Madoff vs. Jones: Differences and Similarities

The fraudulent investment schemes by Madoff and Jones may be found to be similar in many ways, but there is one way in which they differ: the difference in wealth of the victims. This is apparent from the the 1000-to-1 ratio of Madoff's take ($65B) to that of Jones ($50-100M), and from the stories of the victims. It is therefore understandable that sentiment toward the victims, while generally well-meaning in both cases, seems more positive toward Jones' victims. Since they are closer in wealth and situation to most people, it is easier to identify with them. Like them, we similarly feel a sense of confusion when it comes to barely-comprehensible financial instrument in which we are directed toward by banks and financial advisors.

Yet when it comes to Madoff's victims the general sense is that, since they are mostly wealthy individuals, we imagine they would be more savvy when it comes to investing. There is an undercurrent in the media stories and in casual conversations that they should have known better. This is what I'd like to look at in this post: do the wealthy know more than about making good investing decisions than the general population?

Let's start with a hypothetical situation... Congratulations! You've just won $5,000,000 in the lottery. Well that's wonderful news and oh so fortunate for you. After the back slaps and hubbub die down you have to decide what to do with all that money. You could just dump it into a savings account and withdraw from it as needed. Then apart from rewriting your will and some other necessary steps you can be done with it and go on with your now more-comfortable life.

Except this is not what you will do. You will be encouraged by those around you to invest the money, to put it to work and make even more money. This all sounds reasonable since, after all, interest rates are pathetically low. There is also in most of us a seed of benign greed; no matter how much we have, most people will always want more. Getting into the investing game is therefore a near certainty despite your ability to live your life to the fullest by simply drawing on that initial capital windfall. It should also be said that you will be gently nagged by those closest to you to grow the wealth since they hope to benefit from it in various ways. The advice will be well-meaning, yet the pressure will build on you invest the money to best effect.

What will you do? You've never had a need to do more than buy into GICs or mutual funds for your RRSP. That seemed sufficient for your long-term objectives, and also provided the perspective to ride out some brutal market volatility like what we're currently experiencing. However you can't put $5M in your RRSP, so you will have to deal with capital gains and losses, equities and other cash investments. You are beginning to wake up to the possibilities of new ways to invest. You will also recognize that you need help.

Like most people you will ask those around you for recommendations on trustworthy and competent financial advisors. You are likely to trust those whom you are directed by those you already trust. They will tell you of the great results they've had and their advisor's qualities as a person, or even as a family friend. You arrange to meet that person and you are impressed. Few of the investment instruments he mentions are comprehensible to one unschooled in these arcane financial matters, but you like the guy and your relatives and closest friends have nothing but good to say about him. So you give him your money and let him take care of things after some discussion of your personal and family needs. He will even connect you with other professionals, including accountants and lawyers, so that makes things even easier. With that one step all the unfamiliar worries of great wealth are taken care of; you can breathe easier.

In the unfortunate case that the advisor's name is Madoff or Jones, you are lost. As lost as are all those who honestly and passionately made that recommendations to you. You are the victim of a classic con game, albeit on a grander stage and of an unusually long duration.

It may not be too surprising that the average person could fall into Jones' clutches, but surely not those that fall within Madoff's sphere! Yet it is the same. My point is that having money does not magically confer insights into all matters financial. It is much like driving a car and having only the vaguest notion of what electronic fuel injection does. My hypothetical example was meant to illustrate this - many wealthy people are just like you and me, and are susceptible to the same ploy. Except for the few who have been raised within wealthy families or made their wealth in the financial industry, wealthy people are little better prepared to make serious investment decisions than a lottery winner. They go through the same process of soliciting recommendations on who to entrust with their money.

Madoff's scheme differed from Jones' to cater to the targeted victims. The financial instruments were purported to only work for large sums in aggregate; a network of accomplices, both innocent and complicit, provided the reach to a larger network of the wealthy, and; an air of exclusivity was constructed by advertising a false scarcity - that it was difficult to be approved to invest in Madoff's funds. Beyond that the ploy was much the same: draw in the financially-unsophisticated with a carefully-constructed network of trust.

Their Ponzi schemes were bound to fail, as all must fail eventually, so it is hard to know how they might have envisioned avoiding disaster in the end. For those stories we'll have to wait.