What SBF and Bernie Madoff can teach you when it comes to hiring an investment manager.
The high-profile implosion of FTX and the former billionaire founder Sam Bankman-Fried (SBF) is just the latest high-profile financial fraud. Eerily similar to the Bernie Madoff Ponzi scheme, both cons used a cult of personality and high-profile connections to fool regulators and bilk sophisticated investors out of billions. We’re going to discuss the pitfalls first, and then how you can avoid them.
Click here to watch my previous Live on YouTube on this topic!
SBF & FTX
Sam Bankman-Fried, founder of FTX, one of the world’s largest crypto exchanges, was recently convicted of fraud, conspiracy, and money laundering. There are countless threads of scandal intertwined with his scheme; over $10 billion in customer funds were illegally taken to fund SBF’s luxury lifestyle and make political donations. Funds were also used to finance elaborate advertising campaigns designed to entice new investors.
This story raises the question of how someone so deeply unimpressive could successfully scam billions of sophisticated investors involved in the crypto world. As Vox describes him:
The media portrayed him as an unassuming, nerdy savant, frequently noting his down-to-earthness, his messy mop of hair, his penchant for wearing T-shirts and shorts, his Toyota Corolla. Investors were enamored of the fact that he wasn’t a buttoned-up entrepreneur; he played computer games during pitch meetings, and like other modern-day founders, his eccentricities were taken as proof of his distinct genius.
Bernie Madoff
Prior to SBF and FTX, Bernie Madoff perpetrated the most high-profile private financial scandal. Looking back at his story, his deception seems so obvious it’s hard to believe he was able to fool people for as long as he did. I highly recommend the docuseries “MADOFF: The Monster of Wall Street” on Netflix. Very entertaining; not only do you have the intrigue about how someone could have bilked investors out of more than $20 billion dollars, but it also does a great job of reminding you of the historical backdrop in the decades his Ponzi scheme took place.
As with SBF, Madoff had a very quirky approach. Though, rather than embrace the “devil may care” attitude SBF played up, Madoff had a more obviously unstable personality. He avoided making eye contact, lived a lavish lifestyle, and would burst into anger regularly. But setting aside Madoff’s personality defects, the biggest takeaway that should terrify investors is that not only did the regulators investigate Madoff more than three times—each time declaring him legitimate—he also convinced large institutions like hedge funds and banks, who managed money on behalf of clients and pension funds, to invest in his scheme. Everyone involved had a fiduciary duty—and none of them kept it. Madoff himself was at one time part of the regulatory body creating the industry rules he was breaking.
Scammers & Their Universal Strategy
Both Bernie Madoff and SBF used a cult of personality and high-profile connections to fool regulators and bilk sophisticated investors out of billions.
Personality Defects & Claims of a Special Genius
SBF cultivated rudeness, crassness, and mimicking a low-class lifestyle all while flaunting his billionaire status. Somehow he managed to make it seem like he possessed a special investing genius, even while showing up to meetings looking like a hobo and playing computer games during the pitch. I suppose if someone is this brazenly rude while asking you for an investment—it’s hard not to conclude he must have something special that allows him to act like a reprobate.
Madoff, by contrast, lead with his status and wealth and made claims of a proprietary investment style that was simply too complicated to explain to wealthy, sophisticated investors and institutions.
High Profile Connections Fool Regulators & New Investors
Both conmen were able to find new victims because they are assisted or protected by high-powered people and/or regulators—who were also fooled by the fraudulent scheme.
In the case of SBF, he cosplayed himself into being viewed as so genius he should not be questioned. But also helpful was the countless famous investors who touted his genius—Tom Brady and Gisele Bundchen, Stephen Curry, Larry David, Kevin O’Leary, the list goes on. These high-profile investors promoted his scam through social media posts and even a Super Bowl commercial in the case of Larry David. Most shocking among those is Kevin O’Leary, who holds himself out as a successful entrepreneur and financier on Shark Tank. It is hard for the public to identify a fraud when someone so seemingly well-versed in the investment sphere is touting a complete scam.
Avoiding these Scams & Protecting Your Investments
It is important to remember that if con artists can scam supposedly sophisticated high-powered people with high levels of access to the halls of power, they can most certainly fool the rest of us just trying to build a nice life for ourselves.
So here are some ways to protect yourself and escape involvement in financial scams that could cost you everything. This list is certainly not exhaustive, as would-be scammers will go to great lengths, oftentimes fooling even the regulators, BUT, this list gives some guidance on how to protect yourself.
Know Where You Money Is
You should not be giving a money manager direct access to your account. Instead, your funds should be in your name and housed at a custodian. A custodian is a financial institution that holds customers’ securities for safekeeping to prevent them from being stolen or lost. Custodians tend to be large, reputable firms such as banks. Some well-known custodians are: Bank of New York (BNY) Mellon, Pershing, JPMorgan Chase, Schwab, or T.D. Ameritrade. (This list is not intended as an endorsement of any of these companies. There are plenty of other reputable custodians, but be sure to do your due diligence.)
Unfortunately, in the case of Bernie Madoff, even J.P. Morgan was implicated as a custodian and paid more than $2 billion in fines and penalties to settle allegations that they turned a blind eye to Madoff’s scam.1 So again, make sure to take precautions and ask questions—even these large institutions were complicit in some cases.
Understand the Investment Strategy
Investing successfully does not require a top-secret decoder ring, nor is it reinventing the wheel. New strategies are not being developed and implemented each day or week. In the case of FTX, because it sold crypto investments, likely they were able to get away with claiming new strategies made sense, as the asset class itself is relatively new. However, no matter what the investment—new, old, or refurbished—time and time again the single strategy that works consistently is to buy and hold and grow your money with the market. If there is another strategy being proposed (and not explained), this is a red flag.
Let me be blunt: there is no special insight, genius, or strategy. No one knows what the market will do tomorrow or next year. Sure, we can follow trends and maybe get lucky, but ask yourself, if they knew—why do they still work for a living?
Complexity Does Not Indicate Breadth of Knowledge
Madoff not only refused to explain his strategy when questioned, but claimed it was simply too complex for another person to understand. When he was questioned by regulators he claimed it was proprietary and thus, could not be revealed. In the end, it turned out he was claiming such complexities existed to hide what was the most basic robbery—robbing Peter to pay Paul.
Conveniently, SBF also “specialized” in complex investments such as derivatives and leveraged products related to cryptocurrency. By specialize he really meant he was using complexity to cover up simply using their clients’ funds as a piggy bank.
Unfortunately, sometimes when clients ask me for a second opinion on a portfolio crafted by another planner, I often see complexity built in by managers as a means of “proving” their worth. At the end of the day, if your investment advisor cannot easily explain to you what your portfolio is holding and why the returns are as they are, it’s time to move on.
Historical Returns & Your Returns Should Reflect the Broader Market
Bernie Madoff claimed to make great returns consistently, even during periods of down markets. With the exception of a lucky stock pick, which I compare to betting on the right horse at the track, an investment manager will not beat the market and certainly not consistently. If he or she is claiming some clairvoyance that the rest of the market does not have, something is not right.
An investment manager discussing your portfolio with you must open and honest about how it is expected to perform in up and down markets. You should also understand investment growth requires various levels of risk—and is always subject to down cycles of the market.
Do not let these scammers make you fearful of hiring professionals to help you invest. Instead, learn the lessons these cases offer—and before investing ask yourself if something seems off, if there is a lot of complexity, or if the person selling you a service has some personality defect that most normal professionals do not possess. Most importantly, have a realistic attitude to investing—slow and steady and do your due diligence when it comes to where you put your money.