"I Made a Terrible Mistake...!"

This is what Bernard L. Madoff said when he was sentenced to 150 years imprisonment. His self delusion must have been infectious because the list of other players who also made terrible mistakes in this epic financial tragedy grows longer each day. The recent report by Inspector General David Kotz into the investigation of the SEC’s failure to uncover Bernard Madoff’s Ponzi scheme shows that, between June 1992 and December 2008 when Madoff was arrested, the SEC received six substantive complaints which, if properly pursued, would likely have led to questions about whether Madoff was actually engaged in trading. Ignoring the complaints or being inept in their investigations, the SEC’s failures not only permitted the fraud to be perpetuated for 16 years, but gave Madoff the opportunity to enhance his credibility by boasting that the SEC had conducted examinations and investigations and did not detect fraud! What a series of terrible mistakes!

But using euphemism to describe criminal or negligent conduct as a “terrible mistake” minimizes the genuine mistakes made by others, including, it must be said, those made by the victims of the fraud. Indeed, one could say that there are no victims, only volunteers. While this will attract howls of derision, the truth is that Madoff victims fall into two volunteer categories: those who did not belong in a fund that relied on a split strike conversion strategy, the bedrock of Madoff’s allure, and those who should have known better.

We live in a tough world where fairness is seen with the frequency of a halo and, yes, while there are institutions like the SEC intended to protect us, they sometimes fail, as we now know. So, we must recognize that we have a choice when we invest, and that it is an individual’s responsibility to make that choice prudently. Prudent Investment Rule number 1: if you don’t understand how your money is put to work, don’t invest. Prudent Investment Rule number 2: if it sounds too good to be true, the racing certainty is that it’s untrue.

Today, anyone who has accumulated savings knows that there are many investment vehicles to help make one’s money grow. Traditional investments such as stocks, bonds, mutual funds, bank deposits and annuities offer the opportunity for diversification and risk and return management, even before considering more complex vehicles. But a split strike conversion strategy? Come on, who’s kidding whom? For an unsophisticated investor, that’s a terrible mistake! It’s a strategy that involves writing an out-of-the-money call around a stock you own and using the proceeds to buy a protective put. Even a pro has to analyze, model and validate that strategy before writing a check.