Roundtable: Lessons From the Madoff Mess

Earlier today, 71-year-old Ponzi scheme mastermind Bernard Madoff was given the maximum sentence for the 11 criminal counts to which he pleaded guilty: 150 years in jail.

The judge did not mince words: "Here the message must be sent that Mr. Madoff's crimes were extraordinarily evil."

The judge also said that his sentence was symbolic -- to deter any would-be Madoffs from steering down the wrong path. Already, his sentence is substantially more severe than other high-profile fraud cases like WorldCom's Bernie Ebbers (25 years in prison) and Martha Stewart, who served five months in jail on charges stemming from favorably timed sales of ImClone Systems (Nasdaq: IMCL  ) . (Note to future parents: Avoid the name "Bernie.")

Stewart's stock sales saved her about $50,000, according to MSNBC. Madoff stole billions of dollars from investors around the world.

They weren't naive investors, either. According to The Wall Street Journal, victims included asset managers, banks like Spain's Banco Santander (NYSE: STD  ) , and filmmaker Steven Spielberg. Now that the punishment has been meted, though, it's worth asking what we average folks can learn from the Madoff mess.

I put that question to a panel of Motley Fool advisors, analysts, and editors. Here's what they had to say.

Tim Hanson, co-advisor, Global Gains: The first lesson is: Things that are too good to be true probably are. The second and more relevant financial lesson is: Diversification is your friend. One should never have 100% of his or her money tied up in any one thing.

That includes, but is not limited to, one country, one currency, one asset manager, one asset class, one stock, one bank, etc. Immorality, after all, exists everywhere, from famously big companies like Tyco (NYSE: TYC  ) and Enron on down to tiny Chinese names like Fuwei Films, whose principal shareholders were found guilty in China of misusing state assets. So, seriously, diversify.

Robert Brokamp, advisor, Rule Your Retirement: There are a lot of risks out there -- inflation risk, interest-rate risk, market risk, currency risk, and Risk (the game of world conquest, by Hasbro).

In light of the Madoff scandal, we will add another to the list: manager risk, the risk that the person handling your money won't do such a good job of it. This isn't just the possibility that your manager is a malefactor; there's also the chance that your manager has lost his touch, or was not much good to begin with. The classic example these days is Legg Mason's (NYSE: LM  ) Bill Miller, whose Legg Mason Value Trust mutual fund beat the S&P 500 for 15 years straight before lagging an average 10% annually over the past three years.

Like many risks, the way to mitigate manager risk is diversification. Having more than 10% of your investable assets with one manager is probably too much.

Joe Magyer, senior analyst: First, let me just say that there's hardly any punishment that would be too cruel or unusual for Bernie Madoff. Personally, I'd like to see him forced daily to read tales of the ruin he has caused, maybe while being repeatedly kicked by a cadre of unusually cruel oompa-loompas.

That out of the way, investors have two big takeaways from this tragedy. First up: Risk, like the Force, surrounds us. All investments have risk -- especially the ones that look too good to be true.

And that leads to the second takeaway: Diversify. Bernie Madoff managed to fool plenty of pros over the years, pretty well demonstrating that even the savviest among us make mistakes. Running a concentrated portfolio worked for Berkshire Hathaway's (NYSE: BRK-A  ) Warren Buffett, but it has also busted countless investors over time. Diversification is the hands-down best tool you've got with which to protect your savings. So, please, use it!

Anand Chokkavelu, Motley Fool editor: Mark Twain wrote: "Put all your eggs in one basket -- and watch that basket!" Twain is one of my favorite writers, but he was also a notoriously bad investor.

Learn from the heartbreaking stories of the Madoff victims -- no matter how much due diligence you do or how much you think you've vetted management (Madoff ran the Nasdaq Stock Market (Nasdaq: NDAQ  ) , for Pete's sake), make like the Easter Bunny and hide those eggs in many places. A quick real-world example: If you have a hefty portion of your 401(k) in your company's stock, you're betting both your job and your retirement on your company. See Enron for how that can turn out. Or ask employees who scored roughly a 25% (of their highs two years ago) on the General Electric (NYSE: GE  ) Kool-Aid Acid Test.

John Reeves, manager, Motley Fool: It's tempting to say that the investing landscape has changed forever as a result of the Madoff crime. Even the sentence -- 150 years for the 71-year-old former head of Nasdaq Stock Market -- declares that we mean business when it comes to fraud nowadays. No doubt there will be a flurry of activity in the coming weeks at the SEC and FINRA [Financial Industry Regulatory Authority] to make sure this doesn't happen again in the future.

These efforts will be mostly for show, however -- just like the sentence. The SEC is woefully understaffed when it comes to providing adequate oversight, so that's unlikely to change much. And human nature is surprisingly impervious to learning from events like this. One industry professional, quoted in The Financial Times, said recently, that "trust has gone out the window" as a result of this crisis. It's amazing that trust was even in the building after some of the recent financial scandals.

My one takeaway from all of this is that we are on our own when it comes to making sound investing decisions, and we should be very skeptical of those who say they are looking out for us, whether it's the government or a smooth-talking financial advisor. This has always been the case, of course, but like all the good lessons in life, we need to be reminded of it now and again.

For more Madoff madness:

Brian Richards does not own shares of any companies mentioned. Nasdaq, Berkshire, and Legg Mason are Motley Fool Inside Value recommendations. Berkshire is also a Stock Advisor recommendation, as is Hasbro. The Fool owns shares of Berkshire, Hasbro, and Legg Mason. The Motley Fool has a disclosure policy.


Read/Post Comments (19) | Recommend This Article (49)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 29, 2009, at 4:51 PM, TMFOpie wrote:

    << Personally, I'd like to see him forced daily to read tales of the ruin he has caused, maybe while being repeatedly kicked by a cadre of unusually cruel oompa-loompas. >>

    Joe, the oompa-loompas of the first Willy Wonka film scared me as a kid so I couldn't imaged getting kicked by a pack of unusually cruel ones. Brutal.

    150 years in a non-minimal security facility sends a great message to all would be white collar criminals out there, especially those who violate the trust placed in them. That's about the worst thing you can do professionally in this business.

    Fool on,

    Andy

  • Report this Comment On June 29, 2009, at 5:32 PM, plange01 wrote:

    there are still thousands of companys like madoff ran called hedge or trash funds still operating.some better some even worse than him! all of these companys must be forced out of business.....

  • Report this Comment On June 29, 2009, at 5:46 PM, XMFWildjohn999 wrote:

    Is anyone in the SEC getting punished for Madoff's Ponzi scheme? If not what faith does the ordinary investor have in SEC regulations and oversight?

    Both the Washington Post and 60 minutes show that the SEC got plenty of letters and notices of the weirdness happening in Madoff's firm but yet the SEC did nothing:

    http://www.washingtonpost.com/wp-dyn/content/article/2008/12...

    http://www.cbsnews.com/stories/2009/02/27/60minutes/main4833...

  • Report this Comment On June 29, 2009, at 6:24 PM, ARJTurgot wrote:

    It's an old formula: Pride leads to hubris, and hubris calls forth nemesis. So many of the people involved here thought they were special, and I guess they were; special just like everyone else.

    I'm a history student; I find the story here timeless, but one with very few new lessons.

  • Report this Comment On June 29, 2009, at 7:08 PM, jbrt wrote:

    don't think for one minute the traders down on the floor couldn't have suspected something " fishy " all the wjile either . In order for that volume of monies and " supposid securites " they knew . As well as the major brokerages , banks etc. WHO IS KIDDING WHO ? but as long as they were " immune " it was " buisness as usual " , it never changes . The same ol' ... same ol' , in just another scale . Good Luck letting someone else watch YOUR MONIES ! we all know whos mostly concerned on that one .

  • Report this Comment On June 29, 2009, at 7:09 PM, jbrt wrote:

    note the spelling , grammar errors , the entire topic is not worth a minute

  • Report this Comment On June 29, 2009, at 7:42 PM, DGrelle wrote:

    Madoff had more political clout than anyone at the SEC. Even if the SEC had the people and interest in investigating Madoff they would not have been allowed to do it.

    All it takes is a little pressure by a congressman/woman on the right committee. The SEC may have been told that their funding would be cut unless they put their resources elsewhere. It happens to government agencies all the time

  • Report this Comment On June 29, 2009, at 8:27 PM, xetn wrote:

    You people make me sick thinking that some governmental agency is going to protect you from every mistake you make. If you elect to purchase any financial asset with out first doing your homework, then you are to blame, not the fraudster. The biggest fraudster on the planet is the US government which operates a ponzi scheme that is bigger than anything Madoff could have dreamed up: the Social Security system and the FED with its money creation scheme.

    One of the things Fool keeps talking about on article after article is "DO YOUR HOMEWORK". Even then, you will have losses. And while I feel for all of the people that Madoff scammed, they could have hired independent ratings agencies to verify the results of what Madoff was selling, Most were warning of the perils of his scheme. This also applies to the purchaser's of credit swaps, etc which ended up fleecing many of the purchasers, but they could have avoided their losses by using one of the ratings agencies.

    Ask yourselves, if the SEC did nothing to protect you why do you suppose that more regulation and more people hired by the same crew will?

    Probably not.

  • Report this Comment On June 29, 2009, at 8:38 PM, TMFHousel wrote:

    "And while I feel for all of the people that Madoff scammed, they could have hired independent ratings agencies to verify the results of what Madoff was selling, Most were warning of the perils of his scheme."

    Really? The rating agencies knew about Madoff's scheme? Since when?

  • Report this Comment On June 29, 2009, at 8:59 PM, tertertes wrote:

    My guess is that Bernie has an incurable illness, so it doesn't matter to him. No one can convince me that his family is as ignorant as they claim to be. They should all lose every last dime. That money was obtained fraudulently and should be returned. Period! Let his wife and kids be put in the same position of his victims. That would be suffering. Find every last penny that was sent into hiding, and prosecute each person who agreed to cover his butt. She gave up a fur coat? Big deal, how many more does she have.

  • Report this Comment On June 29, 2009, at 10:43 PM, caltex1nomad wrote:

    He's going to have to make a lot of License Plates in 150 years to pay that money back.

  • Report this Comment On June 29, 2009, at 10:47 PM, jesse2159 wrote:

    One good way to stop the financial rip-off's is to sentence the perps to sentences at the Atlanta Federal Prison or Marion Federal Prison, both for the worst of the worst prisoners. Maybe a minimum security prison isn't scary enough.

  • Report this Comment On June 30, 2009, at 7:39 AM, SAMSCREEK wrote:

    I agree with "tertertes". Make the Madoff's poor

    like they did their clients. To me that is a much more viable sentence than 150 years in prison. Let them work for $10 an hour with all of their retirement money lost.

    Between the Madoff's of the world, and greedy CEO's,

    I have lost a lot of faith in the stock market. BUT, I

    am foolish enough to keep investing. I just dig a little deeper in the companies now, before buying. I am 62 years old and what I buy is for the grandkids with a little speculation on the side.......

    Good luck folks.....

  • Report this Comment On June 30, 2009, at 9:16 AM, ArizonaLoon wrote:

    The main tenor of the message the TMF team members are propagating seems to be "Diversify".

    I agree, but...

    "Diversity" doesn't just mean investing in several different companies or funds.

    It also means investing in several different types of asset classes. Yeah, TMF is a stock oriented site and offers a lot of good insight, but we aren't all just stock investors, nor should we be.

    If anything, the last year shows us that if you really want to increase your margin of safety with "diversity", you need to look beyond the stock market and even beyond the country you live in.

    So: Keep your eyes out for different types of investments, from Businesses to Real Estate to Commodities and Foriegn Currency Assets. And for some of us, cash is still a solid part of our portfolio, it's certainly held up better than stocks have over the last few years...

    ciao

    Loon

  • Report this Comment On June 30, 2009, at 10:02 AM, goofycat wrote:

    Investment risks are dicey enough in an honest market, without having to worry about dishonest Ponzi-schemers such as Madoff. As for government schemers, what ever happened to those in Congress who did arm-twisting of the banks to make loans to those who either were too stupid or couldn't read the contracts they signed? What happened to the Freddie Mac and Fannie Mae top dogs who scammed the public? It is apparent to me that no investigation of government or quasi-government agencies has been performed, thus keeping the field of mis-play open for even further scams against the taxpayer.

    Those guys will leave that playing field littered with the broken bodies of folks who never deserved such treatment, and yet those same officials will blithely retire with their fat monthly checks. Nothing will be done because our government is so large and cumbersome that trying to prove fraud by its employees and officials is akin to putting together a mile-square jigsaw puzzle.

  • Report this Comment On June 30, 2009, at 1:08 PM, Colito23 wrote:

    2 Lessons

    1) Hopefully people will understand that proper due diligence should go beyond investing with someone that shares your faith.

    2) The clowns at the SEC are unable or or unwilling to prioritize where the real fraud is in the financial system. They then fall back on the excuse that they are understaffed. Perhaps they are but instead of finding people that actually worked on trading desks they continue to fill there roster with attorney's with no real experience or knowledge of wher fraud is taking place. Let's face it Madoff was given to them years ago on a silver platter!

  • Report this Comment On June 30, 2009, at 2:35 PM, ziq wrote:

    I'm surprised no one on the panel mentioned the SEC, playing Sgt. Schultz when the apparent Ponzi nature of his operation was repeatedly pointed out to them.

    Look all you "government is the problem, not the solution" people: Sure capitalism and markets work--most of the time. There will always be crooks out there ready to game the system. Protecting us from crooks is one of the things government is supposed to be doing. If the police, or the SEC, are on the take, it won't work. It needs to be fixed, not thrown out.

  • Report this Comment On July 03, 2009, at 12:04 PM, atsitaba wrote:

    Diversification IS the first commandment. But it is also purely defensive, no one ever made a fortune by overdiversifying.

  • Report this Comment On July 04, 2009, at 7:38 PM, FuzzySideUp wrote:

    Madoff as head of NASDQ.

    Joe Kennedy as head of the SEC.

    We have had 2 hucksters at the top of the financial world.

    Unfortuantely, only 1 was caught!!!!!

    A firing squad would be too kind for Madoof and his types.

    How could Ruth not have a clue?

    B.S.

    Take everything away forn the old bag.

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