Madoff's death reminds investors to beware

If it's too good to be true … it probably is. How old are most people the first time they hear that? Yet, thousands of people are hoodwinked into making investments that are too good to be true. The recent passing of Bernie Madoff while serving a 150-year sentence in a federal penitentiary is a reminder to beware of those who try to persuade investors to participate in schemes that guarantee investment rates that are much higher than what others are paying. Madoff was the mastermind behind the largest Ponzi scheme in history. He is believed to have swindled over $17 billion from investors. Running a Ponzi scheme involves convincing people to invest in what is believed to be a legitimate venture that does not actually exist. Instead, the scheme takes funds from more recent investors to pay returns to initial investors. These initial investors believe profits are coming from legitimate business activities and have no idea that other depositors are providing the funds. The scheme can sustain the illusion of a legitimate investment as long as new investors continue to participate. The plan can work only when most of the investors do not ask for repayment and assume the investments are valid. It came to an end for Madoff in December of 2008 when he was unable to meet $7 million in customer requests for payment. The customers' demands to withdraw funds were a result of the global financial crisis that started weeks earlier. Along with the record amount of money involved, Madoff counted celebrities and otherwise sophisticated investors amongst his victims. He worked as an advisor for the Securities and Exchange Commission that regulates the investment industry. Madoff also helped launch Nasdaq, the first electronic stock exchange. These roles contributed to the trust his clients had in him and his investing skills. Madoff was likely a high functioning sociopath according to Jonathan Appel, Professor of Psychology and Criminal Justice at Tiffin University. "These individuals can be very sophisticated and use charm and credibility to establish trust with many individuals. Madoff had high status, which increases his attractiveness and believability to even the most intelligent individual," Appel said. One of the interesting aspects of those who invest in Ponzi schemes is that they believe the fund is going to create the promised above-average returns. Do those who turn over their money not ask about the specifics of where their funds are going? Is the person creating the scheme so charismatic that they can convince investors they know what they are doing? Or does the schemer tell the investors their money is invested in something so complex they will not understand it? Greed appears to be a motive for the investors. It is not unusual for people to hand over their entire savings and retirement funds to the person who they think is investing it for them. Few investment advisers recommend putting all the eggs in one basket. Diversity is a basic premise of financial planning. Appel said Madoff was likely appealing to emotions, rather than the intellect of his victims. He had the ability to invoke excitement of achieving financial returns, similar to the emotion created by gambling. It is difficult to tell if people like Madoff think they are smarter than everyone else. Or if they just decide to live off others' money as long as it will last and face the consequences when the law catches up to them. There are things known about individuals who engage in these kinds of behaviors, Appel said. They are likely narcissistic and "think they are smarter and can avoid consequences." So, if someone makes you an offer that sounds too good to be true … Dr. Perry Haan is Professor of Marketing and Entrepreneurship at Tiffin University. He can be reached at haanpc@tiffin.edu.