How Crypto is Using the Behavioral Dynamics of Bernie Madoff’s Fraud

Photograph Source: Ivan Radic – CC BY 2.0

On June 18, 1991 I was having lunch with two of my new investment clients on the outdoor patio of their private country club on Long Island. As their friends stopped by the table, the married couple introduced me as their investment advisor and recommended me to their friends. One friend said to my astonishment: “Can you guarantee me the same 13 percent annual return as Bernie Madoff?”

If one is a reputable, licensed broker, guaranteeing a 13 percent return – or any guaranteed return on a stock portfolio – is a flagrant violation of the rules of the investment industry. It can also strip you of your license, your career, and get you perp walked.

Stock investing is a volatile endeavor. Stocks can go into a bear market and deliver a negative return for years. That is why it is illegal to guarantee to an investor any specific return on a stock portfolio.

I had been reading the Wall Street Journal for years at that point and the name Bernie Madoff did not ring a bell. I asked my clients if they knew this Bernie Madoff. My clients stunned me further by telling me that Madoff had been making good on his promise of a 13 percent return since 1978 – not to just my clients but to numerous other members of this country club.

My cognitive processes sized up the situation like this: if this man is willing to brazenly break the law by guaranteeing stock returns, if he has delivered 13 percent returns steadily for more than a decade – including during years in which the S&P 500 had a negative return — then it is highly likely he is running a Ponzi scheme.

I shared my concerns with my clients and asked to see their account statements. A few days later the husband brought multiple years of these statements to my office. The statements showed negative returns in some years and nothing resembling a consistent 13 percent annual return. I provided my analysis to my client and asked him if I might call Madoff, if I didn’t give Madoff the client’s name. He said I could.

Madoff immediately took my call and was highly indignant at my suggestion that he was running a scam. I was working at the time for a large, old investment firm and I thought it might frighten him to know that I had his statements and was about to turn them over to the sleuths in our compliance department. I don’t know what action the compliance department took.

In late 1995 I left the old investment firm and joined an even older investment firm, one whose founder had been Assistant Treasury Secretary under Abraham Lincoln. Years after joining the new firm I noticed that new order tickets had been printed and the name “Madoff Securities” had been added to the venues that a broker could route his stock orders, alongside the New York Stock Exchange.

I ran to my manager’s office and breathlessly spilled out the story of what had occurred at the country club luncheon. I then decided to call a member of the Executive Committee of the Board of Directors, who was well respected and had an attentive ear. This gentleman, who was located in St. Louis, informed me that he would look into the matter but that he had never heard about Bernie Madoff managing money for investors. He believed his only business was a trading firm called Madoff Securities.

It was not until December 2008 – at the height of the financial crash when everyone was pulling money out of stocks and putting it in safe havens – that Madoff’s Ponzi scheme collapsed. Madoff confessed his Ponzi scheme to his two adult sons who turned him into authorities. Madoff died in federal prison on April 14 of last year at age 82. He was serving a 150-year prison sentence.

I was not the only person to have had suspicions about Madoff and requested investigations. On November 7, 2005, Harry Markopolos sent a 21-page document to the Securities and Exchange Commission (SEC).  The letter followed a five-year effort by Markopolos to get the SEC to open an investigation of Madoff.

Here’s how the SEC characterized the letter from Markopolos in a January 4, 2006 memo: “The staff received a complaint alleging that Bernard L. Madoff Investment Securities LLC, a registered broker-dealer in New York (“BLM”), operates an undisclosed multi-billion dollar investment advisory business, and that BLM operates this business as a Ponzi scheme. The complaint did not contain specific facts about the alleged Ponzi scheme…”

In reality, the Markopolos letter was intensely fact-filled, stating in part:

“I am a derivatives expert and have traded or assisted in the trading of several billion $US in options strategies for hedge funds and institutional clients…(Highly Likely) Madoff Securities is the world’s largest Ponzi Scheme…The [Madoff] family runs what is effectively the world’s largest hedge fund with estimated assets under management of at least $20 billion to perhaps $50 billion…The third parties organize the hedge funds and obtain investors but 100% of the money raised is actually managed by Madoff Investment Securities, LLC in a purported hedge fund strategy. The investors that pony up the money don’t know that BM [Bernie Madoff] is managing their money…Some prominent US based hedge fund, fund of funds, that “invest” in BM in this manner include: A. Fairfield Sentry Limited (Arden Asset Management) which had $5.2 billion invested in BM as of May 2005…Access International Advisors…which had $450 million invested with BM as of mid-2002…Tremont Capital Management, Inc…Tremont oversees on an advisory and fully discretionary basis over $10.5 billion in assets.

“Clients include institutional investors, public and private pension plans, ERISA plans, university endowments, foundations, and financial institutions, as well as high net worth individuals…Madoff does not allow outside performance audits. One London based hedge fund, fund of funds, representing Arab money, asked to send in a team of Big 4 accountants to conduct a performance audit during their planned due diligence. They were told ‘No, only Madoff’s brother-in-law who owns his own accounting firm is allowed to audit performance’…Only Madoff family members are privy to the investment strategy. Name one other prominent multi-billion dollar hedge fund that doesn’t have outside, non-family professionals involved in the investment process. You can’t because there aren’t any…There are too many red flags to ignore. REFCO, Wood River, the Manhattan Fund, Princeton Economics, and other hedge fund blow ups all had a lot fewer red flags than Madoff and look what happened at those places…”

An SEC memo of November 21, 2007 revealed the following about its investigation:

“The staff found no evidence of fraud…All files have been prepared for closing…Termination letters have been sent to Bernard L. Madoff Investment Securities LLC, Bernard L. Madoff, and Fairfield Greenwich Group. The staff has no objection to the eventual destruction of the files and has no knowledge of any impediment to such a disposition.”

This was not the first time that the SEC had let Madoff slip through its grasp. In 1992, the SEC settled an investigation against two Florida accountants, Frank Avellino and Michael Bienes. The pair had started raising money for Bernie Madoff to manage in 1962. Avellino and Bienes had sold over $440 million in unregistered notes to thousands of people. Madoff was not charged in the matter.

Representing Avellino and Bienes in that matter was attorney Ira Lee Sorkin, the former head of the SEC region in New York City. Sorkin also represented Bernie Madoff when he was finally charged in 2008. Put in charge as trustee of the Avellino and Bienes funds and records was Lee Richards. In 2009, the SEC again put Mr. Richards in place as a receiver and document custodian in the Madoff Ponzi scheme, overseeing the London black hole operation known as Madoff Securities International Ltd.

When the news broke all over TV in December 2008 about Madoff’s Ponzi scheme, the SEC was making it sound like the fraud had only been in operation for a brief number of years. I knew that to be a lie. Although I had retired from Wall Street at that point, I still had my old desk calendars. I dug them out, located the exact date of my luncheon in 1991 at the Long Island country club, and called Susan Antilla, a reporter at the time for Bloomberg News. Antilla made it clear in her syndicated reporting about my experience at the country club that the fraud was decades old. The SEC thereafter changed its story line.

Madoff and crypto share an extensive number of behavioral dynamics. Madoff had prominent clients of swank country clubs vouching for him. Madoff also had celebrity clients, including famous Hollywood Director, Steven Spielberg, actor Kevin Bacon, and former New York Mets owner Fred Wilpon.

Crypto’s celebrity endorsers have included Matt Damon, Spike Lee, Tom Brady, Alec Baldwin, and numerous others. (Check out the scrolling celebrity names at the FTX crypto exchange under the banner: “Join some of the world’s biggest names who trust FTX.”)

Madoff and crypto also exploited the behavior instinct known as FOMO – or “fear of missing out.” Otherwise rational individuals at the Long Island country club were being told by prominent friends they trusted that Madoff had been delivering 13 percent returns reliably year after year for more than a decade. They didn’t want to miss out. The seduction of a promise of outsized returns has a long history of trumping common sense. We have been comparing crypto to the Tulip Bubble since 2014.

Both Madoff and crypto also enjoyed the benefits of an inexplicable hands-off policy from the Securities and Exchange Commission. The SEC has been missing in action as millions of investors have been seduced to invest in crypto and thousands of others have been looted.

It is this final aspect, a watchdog that repeatedly fails its mandate to protect investors, that requires a long overdue criminal investigation.

This first appeared on Wall Street on Parade.

Pam Martens has been a contributing writer at CounterPunch since 2006. Martens writes regularly on finance at www.WallStreetOnParade.com.

[class^="wpforms-"]
[class^="wpforms-"]