10 Lessons of Madoff’s Ponzi Scheme

Its been two years since the Madoff crime erupted across headlines. The massive theft punctured what little faith investors  had in the markets, investment firms and regulators.

Fraud rarely has a silver lining, but the least we can do is try to learn from other people’s mistakes. There were many many lessons to be learned from the atrocious theft committed by Bernie Madoff. Those who watch the massive scam unravel should take heed, and consider what lessons could be learned.

Here are my 10 takeaways from the scam:

1. Due Diligence: You must understand what that means, and have the ability to perform it competently. If you do not have the tools to perform adequate due diligence, you should not be invested in any hedge funds, VC, or private equity funds PERIOD.

2. Too good to be true?:  By now, everyone should recognize this: Anything that sounds to good to be true probably is. Low risk, high gain outcomes are extremely low probability. Stop buying lottery tickets, and stop chasing last year’s performance.

3. OPM: Ask yourself who profits from this investment, what interests and conflicts are involved. Is there an  incentivize to take wild risks with other people’s money? Are managers assets at risk along side investor money? Recognize what OPM does to the process.

4. Instincts: Don’t be afraid to rely on your Spidey-Sense if you are skeptical about an investment. If something seems amiss, walk away. Someone doesn’t charge fees? Performance is improbably stable for equities? They give you a Wink Wink Nudge Nudge that something is borderline illegal ?  WALK AWAY

5. Know What You Own: Do not invest in anything you do not understand: How does this make money? What makes this unique? What is the basis for this investment? What are the risks? If you cannot answer those questions, you should not be risking your capital.

6. No Outsourcing: Do not outsource your thinking or due diligence. Do not rely on 3rd parties, fund of funds, lawyers, advisors or consultants. We have learned that most are worthless. What is the value add does this fund manager provide? What are they doing, and should I be doing that myself? This is true for consultants, economists, strategists, traders, and managers.

7. You must not keep all of your money with one manager: I was astonished how many people had all their money with Madoff. If the worst happens, this is a recipe for disaster. Diversify your holdings across several professionals in unrelated firms.

And firms that Self-Clear are simply verboten.

8. People:  Which leads to this you must understand the people of any organization, along with its principles and partners. What are their ethical standards, history, and reputations? Do you know them well enough to know their hobbies, foibles, personal vices?

9. What if you suspect you are in a Ponzi scheme? Withdraw your cash. Send an fax and a registered letter. Never reveal to the scammer why, simply insist upon getting your money back — If you must explain, only say “Its for personal reasons.”  Then you must create meticulous records as to what your contributions were, what your net gains were. Set up a second account for any gains — you must assume that they can be clawed back within a certain number of years.

10. Its Your Money: You are on your own — don’t expect help from the SEC or the media or anyone else. Its your cash and your retirement. You best act that way. I am not seeking to exonerate the many failures of 3rd parties — rather, I am emphasizing that it is your responsibility.

That’s my list; feel free to make your own suggestions . . . .