Strategy

Why Bernie went bad

How does a financial industry giant like Bernard Madoff turn out to be a crook?

When Bernard Madoff was arrested last week for swindling billions of dollars from high-profile investors, most in the financial industry were dumbfounded. Some were shocked that his hedge fund operation was actually a $50 billion Ponzi scheme, while others stared wide-eyed at his list of investors ? Steven Spielberg, New York Mets owner Fred Wilpon and even the Bank of Scotland all lost huge amounts of money. But what might be the hardest part of this story to swallow is how a seemingly well-rounded and respected businessman ? he was once chairman of NASDAQ and gave millions to Jewish charities ? turned out to be nothing more than a crook.

The story of the charming, powerful professional-turned-alleged criminal is all too familiar these days ? think now-disgraced Illinois governor Rod Blagojevich or Enron’s Kenneth Lay. While it’s no longer surprising to see the mighty fall, these cases still beg the question: how does someone who seems like a good and honourable person wind up doing such insidious things?

“That’s very difficult to answer,” says Phillip Slayton, the Toronto-based author of Lawyers Gone Bad . “In some cases the person involved has some pathological condition, but the desire for money can also go beyond what a normal working person can earn.”

If anything, Slayton adds, the jet-setting financial industry giant was addicted to power and prestige. “Everyone wanted to place money with Madoff and everyone wanted to meet him. That has to have a lot of allure to a person.”

Greed, not need

Robert Gordon, director of Simon Fraser University’s criminology department, says that while it’s hard to generalize people’s behaviours, Madoff and others like him have a lot in common with embezzlers.

He explains that “need is not a factor,” when it comes to embezzlement, but rather greed. Throw in an overabundance of confidence and you have a recipe for criminal activity. “With these two motivating factors you can see how someone would plunge headlong into forms of behaviour that, quiet clearly, would lead to reasonably high levels of detection,” says Gordon.

Madoff, however, wasn’t detected for years. He started his company, Bernard Madoff Investment Securities, in 1960, and while it’s unclear how long he was allegedly defrauding investors, it’s safe to assume it was going on for a number of years.

Gordon points out that embezzlers often get so enthralled by their wheeling and dealing prowess that it becomes difficult to quit. “They aren’t able to calculate the risks, or they fail to see the increasing risks they’re facing,” he says. “Those who do get away with it are the people who take the money and run, though they run in a very elegant way and usually raise no suspicion when they pull out.”

Whether Madoff originally intended to set out to defraud investors is still up for debate. But cases like this usually start out in increments, with a person taking a small amount of cash from one place to pay off something else. The person might intend to pay back what they’re borrowing, but after taking cash from client A to pay off client B one too many times, it becomes impossible to recover. “Fraudsters often say, ‘I’ll fix this next month,’ but they never do,” says Slayton. “They start off small to cover up that mistake and before they know it they’re completely out of control.”

Madoff’s story goes beyond the simple, in-over-his-head narrative, however. He was able to operate virtually undetected thanks to a weak regulatory system and the adulation of his friends, co-workers and community. His impressive CV ? he helped start NASDAQ and he was chairman of New York’s Yeshiva University’s business school ? gave off an aura of authority that helped him climb higher and higher up the corporate ladder.

“When people look at someone’s résumé and see something good they think, ‘He must be a fine fellow, so let’s make him chairman of this,'” Slayton explains. “The next one comes along and says, ‘Look at this, he must be a wonderful guy so let’s make him chairman of something else.’ It’s sort of a prescreening thing â?? someone else has already said he’s OK.”

Inept regulation

Laureen Snider, a professor in Queen’s University’s sociology department, doesn’t subscribe to the idea that corporate criminals have a psychological defect; she says they rarely set out to steal. It’s the inept regulatory system, rather, that’s to blame. “Regulators find it very difficult to reign in the most powerful and privileged people in society,” she says. “The worshiping of the rich, and those deemed willing to take risks in order to maximize gains, are cultural heroes.”

It’s also hard to accuse someone of wrongdoing if other wealthy people are making money thanks to their investment manager, so the crime continues. “It’s the whole business of looking a gift horse in the mouth,” says Snider. “Given the track record of success, people who were investing with him had no motivation to question him. And hedge funds are essentially unregulated so no one was keeping an eye on him.”

With a poor regulatory system and a floundering economy, investors shouldn’t be surprised if another one of their investment heroes turns out to be a fraud. It’s when times are tough, and people need their cash, that these underhanded schemes have a way of coming to light. “It’s almost inevitable in this environment where you have people who are celebrated for being risk takers in a mostly unregulated environment,” says Snider. “We might not see something on the same magnitude as Madoff, but more scams will be uncovered.”