How do you explain being taken in the biggest Ponzi scheme in history?

This is the quite real challenge confronting the many investment firms and money managers who invested their clients’ wealth with Bernard Madoff. That wealth is has now evaporated. What lingers are some hard questions: Did they do their due diligence? Were they in on the scheme? Were they just duped?

And, the inevitable lawsuits have begun. Already the sharks are circling. Some of the big-name plaintiff’s firms are already populating the web prowling trolling for clients. “We believe you may have legal claims…please contact us immediately,” urges one firm. “Click here to contact a financial fraud attorney,” says another. Even silk stocking defense firms are setting special units. although the analysis is that the winnings will be small potatoes, $20 million or so, and hardly worth the effort.

Still some people got some ‘splaining to do, as Desi demanded of Lucy. And the answers sound almost as credible as the ditzy redhead’s:

"We have worked with Madoff for nearly 20 years," said a former federal regulator and the head of an investment firm facing losses of $7.5 billion. "We had no indication that we...were the victims of such a highly sophisticated, massive fraudulent scheme."

It's a sentiment a former chairman of the Securities and Exchange Commission: "I've known [Madoff] for nearly 35 years, and I'm absolutely astonished."

"You get hundreds and hundreds of letters and emails; there's no guarantee the SEC is going to catch" any given wrongdoer, said another former commissioner. That said, the commish made clear that there are no excuses.

Frankly these explanations don’t scan. “I didn’t see it coming,” “I got fooled,” and “We get lots of mail,” probably aren’t good legal defenses. And in the court of public opinion they won’t work at all.

The best defense seems a bass-ackwards variant of federal preemption, the legal maxim that the government said it was “okay”so who are you to sue me? In this case, the SEC didn’t catch him; why should we?

Fair enough, but investors will want to know why not, since their firms presumably had more direct and more frequent contact with Madoff than did regulators. And here’s where some good old fashioned contrition comes makes sense. There’s nothing more disarming than a strongly asserted, “we screwed up.” It’s okay to add in this instance, “…like everybody else.” It has the benefit of being true.

There is the catch because the best explanation, which is implicitly understood, is greed. It’s a good reason, really. Why would anybody ask questions or rock the boat if the scheme were paying out. Nobody wants to know if the fix is in at the horse race or if the beast is being doped. Everybody want to put their $2 on a winner. We turned a blind eye for years to ballplayers on steroids. And when it came to Bernard Madoff, nobody really wanted to blow the whistle.

We were shocked to learn that there was a Ponzi scheme going on here, to paraphrase the morally fluid Inspector Renault from the movie Casablanca. But were we really?

Updated 2/5/2009 1:18:01 PM

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