Blame It On The Gains

Blame It On The Gains
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In 2014, the Oprah Winfrey Channel (OWN) aired a “Where are they now” interview revisiting one of the biggest frauds in American history.

At the time, it was one the greatest scandals the public had ever watch unfold. It shook the country, and even the world, to its core. The parties involved were all widely respected in the industry, but when the truth was revealed their reputations were destroyed. Hundreds of millions, or more  were initially deemed lost, and the number of individuals impacted was massive.

Like many frauds, there had been those skeptics asking questions long before the scandal broke, questioning certain inconsistencies that could not be properly explained. Once the fraud was revealed the entire framework came crashing down.

In the aftermath, at least 27 different lawsuits were filed under U.S. consumer protection laws. Including a class action suit on behalf of 1,000 impacted Ohio residents looking to find a way to have their funds recovered.

Although this may sound like the infamous Bernie Madoff scandal, its not. Ironically, all of these details relate to another more mainstream fraud, the 1990 Milli Vanilli lip-syncing scandal.

Milli Vanilli was the brainchild of Rob Frank Fabrian, who after recording an album with a group of vocalists, hired two unknown dancers, Fabrice Morvan and Rob Pilatus. They became the face of the group, and assumed Milli Vanilli’s identity. They were a global sensation and their album generated three number one hits, a Grammy for best new artist, and over $50 million in gross sales. When the truth came out that they never actually sang on the album, many demanded their money back for misrepresentation.

THE SCANDAL

The Bernie Madoff scandal is also a story about misrepresentation, but the financial scale was much larger. The total sum of $65 billion, of which he personally stole $20 billion. The largest Ponzi scheme ever witnessed.  

HOW DID HE GAIN SO MUCH, SO FAST?

Bernie Madoff was a respected member of the investment industry, a builder of the NASDAQ stock exchange and owner of one of the top performing portfolio managers in the industry. What made Bernie Madoff’s strategy so unique and in demand, was that he was able to consistently deliver high non-volatile performance over long time periods.

Madoff made people feel like there were part of an exclusive club allowed to invest with him. There were thousands of victims that included well-respected banks, hedge fund managers, institutional investors in the U.S., and overseas. The list reached athletes, politicians, and celebrities like Kevin Bacon, Kyra Sedgwick, John Malkovich, Steven Spielberg, and Larry King.

WHAT DID HE PROMISE?

Bernie Madoff promised returns too good to pass up. He seemed to consistently deliver above average performance, no matter how the markets were doing. One of his funds appeared to deliver 10.5% consistently for 17 years, through both bull and bear markets.

HOW DID HE DO IT?

Madoff considered his trading strategy proprietary information and never provided further details on it. “The strategy is the strategy, and the returns are the returns” and claimed to use no leverage and had no debt. Even as markets sold off and crashed, he seemed to be able to continue to deliver what people wanted however. Some considered him an outright genius, although just like Milli Vanilli, competitors and some experts were skeptical.

NO, BUT HOW DID HE REALLY DO IT?

What Bernie Madoff was actually running was a Ponzi scheme.

The scheme works by using the money from new investors to pay the promised returns of the earlier investors. No gains are actually made, but the whole success of the scheme is dependent on continually bringing in new money. Otherwise it crashes to the ground.

Madoff kept it going for years. Even through all of the growing doubts, he continued to deliver positive returns, regardless of how the markets were doing. This helped reassure investors that everything was just fine.  At the same time, it made him very rich, making him a reported $250,000 a day. But of course it didn’t last forever. 

HOW DO YOU KNOW IT’S TRUE, AND AVOID THE SAME MISTAKE?

Part of the reason Bernie Madoff was not caught sooner was that even with all the evidence, no one wanted to bring themselves to believe it was a fraud. Everyone investing assumed their friends, the banks, and all the other experts had properly vetted Madoff.

Eventually all the experts asked in hindsight, how could this have happened? The problem is that in general, investors are eternal optimists.

5 TIPS TO PROTECT YOURSELF

  1. If you hear something that sounds too good to be true, it probably is.
  2. Work with people you trust and have a good relationship with.
  3. Don’t invest without doing some of your own research.
  4. Don’t invest in anything you don’t understand.
  5. It is not realistic to generate consistent returns of 10% to 12% in all market conditions. Don’t forget these numbers.

WHERE ARE THEY NOW?

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