Lewis Schiff
Lewis Schiff
The Next Case of Madoff Disease
It can affect smart, affluent clients and even professionals educated at top schools. The disease overwhelms a person’s logical powers with golden promises, such as
non-stop 12-percent returns.

August 19, 2010
by Lewis Schiff

Even shrewd clients and professionals are susceptible to Madoff disease — that seemingly inexplicable investment flu that stuns its victims into becoming non-questioning believers despite the warning signs. To spread, a victim doesn’t even need to touch a Madoff directly, just one of his surrogate carriers.

When clients rely on just the word-of-mouth reputations of investment professionals within their social groups, they miss out on the healthy skepticism and due diligence exercised by an advanced planning group. A referral from a successful friend may be a great place to start, but it’s only a start. The next Madoff may offer different trinkets, but the same seductive allure will still infect some with short memories and weak immune systems.

How One Client Lost $30 Million

Mort Zuckerman knows something about financial matters and analysis. He holds substantial real estate (in Boston, New York, Washington and San Francisco), owns media companies (New York Daily News where he is also publisher and U.S. News & World Report where he is also Editor-in-Chief) and pursues large philanthropic endeavors. After receiving an MBA from the Wharton School, he attended Harvard for his LL.M. and stayed on to teach at the Harvard Business School as an associate professor for nine years. By any account, he would be considered a financially sophisticated client, even if he weren’t familiar with particular investment strategies.

In court papers, Zuckerman said his Charitable Remainder Trust invested $25 million in the Ascot fund run by Ezra Merkin, a very-well connected money manager and financier, who also became Chairman of GMAC, the auto and home lender, about the same time. According to the offering documents, Ascot was to take a value investing strategy adopting “a selective approach in evaluating potential investment situations, generally concentrating on relatively fewer transactions that he can follow more closely. [Merkin] is expected to engage in hedging and short sales." The trust paid an annual fee of 1.5 percent, while Merkin also required strong lock-up restrictions on redemptions. The developer and publisher also invested $15 million of personal money with Merkin’s Gabriel Capital fund. In all, he had given $100 million to various Merkin ventures, since he considered him “trusted advisor.”

On December 12, 2008, Zuckerman received two faxes from Merkin. The first one informed him that a substantial amount of the entire $1.8 billion Ascot fund that was invested with Madoff’s company and likely gone. The Trust was out of $30 million. The second revealed that 30 percent of Gabriel Capital was also gone. Between September 2005 and December 2008, Zuckerman and Merkin had spoken several times. “Never once during their numerous meetings and calls did Merkin mention to Zuckerman the name Madoff,” states the complaint.

Zuckerman is not the only experienced investor to be shocked by Merkin’s activities. As it turned out, Merkin was completely entwined with Madoff. New York University has sued Merkin, claiming $24 million in losses, which occurred when he invested the school’s funds with Madoff without prior discussion and even after officials objected. A separate class action suit brought by a group including professional investors claims that Merkin mislead them by stating that Ascot invested in a diverse portfolio of securities.

As chairman of the investment committee of Yeshiva University, Merkin was even able to place $15 million with Ascot, while taking a 1.5 percent annual fee and at the same time he made charitable contributions to the school. In fact, the school could have invested directly with Madoff without paying the fee. Interestingly, Madoff later served on the board as treasurer.

Skeptics Spoke Out

If an investment strategy is brilliantly successful, you would expect others to jump at the opportunity to borrow that brilliance and offer it to their clients. In 2000, Harry Markopolos, CFA, was working at Rampart Investment Management in Boston and his bosses saw the huge returns Madoff was getting with his hedge fund. They asked Markopolos to reverse-engineer the strategy so Ramparts could market its own high-return product. Markopolos took a look at the hedge fund’s performance and immediately became suspicious. “Only four percent of the [fund’s] months were down months,” the reclusive Markopolos told 60 Minutes in one of his rare interviews. “That would be equivalent to a baseball player in the major leagues batting .960 for a year … No one's that good.”

Jack Nash, the former chairman of Oppenheimer & Co. and one of the fathers of the hedge fund, was another early skeptic. In the early 1990s, he had given Madoff money to invest but soon pulled back his investment. He and his son became alarmed after Madoff couldn’t satisfactorily explain his investment strategy when they learned he relied on a one-person accounting firm for auditing. Later however, Nash and his son invested with Merkin’s Gabriel Capital, but didn’t know about the Madoff connection although they told Merkin about their lack of confidence in Madoff, according to the New York State Attorney General’s case against Merkin.

The fact that Markopolos contacted the U.S. Securities and Exchange Commission (SEC) on five separate occasions isn’t as important to advance planning advisors as the giant blinking detour signs that sophisticated and professional investors and mangers of feeder funds ignored. He calculated that Madoff would have needed to purchase more options on the Chicago Boards Option Exchange (CBOE) to execute his trading strategy than actually existed. As a trustee overseeing the liquidation of Madoff’s assets confirmed in 2009, Madoff’s funds hadn’t made any real trades since at least since 1993.

Madoff and Merkin’s Specials Charms

Both Madoff and Merkin took advantage of their considerable skills of persuasion and suggestion that made smart people want to invest with them, even if logic suggested otherwise. Merkin’s talent wasn’t managing money but gathering it for others to invest.

Clients, for example, respond more positively and with satisfaction when conversing with an advisor who mirrors their statements and gestures. This technique has been taught in many training programs for financial advisors as a means of building rapport. In the hands of someone with evil intentions and more polished technical skill, that persuasion can be powerful. Putting aside the SEC’s blunders in monitoring their investment activities, Merkin and Madoff were able to succeed because the psychological tools they applied may have been just too powerful for many talented and smart people to resist. Robert Cialdini, a social psychologist at Arizona State University, has identified six weapons of influence:

1. Reciprocation — By emphasizing the exclusive nature of his client list and focusing in the early years on the interconnected high-net-worth (HNW) and ultra-high-net-worth (UHNW) Jewish community based in New York and Palm Beach, FL, Madoff quickly built up his business with clients so grateful they gave him very large sums to invest.

2. Commitment and Consistency — Once committed to an idea that seems to be working (such as annual statements indicating what purportedly represents a healthy 12-percent return), it’s hard to stop. Confirmation that continues unbeneficial behavior comes in many forms. “With Madoff, the more that people originally invested, the more they continued to invest and the more they invited theirs friends to invest,” observes Mark Goulston, M.D, a business consultant and a clinical psychiatrist, who writes and lectures about communication skills. “This all served to reinforce their believing they had made the best decision to begin with. Finally, this also caused people to overlook or negate any facts to the contrary.”

3. Social Proof — Madoff had two drivers working for him with this type of influence, which depends on people emulating what others are doing. Since he concentrated on a small universe of clients and advisors who to a large extent knew each other, what appeared as successful investing was visible to many. If smart investors found success with Madoff, natural skepticism would recede.

4. Authority — As the former chairman of NASDAQ and a well-known philanthropist with interests similar to many of his clients’ charitable intentions, Madoff embodied authority and apparent understanding of arcane investments and small company potential.

5. Liking — One of the essential talents of most successful salespeople is likeability — whether it’s based on an ability to connect with customers or massage their egos so they feel good about a transaction they shouldn’t.

6. Scarcity — Madoff emphasized the exclusive nature of his services to a small group of connected clients, advisors and feeder funds. Even if his intention was to keep the investor group limited to provide better control and reduce the chance of troublemakers from entering, the effect was the same.


Madoff and Merkin could succeed in part because Cialdini’s weapons of influence are so powerful, observes Goulston. “Applying them causes the other person to feel empathized with and understood. When people feel that way, they lower their guard and lean into the relationship and trust it more. In essence when people really feel that you get where they’re coming from, they’re much more likely to trust you to take them where you’d like them to go.”

Additional Resources:

Forensic and Valuation Services


Bankruptcy & Insolvency: The Forensic Accountant’s Role


Financial Reporting Fraud: A Practical Guide to Detection and Internal Control


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Lewis Schiff is a senior managing principal of Advanced Planning Group, a family office network for advisors.