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Ponzi Primer: What the Bernie Madoff Case Means to You

Monday, 15 Dec 2008 | 10:02 PM ET
Bernard L. Madoff
CNBC.com
Bernard L. Madoff

By now you’ve probably heard at least a little about Bernie Madoff, the financial legend accused of stealing up to $50 billion from his investors in what could be the biggest ponzi scheme in history.

Madoff promised the investors of his fund big money but delivered with imaginary gains, allegedly paying off old investors with money from new ones. He got away with the alleged crime for years because of lack of oversight, and now clients of all walks of life – from big-time banks to charities to average people – are finding themselves looted.

Whether you’ve been a victim of the alleged Madoff fraud or not, it highlights an oft overlooked fact, that smaller ponzi schemes dupe Americans across the country. You can begin to protect yourself by using common sense and doing the following:

1. If it sounds too good to be true, it probably is! This is an oldie but a goodie, Carmen says (she wrote about it earlier here). The promise of unusually high returns over a short period of time should be a huge red flag. With Madoff, many potential investors and reporters were highly skeptical of his purported performance. They couldn’t understand how he generated double-digit returns year after year, regardless of how the overall market was doing. Trust your gut in these situations, and if you have second thoughts, take your money elsewhere.

2. Similarly, you have to research what you’re being promised. Don’t just take some fund manager’s promises at face value. Again, with Madoff, many people pointed out that the strategy he claimed to use could not actually produce such returns. Barron’s even published an article years ago questioning how he did so well.

3. Ask for transparency. There’s no reason not to ask your fund manager or broker-dealer for proof of method of strategy. In short, find proof of how the business intends to achieve big returns. Madoff’s investment business had none of this – it was on a secured floor, separate from his company’s other legitimate businesses. And when investors asked him for more information about his strategy, he reportedly gently threatened to throw them out of the fund. The Madoff case also highlights that a fund manager’s credentials and reputation shouldn’t stand alone. In researching where you want to put your money, look for third-party information and if you find anything questionable, walk away.