1. Presented to the Risk Management Association, Arizona Chapter
Ponzi Schemes and Investment Fraud How they impact the financial services industry and What investors can do to avoid the con
Presented to the Risk Management Association, Arizona Chapter
October 8, 2009 By
Mike McCann, CFP®, AIF®

2. Bernard Madoff: Con Man Extraordinaire
Bernie Madoff was arrested in December 2008 for investment fraud. He had masterminded a Ponzi scheme that spanned more than two decades and defrauded thousands of investors of an estimated $64 billion.
He pleaded guilty in March 2009 and in June was sentenced to 150 years in prison.
U.S. Department of
Justice photograph, 2008

3. What is a Ponzi scheme?
“The Ponzi scheme is a house-of-cards swindle in which high returns are paid to initial investors out of the funds of later investors. While some initial payments are made to drum up new recruits, the vast majority of investors in a Ponzi scheme end up losing all or most of their money.”
(source: North American Securities
Administrators Association (NASAA)

4. Ponzi Schemes
The con dates back to about 1920 and is named after Charles Ponzi, who developed a scheme to profit on the varying currency exchange rates for International Postal Reply Coupons redeemed for stamps.
The often bewildering variety of investment opportunities available today has created a virtual renaissance of the Ponzi scheme in recent decades.
These schemes often prey on a specific demographic (also known as affinity fraud), such as seniors or a particular religion or ethnic group.

5. The “last guy” you’d expect to cheat you…
What makes the Madoff scam so fascinating (apart from the sheer size and magnitude of the amount he swindled) is that he was the last person one would expect to cheat investors. Madoff had a long, illustrious career as an investment advisor.

6. Who is Bernie Madoff?
Madoff founded the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960.
He actively pursued a presence in the regulatory side of the industry. In the mid-1980s, he was elected to the NASD advisory council and served on several committees and task forces. He also served as non-executive chairman of Nasdaq in the 1990s.
He was a prominent philanthropist who served on boards of nonprofit institutions, many of which entrusted his firm with their endowments.
Madoff is Jewish and his Ponzi scheme preyed heavily on Jews, destroying the fortunes of numerous Jewish charities and institutions.

7. Nature or Nurture?
In 1963, the SEC investigated Bernie Madoff’s mother. Gibraltar Securities, registered under the name of Sylvia Madoff, was one of dozens of firms investigated by the SEC for failing to file financial reports. She eventually withdrew her registration, and the SEC dropped the charges.
According to reports in Fortune and The New York Times, Madoff's childhood friends don't remember his mother trading; the Fortune article hypothesized that perhaps Madoff's father, who had previously been in trouble with the IRS, put his wife's name on the application.
"Either way," the authors wrote, "one of Bernie Madoff's parents was involved in securities -- and got into trouble for it."
(source: PBS Frontline)

8. Another bit of sad Madoff trivia…
Madoff Investment Securities LLC was examined at least eight times in 16 years by the SEC and other regulators, but regulators were never able to uncover the illegal scheme.
(source: Wall Street Journal, January 5, 2009)

9. Madoff’s Legacy Four Decades of Deals and Deception 1960s
Madoff’s firm was initially housed in his father-in-law’s accounting firm in midtown Manhattan. He earned his living as a market maker – matching buyers and sellers who wanted to trade “penny stocks” that weren’t listed on the big exchanges. The firm eventually became one of the top market maker businesses on Wall Street.
According to SEC documents, by 1962 he was managing investments channeled through his father-in-law’s accounting firm and business partner, Frank Avellino. The first investors were friends and associates.
1970s
Madoff's trading business skyrocketed through a controversial practice known as "pay for order flow,” in which which a dealer pays a broker for the right to execute a customer's order. This practice has long been called a "legal kickback."

10. Madoff’s Legacy cont.
1980s
Avellino and his associate Michael Bienes decided to drop their accounting services and work full time on recruiting clients for Madoff. By the mid-80s their cut had reached several million dollars a year.
1990s
Madoff started getting into bigger money when he took on management of several hedge funds. He used his position as chairman of Nasdaq to lobby Washington. His power and influence continued to grow. Yet, his investment advisory business was not even registered with the SEC.
The SEC launched an investigation into Avellino and Bienes under suspicion they were operating a Ponzi scheme. They were fined and required to return investors’ money. Madoff claimed ignorance about his two front men operating illegally.

11. Madoff’s Legacy cont.
2000
Investment professional Harry Markopolos submitted 8-page memo to the SEC outlining his theory that Madoff was running a Ponzi scheme.
2001
Two major articles published in the financial papers called into question the legitimacy of Madoff’s dealings. Yet, Madoff’s success continued.
2005
Markopolos continued to write memos to the SEC. By that time, the SEC was receiving letters from others, as well.
2006
Madoff was finally interviewed by the SEC. Investigators said they “found no evidence of fraud,” though they did tell Madoff he must register as an investment advisor.

12. Madoff’s Legacy cont. Fall 2008
The collapse of Lehman Brothers in the September signaled the beginning of the end for Madoff’s house of cards. Credit markets froze and the stock market began its free fall. By November, hundreds of hedge funds shut down or stopped allowing withdrawals.
Madoff told one of his sons that he was facing $7 billion in redemptions and having a hard time meeting those obligations. He also asked his wife to make wire transfers from a brokerage account to her personal bank account – totaling $15.5 million – so they would have cash on hand.
December 2008
On December 10, Madoff's sons told authorities that their father had just confessed to them that the asset management arm of his firm was a massive Ponzi scheme, and quoted him as saying it was "one big lie.” The next day, FBI agents arrested Madoff and charged him with securities fraud.
(sources: PBS’s Frontline, Wikipedia)

13. How does a scandal like this impact reputable professionals in the financial services industry?
Madoff was a smooth operator; the ultimate con man.
Because of his misdeeds, we must raise the bar on our communication with clients. It means we have to work harder.
This is not necessarily a bad thing.
Improving communication & better educating clients are worthy goals, regardless of the circumstances that inspired them.

14. Spotting the Red Flags
One of the easiest ways to spot an investment scheme is if the opportunity promises high, guaranteed profits.
All legitimate investments involve some degree of
risk. And, generally speaking, the higher the
potential return, the higher the level of risk involved.
Another red flag of Ponzi schemes is when investors are pressured to reinvest or roll over profits.
While long-term investing is generally a wise
approach, investors should be suspicious of any
promoter or advisor who is reluctant to let them
cash out gains.

15. Ponzi schemes only work when investors are kept in the dark.
There are several good pieces of general advice that
will help the average person shed light on their situation
and avoid Ponzi and other investment scams:
Work with financial advisors who were referred to you from a trusted source
Make sure your advisor is acting as a fiduciary (get it in writing)
Ask for disclosures on all forms of compensation
Ask questions about the advisor’s style of investment management
Make sure you are truly diversified across a wide variety of asset classes
Check with either the SEC or FINRA for the advisor’s background

16. If it sounds too good to be true…
This advice is no guarantee, unfortunately. Following it would not
necessarily have helped Madoff’s victims avoid being conned.
The Associated Press recently reported on telephone transcripts
released from the investigation. In one tape from 2005, Madoff
coached a potential witness about fooling federal regulators,
saying “you don't have to be too brilliant” to get away with it.
"The guys ... ask a zillion different questions and we look at them
sometimes and we laugh, and we say are you guys
writing a book?“ (Source: Associated Press, Sept. 10, 2009)
Bottom line:
Madoff was a liar, a con man, a thief.
He was really good at it.

17. It Happened Before. It Will Happen Again.
Even with all the attention this scandal has gotten, we continue to hear
news of more Ponzi schemes and more victims. The SEC's failure to
uncover Madoff's massive scheme for so many years, of course, has led
the agency to beef up its enforcement efforts. Here are some recent news
release headlines from the SEC:
SEC Charges Detroit-Area Stock Broker Who Lured Elderly into $250 Million Ponzi Scheme
SEC Charges New York-Based Money Manager in $40 Million Ponzi Scheme SEC Halts $50 Million Offering Fraud and Ponzi Scheme in Detroit Area
SEC Freezes Assets of Illinois-Based Hedge Fund Manager Who Was $2 Billion Feeder to Petters Ponzi Scheme
SEC Charges Calif.-Based Hedge Fund Manager for Operating Ponzi-Like Scheme
SEC Charges Operators of $80 Million Ponzi Scheme Targeting Korean-Americans
SEC Charges Colorado Advisor for Conducting Multi-Million Dollar Ponzi Scheme
The list goes on…

18. Keep Your Guard Up
These are just a handful of the SEC investigations into Ponzi schemes in the past few months.
They are all examples of how the average person can still fall prey to a Madoff-type scam if they don’t take steps to protect themselves.
This type of scam happens in cities all over the country, not just in New York.
Con artists will continue to use the Ponzi scheme because, sadly, it works.

19. Beware the Façade
Investors should not rely solely on the character or reputation of their advisor. The Madoff scandal is a stark reminder that that so-called reputation can be hiding something sinister.
The good news is that investors and financial professionals can do more than simply “be careful.”
They can follow specific practices for investment fiduciaries designed to protect investors.

20. The Investor’s Best Defense – Global Fiduciary Practices
The Center for Fiduciary Studies (Fiduciary 360) has developed
Global Fiduciary Practices as a guide for investment fiduciaries to
follow to demonstrate prudence in managing investment decisions.
These have been compiled in a series of handbooks:
Prudent Practices for Investment Fiduciaries
In addition to listing and explaining the minimum process
prescribed by law, the handbooks include criteria that represent the
Global Standard of Excellence.

21. Separate Functions
If you walk away today with just one piece of useful
Information today, let it be this.
The investor’s best defense against fraud is to maintain three
separate functions of portfolio management.
Investment Custodian
Investment Advisor
Investment Manager
Separating portfolio management functions is a key
recommendation from Fi360. It provides a proven system for
checks and balances against potential fraud and conflicts of
interest.

22. Periodic Table: Global Fiduciary Practices
This Fi360 table shows how the functions are separated. A PDF version is available
online at

23. Learn More The Center for Fiduciary Studies provides training for the
Accredited Investment Fiduciary (AIF) designation, through Fi360.
Fi360 offers a range of investment fiduciary education, practice
management, and support to the industry.
This organization is a great resource if you want to learn more
about investment fiduciary responsibilities and how to best serve
and protect your clients’ assets.

24. Additional Resources http://www.MoneyAZ.com
A copy of this Power Point presentation is available for download at

25. About Mike McCann, CFP®, AIF®
President and Founder
Investment Advisor
Perspective Financial Services, LLC
Mike has worked in the financial services
industry since 1991, interacting directly with
individuals as an investment advisor and also
behind-the-scenes in high-level trading
and managerial positions.
He is a Certified Financial PlannerTM
practitioner and an Accredited Investment
Fiduciary®