Phil Friedman

7 years ago · 2 min. reading time · ~100 ·

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The Madoff Syndrome: Two Profiles in Scams

The Madoff Syndrome: Two Profiles in Scams

The Madoff Syndrome: Two Profiles in Scams


It's not just greed that leads people into becoming marks in schemes that are pretty much preposterous on the face of it. No, there is something else at work, when victims act on promises that are simply too good to be true.

The Madoff Syndrome: Two Profiles in Scams

Two separate major investment Ponzi schemes came to light during the period 2008 - 2009. One was run by convicted lawyer Scott Rothstein of Miami, Florida, the other by convicted investment fund manager Bernie Madoff of NYC. Both promised investors wildly higher returns than could be achieved elsewhere in the financial markets. Both used new investor money coming in to pay impressively high returns to earlier investors, without actually re-investing the bulk of the money coming in. They did, however, differ from one another in several important respects.

The Rothstein scheme was run-of the-mill fraud, but Madoff's scam exhibited some touches of criminal brilliance..

Rothstein's schtick was that he was purchasing the rights to anticipated awards and settlements to plaintiffs in civil suits, much like the firms dealing in viaticals were purchasing life insurance policies from insureds in anticipation of eventually receiving the death benefit payout. It was supposed to work like this: a plaintiff might be suing for, say, two million dollars; and the case (as evaluated by Rothstein's team) was nearing either a successful judgment or a potential settlement, anticipated to be at least a million dollars. The plaintiff either couldn't or didn't want to wait for the suit to conclude or a settlement to be reached. So, Rothstein would (supposedly) purchase the rights to the judgment or settlement from the plaintiff at, say, $700K. When the judgment or the settlement were concluded, the gross profit would be at least $300K — or possibly more, if the judgment or settlement turned out to be more than a million dollars. The returns on investment could be potentially enormous, and wildly higher than those in the traditional financial markets.

The Madoff Syndrome: Two Profiles in Scams
Rothstein bolstered his credibility with potential investors by running his investment fund out of the same offices as his "legitimate" law firm, into which he attracted numerous practicing lawyers with excellent credentials. He also spent lavishly in the political arena, and became the darling of several major politicians on the Florida scene. He even co-opted a vice president of TD Bank, U.S., to provide potential Rothstein investors with a sense of legitimacy and security by means of false statements and documents.

In other words, Rothstein created a criminal conspiracy that included both witting and unwitting players of the kind an investor would normally turn to in the course of checking up on the legitimacy of a potential investment. That the investors were stung is the result of their faith in "normal channels". Not exactly blinded by greed, but certainly with the bright sun of much higher than normal investment return in their eyes, they trusted the recommendations of people whom they had every reason to trust. Much in the way our nation trusted the large national certified public accounting firms who conspired to produce falsified ratings of "bundled mortgage securities" during the real estate bubble. I’m not sure how much we should “feel” for Rothstein’s marks, but in a way, I can somewhat understand how they were deceived.

The Madoff case is, to my mind, significantly different in nature from Rothstein ...

Madoff reportedly created an veil of secrecy and the aura of investors belonging to a very private and exclusive club. If you wanted to invest in Madoff's fund, you had nominally to  be recommended by another investor and additionally pass muster at an "interview". If you were granted the privilege  of entry into Madfoff's circle of investors, you were expected to deposit your money into the fund, and keep your mouth shut. You paid your money, if Madoff deigned to let you do so, then you collected your returns. No questions about performance or how things were going, no audited statements, nada, zip, zero, bubkas.

Some potential investors were rightly troubled by this, and walked away after initial contact. But many more than a few drank the Kool Aid  — to the tune of nearly $200 billion. The interesting question is WTF were they thinking?

Did they think Madoff was so much more brilliant than anyone else in the financial marketplace? I don't think so. Were they just stupid greedy? Again, I don't think so, for it takes some measure of intelligence and business acumen, or at least cunning, to accumulate the assets they possessed. No, I ruminated, there must be something else at work. Then it struck me.

A number of potential Madoff investors who walked away without being caught up, clearly found the entire proposition preposterous. While those who were drawn in had to have felt that the investment was relatively safe. And as I thought about it, a theory emerged as to why they might so believe.

It was a one-two punch. One, there was the belief that Madoff could do wildly better than the average fund manager because he was almost certainly doing something illegal — probably trading on insider information. And two, the belief he was likely operating outside the law held for them a special kind of appeal, which seasoned the transaction with the spice of getting it over on the "plebeian" crowd.

Our contemporary western society is fascinated by "the hack"...

The term "hacking" was for many years used as a designator for malicious and illegal activity in the sphere of computers and networks. It has now mutated to encompass any crafty form of upsmanship implemented in working "the system", and now carries with it an air of admiration and respect. These days we read about things like "5 Great Hacks for Marketing on Twitter"  or "Entrepreneurial Hacks for Start-ups". And when we do, the nearly universal implication is that getting it over on others, the competition, through cunning and chutzpah, is something not only pragmatically necessary, but also very positive in itself.

The Madoff Syndrome: Two Profiles in Scams

This attitude permeates all levels of society today. And it is, I submit, this attitude that helped draw Madoff's marks into the spider's web. They knew the goings on that centered around him were "off", and didn't line up with normal or standard practice, certainly not with conservative practice in the financial sector. But they just didn't care.

That they suspected Madoff to be, if you will, an "investment hacker", did not undermine their confidence in Madoff's ability to deliver wildly better than average returns on their investments; it actually bolstered their confidence that he could. And the same tinge of presumed illegality which bolstered their confidence, contributed a patina of excitement that sealed the deal.

If a deal sounds too good to be true, it most likely is...

It's our propensity to naive, careless, and downright stupid behavior that draws us into becoming prey for scam artists. For most confidence schemes are on their face preposterous, and require a mark to suspend all common sense.

I once had a conversation with the head of security for a major NYC bank. I was trying to confirm for a business consulting client the bona fides of a purported VP in the bank's "private banking" division. My client was seeking a substantial loan for working capital, and had been offered through an intermediary what he felt was a great deal. I felt the entire proposal smelled of scam.

The Madoff Syndrome: Two Profiles in Scams

The bank's head of security patiently explained to me that he could neither confirm nor dis-confirm details pertaining to their private banking infrastructure. But when I told him that I had letters of representation on what appeared to be legitimate bank stationery, he gave me this advice: If the deal seems too good to be true, it very probably is.

Facing a good deal of resistance, I backed my client off of the proposed loan deal, which afterward, indeed, turned out to be a scam — confirmed when several months later I ran into an industry acquaintance of mine who had been stung by the same players using the same con. All of which is itself a pretty interesting story, but for another time.

It's not exposure to a potential scam that is a danger; it's our own stupid, naive, and reckless behavior that draws us into becoming prey for con men.   — Phil Friedman

Author's Notes: In writing this piece, I've relied, in the main, on several publicly available FBI reports, including case and sentencing summaries as well as on published articles too numerous to mention, in such newspapers as the Miami Herald, Sun Sentinel, and the New York Times. I've also had some contact with a couple of completely reputable South Florida lawyers who were innocently associated with Scott Rothstein's law firm at the time, which law firm was distinct and separate from his investment fund operation. However, not too much should be expected in terms of scientific investigation here, for this post is not intended to be a scholarly treatise, but rather a light and entertaining exercise in, what might be termed, socio-philosophical speculation.

If you found this post interesting, you might also want to take a look at:

“If I Told You I Could Push Your Posts onto a Pulse Feature Channel Every Time... Would You Pay Me from Several Hundred to Several Thousand Dollars to Do So?"

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"Maximizing Throughput on Fixed Assets and Overheads"

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About me, Phil Friedman:  With 30 some years background in the marine industry, I've worn numerous hats — as a yacht designer, boat builder, marine operations and business manager, marine industry consultant, marine marketing and communications specialist, yachting magazine writer and editor, yacht surveyor, and marine industry educator. I am also trained and experienced in interest-based negotiation and mediation. In a previous life, I taught logic and philosophy at university.

The Madoff Syndrome: Two Profiles in Scams
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The Madoff Syndrome: Two Profiles in Scams

Phil Friedman

7 years ago #5

I agree, Ken. Money also sometimes drives us to accept activities that we feel are just over the line, legally and morally.

Ken Boddie

7 years ago #4

Great post, Phil, and impressive research. If you'll indulge me the extension of an old proverb "common sense is remarkably uncommon" but naivety and, to a lesser extent, greed is. Goes to show that money (or the lack of it) motivates us far more than it should.

Phil Friedman

7 years ago #3

Thank you, Donna-Luisa Eversley, for reading and commenting..

Phil Friedman

7 years ago #2

Paul Croubalian - I understand that the term "hack" -- which by the way originally had a meaning closer to the one common today -- has morphed from black hat activity more to white hat work. However, I submit that it still carries a connotation of a "cool gaming" of the system. But anyway, as you know, I always enjoy arguing with you, because you are always a good sport, and never act self-impressed. Looking forward to bantering on beBee.

Phil Friedman

7 years ago #1

Yes, Mike, after much reflection, it finally occurred to me that if they didn't smell a bit of illegality (insider information or some form of manipulation), they would not have believed in the ability to pay out the returns. For them, the promise was not too good to be true. It just couldn't be true unless they supposed a bit of hanky panky was going on -- which they didn't care about, as long as the returns came in. Thank you for reading and commenting.

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