ponzi scheme

Made Off Theft (Madoff)

by Thomas Mullooly on December 19, 2008

The federal, state and local governments are co–losers with Madoff investors.

Lots of questions are starting to surface regarding Bernard Madoff, and the scam that he’s been running — apparently, for years.

I’m starting to read questions like “not charging an advisory fee, only working for the commissions…isn’t that a conflict of interest?” Of course it is — and no investment advisor would ever (or should ever) work under terms like that.

Another question that’s being asked is “when did this actually stop being an investment program and start becoming a Ponzi scheme?” Until all the details are in, I think people need to assume this has been a Ponzi scheme…all along… from the very beginning.

One more question being asked (which I addressed earlier) is “how can one person run a scheme like this — on this magnitude, and for this length of time — without anyone else being involved, or aware of it?” Of course. We should all be skeptical.

Another red flag (and how could so many smart people miss this one?): how was it that no dividends were ever reported? Sometimes you wind up holding a stock through the dividend — by accident! And not one dividend was reported…ever?

The topic I raised on several blog posts elsewhere, took a different slant from the “shock and surprise” many commenters posted. My point was this: it’s probably a safe assumption that people paid ordinary income and capital gains on fictitious transactions — in many cases, for years. We’re talking about a tremendous amount of taxes being recouped by investors who can file amended returns.

Taking that concept one step further: let’s assume that everything was fictitious — the statements, the trades, the returns — everything. What we’re really looking at is not losses, but… theft.

I’ve heard that theft losses can be written off entirely against your income. I’m not an accountant, and don’t give tax advice. Let’s put this in perspective: if you lose money in the stock market, you “net” your gains and losses and can take a maximum of $3000 capital loss each year. The remainder gets carried forward into the future, until it is completely used up.

However, if you lost $1 million, due to theft, you can write off the entire $1 million as a loss against your income. And if that wipes out your entire net income for the current year, you can go back the last three years and amend those tax returns — and then carry the remainder forward — until is used up.

Will investors be made whole? No. No chance.

Under this scenario, the federal, state and local governments are the co–losers with Madoff investors. And who will make up the deficit caused by this?

You got it.

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Bernard Madoff: Made off with the money

by Thomas Mullooly on December 13, 2008

Former NASDAQ chairman Bernard Madoff disclosed this week that the investment advisory firm he has run (aside from his market making business) was, in fact a fraud. It’s unknown exactly how much money has been lost, but it appears to be somewhere between $17 billion and $50 billion.

By comparison, think about the money being considered for bailing out the auto makers: $14 billion.

Part of the reason why the entire scam was uncovered was because Madoff posted returns that were quite different from everyone else.

For many years, Madoff reported gains in the vicinity of 1% per month. In hot markets, sometimes 2% per month. He rarely (if ever) showed losses. These numbers (in many years) were “good enough” to attract very wealthy investors. They weren’t the highest returns, they were not the lowest returns either. Madoff stated that he managed $17 billion in assets, with somewhere between 11 and 25 clients. These are some very wealthy clients.

One of the clients happens to be Sterling Equities — a partnership between Saul Katz and Fred Wilpon, who own the New York Mets, along with commercial real estate in the greater NYC area.

Two related events exposed Madoff:

First, the general nervousness regarding the stock market in recent weeks led to requests from his clients for redemptions (they wanted their money back). A Ponzi scheme tends to fall apart when more than a few people want their money back at the same time. Madoff received requests to return $7 billion in capital, money which he just didn’t have.

The second event was his own doing: he posted nearly flat returns during recent months, while claiming to be invested in large cap stocks. By comparison, his peers posted returns in October of -16%.

Something just didn’t add up. As more and more questions were being asked, it became increasingly clear that something was awry.

As the owner of an investment advisory business, I believe it’s important to have a “see-through” business: Mullooly Asset Management does not maintain custody of our clients assets. Our clients assets are always sitting in an account in your name at a discount brokerage firm — or in your own retirement plan at work. And regular statements are issued only from the brokerage firm or the retirement plan — not from our firm.

If an investment adviser has custody of the assets (which is what Madoff was doing), it’s really hard to tell where the assets actually are, and how the money is invested. All you have to rely on are the periodic statements from the advisor. That’s an enormous amount of trust to place in a single person or firm. And that is a liability I’d just rather not get involved in — from my perspective, it’s not worth it.

If you’re not familiar with a Ponzi scheme, here’s how it works: you raise money from an initial group of investors, promising to invest the money for them. You continue to raise money from new investors. When one of the original investors wants their money back, you take the money from the newest investor and simply “pay back” the original investor…with the newest investor’s money.

The original investor sings your praises — after all, you “invested” his money, grew the money, and then returned the money as promised to the original investor.

Going forward, the word begins to spread about your success. And, as new investors line up, old investors are paid back and the cycle continues. Eventually, the cycle ends (typically when too many investors want their money back all at once) and the whole scam is uncovered. Everyone left in the scam (at the end), winds up losing everything.

You can click here to read an interview from 2001 with this fraud.