Why We Keep Falling for Financial Scams - WSJ Essay

Stephen Greenspan Ph.D., a psychologist, recently wrote a book, "Annals of Gullibility" focusing on a multi-dimensional theory that attempts to explain how so many people can find themselves in situations that could have been avoided. After Dr. Greenspan wrote his book, he found that much of his retirement savings had been invested in the Rye Prime Bond Fund, part of the Tremont family funds, a subsidiary of Mass Mutual Life. Unfortunately, the Rye Prime Bond Fund was a feeder fund of Madoff's Ponzi scam.

Why We Keep Falling for Financial Scams (Stephen Greenspan, WSJ, 1/3/09)

The following is a quote from Greenspan's essay:
"In my own case, the decision to invest in the Rye fund reflected both my profound ignorance of finance, and my somewhat lazy unwillingness to remedy that ignorance. To get around my lack of financial knowledge and my lazy cognitive style around finance, I had come up with the heuristic (or mental shorthand) of identifying more financially knowledgeable advisers and trusting in their judgment and recommendations. This heuristic had worked for me in the past and I had no reason to doubt that it would work for me in this case."

The article explores the topic in-depth.

Latest Ponzi Scheme:

Cosmo Ponzi Scheme Took in $370 Million, U.S. Says (Bob Van Voris and Patricia Hurtado, Bloomberg, 1/27/09)

Nicholas Cosmo of Agape World Inc. was accused of running a Ponzi scheme from 2003 through December 2008. He lied to his investors by telling them that the money was invested in "bridge loans". In reality, he invested in commodity futures, loosing about $80 million dollars out of an investment of $100 million.

According to the article, Cosmo was sentenced to prison in 1999 for misappropriating funds when he was a stockbroker. He also was ordered to receive therapy for a gambling problem. That information should have caused his investors to think twice before plunking down large sums of money into his scheme.

Nicholas Cosmo

Photo from Bloomberg.com

Bernie Madoff

Photo from NY Times

Perjury Charges Against Madoff? SEC Officials Believe That He Lied to Them During Past Examinations (Kara Scannell, WSJ, 1/27/09)

"Lawmakers expressed frustration at regulators' explanations for failing to catch Bernard L. Madoff's alleged multibillion-dollar fraud but drew little blood because officials declined to discuss details of the case.

Linda Thomsen, chief of the Securities and Exchange Commission's enforcement division, suggested in Tuesday's hearing at the Senate Banking Committee that federal prosecutors may pursue charges against Mr. Madoff over what they believe were his lies to SEC officials during past examinations."

MADOFF IS NOT JAIL!

Madoff's list of victims is getting longer. Alexandra Penney, the former editor of Self Magazine, gave her life savings to Madoff's firm. She has shared her experience on her blog, "The Bag Lady Papers", on The Daily Beast.

RELATED

Zsa Zsa Gobor lost millions due to Madoff (Reuters, 1/24/09)

91-year old actress Zsa Zsa Gabor lost up to $10 million dollars investing in Bernie Madoff's fraudulent investment firm.

Report: Larry King the Latest Big Loser in Bernie Madoff Scandal (FoxNews.com 1/23/09)

Of Human Competence - Stephen Greenspan's Blog

Keynesian + Behavioral Finance?

Robert J Shiller: Irrational Exuberance

George A. Akerlof and Rober J. Shiller Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism

Unregulated Funds of Funds & Bernie Madoff: Videos from CNBC

SIPC Liquidating Madoff Securities' Assets

Future of Hedge Funds

Revealing Video: Madoff
(Bernie Madoff- In his own words)

Zuckerman on Madoff
Zuckerman did not know that 30 Million of his charitable funds were funneled by a fund manager into Madoff's scheme. It was part of another fund that put 9 billion with Madoff. This calls into question the "fund-to-fund" methods of fund management, without due diligence.

Madoff Fallout

From Ponzi to Madoff: Interactive Graphic from the Wall Street Journal

Here is the link:

From Ponzi to Madoff

"The arrest of investment manager Bernard Madoff for allegedly running an ongoing $50 billion swindle is the latest scam of the kind made famous by Charles Ponz in the 1920's. In these schemes, early participants are paid returns from the principle received from later and different investors." -Wall Street Journal

Market Wizards or Wizards of Oz? Bernard Madoff, hedge funds, and loss of trust.

Market wizards, or Wizards of Oz?

Right now there is a discussion on CNBC about Bernard Madoff's fraud/ponzi scheme. "Low volatility, with consistent growth of 8-10 percent every year, quick liquidity... Put it all in there!".

People with millions listed to the wizard and put most of their money in Madoff's funds. And now the money is gone, and trust is lost.

Some of Madoff's clients:
Sterling Equities, owned by Fred Wilpon (NY Mets owner)
Benedict Hentsch (Swiss private bank)
Bramdean Alternatives (U.K. asset manager)
Fairfield Greenwich Group - Fairfield Sentry Ltd.(Hedge fund firm)
Kingate Management -Kingate Global Fund Ltd.
Fix Asset Management
Pioneer Alternative Investments- Primeo Select Fund
Union Bancaire
Optimal Investment Services SA
For more information, see "Factbox-Firms exposed to Madoff's alleged fraud"

Wizards of Oz = Hedge Fund Managers?

Kenneth C. Griffin, founder of the Citadel, has been called a hedge-fund wizard. According to an article in the NY Times (10/7/08), "Between 1998 and 2007, he handled investors an average annual return of 20 percent, more than three times that of Standard & Poor's 500-stock index."

An article in the Chicago Tribune (12/12/08), mentions that quite a few smart people work at the Citadel..."generous payouts helped Citadel recruit a stable of PhDs, market wizards and computer gurus who could engineer a recovery."

I guess things were too good to be true. According to CNBC, Citadel's funds are down about 50%, and the company will not allow investors to withdraw funds for several months.


Related:

Hedge Fund Wizards (Washington Post, 12/19/07)
Nearly one year ago, Dean P. Foster, a professor of Statistics at the Wharton School of Business, and H. Peyton Young, a professor of Economics at the University of Oxford, wrote this article. Here is a quote that foreshadowed the current crisis:

"Hedge funds are risky for another reason. It is extremely difficult to tell, based on past performance, whether a fund is being run by true financial wizards, by no-talent managers who happen to get lucky or by outright scam artists... Although individual hedge fund managers may drag their feet, it is actually in the industry's best interest to encourage greater regulation and transparency. Otherwise, a rising tide of failed funds could cause a collapse in investor confidence, putting both the good and the bad wizards out of business."

Top Broker Accused of $50 Billion Fraud (WSJ)

Fees, Even Returns and Auditor All Raised Flags (WSJ)

Fund Fraud Hits Big Names (WSJ)

Hedge Funds Mystify Markets, Regulators: Deeply Powerful, Largely Unchecked (David Cho, Washington Post, 7/4/2007)

Stockbroker Fraud Blog
(Attorneys: Shepherd, Smith & Edwards)

How do we invest in "real" when it has been "all one big lie'? What to make of Bernard Madoff

Do you remember the story, "The Emperor's New Clothes"? All of the adults in the story were convinced that the Emperor had wonderful clothes, and that the clothes were REAL. The only problem was they didn't seem to realize that the emperor was really NAKED. Just one little boy noticed that it was all fake.

Like the little boy in the story, we are now discovering that the trappings of many Wall Street investment companies are fake, and have been so for a very long time. The emperor is really naked. How could so many of us let ourselves become bamboozled?

Here is an excerpt from today's New York Times:

"Prominent Trader Accused of Defrauding Clients"
Diana B. Henriques and Zachery Kouwe

"Bernard L. Madoff, a legend among Wall Street traders, was arrested on Thursday morning by federal agents and charged with criminal securities fraud stemming from his company’s money management business."

"The arrest and criminal complaint were confirmed just before 6 p.m. Thursday by Lev L. Dassin, the acting U.S. attorney in Manhattan, and Mark Mershon, the assistant director of the Federal Bureau of Investigation."

"According to the complaint, Mr. Madoff advised colleagues at the firm on Wednesday that his investment advisory business was “all just one big lie” that was “basically, a giant Ponzi scheme” that, by his estimate, had lost $50 billion over many years."

"....The senior employees understood him to be saying that he had for years been paying returns to certain investors out of the principal received from other, different investors. Mr. Madoff admitted in this conversation that the firm was insolvent and had been for years, and that he estimated the losses from this fraud were at least $50 billion, according to the regulatory complaint."

"Andrew M. Calamari, an assistant director in the S.E.C.’s regional office in New York, said the case involved “a stunning fraud that appears to be of epic proportions.”"

A visit to the Madoff Securities website provides a quick snapshot of what an investor sees at first glance:

A Global Leader in Trading US Equities

"With more than $700 million in firm capital, Madoff currently ranks among the top 1% of US Securities firms. Our sophisticated proprietary automation and unparalleled client service delivers an enhanced execution that is virtually unmatched in our industry."

An Intricate Interweaving of Advanced Technology and Sophisticated Traders

"Madoff Securities also utilizes its computers to seek out opportunities for hedging its inventory of securities. The firm uses a variety of futures, options, and other instruments to hedge its positions and limit its risks. While these hedging strategies are an important tool in protecting the firm's financial position, ultimately,these highly prudent risk management policies protect the interests of clients as well."

The Owner's Name is on the Door

"In an era of faceless organizations owned by other equally faceless organizations, Bernard L. Madoff Investment Securities LLC harks back to an earlier era in the financial world: The owner's name is on the door. Clients know that Bernard Madoff has a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm's hallmark."

The "unblemished" record was fake.... Maybe it is time we invested in something real.


Related:

Interactive Map of Bernard L. Madoff Investment Securities

via Muckety "Exploring the paths of power and influence"