The Madoff Affair by cGYCwrJ


Bernard Lawrence "Bernie" Madoff; (born April 29, 1938)
is an American former financier and convicted felon.
Madoff, who once served as a non-executive chairman of the
NASDAQ stock exchange, pled guilty to an 11-count criminal
complaint, admitting to defrauding thousands of investors
of billions of dollars. He was convicted of operating a Ponzi
scheme that has been called the largest investor fraud ever
committed by a single person.
Federal prosecutors estimated client losses, which included
fabricated gains, of almost $65 billion. Other estimates of
the fraud, excluding the fabricated gains, are $14-21 billion.
On June 29, 2009, he was sentenced to 150 years in prison,
the maximum allowed
Madoff founded the Wall Street firm Bernard L. Madoff
Investment Securities LLC in 1960, and was its chairman until
his arrest on December 11, 2008. The firm started as a penny
stock trader with $5,000 (about $35,000 in 2008 dollars) that
Madoff earned from working as a lifeguard and sprinkler
installer. His business grew with the assistance of his father-in-
law, accountant Saul Alpern, who referred a circle of friends
and their families. Initially, the firm made markets via the
National Quotation Bureau's Pink Sheets. In order to compete
with firms that were members of the New York Stock Exchange
trading on the stock exchange's floor, his firm began using
innovative computer information technology to disseminate
its quotes. After a trial run, the technology that the firm
helped develop became the NASDAQ
Madoff founded the Wall Street firm Bernard L. Madoff
Investment Securities LLC in 1960, and was its chairman
until his arrest on December 11, 2008. The firm was one of
the top market maker businesses on Wall Street, which
bypassed "specialist" firms, by directly executing orders
over the counter from retail brokers.

Madoff was a prominent philanthropist, who served on
boards of nonprofit institutions — many of which
entrusted his firm with their endowments. The collapse
and freeze of his personal assets and those of his firm
affected businesses, charities, and foundations around the
world, including the Robert I. Lappin Charitable
Foundation, the Picower Foundation, and the JEHT
Foundation which were forced to close.
Ponzi Scheme
Ponzi scheme is a scam investment designed to
separate investors from their money. It is named after
Charles Ponzi, who constructed one such scheme at
the beginning of the 20th century, though the concept
was well known prior to Ponzi.

The scheme is designed to convince the public to place
their money into a fraudulent investment. Once the
scam artist feels that enough money has been
collected, he disappears - taking all the money with
Features of Ponzi Scheme
 The Benefit: A promise that the investment will achieve
  an above normal rate of return. The rate of return is often
  specified. The promised rate of return has to be high
  enough to be worthwhile to the investor but not so high as
  to be unbelievable.

 The Setup: A relatively plausible explanation of how the
  investment can achieve these above normal rates of return.
  One often-used explanation is that the investor is skilled
  and/or has some inside information. Another possible
  explanation is that the investor has access to an investment
  opportunity not otherwise available to the general public.
Features of Ponzi Scheme (Contd.)
 Initial Credibility: The person running the scheme needs
  to be believable enough to convince the initial investors to
  leave their money with him.

 Initial Investors Paid Off: For at least a few periods the
  investors need to make at least the promised rate of return
  - if not better.

 Communicated Successes: Other investors need to hear
  about the payoffs, such that their numbers grow
  exponentially. At the very least more money needs to be
  coming in than is being paid back to investors.
Steps in the Ponzi Scheme
1.   Convince a few investors to place money into the investment.

2.   After the specified time return the investment money to the
     investors plus the specified interest rate or return.

3.   Pointing to the historical success of the investment, convince
     more investors to place their money into the system. Typically
     the vast majority of the earlier investors will return. Why
     would they not? The system has been providing them with
     great benefits.

4.   Repeat steps 1 through 3 a number of times. During step 2 at
     one of the cycles, break the pattern. Instead of returning the
     investment money and paying the promised return, escape
     with the money and start a new life.


 The investors give money to the Firm
 The Firm gives back money to the investors with returns
 This way the firm makes its first set of customers
 These customers spread the word to other potential investors
 These new investors invest in the firm and receive returns
 Newer set of customers is made
 The investors again refer a newer set of investors
 This is how the funds of the firm increase
The complete events of the Company can be broken
down into 2 main Phases,

• Phase I (1960-1992)
• Phase II (1992-2008)
Phase I

 Madoff started career in his father's accounting firm in NY
  as a market maker

 He Also had a side business as an investment advisor

 It was completely off the radar, that is it wasn't registered

 He basically started small, with a handful of closely known
  people, promising a return of around 14-20%, depending
  on the investment
 Brought In two accountants from his father-in-law’s firm,
  Frank Avellino & Michael Bienes
 They handled the funding part, taking small percentage of
  the total funds
 Interestingly, the firm had their name. That is it was called
  Avellino & Bienes Co.
 The initial investors had not heard of Madoff at all

  Mid 80s

 Avellino & Bienes’ share reached $10 million per year

• SEC (Securities and Exchange Commission ) Launched
 an investigation after a complaint from an Investment
 advisor, suspecting a Ponzi scheme

• Above 3000 clients were being served

• By November 1992, SEC ordered shutting doing the Co.

• Avellino and Bienes paid back all the investors money

                     End of Phase I
Phase II

 Madoff took over the company in public
 Michael D Sullivan took 30 accounts of Avellino and
  Bienes in the firm
 Avellino & Bienes themselves invested their personal
  money with Madoff
Mid 90s

 By now Madoff had Bigger players in his scheme,
  Private banks had started to pool in money
 The family of the investors did the marketing
 It had started being marketed to the wealthiest and
  famous people all around the world
  Conditions implied to customers
  i.    Funds were forbidden from Listing Madoff as
        investment advisor
  ii.   Madoff’s firm was still unregistered with SEC,
        although serving thousands of investors

 Madoff showed his investors his office

 The office had a nice ethical working standard

 Madoff also used his name as part of marketing as he
  was one of the most respected and influential people
  on Wall Street

Madoff did well till 2008. In 2008, almost 1/3rd of all
  Geneva fund managers had invested with Madoff
How did it collapse?
 In 2007 after the Housing bubble burst, most of the
  companies in the market allowed it’s investors to
  withdraw money or were simply shut down
 By December of the same year, There were more
  requests of withdrawals in the firm than deposits
  This was because most of the investors needed money
  to pay their own customers and/or to run their own
 The firm was unable to pay the customers and the
  scheme came to light
The 2 main rules of Ponzi scheme are:

 To have newer customers &
 There is no sudden outflow of customers
 These rules are put to a shock test whenever there is a
 downfall in the market

 Finally on December 10 2008 Madoff confessed to his 2
 sons about his funds being a Ponzi scheme and the
 next morning the FBI were at his doorstep
 He was later granted a sentencing of 150 years, being
 accused of Fraud and 8 other cases
  Even before the SEC busted the scheme, there were a
  lot of obvious catches which, if had been taken into
  consideration at the right time by the SEC, could have
  prevented this from happening. They are as follows:
 The company being Unregistered although serving
  thousands of customers
 There was always a steady rate of return even if the
  market goes up or down
 The statements sent to customers was always given in
  printed form and were never available online
Catches (Contd.)
 Statements were set to customers 3-5 days AFTER a
 deal in the market was made, resulting in
 foresightedness. e.g.: Betting on a horse race AFTER it
 has begun
 Statements showed names of firms whose names had
 changed and were not open to new investors
 If customers complained on any of the above issues,
 the firm would threaten to return back the money
Catches (Contd.)
 The 3rd party Due Diligence (Auditor) officer had his
 office in Bermuda, a place not known for having such

 Whistle Blowers Like Marco Polo published these facts
 in 2001 but SEC did not act accordingly

 Steady flow of letters were doing the rounds to SEC
 office regarding Madoff
In 2006 SEC finally launched an investigation into the

Following are SEC’s responsibilities which should have
been checked:

 SEC should have checked if the firm was registered or not
 Should have proactively taken the initiative to check on
  the firm of its funds
 Even after the warnings from whistleblowers, the SEC
  should have swiftly acted on the situation
 PBS Frontline - The Madoff Affair

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