The further to the left or the right you move, the more your lens on life distorts.

Monday, December 15, 2008

Caveat Emptor

When I was a very young man, just married, I invested all of our wedding gift money ($1,000, it wasn't very much by today's standards) into an investment fund that was recommended by those much older and wiser than me. I was told that lots of sophisticated investors were receiving a guaranteed return (well above the fed rate) against gains in a stock investment fund. The fund was a Ponzi scheme that began to unravel less than a year after my investment.

The perpetrator, one “J. Bennett Raffer,” was indicted, and I was subpoenaed to travel in lower Manhattan to the U.S. district attorney’s office to be deposed as a victim of the fraud. After my brief deposition and as the stenographer was closing down her equipment, I looked up at the Assistant District Attorney as asked, “Sir, do you think I’ll get my money back?”

The ADA, a man in his mid-thirties who was my elder by 12 years, smiled wanly, and asked, “Did you go to college?”

“Yes,” I answered.

“Did you learn anything in any of the courses you took”? he queried.

“I did.”

He paused as if thinking how best to deliver bad news. “You won't get a dime back. But look at it like you took a rather expensive college course. If you learn from it; if you understand that things that are too good to be true almost always are, then you’ve made a good investment with Raffer, because you’ll never make the same mistake again.”

Wisdom from a nameless ADA so many years ago.

Many people are asking how sophisticated investors lost billions in the Bernard Madoff Ponzi scheme. Richard Fernandez of The Belmont Club explains:
Some of those who escaped ruin may have owed their survival to crass skepticism. Despite Madoff’s long record of producing returns one country club member refused to participate because Madoff would not explain his methods. In a world that ran on trust, he impolitely insisted on evidence.

Madoff remained above suspicion in part because he knew how to exploit the allure of exclusivity. He did not seem anxious to take just anyone’s money. You almost had to ask him to take it. The New York Post explains “He had a closed fund, which is why people put more money into it, instead of diversifying … you couldn’t just come in off the street and plunk down $100,000.” Lawrence Leamer adds, “He didn’t take just anybody. He turned down all kinds of people, and that made you want to give the man even more of your money. When he took your fortune, he told you that he would tell you nothing about how he achieved his returns. He was a god. He had the Midas touch.”

It wasn’t about stupidity or greed as much as it was about the need to belong to a very exclusive group (entry into Madoff’s funds was a sure sign of wealth and prestige). The rich and famous forgot the thing I learned from a lowly ADA those many years ago—“things that are too good to be true almost always are.” Caveat emptor.