The Man Behind the Biggest Ponzi Scheme
65 Billion Dollars Lost
At first glance Bernard Madoff appeared to be an elderly respected member of Wall Street, many sought after him and he had access to elite circles in the financial world. However, the man behind a devastating Ponzi scheme, charismatic Madoff lured in investors with promises of a steady return on their investments regardless of market instability. He was finally charged with securities fraud, investment advisor fraud, mail fraud, wire fraud, money laundering, false statements, perjury, false filings with the SEC, and theft from employee benefit plan. Through an overview of the fraud, the consequences for the stakeholders, and the role of the auditors, we can see that it is his securities fraud that caused the greatest outrage due to the number of people it affected and the volume of money involved.
Overview of the Fraud
An American stockbroker, investment advisor and financier, he was also a non-executive chairman of the NASDAW stock market and the mastermind behind a Ponzi scheme, which is considered by many to be the largest financial fraud in U.S history. He founded the Wall Street firm Bernard L Madoff Investment Securities LLC in 1960. He was considered to be a pioneer in the field with his use of modern technology and computerised trading, creating NASDAQ which listed primarily high-tech companies not listed on other markets. Another branch of this was the investment side where Madoff invested peoples’ money for them promising a 1% return a month and 10 – 12% annually.
His investors had to know him personally. Steve Fraser, Columbia History Professor, said “you practically had to have an embossed invitation testifying to your worthiness to invest in Bernie Madoff’s Ponzi scheme”. In fact what he did was pay investors with money received from other investors, never actually buying or selling a single share of stock. The monthly reports he issued with diversified stock and safe returns were fictitious. Many were shocked when he was finally arrested on Dec 11, 2008 for securities fraud with paper losses totalling $64.8 billion and cash losses nearing $18 million. Victims of the fraud included major charities, universities, offshore hedge funds and middle-income investors, many of whom were members of his own extended family.
Consequences for key stakeholders
The Ponzi scheme may have begun as early as the 1970’s, and the consequences for investors were detrimental. As Madoff moved up in the world, the economic climate was beneficial as in order to sustain his scheme he needed access to the more money. The largest amounts of money came from hedge funds which was made possible by a pervasive insiderism – everyone wanted to get in on Madoff’s trading abilities and make a steady return on their investments. Following the 2008 financial crisis, investors looked for someone blame and Bernard Madoff gave Americans someone to focus their anger and fury on. Many investors had entrusted their life savings to Bernard Madoff. One such investor, Norman Braman, had $70 million of his family’s money invested with Madoff. The scam of the century, investors lost the money they planned to retire on.
Madoff used fund managers who set up special investment pools for him with feeder funds. Some of these stakeholders put all their own money, their family’s money and the money of those who trusted them into Madoff’s hands. Rene-Thierry Magon de la Villehuchet, a hedge fund operator with a $1.4 billion fund invested with Madoff was so distraught that he committed suicide. Perhaps what is most shocking is money that Madoff stole from charities such as the Elie Wiesel Foundation and Steven Spielberg’s Wunderkinder Foundation. After trying to recover as much as they could from Madoff Securities, people turned to the SEC, asking why they had failed to protect them.
Auditors and their role in the scandal
The SEC was formed in the early 1930s in the aftermath of the stock market crash in order to restore faith in the markets but it was only in the 1980s that Wall Street regained its central place in American culture. The SEC struggled to keep up with the changes and its resources were spread thin, making it easy for companies to hide things. When the Bush Administration came in, it had to make sure that the US remained competitive in an increasingly global financial marketplace. Inevitably that pushed other priorities aside and made way for a host of problems on Wall Street. People were convinced that deregulation was needed and that people like Madoff should be left to do what he does best. Little did they know that what he did best was steal their money.
Harry Markopolos was a competitor who realised that Madoff’s performance was flawed in the early 2000’s. He rain mathematical models to try to reproduce his performance and warned the SEC several times that there were red flags and that Madoff was either operating a Ponzi Scheme or he was Front-running. Although there were six botched investigations by the SEC of Madoff since 1992, it was only when his own sons turned him in in December 2008 that he was finally arrested. Although the SEC investigated him for front running and gave him a clean bill of health, they did not then go on to investigate him for having a Ponzi scheme.
Agency theory illustrates how there is a relationship between investors and managers. The investors of Madoff securities would have benefited from an accurate audit by the SEC. Unfortunately, the assurance they had was false. The main reason why the SEC failed to pick up on the fraud was incompetence and a lack of professional scepticism. Auditing is needed from an economic standpoint as it acts as insurance for investors who can then sue the auditors for negligence if they have been grossly incompetent in providing an opinion on financial statements. Furthermore, it is demanded by a wide range of users and the cost of an audit failure to society is proven in this case with employees losing their jobs and savings invested in Madoff Securities, suppliers losing money owed to them, investors losing their investment, and government losing unpaid taxes, the SEC lost its reputation. The social benefits of an audit are investor protection, protection of other stakeholders, and demand for governments to do something in a financial crisis.
Sadly the fraud committed by Bernie Madoff and various family members involved such as his brother Peter who served 10 years, dragged his whole family into a downward spiral. His wife, Ruth Madoff, claims that they tried to commit suicide shortly after the scandal came out and suspicion lies heavily on members of the family, as she withdrew $15 million dollars the day before he confessed to his sons. While Madoff is currently serving his 150 year prison sentence, other people involved in the fraud were David Frieling, who pleaded guilty in November 2009 to securities fraud, investment adviser fraud, false filings to the SEC and obstructing IRS. Frank DiPascali also pleaded guilty in August 2009. In November 2011, David Kugel pleaded guilty to charges that he helped Madoff create false statements for a paper trail that were supplied to clients.
The Madoff scandal illustrates the importance of auditing and regulation in the financial world. Despite repeated warnings from Markopolos, the federal regulatory agency failed to notice the biggest fraud in history of trading. It confirms that auditing is very much needed for social and economic factors and benefits investors and managers alike. While the victims of Madoff Securities are still suffering from their losses, perhaps it will serve as a lesson to investors and regulators in the future.