Bernard Madoff’s Madoff Securities lost $50 Billion in an apparent Ponzi scheme.
You can read about the details anywhere—try the Wall Street Journal, for example. But the details don’t answer one question.
How? How could some of the world’s supposedly smartest investors—hedge funds–have been hoodwinked by something that, in the rear view mirror, was a blatant scam?
The answer reveals a common myth about trust in business. The myth is that good businesspeople make rational decisions about trust.
They often don’t. And in the rush for “best practices,” many “good businesspeople” shortchange commonsense for wishful thinking.
I have written about the Trust Equation: the trustworthiness of an individual can be expressed as a function of credibility, reliability, intimacy, and other-orientation. Someone who rates highly on these dimensions, as seen by others, is trustworthy.
But a con man is as good as the gullibility of those who want to believe him. Let’s examine the trust equation point by point.
1. Credibility: the man was the former Chairman of Nasdaq, and remains on their nominating committee. He is known as a leader in the industry. And his own website says he has "a personal interest in maintaining the unblemished record of value, fair-dealing, and high ethical standards that has always been the firm’s hallmark."
Never mind there were complaints to the SEC, questioning articles in Barron’s, unavailable data, and a one-man accounting firm of record. Don’t wanna go there, uh uh.
2. Reliability: the man had a multi-year track record of over-market returns. Regular. Dependable.
Never mind that he lacked the data, or explanations, to back up just why those returns were so steady.
3. Intimacy. Many people knew him personally; he was a regular at toney golf clubs in Palm Beach and Boca Raton.
In language we usually hear about mass murderers, acquaintance Jon Najarian said, “He always seemed to be a straight shooter. I was shocked by this news.”
And in classic Big Brother language, his lawyer stated—after Madoff’s apparent confession to operating a Ponzi scheme—stated “he’s a person of integrity.” And I’m the Pope.
Never mind that “intimacy” may be the easiest factor of the four in the trust equation to fake. It’s probably the favorite factor of con men.
4. Self-orientation. Clearly his customers thought he was generous, a regular attendee of the Red Cross Ball, a desirable acquaintance by virtue of his willingness to share advice.
Never mind his broker-dealer business model was under-powered to take advantage of his supposed insights, casting doubt on his motives. Conflicts of interest were present in the situation of a funds manager using a related broker-dealer.
Trust is a funny thing. Trustworthiness can be analyzed. But it often isn’t. Which means trust is as much about the one doing the trusting as the one being trusted.
In the days to come, the absence of regulatory action will be rightly noted. Where was the SEC?
But at the same time, let’s not forget the willingness of the sheep to be fleeced.
If it looks too good to be true, it is.
There’s no such thing as a free lunch.
An emperor without clothes is just a naked man.
We know that untrustworthy people are often greedy. We can protect against that to some extent.
It’s harder to legislate against greed and willful stupidity on the part of those doing the trusting.
When commonsense takes a back seat to greed, it’s a con-man’s market.