A FOOL and his money are easily parted, as those who invested some $50 billion (€35 billion) with New York money manager Bernie Madoff have now discovered. What may well be the biggest financial fraud in history shows that rich fools are not in short supply. Where any investment proposition sounds too good to be true, it may well be. And prudent investors generally heed that cautionary advice before making investment decisions.
Mr Madoff's wealthy clients, however, thought otherwise. They ignored financial risk in anticipation of financial reward. They focused on Mr Madoff's remarkable investment performance but failed to question just how he had achieved it. For years he had outperformed the markets, delivering above average financial returns to investors but without ever revealing a clear investment strategy. His success as a money manager should have attracted healthy scepticism and closer critical scrutiny of his investment methods. That never happened. His blue-chip clients included wealthy private investors, major European banks and hedge funds. It seems they failed to carry out adequate due diligence on his investment methods and have now paid the price.
Mr Madoff was not a financial genius. He is a self- confessed fraudster who has been charged with securities fraud. He told investigators his investment-advisory business was "one big lie". It was, as he acknowledged to his sons, a "giant Ponzi scheme", not unlike a pyramid selling operation. Quite simply, he paid high returns to early investors using money raised not from real investment returns but cash from new investors. The economic downturn changed matters. As more investors tried to redeem their investment, this fraudulent form of funding became impossible.
The collapse of the fund represents a further major blow to investor and public confidence in financial markets and comes at a critical time. The chairman of the Securities and Exchange Commission (SEC), which regulates markets and protects investor interests, has admitted that allegations regarding Mr Madoff's wrongdoing were first raised with the SEC a decade ago. On examination, the SEC found no evidence to sustain those claims. But the Madoff scandal also represents major embarrassment for the accountancy profession, the leading lights of which were auditors of feeder funds that invested with Mr Madoff's brokerage firm. Alarmingly, this alleged $50 billion fraud, it seems, went undetected for 20 years and only came to light when Mr Madoff, effectively, turned himself in.