by Ethics Newsline® editor Carl Hausman

A $50-billion dollar swindle (or, legally, alleged swindle) certainly captures one’s attention. But now, for those of us who write and report about ethics, things are going to get really interesting. In the coming months and years, the court system is going to be assigning blame, in relative proportions, to a variety of actors in the Bernard Madoff case.

The proportion of blame is important, because as the case wends its way through the various courts involved, investors will be seeking to recoup their losses and the law will have to decide how much of what’s left over they will receive. Part of that calculation involves whether investors bear any responsibility for their losses, and if so, how much.

In criminal court, prosecutors may move beyond Madoff and set their crosshairs on minor players in the sorry affair, and judges and juries may have to translate the percentage of involvement into fines and years behind bars.

While the repayment and retribution issues are couched in legality, at its heart this is really a moral question: Did the people who enabled Madoff — by attempting to profit from his deeds or consorting with him — act unethically? If so, how much of the consequences do they deserve?

Blaming the victim seems inherently unfair, but let’s face it: Some (but certainly not all) of these people really should have known better. Many were sophisticated institutional investors whose antennae should have picked up the signals of a swindle, such as unremitting high returns and oversight from a no-name audit firm. Many put all of their eggs in the Madoff basket, ignoring the fundamental principle of diversification extolled in texts as basic as Personal Finance for Dummies.

What about the people who smelled a rat and deserted? Interestingly, there’s a legal precedent holding that those who profit from a scheme stand to lose not only those profits but the original investment as well. According to a report from Newsweek, the standard was set in a case involving a Ponzi scheme called the Bayou Group. In 2008 a judge ruled that Bayou Group investors had to give back profit and principal if they abandoned ship because they suspected wrongdoing. While those investors eventually may be eligible to ask for a share of the recovered money, it is likely to be pennies on the dollar — a scenario that also may confront Madoff investors.

And what of the secondary players? Some wealthy and distinguished people who hung around the Palm Beach country club introducing prospective investors to Madoff — sometimes for a cut of the profits — now are wishing they hadn’t. These go-betweens, according to Forbes, could face prison time, even if they did not posses explicit “knowledge and intent,” which are the standard elements of a fraud case.

Instead, prosecutors may pursue the theory of “willful blindness.” Lawyers use a classic example: If you are in Colombia, handed a package, and offered $10,000 to deliver it to the United States, you’re culpable even if you had no specific knowledge or intent of participating in a drug deal.

It gets complicated because some of the big losers were investors in “feeder funds” that in turn invested with Madoff, meaning that some who bought in probably had no mechanism to receive clear signals that something was amiss. Others were individual investors lured into the deals by trusted friends.

Somewhere in the chain, though, somebody had to be willfully blind. I’m uncomfortable with the concept of blaming victims, but from an ethics standpoint I believe we do have to factor in some culpability for willful blindness.

Look at the broader implications. While it’s hard to believe that anything could dwarf the Madoff scandal, consider how a collective ethical blind eye contributed to moronic lending practices that precipitated the collapse of the real estate market, which in turn knocked the legs out from under Wall Street, which in turn pulverized the economy and produced damages that may total in the trillions of dollars.

What’s your opinion? Do some of the Madoff investors share the blame? Email me your view. If we get a sizeable collection of responses, we will summarize them in next week’s edition.

©2009 Institute for Global Ethics

Questions or comments? Write to newsline@globalethics.org.

For more on the Madoff scandal and the concept of willful blindness, see: Forbes, Jan. 7 — Newsweek, Jan. 3.