Bernie Madoff Paper

Amina Karim

Professor Rampulla

ACCP 475

December 16, 2018

Bernard L. Madoff

        One of the biggest Ponzi schemes ever created was done by Bernard Madoff, the former chairman of the board of directors of the NASDAQ stock market. A Ponzi scheme is a type of fraud in which profits are paid to earlier investors by using funds from more recent investors. On December 10th, Madoff’s sons, Andrew and Mark, called the authorities on him and the next morning he was arrested. Madoff was charged with 11 federal crimes: securities fraud, investment advisor fraud, mail fraud, wire fraud, three counts of money laundering, false statements, perjury, making false filings with the SEC, and theft from an employee benefit plan. The SEC charged the auditors of Madoff’s broker-dealer firm with committing securities fraud by representing that they had conducted legitimate audits, even though they did not.1

        Bernie Madoff, at the age of 70, was convicted for fraudulent activities in regards to his company, Bernard L. Madoff Investment Securities LLC. BMIS, located in New York City, was registered as a broker-dealer in 1960 and as an investment advisor in 2006. They had three types of operations: investment advisor services, market making services, and proprietary trading. Madoff oversaw and controlled the investment advisor services as well as all overall finances for the company. Madoff kept his investment management business very quiet under his legitimate market-making operation. His investment advisor business was on a separate floor in their New York office. At the time of his arrest, Madoff was ranked among the top 1% of US Securities firms. According to the SEC Complaint, the firm’s financial statements were always under lock and key and Madoff never really explained the advisory business with other employees of BMIS. In March of 2009, Madoff was charged with 11 federal crimes on behalf of BMIS. It is believed that from at least the 1980’s till December of 2008, Madoff and BMIS conducted a Ponzi scheme throughout his investment adviser and brokerage services. In the first week of December, Madoff told a few senior employees that clients have been asking for billions of dollars in redemptions, and that he was struggling to obtain the liquidity needed to meet his client’s obligations. He soon admitted that his advisory business was a fraud, that he was “finished,” that “it’s all just one big lie” and “basically, a giant Ponzi scheme.”2 He also admitted to these employees that for years, he had been paying returns to certain investors out of the principal amount he got from other, more recent investors. Madoff states the business has practically been insolvent for years and that estimated losses from the fraud are about $50 billion. Madoff was also intending to distribute bonuses to his employees. This was strange because in previous years, bonuses were paid in February for prior year work.  To make sure this does not happen, the US Securities and Exchange Commission imposed asset freezes on Madoff, to appoint someone to watch over BMIS, to prevent the destruction of any documents,  and to have Madoff provide proof of any verified accounts.2 The trustee appointed to oversee the liquidation of BMIS was Irving Picard. Along with the bonuses, Madoff said he had about $200-$300 million left which he planned to make payments to select employees, family, and friends. He said he needed one week to do this and then was going to report himself to the authorities. However, this never happened as he was arrested the next day.

As BMIS was a broker-dealer, it was required to file an annual report, including financial statements and related disclosures. An independent auditor’s report was to address these financial statements as well as any materially inadequate information in BMIS’ internal controls. Since 1991, David G. Friehling had signed BMIS’ annual audit reports. Friehling always said the financial statements were fairly stated and stated that BMIS was a sound broker-dealer. Their audited annual report made customers trust that BMIS will handle their investments in a sound manner.  Clients also invested more money with BMIS because of what the financial statements portrayed. They had no idea that the audited reports were false and had no factual basis to them.

A reason that this was able to go on for so long without detection was because Bernie Madoff was an entrusted person in the financial industry. He helped the launch of the NASDAQ stock market as well as sat on the board of National Association of Securities Dealers. He even advised the SEC on trading secutires.12  Madoff’s investors really did believe they were making profits. As long as new investors continually tried to invest with Madoff, he always had enough to back old investors. And as long as the markets were doing well, no one tried to take their investments out. Instead of investing the money his investors gave him, he spent it on family and friends. However, the problem started to bubble during the crash of the market in 2008. Scared investors wanted to withdraw their money. Clients had requested a total of $7 billion back in returns but Madoff only had $200 to $300 million left to give out.11 Madoff had all three components of the fraud triangle: pressure, opportunity, and rationalization. Madoff probably thought that he had to consistently bring out good returns or people would start asking for redemptions, so he was always under pressure to bring it more clients so he would always have enough to pay back previous investors. Madoff had the opportunity to commit this scheme because no assumed that he would do something like this. For almost 20 years, investors were never disappointed and they typically never took money out, they usually put more money in to invest with him. Madoff rationalized what he was doing because he did disclose that in this line of business, that it could possibly lead to losses. However, investors saw the profits and didn’t think or care to ask how or why they were so consistent. They just believed they were making money. Madoff was also always very quiet of his investment strategies, saying that that’s the way he was able to give his investors such good returns. No one actually knew it was all a scam, and he had people make fake profits for the investors.  

        Madoff violated Sections 206(1) and 206(2) of the Advisors Act. This states that BMIS employed schemes to defraud clients and engaged in activities of business which operated as fraud. Section 17(a)(1) of the Securities Act was violated which states that from at least 2005, Madoff in the offer and sale of securities tried to defraud investors. Madoff also violated Section 17(a)(2) and 17(a)(3) of the Securities Act which says that BMIS obtained money through untrue statements of material fact. Violations of Section 10(b) of the Exchange Act and Rule 10b-5 also were claimed which says that untrue statements of material fact were made.2 

        The signs of fraud were seen by Harry Markopolos, securities executive and whistleblower of the Madoff Ponzi scheme. Markopolos tried many times to raise the concern of Madoff’s company. He first depicted of fraud when his employer asked to create a product that produces similar returns as Madoff did. Madoff was consistently producing 1% to 2% returns every month with practically no volatility.7 The performance chart of the returns went up a 45-degree line which just did not exist in finance. Within minutes of analysis, Markopolos concluded that this must be impossible because there was no way to smooth out the ups and downs of the S&P index performance.8 Markopolos approached the SEC as early as 2000, with supporting documentation, but they mainly ignored him. Markopolos believed this was the case because SEC staff were lawyers rather financiers so they could not follow his reasoning. He also thinks there was tension between the Boston Branch and the New York Branch so there was not enough communication between the two.8 Markopolos also explains poor investigative ability of the SEC, explaining that one staffer wouldn’t follow up because Markopolos was not an employee of Madoff, which didn’t make him an insider. Another SEC staffer said he would only qualify as a whistleblower if Markopolos has it on tape that Madoff was actually running a Ponzi scheme. He also says that it was just unthinkable that this was going on as well. The media didn’t believe him and thought he was obsessive and “a little bit nuts”. Markopolos also believes that several high-end clients, like hedge funds, probably chose not to look too closely at what Madoff was doing. Even though Markopolos was almost certain of Madoff’s fraud, no one ever believed him. Markpolos wrote a book called No One Would Listen: A True Financial Thriller on his decade-long trail to following Madoff as well as the wrongdoings of the Securities and Exchange Commission. Markopolos has proposed to move the SEC agency from Washington to New York, to actually have experience financiers as staff rather than lawyers, as well to improve their database.7 After the scandal, the Securities and Exchange Commission did try to fix some of these concerns.

        Bernie Madoff was arrested on December 11, 2008. He confessed to his two sons that his multibillion-dollar investment firm was a complete fraud. Madoff took his sons to his apartment in Manhattan to tell them everything that was going on. It was there that he explained his entire investment advisory business was a fraud. Madoff’s sons, Andrew and Mark, informed the Federal Bureau of Investigation (FBI), and agents arrested him the next morning. On June 2009, Madoff was sentenced to 150 years in prison, the maximum amount for his crimes. He will serve the rest of his life in the Butner Federal Correction Complex in North Carolina.6