Bernard L. Madoff Investment Securities LLC:

Case 1

Bernard L. Madoff Investment Securities LLC:

Wall Street Trading Firm

Bernard L. Madoff Investment Securities LLC was founded in the 1960s as a

small investment firm on Wall Street. With $5,000 in savings from summer jobs

and at the age of 22, Madoff launched the firm that in the 1980s would later rank

with some of the most prestigious and powerful firms on Wall Street. Madoff

began as a single stock trader before starting a family- operated business that

included his brother, nephew, niece, and his two sons. Each held a position that

was quite valuable within the company.

Madoff had also created “an investment- advisory business that managed

money for high- net- worth individuals, hedge funds and other institutions.” He

made profitable and consistent returns by repaying early investors from the money

received from new investors. Instead of running an actual hedge fund, Madoff held

this investment operation inside his firm on the seventeenth floor of the building

where only two dozen staff members were permitted to enter the secured area.

No employee dared question the security and confidentiality of the “hedge fund”

floor due to the prestige and power that Madoff held. The $65 billion investment

fund was later discovered to be fraudulent, involving one of the largest Ponzi

schemes in history and shattering the lives of thousands of individuals, institutions,

organizations, and stakeholders worldwide.

The Man with All the Power

Bernard Madoff’s charisma and amiable personality were important traits that

helped him gain power in the financial community and become one of the largest

key players on Wall Street. He became a notable authoritative figure by securing

important roles on boards and commissions, helping him bypass securities regulations.

One of the roles included serving as the chairman of the board and

directors of the NASDAQ stock exchange during the early 1990s. Madoff was

knowledgeable and smart enough to understand that the more involved he

became with regulators, the more “you could shape regulations.” He used his

reputation as a respected trader and perceived “honest” businessman to take

advantage of investors and manipulate them fraudulently. Investors were hoodwinked

into believing that it was a privilege to take part in Madoff’s elite investments,

since Madoff never accepted many clients and used exclusively selective

recruiting in order to keep this part of his business a secret.

Madoff was even able to keep his employees quiet, telling them not to speak

to the media regarding any of the business activities. While several understood

something was not right, they ignored suspicions due to Madoff’s perceived

clean record and aura: “He appeared to believe in family, loyalty, and honesty. . . .

Never in your wildest imagination would you think he was a fraudster.”

34 Business Ethics

Dr. Meloy, author of the textbook The Psychopathic Mind, states that “typically

people with psychopathic personalities don’t fear getting caught. . . . They

tend to be very narcissistic with a strong sense of entitlement.” This led many

analysts of criminal behavior to observe similar traits between Madoff and serial

killers like Ted Bundy. Analysts discovered several factors motivating Madoff toward

a Ponzi scheme: “A desire to accumulate vast wealth, a need to dominate

others, and a need to prove that he was smarter than everyone else.” What ever

the motivating factors were, Madoff’s behavior was still criminal and affected a

large pool of stakeholders.

Early Suspicions Arise

Despite the unrealistic returns and questionable nature of Madoff’s business

operations, investors continued to invest money. In 2000, a whistle-blower from a

competing fi rm— Harry Markopolos, CFE, CFA— discovered Madoff’s Ponzi scheme.

Markopolos and his small team developed and presented an eight- page document

that provided evidence and red fl ags of the fraud to the Securities and

Exchange Commission (SEC)’s Boston Regional Office in May 2000. Despite

the SEC’s lack of response, Markopolos resubmitted the documents again in

2001, 2005, 2007 and 2008. His findings were not taken seriously: “My team and

I tried our best to get the Securities and Exchange Commission (SEC) to investigate

and shut down the Madoff Ponzi scheme with repeated and credible warnings.”

Because Madoff was well respected and powerful on Wall Street, few

suspected his fraudulent actions. The status and wealth that Madoff had created

gave him the means to manipulate the SEC and regulators alike.

Negligence on All Sides

The negligence and gaps in governmental regulation make it very difficult to

point to only one guilty party in the Madoff scandal. The SEC played a crucial

role by allowing Madoff’s operations to carry out for as long as they did. For

over 10 years, the SEC received numerous warnings that Madoff’s steady returns

were anything but ordinary and nearly impossible. The SEC and the Financial

Industry Regulatory Authority, “a non- government agency that oversees all

securities fi rms,” were known to have investigated Madoff’s fi rm over eight times

but brought no charges of criminal activity. Despite the red flags and mathematical

proof that Markopolos presented, SEC staff allowed Madoff’s operations to

continue unchallenged. Spencer Bachus, a politician and a Republican member

of the U.S. House of Representatives, stated that “What we may have in the

Madoff case is not necessarily a lack of enforcement and oversight tools, but a

failure to use them.” Unfortunately, there could be another side to the story. David

Kotz, currently the SEC’s inspector general, planned an ongoing internal investigation

to understand the reasoning behind the negligence and to determine if any

conflict of interest between SEC staff and the Madoff family could have been part

of the problem. Arthur Levitt Jr., who was part of the SEC and a chairman from

1993 to 2001, had close connections with Madoff himself. He would rely on

1 The Changing Environment and Stakeholder Management 35

Madoff’s advice about the functioning of the market, although Levitt denies all accusations.

In September 2009, it was officially stated that no evidence was found

relating to any conflict of interest: “The OIG [Office of Inspector General] investigation

did not find evidence that any SEC personnel who worked on an SEC examination

or investigation of Bernard L. Madoff Investment Securities LLC had

any financial or other inappropriate connection with Bernard Madoff or the Madoff

family that influenced the conduct of their examination or investigatory work.”

Unfortunately, the SEC is not the only party to blame. JPMorgan Chase has

also been criticized for its actions regarding the Madoff scandal. Instead of investing

client’s money in securities, as Madoff had promised to do, he deposited

the funds in a Chase bank account. In 2008, federal court documents show that

“the account had mushroomed to $5.5 billion. . . . This translates to $483 million

in after- tax profits for the bank holding the Madoff funds.” As one of Chase’s largest

customers, Madoff’s account should have been monitored closely. Internal

bank compliance systems should have detected such red flags. Unfortunately,

Madoff was savvy enough to move millions of dollars between his U.S. and London

operations, making it seem like he was actively investing clients’ money. The

massive account balances of investors should not have been difficult to overlook.

Don Jackson, director of the SecureWorks Counter Threat Unit Intelligence Services,

noted that “The only way to stop this kind of fraud is for the bank to know

its clients better and to report things that might be suspicious. It really comes

down to human control.” This was an area of weakness for JPMorgan Chase at

the time.

Where Were the Auditors?

For Madoff to successfully perpetrate such a large scam spanning more than

a de cade, he needed the help of auditors to certify the financial statements of

Bernard L. Madoff Investment Securities. The company’s auditing ser vices were

provided by a three- person accounting fi rm, Friehling & Horowitz, formerly run

by David Friehling. For over 15 years, Friehling confirmed to the American Institute

of Certified Public Accountants (AICPA) that his fi rm did not conduct any

type of audit work. Because of this confirmation, Friehling did not have to “enroll

in the AICPA’s peer review program, in which experienced auditors assess each

fi rm’s audit quality every year . . . to maintain their licenses to practice.” Friehling

& Horowitz had in fact been auditing the books of Madoff for over 17 years, providing

a clean bill of health each year from 1991 through 2008. Authorities state

that if Friehling provided integrity in his findings, the scandal would not have

continued for as long as it did: “Mr. Friehling’s deception helped foster the illusion

that Mr. Madoff legitimately invested his client’s money,” stated U.S. Attorney

Lev Dassin. In addition to receiving total fees of $186,000 annually from the auditing

ser vices provided to Madoff, Friehling also had accounts in Madoff’s fi rm

totaling more than $14 million and had withdrawn over $5.5 million since the year

2000. Friehling deceived investors and regulators by providing unauthorized

audit work and verifying fraudulent financial statements. Given the size of the

36 Business Ethics

accounting firm, a red flag should have been raised. Madoff’s operations were

too large in size and complexity for the resources of a three- person accounting


Revealing the Fraud

As the U.S. economy entered the 2008 recession period, investors began to panic

and withdraw their money from Madoff’s accounts, totaling more than $7 billion.

Madoff was unable to cover the redemptions and struggled “to obtain the liquidity

necessary to meet those obligations.” He confessed to his sons that the business

he was running was a scam. On December 11, 2008, Bernard Madoff was

arrested by federal agents— one day after his sons reported his confession to the


Global Crisis

The Ponzi scheme that Madoff ran for more than a de cade affected the lives of

thousands of individuals, institutions, organizations, and stakeholders worldwide.

A 162- page list was submitted to the U.S. Bankruptcy Court in Manhattan

detailing the affected parties. The lengthy list consisted of some of the wealthiest

investors and well- known names around the region: “They reportedly include

Philadelphia Eagles owner Norman Braman, New York Mets owner Fred Wilpon

and J. Ezra Merkin, the chairman of GMAC Financial Ser vices.” Talk show host

Larry King and actor John Malkovich were on the list, among others. Many

investment- management fi rms, such as Tremont Capital Management and Fairfi

eld Greenwich Advisors, had invested large amounts in Madoff’s funds and

were hit the hardest financially. Major global banks, “including Royal Bank of

Scotland, France’s largest bank, BNP Paribas, Britain’s HSBC Holdings PLC and

Spain’s Santander” were also known to have lost millions. Charitable foundations,

such as the Lautenberg foundation; and financial institutions, including Bank of

America Corp., Citigroup, and JPMorgan Chase were all stakeholders in the

Madoff scandal. Ordinary individuals also invested much of their life savings into

what they believed was a “once in a lifetime opportunity.” William Woessner, a

retiree from the State Department’s Foreign Ser vice, agreed that the investors

“were made to feel that it was a big favor to be let in if you didn’t have a lot of

money. It was an exclusive club to belong to.” It has been reported that individual

losses were between $40,000 to over $1 million in total. There were 3,500 investors

from New York and more than 1,700 from Florida.

The repercussions of Madoff’s Ponzi scheme have been emotional as well

as financial. A French aristocrat and professional investor living within the suburbs

of New York, Rene- Thierry Magon de la Villehuchet, had invested almost

$1.4 billion in Madoff’s accounts. He had invested both his and his client’s money,

only to lose everything. Villehuchet felt personally responsible for the loss of his

clients’ money: “He had a true concept of capitalism. . . . He felt responsible and

he felt guilty,” said his brother Bertrand de la Villehuchet. Villehuchet’s depression

grew to such a point that he committed suicide on December 22, 2008.

1 The Changing Environment and Stakeholder Management 37

Consequences and Aftermath

On June 29, 2009, Judge Denny Chin found Madoff guilty on eleven criminal

counts and sentenced him to 150 years in prison, the maximum possible sentence

allowed at the time. Chin’s severe sentence was influenced by the statements

given by Madoff’s victims and the 113 letters received and fi led with the

federal court: “A substantial sentence may in some small measure help the victims

in their healing process,” stated Judge Chin. Madoff was also forced to pay

a $170- billion legal judgment passed by the government, stating that this amount

of money “was handled by his fi rm since its founding in the 1960s.” David Friehling,

the auditor for Madoff’s books, was also arrested on fraud charges. He was

initially “released on a $2.5- million bond and had to surrender his passport.”

Friehling lost his CPA license in 2010, and his sentencing has since been postponed

four times. He faces a sentence of more than 100 years in prison.

Lawyer Irving H. Picard is a bankruptcy trustee in the Madoff scandal. As a

court- appointed trustee, Picard has fi led numerous lawsuits and has collected

$1.2 billion in recovered funds from “banks, personal property, and funds around

the world.” It is estimated that from this $1.2 billion, Picard has earned approximately

$15 million. More than $116 million has been given to 237 Madoff victims,

each receiving up to $500,000. In order to help the victims of the Madoff scandal,

Picard started a program called “Hardship Case.” He has also fi led a $199

million lawsuit against the Madoff family, including Madoff’s brother, his two

sons, and niece, all of whom worked alongside Madoff. An additional lawsuit was

fi led against Madoff’s wife for $44.8 million, stating that she had transferred large

amounts of money from the fi rm “over a six- year period.” As of now, none of the

family members— Madoff’s two sons, brother, niece, and wife— have been found

guilty on any of the charges. Madoff’s oldest son, Mark, 46, committed suicide in

December 2010. Madoff’s victims took swift action against the negligence of SEC

and JPMorgan Chase. U.S. District Court Judge Colleen McMahon threw out

most of the $19.9 million charges against JPMorgan in November 2011, however.

The New York Mets owners paid a settlement of $162 million in March of 2012 to

avoid going to trial to answer the allegations made by Irving Picard.

Hidden Secrets?

Despite the accusations of negligence that JPMorgan Chase received from the

public, it was one of the biggest- profiting financial firms in the Madoff scandal.

As stated earlier in the case, JPMorgan made a profit of $483 million. During

2006, “the bank had started offering investors a way to leverage their bets on

the future performance of two hedge funds that invested with Mr. Madoff” and

decided to place $250 million of their own money inside these funds. A few

months before Madoff’s arrest in 2008, JPMorgan withdrew its $250 million,

stating that it had become “concerned about the lack of transparency and its

due diligence raised doubts about Madoff’s operations.” It is surprising that the

bank was suspicious and apprehensive toward investments with Madoff, but

at the same time raised no concerns about the large amount of money being

38 Business Ethics

deposited in Madoff’s accounts within the bank. JPMorgan also failed to alert

investors to move their money, stating that “The issues did not meet the threshold

necessary to permit the bank to restructure the notes. . . . We did not have

the right to disclose our concerns.” Regardless of the public statements made

by JPMorgan in support of its actions, many lawyers and investors believe that

the bank had knowledge of Madoff’s scam but wanted to secure high returns for

as long as possible.

Ethical Flaws

In a 2011 New York Magazine interview, Madoff stated that he never thought the

collapse of his Ponzi scheme would cause the sort of destruction that has befallen

his family. He asserted that unidentified banks and hedge funds were somehow

“complicit” in his elaborate fraud, an about- face from earlier claims that he was the

only person involved. “They had to know,” Mr. Madoff said. “But the attitude was

sort of, ‘If you’re doing something wrong, we don’t want to know.’ ” To date, none

of the major banks or hedge funds that did business with Mr. Madoff have been

accused by federal prosecutors of knowingly investing in his Ponzi scheme.

However, in civil lawsuits Picard has asserted that executives at some banks

expressed suspicions for years, yet continued to do business with Madoff and

steer their clients’ money into his hands.

In some ways, Madoff has not tried to evade blame. He has made a full confession,

saying that nothing justifies what he did. And yet, for Madoff, that doesn’t

settle the matter. He feels misunderstood. He can’t bear the thought that people

think he’s evil. “I’m not the kind of person I’m being portrayed as,” he told New

York Magazine.

A main issue in this controversy is the continuous fraudulent operations that

Madoff was able to maintain for a decade that created a $65 billion Ponzi scheme

and shattered the lives of thousands around the world. For most of the world,

Bernie Madoff is a monster: he betrayed thousands of investors, and bankrupted

charities and hedge funds. On paper, his Ponzi scheme lost nearly $65 billion;

the effects spread across five continents. And he brought down his own family

with him, a more intimate kind of betrayal.

Bernard Madoff was the central stakeholder who manipulated and involved

his brother, two sons, and niece, all of whom worked inside the Bernard L. Madoff

Investment Securities LLC. Other key stakeholders included Madoff’s employees,

who had invested their money into an operation they believed was legal and

ethical. The financial community were also major players, including financial institutions,

investment management fi rms, charitable organizations, and global

banks. The government, specifically the SEC, and the justice department, were

also heavily involved. The lawyer Irving Picard was a key player, as was the whistleblower

Harry Markopolos and his team who revealed the nature of the scam

early on, even though the SEC and other government regulators did not move on

the evidence.

As of October 2013, Federal authorities are working toward mounting a

criminal investigation into JPMorgan Chase, believing that the bank may have

1 The Changing Environment and Stakeholder Management 39

intentionally neglected Madoff’s Ponzi scheme. Having recently agreed to a $13

billion settlement with the U.S. government to settle charges that the bank overstated

the quality of mortgages it was selling to investors in the run- up to the

financial crisis, the threat of criminal charges over the Madoff case represents

another major threat to the reputation of the nation’s largest bank. The resolution

of this scheme is not over.

Questions for Discussion

1. What did Madoff do that was illegal and unethical?

2. Identify some of the main reasons that Madoff was able to start and sustain

such an enormous Ponzi scheme for as long as he did?

3. Who were/are the major stakeholders involved and affected by Madoff’s

scheme and scandal?

4. Did Madoff have accomplices in starting and sustaining his scheme or was

he able to do it alone? Explain.

5. How was he caught?

6. What lessons can be learned from Madoff’s scandal?


This case was developed from material contained in the following sources:

Abkowitz, Alyssa. (December 19, 2008). Madoff’s auditor . . . doesn’t audit? http:// money .cnn .com /2008 /12 /17 /news /companies /madoff

.auditor .fortune /, accessed March 22, 2012.

Berenson, Alex, and Mathew Saltmarsh. (January 1, 2009). Madoff investor’s suicide

leaves questions. http:// www .nytimes .com /2009 /01 /02 /business

/02madoff .html, accessed March 23, 2012.

Carozza, Dick. (May/June 2009). Chasing Madoff: An Interview with Happy

Markopolos, CFE, CFA. http:// www .fraud -magazine .com

/article .aspx ?id=313, accessed March 22, 2012.

Chew, Robert. (March 25, 2009). Madoff’s banker: Where was JPMorgan Chase? http:// www .time .com /time /business /article /0 ,8599 ,1887338 ,00 .html,

accessed March 22, 2012.

Chew, Robert. (May 30, 2009). Irving Picard at center of post- Madoff storm. Time.

com. http:// www .time .com /time /business /article /0 ,8599 ,1901593 ,00 .html,

accessed March 23, 2012.

Creswell, Julie, and Landon Thomas. (January 24, 2009). The talented Mr. Madoff. http:// www .nytimes .com /2009 /01 /25 /business /25bernie .html

?pagewanted=1 & r=1, accessed March 22, 2012.

Dienst, J., and K. Honan. (December 13, 2010). Madoff son found dead in suicide. http:// www .nbcnewyork .com /news /local /Mark -111717634

.html, accessed March 23, 2012.

Efrati, Amir, Tom Lauricella, and Dionne Sercey. (December 12, 2008). Top

broker accused of $50 billion fraud. http:// online .wsj .com /article

/SB122903010173099377 .html, accessed March 22, 2012.

Ellis, David. (January 5, 2009). Congress looks for answers in Madoff scandal. http:// money .cnn .com /2009 /01 /05 /news /companies /madoff

_hearing /index .htm, accessed March 22, 2012

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