21 May DISCUSS THE ORIGINATION OF THE PONZI SCHEME AND HOW MADOFF USED IT.
Bernie Madoff’s Ponzi scheme
Bernie Madoff, 73, a past chairman of the Nasdaq stock exchange, was a pillar of Wall Street. A member of elite country clubs in Palm Beach and Long Island, he was respected and admired by financial institutions and rich individuals in America and Europe. In December 2008, he was charged with fraud by operating a giant Ponzi scheme over 17 years. Such schemes use incoming investments to pay existing investors a steady dividend and to refund investments when requested. Clearly such schemes hinge on rising share prices and ever increasing investment into the fund. The recession put an end to all that. Madoff ran a brokerage business from a three floor office in mid-town Manhattan; but that turned out to be just a front for the Ponzi scheme. In March 2009, he pleaded guilty to fraud and faces the rest of his life in prison.
His fund recorded at least $65 billion worth of assets invested for some 5,000 clients. Less than a billion has been recovered. His investors included hedge funds, movie moguls, Swiss banks, and charities, as well as individual rich investors. Santander Bank has offered 1.4 billion euros to customers for savings invested on their behalf in the Madoff fund. Other banks also lost money including HSBC, Royal Bank of Scotland (see HBOS case in this collection of cases), and BNP Paribas. The hedge fund Man Group (see case in textbook) has brought an action to recover $360 million.
There had been warning signs. Some had suggested that the fund’s returns were too consistent given market movements, others that such returns could not be earned by the strategy Madoff claimed to follow. Nevertheless, the SEC (US Securities and Exchange Commission) failed to detect the fraud over many years, even though allegedly they had had warnings from a whistle-blower.
In the United States, the SEC, the FBI, and the US Attorney General were involved in the investigations. In the UK, the SFO (Serious Fraud Office) investigated Madoff’s London office. Madoff’s auditor David Friehling 49, a sole practitioner in suburban New York, and Madoff’s brother-in-law were also been prosecuted. Madoff was tried and is now serving a 150 year sentence at a prison in North Carolina. Searches were made for funds held by Madoff or members of his family but there was little chance of significant restitution.
Madoff’s victims included Hollywood stars, millionaire hedge-fund managers, and middle class pensioners often from the Jewish communities in Florida and New York. Madoff expressed no sympathy, because, as he explained, all his clients had declared that they had enough wealth to withstand trading losses.
Why did people trust him? Perhaps because they were impressed by his credentials, perhaps because they were influenced by other investors who trusted him, or maybe they thought the returns were so good that he had must have insider information and they wanted to join in.
A report in the London Times (22 March 2012) reported that in e-mails from his prison cell, Madoff had attempted to shift part of the blame for his crimes to his customers. He attacked wealthy victims who had been obliged to sell their “second or third vacation homes, which were paid for by years of legitimate profits from my fund.” He regretted confessing to fraud instead of pressing for a full jury trial, claiming that things had turned against him in the global financial crisis, which started in 1987, when clients insisted on withdrawing large sums from their funds in spite of long-term hedging strategies designed to protect them.
Discussion questions for the report
1. Discuss the origination of the Ponzi scheme and how Madoff used it. (10%)
2. Which corporate governance theory do you think will apply to this case? Discuss the theory in relation to this case (25%)
3. Why do you think individuals, banks, and hedge funds invested in the Madoff fund? (20%)
4. Discuss the US corporate governance guidelines that can safeguard investors from such schemes in the future? (25%)
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