The Corporate Observer : Washington D.C. Class Action Lawyer & Attorney : Steven Berk Law Firm : Consumer Protection, Corporate Abuse : The Corporate Observer Blog

It is time to return the term 'Ponzi scheme' to the microfiche headlines of the 1920s where it belongs.  To do so, regulators must start regulating and courts must start finding banks liable.

Over the past year or so, the term “Ponzi scheme” has sadly become as common as “Let’s have lunch” or “Text me.”  Yes, these schemes are emblematic of good old greed and the over-exuberance and blind optimism seen in all markets, but they also illustrate a serious failure in our banking system.  With leading reputable banks at their side, Ponzi schemes have the means to grow, metastasize, and take hard-earned (often retirement) monies from hundreds of thousands of victims.  Change needs to come in the form of enhanced regulation and the courts’ willingness to hold banks accountable.

One notable example is the case of an online Ponzi scheme called ADSURF.  Participants in this scheme were told in compelling YouTube videos, religious-type rallies, and internet ads that they could earn money by simply surfing the web.  When it sounds too good to be true, it is too good to be true.  All ADSURF was doing was recruiting new participants to pay into the scheme; this allowed the organizers to profit wildly while the unlucky newcomers got left holding the bag—just like all good Ponzi schemes.  

Contrary to core compliance requirements recently expanded and tightened in response to funding made available to the 9/11 terrorists, Bank of America placed itself at the heart of the ADSURF Ponzi scheme.  With the help of Bank of America, the ADSURF scheme went on to victimize over 100,000 participants who lost hundreds of millions of dollars.  Bank of America was privy to a slew of information that inexorably led to the conclusion that ADSURF was one big scam:

*         ADSURF was the brainchild of Thomas Bowdoin, a convicted felon with a history of securities fraud violations and failed business ventures.

*          ADSURF sold no products or services, held no intellectual property rights, and had no successful business professionals in management or on its Board.

*          ADSURF had no colorable, legitimate means to produce the massive profits (365% per year) Bowdoin and his co-conspirators promised investors.

*          ADSURF also lacked the means to legally generate the tens of millions of dollars a month flooding its tiny office—a former floral shop—in the small town of Quincy, Florida.

While unthinkable just a few years ago that one of the nation’s largest and most respected financial institutions could act so irresponsibly, their conduct is sadly consistent with a range of lax business practices.  A corporate culture that placed increased profits, seven-figure bonuses, and a higher stock price above sound banking judgment—this is the same culture that caused the Bank’s near-failure last fall (requiring a $45 billion dollar federal bailout because they were deemed “too big to fail”).

It is time to return the term “Ponzi scheme” to the microfiche headlines of the 1920s where it belongs.  To do so, regulators must start regulating and courts must start finding banks liable for knowingly assisting Ponzi schemes and other obvious fraudulent schemes.

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As harsh as it was, the Madoff sentence does virtually nothing to protect investors on Main Street.  What will?  Cleaning up the banks is a good start.

By now it’s old news: Bernard Madoff sentenced to 150 years in jail.  While news agencies and pundits debate ad nausea the deterrent effect and importance of this “symbolic sentence” (with good behavior Mr. Madoff will be released when he is 221 years old), a critical issue remains out of the public glare.  What about the bank Madoff and company used to support the largest and longest-running Ponzi scheme in history?  Remember that Madoff’s scheme relied upon him not buying any securities for his money management clients for over two decades.  Let me say it again, Madoff did not buy any securities for his clients since 1986.

So what did he do with the billions flowing in from feeder funds and a worldwide network of well-heeled promoters from around the world?  The simple answer is he put the money in the bank.  Not just any bank, but one of the world’s largest and most respected financial institutions: JPMorgan Chase.  Month after month, year after year, Madoff deposited billions.  Surely if he was running a legitimate money management firm those deposits would have been a mere fraction of that amount.  Why?  Because the money would be needed to buy securities and stocks for investors.  But he never bought those securities or stocks.  Statements given to his clients were no more real than a romance novel.  The stocks and bonds listed were never purchased, held or traded.  It was all a big lie.

Did JPMorgan Chase ever hush a word of this to the SEC or other regulators?  Did anyone say “this ain’t right”?  Probably not—the bank had huge accounts to service and there was plenty of money to be made.  Despite strict regulations placed on JPMorgan Chase by the Patriot Act, Anti-Money Laundering Act and Bank Secrecy requirements to be on the lookout for suspicious activity, the beat went on until the music finally stopped.

As harsh as it was, the Madoff sentence does virtually nothing to protect investors on Main Street.  What will?  Cleaning up the banks is a good start.  Empowering regulators, prosecutors and private attorneys to go after the banks is a good start.  Because without the banks' complicity, Madoff would have had no ability to take in billions every year.  Even he could not have gotten away with accepting cash or banking at anything less than a large money center bank.  Unless we clean up the banks, the chances are good, indeed certain, that we will see many more Ponzi schemes blossom before Mr. Madoff hobbles out of jail at the ripe old age of 221.

(Post was prepared with the assistance of David Martin, University of North Carolina 2010)

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"A novel in quarterly installments"

I recently had the opportunity to review one of the quarterly statements Madoff sent regularly to victims of his odious crime.  They are rather chilling: 

• You begin from the top with those addresses: very legitimate: just off Wall Street and London’s exclusive Mayfair neighborhood; but as you go down the page it gets even more interesting.
• Exact stocks are listed, good blue chip companies, Coca Cola, Hewlett Packard, ExxonMobil (household names) with precise shares and values.
•  You then see those Treasury Bills and a purported transfer (transfer numbers included) between long and short positions in stocks to bonds. Truing up at the end of the month in some elegant cosmic unified theory (he touted as a “split strike or conversion strategy used no less to “reduce risk”).
•  No penny stocks, middle market unknowns, or exotic derivatives or futures on Manchurian sawdust.
• All the numbers add up – or so they seem

But it was all a fiction, “a novel in quarterly installments”. According to the court appointed receiver, Madoff hadn’t purchased a security since 1992. These statements were written, devised and distributed to deceive. They did so masterfully; month after month, year after year.  In many cases they were sent to sophisticated investors.  But when you are winning it's only natural to congratulate yourself and not look too hard for problems (“I’m invested with Madoff and I’m making money”). It’s like a poker player who wins three or four hands in a row; it’s not luck or someone feeding him the cards – no it's skill, experience and pure gravitas.

My first reaction to seeing these statements was this could hardly be the work of one man. Surely not a 70 year old man without computer training who likely couldn’t program his cell phone; maybe a computer geek – extraordinaire (think Napster in Italian Job), but that’s only possible in the movies (poor Steven Spielberg, prominent Madoff investor).

No it had to have taken the work of a small – very loyal – cadre of confederates at many levels (heck Danny Ocean needed 11 to steal $150 million). These detailed quarterly statements, tell me it was the work of an IT department and many more generating these lies of a comfortable retirement and money enough for generations. You’d think years ago – someone would have cracked and spilled the beans.

But my overriding reaction to seeing those statements (besides empathy for my client) was how true? how accurate? is my own brokerage or IRA statement? Do the stocks listed really exist somewhere and what if I need the cash one day – that day. In fact, how many statements are true?

You’d think the SEC, with its expertise and subpoena power could have asked to see a few of those “transfers” or verify all those purchases detailed in Madoff’s quarterly novellas. And what about the third party custodians controlling at least 1000 IRA accounts invested with Madoff? They surely never checked the basics: custody.  Where were these t-bills and stock certificates listed on those statements? Who had custody? One simple audit would have unraveled this house of cards.

We have long been in an electronic age with trillions of securities transactions daily. Investment houses and banks don’t have to have stock certificates in a big old vault (like the one visited by Harry Potter before heading off to Hogwarts) – but we have the technology to check, to verify, to audit, to ask the right questions, to design the right software to ferret out fraud.   We need to use it.

Why not use some of those stimulus dollars to improve technology, coupled with stricter compliance regulations at the state and federal level. Private rights of action that hold banks, custodians and anyone allowed who is entrusted with someone else’s assets accountable are also key. Finally, courts must judge these entities as fiduciaries – requiring them to exercise the highest duty recognized by law.

Creating those protections will not eliminate the next Madoff, but it might just reduce the number and size of future schemes. We will always have swindlers but we must do everything possible to reduce the sheer volume of these schemes, making less likely the enormity of pain and ruined lives Madoff and his confederates left in their wake.

Finally, more protection for all investors will create a higher level of confidence: critical to getting Main Street back into the markets and the financial system back on its feet.        

* Steven Berk is currently co-lead counsel against FiServ and other entities that served as the exclusive third party IRA custodian for Madoff Securities.

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