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Mad About Madoff

One of the most infamous “faith based frauds” of the 21st century – so far

Warren Cole Smith

Editor’s Note:  Bernard Madoff died this morning in a prison in North Carolina.  He was 82 years old.  In 2009 he pled guilty to one of the largest Ponzi schemes in history.  He also has nearly a chapter devoted to him in my book Faith-Based Fraud.  Below is an excerpt from that chapter.  The book will be published on May 4 by Wild Blue Press.  You can pre-order the Kindle edition here.

Like Allen Stanford — or, more specifically, like Jimmy Davis and others around Allen Stanford – the other key figure we’re discussing in this chapter, Bernard Madoff, also used his contacts in the religious community to betray the trust of those in that community. Also like Stanford and Charles Ponzi before him, he used later investors to keep the earlier investors happy. However, while Charles Ponzi may have given the Ponzi scheme its name, it took Bernard Madoff to elevate the Ponzi scheme to the level of a near art-form.

Indeed, in March 2009, when Madoff finally pleaded guilty to eleven federal crimes, the full measure of his fraud became clear, and the bottom line was this: Bernard Lawrence Madoff, born April 29, 1938, now holds the dubious distinction of having perpetuated the largest Ponzi scheme in history. The court-appointed trustee who was responsible for sorting out the mess estimated that more than $18 billion had been lost by investors. If you count the gains that the investors thought they had but which in fact had been merely fabricated, the total losses approached $65 billion.

So, this was certainly a fraud, the largest in American history. But a faith-based fraud?

Absolutely. As we will see, Bernard Madoff used his contacts in the Jewish communities—beginning in New York, then in Florida, and then around the world—to attract investors.

And there is another reason to take a close look at the Madoff fraud. As we have mentioned earlier, one of the questions always asked after a fraud is exposed is this: “How could people be so gullible, so naïve?” In the Madoff fraud, however, we see that some of the richest and most savvy investors in the world were taken in. How could that happen?

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Certainly greed played a role, but in this chapter we also look at another motive.  That other motive, which may even be more powerful that financial greed, is the longing for community, or at least to be in the “inside circle.”

If you were a Madoff investor, you were part of an exclusive inner circle. We see this phenomenon over and over, but we discussed it most fully in the last chapter in reference to the New Era scandal.  John Bennett and Bernard Madoff—indeed, even Charles Ponzi and Jim Bakker—provide a sense of belonging. You were part of (pick your era) the in-crowd, the cool kids, the smart set.

To help us understand this motivation more, let’s first look at the man at the center of the madness.

What’s a Nice Jewish Boy Like You . . .

Madoff was born into a Jewish family in the Queens borough of New York in what in some ways was the perfect year for a striving, upwardly mobile entrepreneur: 1938. Though born in the Great Depression, the Depression was not a part of his personal experience. He was too young to serve in either World War II or Korea and too old for Vietnam.  But the peace, stability, and economic prosperity created in part by these wars were the milieu in which Madoff made and lost billions. His was a life of wealth without any real sacrifice.

Madoff’s first foray into the financial world came when he founded Bernard L. Madoff Investment Securities in 1960, just after his graduation from Hofstra University. The company got its start buying and selling so-called penny stocks. Penny stocks are not necessarily stocks that cost a penny, but stocks that are very cheap, sometimes even selling for even less than a penny.  They are stocks for which no ready market exists.   That is to say: they are not listed on any of the major stock exchanges, such as the New York Stock Exchange. So firms such as Madoff’s are sometimes called “market makers.” If you wanted to buy or to sell penny stocks, you could go directly to Madoff’s company.

But the stock prices were low and the companies being traded had very small market capitalization, or total value. They are sometimes called microcap stocks. So for Madoff to make money, he had to charge higher commissions than normal stock brokers, and he had to be extraordinarily efficient. The 1960s was the very beginning of the era in which computers were used on Wall Street. Madoff’s firm was in the forefront. It developed innovative computer technology to handle the trades.

It’s important to note that penny stocks occupy a special niche in the investment world. They are not illegal, but they are less regulated than the stocks of more established companies, the stocks traded on the major stock exchanges. Proponents of penny stocks say the microcap market provides capital for companies, especially technology companies, too new and too innovative for traditional stock markets.  Over the years, the microcap markets have produced just enough success stories to keep this myth alive. Examples: Sun Microsystems and Sprint/Nextel had their roots as microcaps, or penny stocks.

But because the stock prices are so low and so thinly traded (relatively few people buying or selling the stock on any given day), they are subject to price manipulation.

A simple price manipulation scheme might look something like this: Imagine a stock trading for a penny that trades infrequently, once a week or so. A manipulator buys 1-million shares of this stock for $10,000. If this same buyer “bids” two cents a share the next day, he will likely find plenty of sellers, because that’s twice the price the stock was just yesterday.

So our manipulator purchases more shares, though this time not nearly as many, perhaps another 100,000 shares, one-tenth the amount he purchased the day before. Because he paid twice the price per share, this transaction costs $2000.  He now has $12,000 into the stock, and he owns 1.1 million shares.

But a few people are beginning to notice. Why did the stock double in price in a single day?  Does somebody know something I don’t?  I’d better buy a few shares just so I don’t miss out.  And, of course, people who already own the stock are happy for the price jump.  Some of them decide to sell at the higher price and make a profit.

But human psychology begins to override the fundamentals of the company itself.  For every person who decides to sell their stock for a profit, others feel validated in the decision they made to purchase the stock, or perhaps they just get greedy.  Whatever the reason, many of them are no longer willing to sell at two cents a share. They now want three cents. Buyers now paying attention to the stock price are willing to pay, because the stock is still very cheap. Even at three or four or five cents a share it’s a good deal if the stock eventually goes to a dime, or a dollar. More buyers notice.  They notice, in part, because firms like Bernie Madoff’s firm, so-called “market makers,” are calling everyone they know to tell the story.  A frenzy ensues. The stock does hit a dime and then a dollar.

But wait.  Do you remember our original buyer, the guy who got the ball rolling? He now owns 1.1 million shares of a stock worth $1 a share: $1.1-million and all that money in a matter of weeks or months with only a $12,000 investment.

Such blatant, easy to follow manipulations rarely (if ever) occur just as I’ve described them.  They can be too easily seen as manipulations, and manipulating stock prices is illegal. Today both market pressures and regulations tend to prevent such schemes.  But what is not unusual is for investors with a high tolerance for risk, or money they’re willing to lose, or both, to buy and sell small-cap stocks in the hope that a relatively small movement in the stock price will produce a large profit.

And there’s one more thing to note: every time a stock changes hands, whether the transaction produces a big profit or a big loss, the broker gets a paycheck. And by the 1980s, Bernard Madoff was one of the biggest brokers of such transactions in the world.

Many people consider the promoting of penny stocks unethical, even when it’s legal, because the buying and dumping of penny stocks do little to help build the companies these stocks represent. The purpose of stock ownership is to provide capital for a company’s growth and development. Stock owners are not owners of a piece of paper. They are part owners of a company. Certainly from a Christian point of view, this kind of ownership carries with it a responsibility of stewardship.

But such notions are mostly lost in the stock market generally and in the penny stock world in particular.  Indeed, operating in this netherworld of the financial services industry often becomes a refuge for the ethically challenged.  Despite that, or perhaps because of that, Bernard Madoff thrived.  His firm became the largest market maker at the NASDAQ, the stock exchange that ultimately grew out of small-cap stocks, and became one of the largest market makers on Wall Street.

But what really turbo-charged Madoff’s cash machine was the wealth management arm of his company.  As Madoff’s brokerage business grew, his clients made money and needed someone to manage it for them.  Madoff quickly moved into that arena.  Like Ponzi and Stanford before him, Madoff promised outsized returns – in excess of 12 percent – year after year.  And like Stanford, Madoff claimed a “black box” methodology he wouldn’t reveal, saying that to reveal the methodology would destroy his competitive advantage.

As the cash rolled in, Madoff began to take on the trappings of success and respectability. By 2009 Madoff had an ocean-front residence in Montauk on Long Island, as well as a home on the Upper East Side of Manhattan valued in a 2009 filing at $7 million. He had a home in France and a mansion in Florida, where he also kept a 55-foot fishing yacht. The list of outsized assets goes on.

Madoff could buy cars and boats and real estate.  Buying respectability is a bit more complicated.  Philanthropy is one way to do that.  Political contributions were another.  Madoff began to make contributions to the Democratic Party.  He was not a mega-giver, but he was a steady giver, and he seemed to calculate his giving so that he gave just enough money to give him access to the politicians — and the big donor events and parties that would allow him “face time” with current and prospective clients.

Democratic Senator Charles Schumer, Madoff’s own senator from New York, received about $30,000 from Madoff over the years.  In total, Madoff gave about $240,000 to federal candidates between 1991 and the time the scandal was publicly revealed in 2008.  These candidates included Senators Barack Obama and Hillary Clinton, and U.S. Representatives Charles Rangel and Vito Fossella.

Did all of this money buy Madoff special treatment from legislators and regulators? We have no direct evidence of that.  But that possibility is one more reason regulations are inadequate to fight fraud, said Albert Meyer, the hero of the New Era scandal we discussed in the last chapter.  Even those regulators who are honest are bound by a bureaucracy that prevents them from moving nimbly enough to catch bad guys. For these reasons, Meyer says flatly: “Regulators can’t be trusted.”

Weeping and Gnashing of Teeth

Bernard Madoff’s fraud was devastating to his clients, and its sheer size had ripple effects through the economy has a whole.  But it was particularly egregious and damaging for reasons quite apart from its sheer size.

First, Madoff was a former chairman of the NASDAQ.  While he may have begun his career on the fringes of the financial services industry, he had moved into the mainstream. Indeed, he had become an establishment figure. If a guy like Madoff could be so crooked for so long, can anyone be trusted?  Madoff’s fraud raised questions about the integrity of the entire financial system.

In fact, a Cornell University study published in 2017 found that “people who knew Madoff’s victims or who lived in areas where victims were concentrated lost trust in the financial system and dramatically changed their behavior.”  According to the study, these investors “yanked $363 billion from the financial advisers they had entrusted – even though many of these advisers had nothing to do with Madoff.”

This study quantifies what even casual observers knew:  Bernard Madoff’s fraud sent waves through the already jittery financial markets in 2008.  The Madoff scandal made material contributions to the great recession of 2008-2009. Not only did $65 billion in wealth vaporize from the personal net worth of thousands of investors, but the erosion of confidence caused by the Madoff scandal hit both Wall Street and Main Street hard.

Another group hit hard was Jewish charities. Take, for example, the Robert I. Lappin Charitable Foundation, which has financed the trips of hundreds of Jewish youth to Israel.  Soon after news of the Madoff scandal broke, the group posted a stark message on its website: “The programs of the Robert I. Lappin Charitable Foundation and the Robert I. Lappin 1992 Supporting Foundation are discontinued, effectively immediately. This includes Youth to Israel and Teachers to Israel. The money used to fund the programs of both Foundations was invested with Bernard L. Madoff Investment Securities and all the assets have been frozen by the federal courts. The money needed to fund the programs of the Lappin Foundations is gone.”

They were not alone. The JEHT Foundation, which supports reform of the criminal justice system, said it would also shut down because its largest donors were Madoff investors.  The Chais Family Foundation, which gives about $12.5 million each year to Jewish causes in Israel and in the former Soviet Union, laid off its staff and shut down after losing $8 million with Madoff. This closure will also cause other ripple effects: The United Jewish Communities and the American Jewish Joint Distribution Committee were among its main beneficiaries.

For Madoff, the fraud unraveled quickly.  On Dec. 10, 2008, Madoff confessed to his two sons, Mark and Andrew, what he had done.  In what was a courageous decision – but one which must also have been heart-wrenching — they immediately went to the authorities, who arrested Madoff the next day.  On June 29, 2009, Madoff was sentenced to 150 years in prison, the maximum allowed at his age, which was then 71 years old. 

At his sentencing, he said, “I have left a legacy of shame, as some of my victims have pointed out, to my family and my grandchildren. This is something I will live in for the rest of my life. I’m sorry.”

For the 4,800 investors who had been victimized by Madoff, who had lived most of his life in luxury, Madoff’s words and his life sentence were small consolation.  Madoff’s victims suffered far more than he has.  Among those victims were his own sons.  On Dec. 11, 2010, exactly two years after Madoff’s arrest, Mark Madoff committed suicide.

Lessons from Madoff and Stanford

The massive frauds of Bernie Madoff and Allen Stanford contributed to the financial crisis of 2008 and 2009.  The federal government eventually had to pour $700-billion in the economy to keep it from a complete meltdown.  So it is not an overstatement to say that every single American taxpayer – at least indirectly – was a victim of Madoff and Allen Stanford.

One of the lessons of these two stories is that the damage such men cause is not isolated merely to a few rich investors who could afford to lose the money. Thousands of people who were not wealthy lost money. Some lost their life savings. Thousands of people lost their jobs as a direct or indirect result.  Scores of nonprofit organizations lost financial contributors and, in the case of Madoff’s victims, some of those nonprofits were driven out of existence altogether.

In a nutshell: The damage these scandals cause is profound and, as in the case of Mark Madoff’s suicide, tragic.  Mark and Andrew Madoff had done the right thing in turning in their father, but it is inconceivable that their actions did not exact a tremendous emotional and spiritual toll on them.  In fact, when Mark Madoff died, one press report said he had grown despondent after carrying for two years the “toxic burden of a name that meant fraud to the world.”

A second lesson to be found here is the same lesson we have found elsewhere: Transparency is the only sure-fire way to avoid such scandals.

Both Stanford and Madoff led investors to believe they had a black box of proprietary information and techniques that earned them returns no one else had been able to duplicate. In both cases, their claims ended up being false. Once again, we learn that secrecy is the forerunner of disaster.  Transparency is the cure for fraud.

Finally, we see yet more evidence for Albert Meyer’s contention that government regulators can’t be trusted to prevent such frauds. Indeed, Madoff and Stanford operated in one of the most heavily regulated industries in the world. Yet they still found out a way to “game” the regulators.

Given that, Meyer would not be surprised by this final irony: Both Madoff and Stanford were well-known contributor to politicians in both parties. But Madoff, as I said earlier, had a favorite, New York’s Democratic Senator Charles Schumer, who has received at least $30,000 from Madoff since 1992.

What I did not mention earlier was this: Schumer is a senior member of the Senate Banking Committee, one of the bodies that is supposed to be watching the financial services industry.

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Warren Cole Smith
Warren Cole Smith

Warren previously served as Vice President of WORLD News Group, publisher of WORLD Magazine, and Vice President of The Colson Center for Christian Worldview. He has more than 30 years of experience as a writer, editor, marketing professional, and entrepreneur. Before launching a career in Christian journalism 25 years ago, Smith spent more than seven years as the Marketing Director at PricewaterhouseCoopers.

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