Chapter Seventeen

Too Good to Be True

“You’ve got to get in on this! This investment seems too good to be true!”

Warning: Too good to be true nearly always is.

In my 2009 book, How to Smell a Rat, I wrote about the five signs of financial fraud. This was in the wake of the massive, billion-dollar, decades-long Madoff Ponzi fraud’s coming to light—made more tragic because it was easily avoidable. How so? The key decision maker was also the custodian—the number-one sign a Ponzi is possible.

What does that mean? Madoff was responsible for deciding what to buy and sell and when for client portfolios. And clients deposited funds with Madoff Investment Securities. The fox was guarding the hen house.

Madoff founded Madoff Securities in 1960, and it was then and appears now to have always been a legit brokerage—it had been one of America’s biggest market-makers in both NYSE and NASDAQ securities. The brokerage firm wasn’t the problem—not on its own. The problem was Madoff controlled it and the hedge fund. Because Madoff controlled both the advisory and the custody sides, it was technically nothing for him to dummy up statements and take money out the backdoor—for years!

This is the basic structure for every financial Ponzi I’ve studied. Either the adviser and the custodian were ultimately under singular control, or the adviser had some form of influence over the custodian. And amazingly, in the tsunami of reporting that followed the Madoff and Stanford Ponzi scandals, none I saw focused ...

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