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Bernie Madoff’s June 29 sentencing date is fast approaching. If you still don’t quite understand what happened there, do yourself a favor and watch a recent Frontline documentary on the subject. “The Madoff Affair,” premiered on PBS on May 12, but if you missed it, you can watch the entire program, along with lots of bonus material, on the Frontline web site.

“The Madoff Affair” was produced by Martin Smith and Marcela Gavaria of Rain Media. Smith and Gavaria have made more than two dozen episodes on subjects like Bin Laden, North Korea and psychiatric meds for kids. (Full disclosure: I’ve worked on Frontlines in the past, though none with Rain Media).

This Frontline doesn’t really break any news on Madoff, or his $50 billion Ponzi scheme, but it effectively distills what is an incredibly complex story into something that can be easily absorbed. Beyond that, they managed to get some great interviews with Madoff insiders.  Their interview with Michael Bienes, who began funneling investors to Madoff in the 1960s, perhaps provides the most salient window into who Madoff is, and how his scheme worked. Check out the extended interview with Bienes online.

We spoke to Smith about his experience making this film, what he learned and what we should all take away from the Madoff story in general.  One thing seems certain: People will still be trying to understand Madoff the man, long after they’ve figured out how he ripped so many people off.

MainStreet: What do you think is the most important piece of information the average investor should take away from this story?
Smith: We were surprised all along at how so many people gave their money over to Madoff or to a feeder fund and then asked very few questions.  Those that did were rebuffed by Madoff's staff, but they left their money in his hands.  I think ordinary investors should make sure they understand the statements they're getting and the strategy used to generate profits.  If it's a secret proprietary strategy, then an investor should be aware of the risk.  A track record is nice but it is not hard to find managers who have succeeded for years only to falter badly.  If 90% of professional money managers fail to beat the market over the long run, then it seems an investor should either park their money in an index fund or really know what risks they are taking.  Ask questions.  And make sure you understand the answers.  Madoff's investors seemed only to focus on that bottom line. 

What are some red flags investors should look out for?
A big red flag, which we didn't get to explore in the piece, was the fact that Madoff was his own custodian, broker and investment advisor with a tiny unknown accounting firm doing his audits.  He was accountable to no one but himself.  Any investor should steer clear of such a set-up.  A third party should hold your assets, not the investment advisor.  That alone should insure that someone other than your advisor is verifying the trading. 

Some investors lost everything with Madoff. What lessons are there in terms of the importance of diversifying your investments?
Well, diversification usually refers to mixing up your portfolio among various types of asset classes.  And, if you believed Madoff's statements, it didn't look so bad. The problem was, it was all a lie, of course.  Ordinarily, diversification doesn't mean you need to divide your money among several different managers.  One good manager or advisor who diversifies your holdings is sufficient.  Just make sure you can trust that advisor.

What did you learn about the Securities and Exchange Commission, in terms of how it works and how it ultimately protects investor interests?
That's a big question.  Unfortunately, the SEC did not co-operate with Frontline in the making of the piece. We had background conversations and a couple of interviews with former chiefs.  But to get inside one needs to talk to those inside the enforcement division.  We heard recurring themes and I refer you the transcript of an interview with Diana Henriques of the New York Times. She's covered the SEC for years and in the last part of her interview she addresses this question.

You went through Madoff documents that detail trades he was supposed to have made on behalf of his clients, and found that some of the companies being traded weren’t even available to investors. Do you think it’s possible for the average investor to scrutinize trades at this level?
Yes.  I don't think it's that hard.  We called up Fidelty and asked them about Fidelity Spartan fund.  They told us the name had changed, the new fund was closed to new investors and that Bernard Madoff never owned any Fidelity Spartan when it did exist.  At the very least, a random check of something that was clearly too good to be true is good idea.  If you can't do any checking then you are probably better off in an index fund. 

[Ed. note: Take a look at some of the actual account statements Frontline analyzed.]

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The SEC was alerted of Madoff’s shady practices up to a decade before he was actually brought down, but didn’t stop him. Some in the film suggested the SEC wasn’t sufficiently staffed. Did you find any evidence that it was understaffed, or that there was willful negligence?
Madoff conned the SEC into believing he was legitimate.  One fund manager told us early in our research that you should not underestimate how much of business on Wall Street is simply based on trust.  That was the problem here.  SEC investigators were fooled by Madoff's stature and let their guard down.  In concluding that he should be cleared in 2007, for instance, staffers remarked that while they could find no fraud, they did learn about some impressive and innovative trading strategies.  I don't know exactly what happened but we now know that had they verified Madoff's purported trades with counterparties, they would have found out that the trades didn't exist.  Why they missed that I can't say.  There is also the problem of being overwhelmed by the growth in funds and in various complex derivative strategies.  The SEC is staffed by lawyers who don't have full grasp of these financial instruments.  They need more financial expertise, according to those we spoke to inside the organization.  One example was that I asked former SEC chief Harvey Pitt if he understood the "split strike conversion" strategy Madoff said he was using.  Pitt said he did not.

Because he was involved in the Securities Industry and Financial Markets Association, Madoff had access to lawmakers and regulators in Washington. Do you think this played a role in his ability to avoid prosecution over the years?
I don't know.  I tend to doubt anything that smacks of outright conspiracy.  But, I do believe that his reputation, as with any con artist, provided the smoke screen he then exploited.  The fact that he sat on various SEC and FINRA [Financial Industry Regulatory Authority] boards made him seem an unlikely candidate for running the world's biggest Ponzi scheme.  At the same time this closeness to regulators enabled him to hide in plain sight.

Is there a particular incident that shocked you the most about this entire affair?
What is shocking is what Irving Picard, the court appointed trustee, is now charging against Stanley Chais and Jeffry Picower [philanthropists who invested millions with Madoff]: Namely, that they were able to demand set annual rates of return.  In the case of Picower, Picard charges he made 100% annually on 14 different occasions and up to 950% at one time.  That is shocking.  But that is news that has leaked since we aired.  I guess this is just going to get stranger and stranger.

Madoff said he had never invested any of his clients' money from the inception of the scheme. But he had a busy trading floor. You showed it and interviewed some of his employees. What were these guys doing, if not trading?
The 19th floor trading operation was handling trades for big clients like Schwab (Stock Quote: SCHW) and Fidelity and others. So if Fidelity needed to buy a large number of shares of IBM (Stock Quote: IBM), let's say, they would go to a market maker or broker dealer like Madoff to make the purchase.  Madoff gave them a good deal on such big wholesale trades.  The heart of the fraud wasn't there, it was two floors below on 17, where Madoff was purportedly running his proprietary trading strategy on behalf of investors. 

We still don’t exactly know how Madoff carried out this massive con. Do you think we ever will?
I am sure it will be untangled.  I think prosecutors who have full access to his records may already know. 

For this documentary, you spent time with people who were very close to Madoff. Do you think you were able to get inside Madoff’s head,  to understand what made him tick?
I can only speculate about what went on inside his head.   And those that we spoke to who knew him tell us that they never felt close to him themselves.  He was private.  But they do say that though he was aloof and distant, he commanded respect.  At times, such as during the 2006-07 SEC investigation he was reportedly very irritable.  But that seems a reasonable response.  I'm afraid Madoff will remain a mystery even as more accounts of the fraud are divulged.  Ultimately, I hope he talks.

You’ve covered some serious “villains” in the past: Bin Laden, the Taliban, Kim Jong Il. How does Madoff stack up?
Well, if you had all your money parked with the guy then I suppose he fits in with that company.  But, compared with those folks, Madoff is small potatoes really.  I doubt he'll face a trial in the Hague.

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