen $50 billion over more than two decades without being caught?

Mr. Madoff confessed last week to running what may be the largest Ponzi fraud ever. It's a con that attracts gullible investors by offering high returns. Early investors are paid off with income provided from later investors, building an investment bubble that eventually bursts when the con man departs with a large sum of money. The scale and long success of the Madoff scheme have raised fundamental questions about the quality of the nation's securities regulatory system and offers yet another reminder of the dangers of greed.

For all his conniving, Mr. Madoff appeared to be a class act. He gave generously to charities, belonged to all of the right clubs and refused to take potential clients' money unless they agreed to invest large amounts and asked no questions about how it was invested. His was an exclusive club. Finally, and most importantly, he claimed to produce a steady 10 percent return on the fortunes he managed, in good times and bad.

The victims, some of whom appear to have been impoverished by the Madoff firm's failure, must be asking themselves how they could have been so easily duped. The remarkable consistency of his returns over the years, his apparently fly-by-night auditing firm, and his limited reported trading - despite having so much money under management - should have raised all kinds of alarms for prudent investors.

Still, they might be excused for trusting Mr. Madoff: His business appeared to have been subject to due diligence by many of the most experienced professionals in the global markets, while the alleged criminal activity continued unfettered and undetected. Even the private due-diligence firms and public regulators failed to effectively scrutinize his dealings. Perhaps they were too beguiled by Mr. Madoff for the public's good.

That disturbing thought prompted President-elect Barack Obama and congressional leaders this week to promise serious reforms to a regulatory system that left Mr. Madoff to commit his sins. Reports said the Securities and Exchange Commission had been tipped as early as 1999 that Mr. Madoff, a former Nasdaq chairman, was running his private investment operation as a Ponzi scheme. The SEC sent examiners to the firm twice, including an enforcement team last year, but came up with nothing.

The SEC's failure to unearth the apparent Madoff fraud despite repeated credible tips illustrates a frightening collapse of the agency's regulatory capability. SEC Chairman Christopher Cox acknowledged that other huge frauds may still be operating freely, and he promised an internal investigation of his agency. Regulators have clearly been challenged by the extraordinary growth in the size and number of investment hedge funds that have largely avoided scrutiny, the increasingly swift flow of capital around the globe and introduction of complex investment instruments.

Apart from the regulatory challenge, the most important lesson from Mr. Madoff's con is about men, not markets. Human nature doesn't change, and crooks will always be with us.

For investors, other lessons are the eternal ones of diversification and diligence. Don't trust your life savings with any single money manager or investment. Don't assume that passing some new federal law will banish financial fraud, any more than "campaign finance reform" will stop the likes of Illinois Gov. Rod Blagojevich from trading political favors for political contributions.

As Shakespeare reminds us, the fault is not in our stars, but in ourselves.

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