Academic

The Madoff Victims: What Do Victims of Financial Services Fraud Do?

By Gordon Smith, Christine, Hurt, Vic Fleischer, Fred Tung, Lisa Fairfax, David Zaring

So, in preparing to talk about Bernard Madoff's fraud last night, I read many accounts of the victims' claims against him.  Of course, the interesting distinction comes between the principal that his victims entrusted to him to invest in securities and the principal amounts listed on the account statements given to the victims.  Because there was no investing going on for decades, there is a vast disparity between the losses depending on calculation.  If the victims "lost" only the principal they sent to Madoff, then the loss may be around $65 billion; if the victims "lost" the money they were told that they had earned with Madoff, then the loss may be around $170 billion.  Either way, we are talking B-B-Billions.  I feel like I'm in an Austin Powers movie.

One issue that we don't talk a lot about in securities fraud is the role that the Securities Investor Protection Corporation is playing in the restitution to the Madoff victims.  The SIPC is a member-funded pool that restores investor funds up to $500,000 in the event of financial firm fraud.  I've never mentioned SIPC in Securities Regulation before because it does not "insure" brokerage accounts like the FDIC insures bank deposits.  In the event of issuer fraud, the SIPC has no role.  In the event of issuer failure or market downturn, the SIPC plays no role.  The SIPC does not insure against investment risk -- only fraud of a financial services firm -- when client funds go missing.  Now, half a million dollars sounds like a lot to most investors who use financial services firms to manage rollover IRAs, 529 plans, Roth IRAs, etc., but to the Madoff investors that lost millions and millions, SIPC seems to be cold comfort.

However, financial services fraud seems to be the prosecution du jour.  For example, last week the SEC charged John Donnelly of Charlottesville with bilking 33 clients out of $11 million dollars entrusted to him for financial management.  One type of securities fraud that we don't emphasize is that of financial management fraud.  With so many people turning to the services of financial advisors to manage rollover IRAs, inheritances, etc., most investors don't have a lot of tools to assess the creditworthiness or profitworthiness of these advisors, some of whom work independently.  We emphasize "diversifying your portfolio," but if your diverse portfolio is with one untrustworthy financial advisor, it doesn't do much good.

Full post as published by Conglomerate on March 16, 2009 (boomark / email).