“The Legacy Of Madoff, A Decade Later”
Law360 11/20/18 Nicholas D'Amico
Dec. 11, 2018, shall mark the 10th anniversary of the Madoff Ponzi scheme being revealed to the world via the arrest of the since disgraced financier, Bernie Madoff. The trustee appointed to oversee the liquidation of Bernard L. Madoff Investment Securities continues to pursue, on behalf of customers around the globe, the most far-reaching, historic and successful recovery initiative in American history.
The Madoff scandal has secured its infamous place upon the Mount Rushmore of economic fraud. The collapse of the scheme, in tandem with the subprime housing market debacle and the destruction of Lehman Brothers, spawned a recession unlike anything seen in America since the Great Depression. The U.S. Securities and Exchange Commission Office of Inspector General put out a 477-page self-diagnosis, which investigated and documented "The Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme," along with making numerous, going-forward recommendations. The Dodd-Frank Act was thereafter enacted in large part as the anti-fraud, legislative response to the Madoff scandal. Nearly a decade later, that legislation sits at the heart of a fierce political debate over the proper levels of regulation and oversight needed for the securities and banking industries, as well as whether, and to what extent, the law should create monetary incentives for whistleblowers.
There are many lessons from the Madoff scandal that endure today. Some include: (1) investors must perform their own rigorous due diligence; (2) investors must react and question warning signs or red flags; (3) investors must be skeptical of "exclusivity" investment pitches; and (4) investors must appreciate that there is no such thing as "guaranteed" returns (or its often stated corollary — if something seems too good to be true, it likely is). Notwithstanding these and other lessons, the passage of Dodd-Frank, heightened SEC enforcement in the aftermath of the crisis, and deepened investor and industry awareness of what constitute "red flags," the Ponzi scheme and financial fraud generally continue to thrive, undeterred by frauds from the past. Negative history repeats itself on what seems like a daily basis.
For example, in a recent Florida-heavy fraud, the Woodbridge Group of Companies and the individual owners were charged with bilking over 8,000 retail investors, mostly seniors, out of $1.2 billion through the purchase of unregistered securities, predicated upon bogus loans to third-party commercial property owners. Investors were promised steady returns and were actively discouraged from "cashing out," like in Madoff, during seminars on "conservative retirement and income planning," as well as aggressive radio, television and internet marketing campaigns conducted by individuals not registered as broker-dealers.
Since 2009, economic frauds and Ponzi schemes, large and small, have spanned a diverse range of securities, including Broadway tickets, consumer debt, cryptocurrencies, diamonds and poker. These schemes have targeted a diversity of religious, social and ethnic groups, and the perpetrators have come from all walks of life, including (among many others) athletes, billionaires, coaches and priests.
The exposure to litigation and potentially billions in liability from these schemes extends far beyond just the direct perpetrators. Inevitably, when the house of cards crumbles under the weight of the fraud (due to the absence of new money to fuel the fraud), recovery will be sought from third-party financial institutions, most especially from banks. Theories of liability against "secondary" actors include aiding and abetting the fraud, breach of fiduciary duty, conspiracy, fraudulent transfer, and violations of state blue sky laws.
While the culpability of global banks and other third‑party actors will virtually always be at issue in a fraud, the common numerator and denominator to every scheme are the fraudster and the investor. The investor retains the power, wherewithal, desire and opportunity to "cut off the fraudster’s blood supply." Today's investor is armed with a spate of anti-fraud information, checklists and investor education prompts, as well as their knowledge of a long-standing history of investor fraud and deception in the marketplace. She therefore must not rely solely, or even principally, upon regulators, banks or other service providers in order to protect herself from fraud; rather she must do everything within her control to make sure she is not being duped.
The opportunity for such fraud has also grown quite dramatically since Madoff was arrested. Access to victims across the globe at lightning speed via the internet and other extraordinary technological advances conspires with the marketplace's insatiable appetite for "easy money" investments, to allow financial predators to remain at their exploitative, cunning best. All investors must therefore be more skeptical then ever of any pitch that claims the manager can "always beat" the market, or otherwise deliver "risk-free" returns. An honest, truly innocent investor shall reduce the likelihood of becoming ensnared in a Ponzi scheme, by conducting and properly reacting to meaningful due diligence.
To be sure, such due diligence is far more exacting than simply "googling" an investment manager. It is not simply looking at historical returns, reputations and track records. Surface or "check‑the‑box" due diligence will, as history has repeatedly demonstrated, prove woefully insufficient as a protection against fraud. Investors, their agents and their representative service providers must come to understand many variables before any investment is ever made, or when they are monitoring already existing investments. These variables include (without limitation) an investment manager's operations, the service providers, the disclosed strategy, how that strategy should react to market fluctuation, the reliance on technology to execute the strategy, and any number of other qualitative and quantitative factors.
An extreme illustration may help crystallize the varying levels of diligence one can utilize to try and avoid becoming a victim of investment fraud. Person A alarms her house, locks all the doors, has a guard dog, and keeps valuables and cash in a dead-bolted double safe. Person B leaves her house unlocked, with no alarm, no guard dog, and with all her valuables basically in plain sight, relying solely on the thief to act honorably. If a break-in or theft occurs at either house, the thief is still the thief and is of course responsible for committing the crime. But in the case of Person A, she took reasonable, if not exceptional, measures to reduce the risk of being victimized, whereas Person B did not, even though Person B knows it would be much safer to protect her home and lock valuables away out of plain sight so as to not make it easier to be victimized. Before investors part with any of their money to any strategy or manager, as well as while they are conducting ongoing, monitoring diligence on any of their investments, they should always strive to protect themselves through the highest degree of skepticism, or platinum standard diligence, more akin to Person A than the minimal standard of diligence employed by Person B.
Most importantly, tempting as an investment opportunity may seem, a reasonable investor must always be prepared to pass if that opportunity is touted as one that shall consistently deliver high returns, without meaningful risk of loss, regardless of market conditions. With due respect to Gordon Gekko’s creed that "greed is good," such greed is often what allows a Madoff or other scammer to operate a fraud in plain sight. Investors, banks, financial intermediaries, service providers and other market participants, along with the regulators of the securities industry, all play a role in the legitimacy or lack thereof in securities markets and particularized, investment offerings. If Madoff’s legacy and the many schemes that followed have taught us anything over the last 10 years, it is that none of the market participants can or should stick their head in the proverbial sand.
 Madoff is serving a 150-year sentence.
 As of Sept. 30, 2018, over $13 billion, or more than 75 percent, of the lost principal (estimated to be just under $18 billion) has been recovered. Building the Customer Fund, Madoff Recovery Initiative.
 The $65 billion in "fake profits” and the global nature of the devastation places Madoff at the top of all Securities Frauds See, e.g., Bruce Carton, Madoff Scheme Leads to Host of Problems, Compliance Week (Jan. 13, 2009).
 See Colleen P. Eren, Bernie Madoff and the Crisis: The Public Trial of Capitalism, (1st ed. 2017).
 Report of Investigation, Case No. OIG-509.
 Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 11-203.
 According to Madoff, his crimes "had nothing to do with causing the Financial Crisis [but were] however a direct reflection of the culture of Wall Street and the banking system and hedge funds.” Eren, supra, note 4. Steven Fischman, who interviewed Madoff in prison, believes that "Bernie is the poster child for a world where deregulation is the rule.” Ponzi Super Nova (Oct. 27, 2017). On May 22, 2018, President Donald Trump signed into law the Economic Growth, Regulatory Relief and Consumer Protection Act, partially repealing Dodd-Frank (exempting banks from certain core regulations). See Kelsey Ramizez, President Trump Signs Dodd-Frank Rollback into Law, Housing Wire (May 24, 2018).
 Harry Markopolis presented evidence and pleaded to the SEC that Madoff was running a fraud, but his pleas went unheeded. See Madoff Whistleblower: SEC Failed to Do the Math, NPR (Mar. 2, 2010). As a result, Dodd-Frank established a whistleblower program incentivizing persons to come forward with tips and information that aid in successful enforcement actions and recoveries from alleged fraudsters. See Jason Zuckerman & Matt Stock, One Billion Reasons Why the SEC Whistleblower-Reward Program Is Effective, Forbes (Jul. 18, 2017). Under this program, the SEC has paid over $320 million in awards, including its highest ever in September 2018 with two individuals sharing a nearly $54 million payout. Press Release, SEC Awards More Than $54 Million in Two Whistleblowers (Sept. 6, 2018). The SEC recently proposed amending its whistleblowing program to place limits or caps on awards after certain monetary thresholds. See Francine McKenna, SEC Proposes to Limit Whistleblower Awards, Market Watch (Jun. 28, 2018). During the comments period, there has been a great deal of "it ain’t broke don’t fix it” pushback from the opponents of any such amendments. See id.
 See e.g., Norb Vonnegut, Three Lessons from the Bernie Madoff Scandal, Enterprising Investor (July 26, 2017); William P. Barrett, Lessons from Madoff, Forbes Magazine (Jan. 12, 2009).
 In the year after Madoff was arrested, more than 150 Ponzi schemes collapsed, totaling over $16.5 billion across all 50 states — nearly three and a half times that of 2008. See Busted Ponzi Schemes Quadrupled in 2009, CBS Money Watch (Dec. 28, 2009). By contrast, from 2014 to 2016, the number of uncovered schemes had dropped to an average of 63 schemes. See 2014-2016 Ponzi Scheme List, Ponzitracker. In 2017, SEC enforcement actions as a whole were at their lowest numbers since 2013, with 754 actions — down from its peak of 868 actions in 2016. Press Release, SEC, SEC Enforcement Division Issues Report on Priorities and FY 2017 Results (Nov. 15, 2017).
 "What are some Ponzi schemes ‘red flags’?" SEC, Ponzi Schemes — Frequently Asked Questions (high investment returns with little or no risk; overly consistent returns; unregistered trademarks; unlicensed sellers; secretive and/or complex strategies; issues with paperwork; difficulty receiving payments).
 "It’s long past time to accept that scams are hard-wired in human nature.” Mitchell Zuckoff, A Parade of Ponzis, CNNMoney, (Jan. 28, 2009).
 See Ponzitracker — The Ponzi Scheme Authority, http://www.ponzitracker.com.
 Florida remains one of the "leading” states when it comes to economic fraud and Ponzi schemes. David Allison, Florida No. 1 in 2016 for Fraud Complaints in New Federal Trade Commission Report, Orlando Bus. J. (Mar. 16, 2017) (1,305 fraud complaints per 100,000 people); Doreen Christensen, Florida is the U.S. Scam Capital and Seniors are the Prey, FTC Says, SunSentinel (Mar. 1, 2018) (2.7 million fraud complaints to the FTC in 2017 — highest in the nation; $905 million in reported losses). See, e.g., Press Release, SEC, SEC, Criminal Authorities Halt Florida-Based Ponzi Schemes Targeting Investors Through YouTube Videos(Apr. 8, 2014) (Investors could purchase ATM like virtual concierge machines, "needed to do nothing” in order to make guaranteed returns of 300-500 percent over four years); Press Release, SEC, SEC Charges Sarasota-Based Private Fund Manager With Stealing Investor Money and conducting Ponzi Scheme (solicited $3.8 million from investors, created bogus financial statements, used proceeds to fund his home); U.S. v. Rothstein, Nv. 09-6031 (S.D. Fla 2010) (Scott Rothstein sentenced to 50 years in prison as mastermind of a $1.2 billion Ponzi scheme in Florida).
 See Investor Alert: Ponzi Schemes Targeting Seniors, SEC (Apr. 9, 2018).
 Press Release, SEC, SEC Charges Operators of $1.2 Billion Ponzi Scheme Targeting Main Street Investors (Dec. 21, 2017).
 Bruce Kelly, SEC Charges Five Unlicensed Salespeople in Woodbridge Ponzi, InvestmentNews (Aug. 20, 2018).
 Compare Tom Petters Case Summary, U.S. Dept. of Justice (May 1, 2015) ($3.65 billion Ponzi scheme) with Andy Thompson, Investment Schemes Bilk Unsuspecting Investors in Wisconsin, With Losses in the Millions, Post Crescent (June 3, 2018) (while most people associate schemes with Madoff, smaller scale Ponzi schemes "happen here all the time”).
 See e.g., SEC v. Mell, et al. No. 1:17-rv‑00632 (S.D.N.Y. Jan. 2017) ($81 million Hamilton tickets scheme); SEC v. Merrill, et al. No. 1:18-rv-02844 (D.Md. Sept. 2018) ($360 million scheme involving debt portfolios); U.S. v. Zakavskiy , 2018 WL 4346339 (E.D.N.Y. Sept. 2018) (cryptocurrency is a security subject to criminal prosecution under U.S. securities laws); SEC v. Dalton et al., No. Wis. Civ‑02794 (D. Colo. 2010) ("guaranteed returns" of 48 to 170 percent on purchase of "rough diamonds" from African Nations); U.S. v. Pokerstars et al., No. 1:11-rv-02564-LB) (Sept. 2011) (money laundering and forfeiture complaint for online poker, Ponzi Scheme; $731 million settlement reached).
 See e.g., SEC v. Beachy, No. 11 Civ‑00320 (N.D. Ohio 2011) (Amish Mennonite fraud); SEC v. Management Solutions, Inc., et al., No. 2:11-rv‑01165 (D Utah 2011) (using the Church to gain members trust); SEC v. Newman and Newman Financial Inc., No. 2:17-rv-03142 (C.D. Cal. 2012) (Persian-Jewish community targeted) SEC v. City Capital Corp., et al., No. 12 Civ. 01249 (N.D. Ga. 2012) ("Social Capitalist" touting himself as youngest African‑American CEO, targeting African‑American victims).
 See e.g. Paula McMahon, Ex‑Dolphin Pleads Guilty to Operating Ponzi Scheme Linked to Pro Athletes' Loans, SunSentinel (Sept. 2018); Stephen Montemayor, Ex-Viking Stu Wright Guilty on One Bank Fraud Count, StarTribune (Feb 2016); Ex‑NBA Player Tate George Sentenced to Nine Years, Associated Press (Jan. 2016); SEC v. Honig et al., No. 18TY-08175 (S.D.N.Y. 2018) (South Florida‑based biotech firm and billionaire Phillip Frost charged in stock fraud); Cameron Smith, Former High School Hoops Guard Arrested for Running Madoff Like Ponzi Scheme Yahoo Sports (Dec. 2012); SEC v. Donnan et al., No. 1:12-CV‑02831 (N.D. Ga. 2012) (Hall of Fame coach charged in $80M Ponzi); U.S. v. Sigillito et al., No. 4:11‑FR168 (E.D. Mon. 2008) (Bishop accused of Ponzi scheme).
 Kenneth C. Johnston, Kellie M. Johnson, & Joseph Hummel, Ponzi Schemes and Litigation Risks: What Every Financial Services Company Should Know, 14 N.C. Banking Inst. 29, 34-35 (2010).
 E.g., Silvercreek Mgmt. et al. v. Citigroup Inc. et al. , 2018 WL 4682783 (S.D.N.Y. Sept. 28, 2018) (summary judgment motion by banks denied as to aiding and abetting and conspiracy claims arising out of Enron's 2001 fraud); See Mark Kornfeld & Nicholas D'Amico, Law Alert: Banks' Exposure to the Enron Fraud Lives — Seventeen Years Later (Oct. 11, 2018).
 Johnston, Johnson, & Hummel, supra note 22.
 Mitchell Zuckoff, A Parade of Ponzis, CNN Money (Jan. 22, 2009).
 For example, FINRA BrokerCheck is a free tool to research the backgrounds of current and former FINRA-registered brokerage firms and brokers. Investors can also request a Central Registration Depository System Report from their state's securities regulator. Illustrative but not exhaustive diligence questions from investors might include: (i) Will my assets be housed with an independent third-party custodian? (ii) How does the investment strategy create above market returns? (iii) What is the competitive advantage? (iv) What are the barriers that will lock out competitors so that additional capital and supply does not force returns down to market level? (v) What are the conditions under which this investment will lose money? (vi) What is the worst market environment for this investment strategy? (vii) What assumptions or correlations must remain valid for profits to continue?
 See e.g., Press Release, SEC, SEC Halts $100 Million Real-Estate Based Ponzi Scheme (June 25, 2012) (real estate scam touting "risk free" "guaranteed" returns of 12% per annum with a "perfect record"); Ben James, Accused $413 Million Ponzi Schemer Cosmo Cops Plea (Oct. 29, 2010) (Nicholas Cosmo, known as the "mini-Madoff," promised 99 percent risk free returns in a $45 million Ponzi scheme).
 See Brian Willingham, Tips to Avoid an Investment Fraud or Ponzi, Diligencia Group (June 25, 2010); see also Investing Smart from the Start: Five Questions to Ask Before You Invest, SEC (Dec. 14, 2009); Anthony Giorgianni, 6 Ways to Avoid an Investment Ponzi Scheme, Investopedia (May 17, 2017).
 Wall Street, (20th Century Fox, 1987).
 "I wonder why so many smart people ignored the red flags that signal a fraud. With many schemes to disguise the financial statements of underperforming (or fictional) businesses, there were red flags, but people choose not to see them. They miss the black swans. In fact, they become ostriches by burying their heads in the sand." Nancy B. Rapoport, Black Swans, Ostriches, and Ponzi Schemes, 42 Golden Gate U. L. Rev. 627, 631 (2012).