Like many of us, I have been both mesmerized and appalled by the Bernie Madoff scandal. The numbers are staggering – $50 billion gone up in smoke. The names who have been hurt range from the very famous to the nobodies – but the underlying question remains – how did it happen that no one figured it out? And even more to the point, what human factor allows and even encourages one to engage in this kind of investment?

Stephen Greenspan, a psychologist, has analyzed some of the behaviors in his recent article in the Wall Street Journal. Herewith are some of his thoughts (intertwined with a few of mine).

Situations: Greenspan contends that every gullible act occurs when an individual is presented with a social challenge that he has to solve -- and the Madoff story is replete with social feedback pressures --- it was a hard club to get into, Bernie was not accessible, and you could only invest if you knew somebody or were approved by him personally or else you had to go through feeder funds – i.e. access was limited. My Baby Billionaire Rule #215 (with appropriate reference to my personal idol Groucho Marx) is this: Any club that would have me as a member, I don’t want to join.

If it is that hard to get into, then count me out. But we all have the human nature to want to belong and to want to say yes and to be part of something private, special, limited and closed to the hoi polloi. This explains all kinds of clubs, from golf to eating – from investments to tailors and even doctors. When the door is closed, we want to get in even more than before.

So, the question is: Why is it so special that I am willing to suspend disbelief – and especially in the financial world, there is the perception that “the big shots are getting a special deal, and I want some of that also. I want to be special too.” So Baby Billionaire Rule #217 is: Beware of doors that only open with a secret knock.

Greenspan talks about cognition and how it impacts gullibility – and gullible acts are increased by intuition, impulsivity and non-reflective actions. It is amazing that smart people can act so dumb…..and the answer is simple -- because the decision feels good…..feelings are deceptive….smart people often suspend their skeptical faculties when their gut trumps their brains.

If you are ignorant in a certain area, do not assume you can overcome that by trusting other “smarter” people. At some level, the people hurt by Madoff were culpable as well – they were greedy in a benign way – they looked at the other members of the club and they trusted. So Baby Billionaire Rule #311 is: Trust is only earned in a deeply personal way – it cannot be garnered and granted by someone else.

Personality: If you are like most of us, you want to say “yes” more than you say no -- it is easier to say yes and go along for the ride – after all, what can happen --- saying no is a learned response….and in the case of your financial well-being, it is wise to practice your “unloved” quotient from time to time. So remember Baby Billionaire Rule # 210: A movie studio executive would be right 84% of the time if he said no to every film project that came across his desk --- don’t bet against the macro.

Emotion: The emotion to watch out for is two fold – one is obvious and that one is greed….and here is a story I tell often. When I am offered a fabulous deal, I always wonder: why did he call me? If it were so fabulous, why did I get called? Was I his best friend, was I the first call he made, did he owe me one, do I bring something unique to the table that is important to the deal – in other words, what makes me so special that I get this opportunity and if I can’t think of at least two really good reasons – then the obvious conclusion is – why me?

And so Baby Billionaire Rule #225 is: If you look in the mirror and see yourself as opposed to Brad Pitt, then pass the deal or get a new mirror. And finally the best rule of all from the Easter bunny – don’t put all your eggs in one basket.

January 4, 2009