• Bridget Sullivan Mermel CFP(R) CPA

Don't Let Madoff Happen to You

I don't blame the Madoff investors for investing in his hedge

fund. Truth is, we all make some mistakes when investing.

But, like Ben Franklin used to say; "Experience keeps a dear

school, but fools learn in no other." It makes sense to take

a critical look at the way Madoff set up his scheme, then

figure out how to avoid the mistakes his investors made.


Why Madoff had such a successful scheme


First and foremost, Madoff had a lot of credibility. He

created an over-the-counter trading firm in the 1970s and was

the chairman of the NASDAQ stock exchange. Later, he started

the (Ponzi scheme) hedge fund. It's very reasonable to assume

that someone who can run NASDAQ can run a hedge fund.


Madoff was savvy about finding investors. Madoff used a

time-tested strategy known as an "affiliation scam." In an

affiliation scam, you get members of a group to introduce you

to friends and family. You gain the victims' trust through

the affiliation. If your friend trusted Madoff, you were more

likely to trust him, too. This approach worked because it's a

common way that people find legitimate investment advice.


With all this in mind, I really felt for the victim on 60

Minutes who had lost everything. He was moving out of his

house during the interview. He said what was worse than

losing his own money was that he had introduced a bunch of his

friends to Madoff, and they lost their money, too. Madoff

recklessly used this man.


Madoff was a genius at hiding what he was doing. Most people

bought into Madoff through "feeder-funds," which are mutual

funds that pool together other mutual funds and sell them as a

"Fund of funds." These investments in Madoff's hedge fund

were sold to individual investors by commissioned investment

advisors. According to Stephen Greenspan, a Madoff investor

who ironically wrote Annals of Gullibility, he bought the

"'Rye Prime Bond Fund' that was part of the respected Tremont

family of funds, which is itself a subsidiary of insurance

giant Mass Mutual Life. " A trusted advisor sold Greenspan

the fund. All this reduced the chance that any investors

prudent enough to read the prospectus would actually pick up

on any problems.


So Madoff had a good set-up for his scam. With the benefit of

hindsight, there are a bunch of lessons to learn on how to

avoid these scams.


Lesson One: If you don't understand it, don't invest in it.

Investors in Madoff say they did not understand his investment

strategy. Reporting going back to 2001 in Barons tries to

figure out how he produced his returns without success. Madoff

fired clients who asked too many questions and claimed his

strategy was a proprietary secret.


If, after your financial advisor explains how you're investing

and what you're investing in, you can't explain it to your

spouse or friend, think twice. That doesn't mean you have to

regurgitate the strategy word for word months later. A lot

of folks don't commit their financial strategy to long-term

memory. You should, however, understand your strategy and the

investments you are buying well enough to explain it at the

time you are investing. Peter Lynch used to recommend writing

a paragraph about why you are buying a particular investment,

which is a pithy way to test your understanding.


Lesson Two: Use your friends wisely.

When talking to friends about advisor's and investments, ask,

"Do you understand your investments?" If your friend says,

"My advisor just does it all for me," realize that your friend

is assuming a tremendous amount of risk. Everyone makes

investing mistakes and trusts the wrong people sometimes;

blind faith increases your chances.


Ask friends who are not affiliated with your usual circle if

they understand the investing strategy. Stephan Greenspan,

the gullibility expert who was scammed, told a friend about

the potential Rye Prime Bond Fund investment. The friend,

just hearing the details, thought it was a scam. Don't ignore

neigh-saying friends.


Lesson Three: Don't expect consistent high returns with no

down years.

Reports vary as to what returns Madoff promised. Some say up

to 46% returns. According to Stephan Greenspan, Madoff

offered 10-12% returns without bad years. Don't expect 46% in

good years. Unless you are investing in US Treasuries and

CDs, don't expect to avoid down years.


Lesson Four: Diversify your assets.

Unfortunately this piece of advice from Investing 101 wasn't

followed by all of the investors in Madoff. When I hear about

the investors who lost everything, I think, what a shame!

Didn't they hear about investors losing everything in Enron

and diversify? What happened here?


Lesson Five: Keep documentation when you purchase

investments.

According to the Wall Street Journal, victims of the scam are

frustrated because SIPC, the regulatory body that insures

brokerage accounts, wants purchase documentation to prove

investment losses. In some cases, the initial investments go

back to the 1970s. The lesson is: sales information is easy

to find; keep purchase information.


Lesson Six: Doing everything right is no guarantee.

However, trying to do things right is the only approach we've

got.

We'd love the opportunity to connect.
Call or email us.

The first thing we do when you contact us is simply find out a little bit more about you and the issues that you're facing. If it makes sense to talk further, then we set up an appointment to get to know one another. While we’ll ask you to about your finances, all of our conversations and your information is private and confidential.

Sullivan Mermel, Inc.

3744 N. Southport Unit G

Chicago, IL 60613

Ph. 773-404-9344
Fax: 773-327-1461

© 2020 Bridget Sullivan Mermel

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