Lessons from the Bernard Madoff Affair
by David Roth and Ardie Geldman
The financial and philanthropic worlds are in the midst of dealing with the repercussions from Bernard Madoff’s $50 billion Ponzi scheme. As philanthropic consultants, we are concerned whether, given the already difficult economic environment donors will be deterred from their usual funding or from paying extra for advisory services. Or, will they continue to fund as in the past, but be more diligent about their philanthropic investments and insist on accountability, including on-the-ground oversight.
The answer to these questions depends on two key concepts: trust and transparency.
Imagine a world without trust. It is a primitive world, one that takes us back to times in which man was required to hunt and fight to survive. But with trust – one of the bedrocks of modern society, economic and business activity, and human relationships – one can rely on others; one can buy, invest, or donate to individuals or groups because one can have faith in the other side.
Yet trust is not easily acquired, and if lost, is almost impossible to restore. The Madoff affair not only resulted in the loss of a colossal amount of money, but has eroded investors’ and much of the public’s ability to trust others with their money. Yet, a closer look reveals that investors’ reliance on Madoff was not based on trust; it was based on blind trust. Madoff’s long-standing reputation – apparently undeserved – as an honest, ethical, trustworthy individual and financial advisor led people to trust him without questioning his strategies or methods.
And how is blind trust transformed into “non-blind” trust? Transparency – openness, honesty, truth, disclosure; the ability to verify information about a company or organization. It is the opposite of being secretive, shady, or dark.
All scientific research is based on proof. Can you imagine a scientist telling his colleagues to “trust” him that he had proven a new theory without providing evidence? The demand for proof is not borne out of a sense of mistrust or disrespect for the author. Rather, it is based on upholding professional standards that help maintain the integrity of the field, as well as allow ongoing research on the topic. In the case of investments, financial advisors must adhere to a set of standards, a clear methodology, and be able to show their work. If an investment manager is fired or passes away, someone else must be able to pick up where he left off.
Clients, either investors or donors, have the right to ask questions, to have unclear issues explained to them, and to have unfettered access to detailed information about their accounts. They have the right to take their business elsewhere if they are not satisfied.
In Hebrew, there is an expression – kabdeyhu v’chashdeyhu – “respect but suspect,” or, as President Reagan said “trust but verify.” In both the worlds of finance and philanthropy one has to have trust – but not blind trust – in the company or organization in which one is investing. Trust those who have demonstrably earned it. Those who willingly answer your questions, offer transparency and accountability, and are open to external oversight of their actions.
The U.S. political system is based on checks and balances. Jewish Law requires two witnesses who are not related to each other nor to the subject of their testimony. When conflicts of interest exist, they must be disclosed. Those in positions of authority who have fiduciary responsibilities must exercise their duties of loyalty and care on behalf of their institutions with the highest ethical standards. This is the meaning of the word “trustee,” holding the organization in trust.
In the Madoff affair supposedly savvy financial managers, boards of directors, investors, and others entrusted their funds with Madoff because of his reputation. They assumed that others had carried out due diligence, that the SEC was properly regulating the industry, and that so long as the returns on investment were great, why complain.
The Enron scandal placed the issue of proper governance at the forefront of the corporate world. Yet, how often do boards of directors find it difficult to properly investigate the professional staff? Being inside the organization, they must be loyal. What is needed to protect investors and philanthropists is oversight from those outside of the company or organization; a fresh pair of eyes to check things out and ask questions, an individual or individuals untainted by years of personal relationships. Auditors, regulators, and philanthropic consultants are just some of the types of external overseers that can protect financial or philanthropic investments.
The necessity for “non-blind” trust applies to our field as well.
Philanthropic consultants should not ask their clients to blindly trust them either. They must document their work and their processes, and invite their clients to see how they arrive at their findings, analyses, and conclusions. Ideally, they should not touch the donor’s money, but limit their services to providing clients with the necessary information to enable wise philanthropic decision-making.
Transparency and oversight are what enable genuine trust to develop.
May the Madoff affair lead to a period of greater transparency and earned trust.
David Roth and Ardie Geldman are philanthropic consultants with Donor Associates in Israel, Ltd. and occassional contributors to eJewish Philanthropy.