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The Four Big Madoff Questions:
Who's to blame, how much is lost, where's the money, will it occur again?

by Dean Rotbart

December 24, 2008 | 2:33 am

Photo by Tim Wiencis/Splash News

Photo by Tim Wiencis/Splash News

Why is this fraud different from all other frauds?

The Bernard L. Madoff Ponzi scheme will definitely rewrite the record books when it comes to its dollar size, duration, number of victims, concentration within the Jewish community and, yes, the mountain of legal fees it generates.

So say fraud investigators, asset hunters, plaintiffs' attorneys and a former federal prosecutor, all of whom also go out of their way to caution that some of what has already been publicly reported in this case will undoubtedly turn out to include inaccuracies.

There is still so much to discover and uncover.

"It is extraordinary," said Blake Coppotelli, a senior managing director with Kroll, the large New York-based risk consulting company. "We are living in extraordinary times."

Years from now, lawyers, journalists and historians are likely to still be debating the causes and consequences of Madoff's massive deception. Untangling the mess will not only be crucial in the bid to provide restitution to some victims, it will also become a case study of how not to repeat the same mistakes that led so many institutions and individuals to be beguiled.

The Jewish community will require a special dose of self-contemplation, some observers believe. While Madoff's victims come in all religions and nationalities, the Jewish community proved to be a nutrient-rich environment for him to cultivate his infectious financial toxin.

"It somehow becomes more of a Jewish question," said author Julie Salamon, who has written a book on the Jewish concept of charity. "I think it is fair because if as a people you pride yourself on your philanthropy, then you should have pretty strict standards governing it -- both legal standards and moral and ethical standards."

While Passover is still months off, already four big unanswered questions have arisen that seem central to a better understanding of just what happened in the case of Madoff and his Bernard L. Madoff Investment Securities (BMIS). Here are the questions and what can be said with reasonable certainty about them at this stage of the investigation:

  1. Who is to blame?
  2. How much is involved?
  3. Where is the money?
  4. How do we prevent this from happening again?
1. Who is to blame?

According to the Securities and Exchange Commission (SEC), Madoff has already confessed that there is "no innocent explanation" for his activities, describing his actions as "basically, a giant Ponzi scheme."

Complete Madoff CoverageFederal authorities not only have placed Madoff under 24/7 house arrest, they have also taken the passport of his wife, Ruth, although she has not been formally charged with any wrongdoing.

News reports say it was Madoff's own sons, Mark and Andrew, who turned their father in. Madoff's brother, Peter; a niece, Shana; and a nephew, Charles, also reportedly worked for BMIS. None of them has been charged with any wrongdoing.

Exactly how many people worked directly at BMIS is unclear. The firm, which was founded in 1960, operated on more than one floor of a Manhattan high rise.

Radiating out from BMIS were as many as a score of key individuals and institutions that served as so-called "rainmakers," facilitating and likely soliciting the investments of others and taking a finders and/or management fee for their services.

These rainmakers reportedly include pillars of the Jewish community, including Los Angeles philanthropist Stanley Chais and Jacob Ezra Merkin, a major New York contributor to Jewish causes and until the scandal broke, a trustee of Yeshiva University. Non-Jews, too, such as Walter M. Noel of the Fairfield Greenwich Group, allegedly attracted well-heeled investors to the Madoff web.

Add into the mix internal and external auditors and accounting firms, lawyers, regulators and major philanthropies who both received Madoff funds and invested their endowments with BMIS, and there is an auditorium-full of potential confederates for federal and civil investigators to examine.

One former federal prosecutor, who is not directly involved in the Madoff investigation, said it begs all reason to think that Madoff, or Madoff and his wife alone, could have designed, executed and hidden so massive a fraud for so long.

"No chance," said this investigator, who spoke on the condition of anonymity. "It wasn't just a scheme that Madoff did, and he did alone."

The former prosecutor said that based upon his experience with other fraud investigations, government sleuths will zero in on anyone and everyone who handled Madoff funds. "Money comes in from person A as an investment. Where does it go, does it come in as a check or wire, who handles the check?" he asked. Moreover, what document trail did Madoff send back to those who handled the funds?

To be found criminally liable, this investigator said Madoff confederates would have to be proven to have had criminal intent and knowledge. Stupidity and gross negligence alone will not suffice to charge anyone with a crime.

If any members of Madoff's immediate family are criminally culpable, the former prosecutor said he is confident that Department of Justice and SEC investigators "will be able to figure that out relatively easily."

How much is involved?

Madoff told those who arrested him that his scheme resulted in a loss of $50 billion, and the news media have embraced that figure as if it is gospel. It most certainly is not.

The actual amount lost, while still record setting, is most probably significantly less, in part because both Madoff and his victims seem to be counting phantom profits. This point is argued persuasively by John Steele Gordon, a financial and economic historian, who has closely tracked American pyramid and Ponzi schemes predating Charles Ponzi's 1919 fraud, which impacted 20,000 investors.

Put simply, if an investor who placed $100 with Madoff was led in time to believe the investment had grown to $150, the "profit" was never real, so neither is the loss, Gordon explained. "The money was only building up in a phantom sense."

When charities and nonprofits publicly disclose the scope of their lost endowments, it is very likely that they only thought their investments with Madoff were as large as they are reporting.

Consistent with Madoff's life and modus operandi, it seems clear that he also has exaggerated how big a crook he actually is.

Where is the money?

To keep his Ponzi scheme from being exposed, Madoff shuffled funds out his door almost as quickly as they arrived. Indeed, as his investor base grew larger and larger and his ability to attract fresh investors reached a limit, Madoff eventually had more funds exiting BMIS than arriving. Ultimately, the outflows were his undoing.

The former federal prosecutor said the government will likely concentrate its asset search especially closely on Madoff family members, associates and close allies who withdrew funds from BMIS in recent years -- because those withdrawals will likely be subject to forfeiture.

"The law ... is rather clear," said Arthur A. Greenberg, senior partner of the law firm Greenberg & Bass in Encino. Madoff investors with recent withdrawals "are subject to fraudulent conveyance" rules that could require them to give back monies they have spent on homes, cars, jewelry or even charities. Greenberg and his firm often defend fraud victims in actions seeking such disgorgement.

The former federal prosecutor anticipates that investors will find Madoff has squirreled away some significant money, despite his initial public assertions that his own wealth has been wiped out. Hand-in-hand with such large frauds, the investigator said, prosecutors typically uncover money-laundering schemes.

"People commit frauds to benefit themselves," added a colleague.

Reed Kathrein, a lawyer with Seattle-based Hagens Berman Sobol Shapiro (HBSS), which represents some Madoff investors and groups, said his investigators will probe those individuals who raised funds for Madoff, such as Los Angeles' Chais, to see if they still own recoverable assets. In addition, Kathrein said plaintiffs' lawyers will eventually get around to outside auditors and other fiduciaries who may be civilly liable for negligence.

At day's end, the best bet is that the vast amount of real losses incurred by legitimate investors will never be recovered.

How do we prevent this from ever happening again?

Gordon, the author of "An Empire of Wealth: The Epic History of American Power," is one observer who thinks history will continue to repeat itself, despite our best efforts. "P.T. Barnum was right," he opined. "There is a sucker born every minute."

But others, including Salamon, whose book, "Rambam's Ladder -- A Meditation on Generosity and Why It Is Necessary to Give," focuses on the Jewish way of charity, thinks that a post-Madoff post-mortem on how this all came about may provide a safer path in the future.

Many modern philanthropic organizations have themselves grown to be monstrous in size and overwhelmed with bureaucracy, she noted. Such impersonal nonprofits may make it "easier for the rip-off artists to soothe their conscience."

"It's not a legal question, but I wonder is this the right way to raise money -- charity as potlatch and a means of making business connections?" asks Salamon. "Bigger at any cost is just not right."

Dean Rotbart, a former columnist and news editor at The Wall Street Journal, is a Los Angeles-based publisher of media-related Internet sites. He can be reached at dr@deanrotbart.com.

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