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The Innocent Investor

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A while back I was reading about Bernie Madoff's adventures (fascinating story) and the smooth way he operated his giant Ponzi machine. The interesting part of the story was about how some of the damages will be recovered from other investors who were ostensibly lucky enough to withdraw their investments before the house of cards came crashing down.

I suppose if I had lost substantial assets with Madoff, I would want as much money recovered as possible, even if that meant forcing the early investors to forfeit their gains. While it may be true that those investors profited from ill-gotten gains, this presents one with an ethical and moral dilemma.

Suppose you were just an innocent investor in a seemingly legitimate plan and you had decided to take your profits and walk away. Why would you be responsible for future losses if the investment suddenly collapses? You had committed no crime here. You had followed the rules and had bought and sold the investments in good faith. You had taken the same risk as the others, but had the fortune of better timing.

This scenario plays out in the market all the time. Take the recent drop in the stock market. Many investors lost substantial amounts when their shares suddenly plummeted in value and they were forced to sell at ridiculously low prices. Then others stepped in and picked up those shares on the cheap and by now some of them have tripled or quadrupled their initial investments in a very short run. If they decide to sell their shares today and walk away with handsome profits, would they need to worry that the early sellers may come back and try to take away their profits? And if so, how much would they need to forfeit?

The early sellers may argue that abnormal conditions had caused the shares to plunge to artificially low levels and the current owners had profited from the panic and despair that had gripped the market. You may argue that in this case no fraud had taken place, but those "toxic assets" that led to the violent volatility weren't exactly proper either.

I have no problem with going after the swindlers and their cohorts, but for those who took the same risks as others and profited fair and square, there shouldn't be any negative consequences. Why go after the early investors instead of the regulators who were asleep while the fraud was being perpetrated? If every legitimate gain in the market is at the risk of being taken away, what incentive is there for people to invest in anything?


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