On Dec. 11, Bernie Madoff was arrested for running the largest Ponzi scheme in world history and committing the biggest investment fraud in U.S. history.
In a Ponzi scheme (named for Charles Ponzi who committed fraud in 1919-1920), a person claims to be running an investment business, but in fact he uses the funds of new investors to pay fake returns to prior investors. A Ponzi scheme only works as long as enough new money is coming in to cover payouts and withdrawals of earlier investors. Inevitably, when new investments start to dry up, Ponzi schemes collapse.
Madoff’s victims lost an estimated $18 billion. In 2009, Madoff was sentenced to 150 years in prison.
Detecting a Ponzi scheme can be difficult. Madoff was investigated several times, but authorities failed to uncover what was going on, until his sons reported him to authorities.
Those who lost the most money were people and institutions who failed to recognize the warning signs:
- A guaranteed promise of high returns and low risk
- Consistent returns regardless of market conditions
- Investments not registered with the Securities and Exchange Commission (SEC)
- Secret or too “complex” to explain investment strategies
- Not allowing clients to view official paperwork regarding their investment
- Clients having difficult withdrawing their money.
If one follows prudent advice on how to invest, it is not difficult to avoid major losses in such a scheme. Such advice includes:
- If it’s too good to be true, it probably is, so stay away.
- There is no such thing as guaranteed returns, or high return, low risk investments
- A healthy portfolio should be widely diversified so that the loss of any one investment won’t be catastrophic
- A healthy portfolio should also include a variety of assets – avoiding having all one’s eggs in one basket.
- Why do you think investors were willing to pour billions of dollars into Madoff’s scheme?
- What are the warning signs that an investment is “too good to be true?”
- Do you think a sentence of 150 years was appropriate for Madoff’s crimes? Why?