Madoff's Victim, And His Enablers

Last week in The Big Money I wrote about why, given the precedent set by the last big hedge fund fraud, investors who noticed that something seemed suspicious about Madoff and reported it would have been likely to be rewarded by losing their shirts . One reader, Debbie Reches, took me to task for justifying a corrupt, look out for yourself mentality of Wall Street. She wrote me an email:

In the regular world, if someone is aware of a crime or fraud being committed it is expected that they will report it. Yet in the case of these investors, the question becomes, "How can anybody be expected to report on an illegal activity, inknowing it might cost them money?" Better to just ignore the whole thing and hope it goes away. Really? I don't think so. saying that people who suspect something have no choice but to keep quiet shows an entitlement mentality that needs to go.

The last thing I wanted to do, however, was to justify the action of funds like Tremont and Fairfield that seem to have done their level best not to find anything wrong. I have a ton of sympathy for ordinary investors--including very rich ones--who lost money with Madoff, but those guys may well turn out to be little better than silent co-conspirators. However, regardless of what kind of investor we're talking about, I think that you have to separate the ethical question of when a fraud should be reported from the practical question of how to maximize the chances that frauds actually will be reported.

If investors who pull their money out of a scheme like Madoff's and then report it to the SEC wind up being told that they then have to give back what they recovered and share it with other people who were ripped off, the reality is that they simply will not go to the SEC. That just doesn't work. There's no easy solution here, but my impulse is to err on the side of a system that encourages rather than penalizes reporting, while still keeping lucky early investors in a Ponzi scheme get windfall profits.

That said, the theorizing here may turn out to be moot. The question right now is just how entangled Tremont and Fairfield, which essentially marketed Madoff's services, will turn out to be in all this. I'm with Donald Trump on this one: you don't pull off a fraud like this alone. (And I second Trump's suspicions that the sons weren't as clueless as they claim. The Donald's a blowhard, but I imagine that decades in New York and Atlantic City real estate make you pretty good at recognizing the smell of bullshit.)