Is there anyone left in the nonprofit sector who hasn't come across a bevy of articles listing the foundations and charities that have been ripped off by Bernie Madoff and his $50 billion pyramid scheme? The press has been tallying the losses to investors, operating charities, and foundations, but there has been precious little analysis of what this means for the needed monitoring and oversight of how some foundations handle their-our-tax exempt dollars.

What can we learn from Madoff's horrific financial shenanigans? What does it all mean for the nonprofit sector? There are some important lessons here for every nonprofit in the U.S., whether victimized by losing the bulk of their resources or simply outraged by the cozy relationships of investors and foundations-playing fast and loose with tax exempt moneys.

First, if you were surprised, you shouldn't have been.

We're in the middle of a deep recession. Were it not for various social safety net protections dating back to FDR and some minor curbs on the stock market, we would be calling this economic freefall a depression, and if unemployment reaches double digit percentages in 2009, that's what we'll be doing no matter how much happy talk about the strength of our economy emerges from Washington and Wall Street.

But in every recession, in the Great Depression, the number and size of embezzlement schemes rises. Commentators have cited John Kenneth Galbraith's "The Great Crash: 1929? book for his commentary on the role of the "bezzle", as he termed it, during the Depression. He didn't say in any way that Madoff-type embezzlement schemes caused recessions.

But what he did note, that the commentators missed, is that embezzlement schemes multiply in the boom period before the crash and their exposures cascade after the downturn. The first ones discovered, like the mammoth Madoff scandal, tend to be succeeded by more and larger scams. In Galbraith's words:

"In good times, people are relaxed, trusting, and money is plentiful. But even though money is plentiful, there are always many people who need more. Under these circumstances the rate of embezzlement grows, the rate of discovery falls off, and the bezzle increases rapidly. In depression all this is reversed…Just as the [pre-Depression] boom accelerated the rate of growth [of embezzlements], so the crash enormously advanced the rate of discovery."

So, now that we know about Madoff and his many years of escaping from regulatory oversight, look for more down the road. Expect billions more to be ripped off from investors-foundations, nonprofits, and 401(k) retirement funds, being the concern of this column-without recourse or recompense. In fact, prior to Madoff, they were already coming to the fore, notably the recent Petters family $3.5 billion Ponzi scheme in the Twin Cities, Tom Petters focusing on evangelistic Christian investors in contrast to Madoff's emphasis on his Jewish peers. Petters, Madoff, and there will be successors.

So, a bevy of foundations, their donors, and their financial advisors were snookered by Madoff's pyramid scheme (the press called it a Ponzi scheme, but Charles Ponzi's scams, pre-Depression, were penny-ante compared to Madoff), and so were a lot of other rich people. Isn't this simply the story of a hugely successful crook who happened to swindle gullible foundations among his willing victims?

Hardly. Most commentators on Madoff's thievery looting of as much as $50 billion focus on the swindle, but that's hardly the only story. The Madoff story looks so much like the investment trusts of the 1920s, funds that look a lot like Madoff's promising huge returns, the diversification of their investments hidden behind the financial genius of Bernie Madoff much like the deification of the investment trust wizards before they and their investors lost everything in the great crash. Madoff might have been a thief of the highest order, but he was playing the game of promising returns, asking investors (friends, associates, socio-economic peers) to trust his genius, and no one looked behind the veil to see exactly where the money really was.

Therein lies the second lesson-foundations were wrong to sink all of their funds in one narrow vehicle.

These foundations of various political and programmatic hues invested so much of their corpus in Madoff's investment vehicles that when he was exposed, they went out of business overnight. That's more than getting snookered by the man whose just-about-guaranteed investment returns earned him the sobriquet of "the Jewish bond". That's such bad investment behavior, it suggests that these foundations might be open to charges of improper and legally questionable investment of tax exempt funds.

Remember, once these dollars were dedicated to foundations and charities, really good ones and well known ones like JEHT or less publicized ones like Chais and Lappin and even Madoff's own family foundation, they were tax exempt funds. For these foundations and their donors to sink them all with their good friend and social partner Bernie Madoff, it isn't just having made a bad investment bet. There's a question of whether tax exempt funds-yes, funds that would have been public funds BUT for the tax exemption-were misappropriated.

That's the question that the attorney general of Connecticut is asking, in so many words, and well they should. investors in the various commercial funds that sunk their millions with Madoff, such as Ascot Partnership and Tremont Group Holdings, are now contemplating or actually filing litigation against those firms for investing so much in a fund like Madoff's which would have failed most basic due diligence standards. Why shouldn't the representatives of the American people, at least the state AGs, ask those questions on behalf of the taxpayers who trusted tax exempt dollars to these foundations and their diligence-impaired investment advisors?

Realize that the law is not on the side of the taxpayers who gave these foundations their tax exempt play money. As Connecticut AG Richard Blumenthal noted, the liability of the foundation boards for dumping their money brainlessly into Madoff's investment pit "is, obviously, by no means crystal clear." But the appetite for digging into this is limited, as evidenced by the less aggressive approach of Massachusetts AG Martha Coakley, who said that "we", meaning the AG's office representing the taxpayers of Massachusetts (where some foundations have completely shut down due to Madoff), "assume that [the charities' boards] have performed as a board with due diligence to make investments on behalf of their charities [and] we can't hold them responsible for anticipating that someone would engage in criminal activity, particularly someone who was as clever and convincing as [Madoff]."

Malarkey! They sunk huge portions, sometimes all of their charitable assets in this one fund which was palpably dubious regarding audits and controls; maybe you or I might not have figured this out with our tiny investment dollars, but these big money people and their investment advisors should have and could have known. The issue, according to NYU professor Richard Marker, is not to pursue people for stupidity-there were plenty of those in the Madoff imbroglio-but to pursue "charities or foundations that ignored their own investment policies, or conflict of interest policies, in an ill-conceived gamble on the Madoff firm."

Especially Madoff, whose operations were generally termed "black box" investments, there was plenty to raise due diligence questions. How about Madoff's questionable audits done by a relatively unknown 3-person firm (one of the employees was 78 years old and living in Florida, a second was a secretary, and the third was an accountant in Rockland Co., New York, operating in a 13' x 18' office auditing a $50b hedge fund?)? How about the lack of third party involvement in stock transactions? How about Madoff's unwillingness to provide investors with online access to their accounts? How about Madoff's refusal to file with the SEC, claiming that he sold all holdings by the end of the year (or reporting period) and only held cash? How about Madoff's multiple sets of books in order to avoid scrutiny? How about the fact that Madoff generally recruited investors, even up to nearly a week before he was arrested, almost totally through his religious and social networks, the canary in the coal mine warning of the likelihood of "affinity fraud"?

A neat letter from a firm named Aksia outlined a bunch of very obvious reasons why it had constantly told its clients not to invest dollars in Madoff or its feeder hedge funds, all obvious to capable investment advisors-except for those who put their foundations' money at risk with Madoff, apparently. In the clandestine operations of hedge funds, Madoff's operations were akin to Maxwell Smart being treated like he was James Bond.

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