The fraud of the century: The case of bernard Madoff
The fraud perpetrated by Bernard Madoff, which was discovered in december 2008, is based upon a ponzi scheme. Madoff took money from new investors to pay earnings for existing customers. The greater the payout to reting and withdrawing customers, the more revenue or clients he would need to start an “investment relationship” with. The ponzi scheme was named after Charles Ponzi, who in the early twentieth century, saw a way to profit from international reply coupons. International reply coupons were a guarantee of return portage in response to an international letter. Charles Ponzi determined that he could make money, legally, by swapping out these coupons for more expensive postage stamps in countries ehre the stamps were of higher value. while making a significant profit with this system, Ponzi got the idea of enticing investors to provide him more capital to trade coupons for higher priced postage stamps. His promise to investors was a 50 percent profit in a few days.
Touted as a financial wizard and the “Warren Buffet” of his day, Ponzi lived outside Boston; he had a fairly opulent life, bringing in as much $250,000/ day. Part of Ponzi’s success came from his personal charisma and ability to con even savvy investors. The promised payout was supported by the new investors anxious to take advantage of these robust returns because he appeared to crated an image of power trust, and responsability. In July of 1920, the Boston Post ran an article exposing the schame and soon after, regulators raided his offices and chaged him with mail fraud, knowing that his fabricated investment reports were mailes to his clients. The foundational operating principle of a Ponzi shame is that you must constantly attact new investors to pay the old investors the “gains” they were promised. Most Ponzi shemes self-destruct fairly quickly as the alility to keep attracting new investors dwindles. In the case or Bernard Madoff, he may have perpetrade the fraud for many years.
BERNAR L: MADOFF INVESTMENT SECURITIES LLC: “ALL IN THE FAMILY”
Bernie Madoff started in the investment business by legally buying and
selling stocks not listed on the New York Stock Exchange (NYSE). Starting in 1960 as a sole proprietorship he severed as a “wholesaler” between institutional investors. In the early days, working with investment firms such as A.G. Edwards, Charles Schwab, and others, he made his money based on the variance between the offter price and sales price or stocks. In the 1990s, Madoff Securities was trading up to 10 percent of the Nasdaq shares on certain days. Early success and competitive advantage came from Bernie working with his brother Peter (the first of several family members to join his firm), who after graduating from law scholl joined Madoff’s did not operate a hedge fund, which charges a fee house and made his money, in this division, from commissions on sales and profits and as far has been revealed, the profits were not based on fraud.
As Madoff became more successful, he moved the company’s headquarters from Wall Street to Third Avenue to the red granite “Lipstick Building” built by famed architect Philip Johnson. Not unlike. Ken Lay and his lobbying for regulatory changes which would make it easier to trade electronically. Peter took on more oversight of the firm’s securities business. Bernie served as Chairman of the Nasdaq in 1990, 1991, and 1993. Through his successful networking, visibility at the Nasdaq, and promise or consistent returns (10- 12 percent) Bernie was drawing billions of dollars from hundreds of investors. In addition, he held a seat on the goverment advisory board on stock market regulation, served on charitable boards, and his own foundation, which added to his credibility. He developed respectability and trust as a highly lnowledgeable investment specialist. His inaccessibility and “invitaion only” approach to new investors created an air of exclusivity and desire to be involved. It could be equated to the most exclusive of country clubs – the gratest enjoyment is the status of membership. Ruth Madoff, Bernie’s wife, also worked at the firm for a time, indicating a family network of relationships in the firm. Peter’s niece, Shana Madoff, was a rules and compliance officer at Madoff’s firm and worked under her father who was a rules and conpliance officer at Madoff’s arm (not the firm’s money management business). Shana, although not charged with any crimes, is married to Eric Swanson, a former SEC compliance lawyer. Shana Madoff has a respected career and was honored by the Girl Scouts of America as a “woman of distinction”. Although under invertigation, neither of Madoff’s sons, Mark or Andrew, has been charged with any wrongdoing. They were responsible for turning their father in when he condessed to the fraudulent nature of his investment firm. Andrew did have money invested in his father’s firm whereas Mark took his money out of the firm eight years earlier. The two deny any knowledge of the fraud. The family emphasizes the separation of the stock trading business and the investment management business by Bernie Madoff. In march, 2009 when Bernard Madoff stated his guilt, he never indicated the involvement of any other company employees or family members. He stated in the Allocution that, ” I want to emphasize today that while my investment advisory business the vehicle of my wrongdoing – was part of Bernard L. Madoff Securities, the other businesses that firm engaged in, proprietary trading and market making, were legitimate, profitable, and successful in all respects. Those business were managed by my brother and my two sons”. Further inverstigation will determine the extent and level of external support which Madoff had in defrauding thousands. His hiring philosophy for the investment business was to hire inexperienced individuals with no background in finance. They may have been unknowing participants.
EXPLANING THE GROWTH NUMBERS
Madoff claimed he could consistently generate 10 to 12 percent returns for investors. Many of this clients were already wealthy and looking for a staple and constant rate of return. His stated investment strategy was to buy stocks while also trading options on those stocks as a way to limit the potential losses on those stocks. His market timing strategy was called the “split strike convension”. With the large financial portfolio Madoff managed, many indicate ar least one “red flag” would have been the fact that he would have overtaken the market had he traded the options in the columes necessary to meet his dinancial goals. In his “plea Allocution” statement un March of 2009, he indicated that he never invested any of this client’s funds. Madoff simply moved money between chase Manhattan Bank in New York and Madoff securities International Ltd., a United Kingdom Corporation. Madoff stated that his fraud began in the early 1990s. Madoff had relationships wit intermediaries also known as “feeders” to his investment fund. These “feeders” trusted Madoff and ar this point do not appear to be integrally involved un the fraud. One such middleman, Rene-Thierry Magon de la Villehuchhet commetted suicide on December 23, 2008, after losing his life savings to Madoff. The middlemen proofited by receinving fees, and Madoff had a stream of money flowing into his operation. Robert Jaffe operated as a middleman for Madoff starting in 1989 when he became the manager of Boston-based Cohman Securities, adirm co-owned by Madoff to attractive investors. Jaffe was the son-in-law of the of madoff’s earliest investors. He earned a small profit when Madoff took on an investor Jaffe introduced to him.
Stanley Chais was a private investor from beverly Hills who consistently brought in returns of 10 to 15 percent. Chais was funneling all his client’s money to Madoff. Investors with Chains claim they thought he was personally managiang their money and were not awere of the madof connection. In june, Chais sent a letter to clients informing them that he was moving to Jerusalem for six months for medical reasons and his son would take over in his absence. Chais’s fortune in claimed to be devastated as is that of his clients. In addicion, Chais lost sidnificant money in his own charitable found. Jeffrey Tucker was an attorney for eight years at the SEC. Tucker also dacilitated the meeting between Fairfield Greenwich Group and Madoff resulting in the loss of $7.33 billion. Andres Piedrahita wed one of the daughters of Fairfield Greenwich’s co-founder Walter Noel. Piedrahita joined Greenwich and attracted significant revenue from Europe’s wealthiest damilies, operating out of London office. Wealthy Spanish clients invested just under $50 million with the Group and Madoff.