The multibillion-dollar Madoff mess proves one thing: Even the most sophisticated of investors are susceptible to fraud. It also proves that relying on highly paid financial advisers or the Securities and Exchange Commission won't protect you from getting ripped off.
Madoff's alleged $50 billion Ponzi scheme had the appearance of being a legitimate operation. Until recently, Madoff was paying dividends, sending out monthly statements and fulfilling withdrawal requests. It wasn't until early December when he admitted to having requests from clients for approximately $7 billion in redemptions that the Ponzi scheme started to collapse. Madoff simply didn't have the funds to meet those obligations. The jig was up.
In the case of Madoff, investors turned a blind eye to due diligence
that could have been done. "Sometimes the bigger someone is, the less
vetting people do," says fraud expert S. Gregory Hays, managing
principal, Hays Financial Consulting. "Investors sometimes assume that
someone else did their homework." And in the case of Madoff's scheme,
the multitude of seemingly sophisticated investors and accomplished
business people--from Mortimer Zuckerman to HSBC
For most investors the best way to keep a Ponzi out of your portfolio is to follow the common sense rule of "if something sounds too good to be true, it probably is." It also is best to ask lots of questions and beware of any potential investment or adviser that is overly secretive in terms of explaining investment strategy.
In Pictures: 10 Fraud Red Flags
In the case of Madoff, it was difficult to rely on publicly available information to discover that a fraud might have been taking place, since little was available. "There were no lawsuits or claims that he was defrauding people," says Kenneth S. Springer, former special agent of the Federal Bureau of Investigation who is now a certified fraud examiner and president and founder of New York-based Corporate Resolutions.
The one red flag that might have raised suspicions was the fact that Madoff used a tiny accounting firm in New City, N.Y., Friehling &
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Of course the best way to discover a sophisticated scheme would be to hire someone to do on-site financial due diligence. Sometimes, large, institutional investors are even allowed to do surprise audits. "You would want to look at the trading and see what kind of transparency was there to see where the money was really being invested, too," says Springer. "Had people done that, many wouldn't have been satisfied with what they would have found out, and they would have walked away." Investors could have also hired an investigator to examine and interview the prime broker and administrators, he adds.
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