Jane Bryant Quinn on the Bernard Madoff Scandal

By Jane Bryant Quinn
Sunday, December 21, 2008

Why do people wind up with the Bernie Madoffs of this world? Because they've neglected one of Ronald Reagan's favorite sayings, "Trust, but verify."

When it comes to Wall Street, I'm not even sure about the "trust" part, but "verify" is where wisdom begins.

Admittedly, Bernard L. Madoff was a hard guy to be suspicious of. Former chairman of Nasdaq, pioneer in electronic trading, a reputation as a trading wizard -- why would you say anything but thanks when he took you as a client? Then he took your money, too, according to civil and criminal charges filed last week. He stands accused of running a long-standing Ponzi scheme, with losses to investors of at least $24 billion and perhaps as much as $50 billion.

Madoff played to two of our most serious weaknesses as investors and human beings.

As investors, we love to believe in market wizards who hold the secret to making serious money. In fact, there's no such secret, but admitting it is like abandoning a childhood faith. Faith propels the money-management business, despite the evidence that managers rarely beat the market indexes, over time. We especially love a fatherly wizard who's close to his children, plays golf, supports caring charities and lays expensive carpets on his office floor.

As human beings, we love status symbols and, to those who knew him, Madoff was status on wheels. Investing with him proved your wealth, position and general superiority to the poor slobs bobbing around on the fringe. His investors believed they were earning steady monthly increases of 1 percent or 2 percent, even when markets went bad. Who would dream of vetting such a prize?

Even if you tried, it might seem that Madoff would have been impossible to catch. But at least two warning signals flashed for anyone to see.

First, Madoff's accounting firm, Friehling & Horowitz in New City, N.Y., was a rinky-dink shop, as a simple Google search shows. The firm doesn't have a Web page. I found it on a junky site that lists local businesses by type and address, along with the boilerplate comment, "rated as good by a New City citizen." That's an unlikely auditor for the $17 billion that Madoff claimed to have under management. When the fraud came to light, F&H turned out to be a tiny office which, neighbors said, wasn't even open all the time. (The office didn't answer its phone.)

Second, Madoff held your securities (or what he claimed were your securities) in his own advisory firm. That's not the way reliable advisers handle publicly traded investments. The custodian should always be a large, independent financial institution that reports cash flows and trading activity to you directly. When you invest new money, you should make out the check to that account.

Even if your mother is your investment adviser, look to the quality of the oversight. You want a major accounting firm checking the books and a brand-name custodian tracking the trades and the amount of money in your account. If that's not happening, something's wrong.

Many questions have yet to be answered about Madoff's operation.

He ran his investment advisory firm separately from the brokerage house and, according to court documents, kept the records under lock and key. The advisory firm had 20 employees -- what were they doing while the money gushed through?

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