Madoffs Ponzi Scheme - Essay Example

Madoff’s Ponzi Scheme Overview Bernard Madoff devised a Ponzi scheme that took away near about 50 million dollars from his clients through his firm Madoff Investment Securities. Misusing his position in the society as a well-known financial adviser, he easily managed to run the Ponzi scheme evading the scrutiny and investigation of auditors and SEC. Later on, Harry Markopolos, an independent financial investigator developed serious doubts about the marketing strategies of Madoff due to the high returns he offered. In 2005, Markopolos reported to the SEC that Madoff was running the biggest Ponzi scheme in the history. Still it took a long time to assess for the authorities to verify that it was a Ponzi scheme. It was one of the most cold-blooded, deliberately devised and implemented Ponzi scheme. This fraud had serious impact on people’s view about investment. All investors start viewing investment firms and charities with a lot of suspicion and firms faced a considerable fall in business. The only positive element was the fact that it acted as an eye-opener for both the authorities and the public. While public became aware about the need to be careful about the promises of unbelievably high returns, the authorities too understood the need for new statutes to prevent such frauds. Madoff’s intentions still remain a mystery It still remains a mystery why such a prominent figure who was well aware about the movements in the market and also about the implications of such a Ponzi scheme decided to implement such a devilish idea that caused irrevocable loss to many people. It is yet to be resolved as to why he went on paying the withdrawals if he wanted to cheat the investors. In addition, Madoff tried to hold back the firm’s imminent fall ten days before his arrest by receiving a huge sum of 250 million dollar from a close friend (Frank and Efrati). It seems closer to insanity that he admitted that his scheme was a Ponzi scheme and that he did not invest any money as had promised. However, it seems a calculated move that he managed to keep all his family members away from legal complexities by taking the responsibility of the fraud all to himself. One has to assume that seeing his irrational behavior, all other members managed to secure their position by avoiding any position in the company that involved the responsibility of money management. However, a man who could con the authorities and auditors for nearly two decades could easily devise a better plan than this Ponzi scheme if he wanted to. Thus, it still is to be ascertained as to why he chose a Ponzi scheme, the outcome of which he knew pretty well. The best assumption possible is that his extreme wizardry might have turned him insane. I. What are the ethical issues involved in Madoff case? One has to admit the fact that the Madoff’s system was unethical in nature from head to toe as the scheme was a Ponzi scheme. While attracting the investors, Madoff was well aware of the imminent failure of the scheme. All financial experts and even common investors are well aware of the fact that Ponzi scheme always fail due to its own weight as such schemes require an ever increasing flow of money to pay the retiring and withdrawing clients. Once the inflow of fund diminishes, the system collapses. 1) Misusing the office of trust The first element of unethical practice is in Madoff’s misusing his position of repute in the society. He was an educated and experienced person in a position of trust, respectability, responsibility and trust. The aura of authority he created in this field is evident from the list of his clients including influential people, big organizations and even banks. Some of them were The Fairfield Greenwich Group, Tremont Group Holdings and Westport National Bank. All his investors gave him money on the belief that there were many checks and balances to make his investment plan legitimate. Madoff’s Ponzi scheme is the epitome of white-collar crimes as he was misusing his power to defraud people. The graveness of the crime increases as it was totally intentional in nature and as he was well aware of the failure of the scheme. He knew very well not only that he would not be able to provide them the promised benefit but also that many would lose their money totally. The most surprising element is that he never invested the money; instead, he transferred it from one bank to another. According to Sarah Peck (38-50), it is the responsibility of an investment adviser to have adequate care in taking professional decisions about investment and investment recommendations. 2) Giving false promises and the fate of feeders Madoff’s investors were made to believe that they would get 10 to 12 percent return for their money. His clients used to receive statements that contained several pages and they believed the statements to be the proof for the credibility of the business. However, the surprising fact is that he made no investments at all and that he was aware of the fact that ‘this day would come’ (p. 411). Yet another treachery was towards feeders or middlemen who used to canvass investors for Madoff on very small profit. Some of them had to leave the place while some ended their life being the victims of this fraudulent scheme. The severe nature of the crime is evident from the fact that he wanted to hide the facts even from his employee. For that purpose, he used to appoint inexperienced individuals in his business firm and thus they became unknowing participants in the treachery. 3) The plight of third-party investors Yet another serious concern is the pathetic situation of third-party investors including the investors of Westport National Bank. A considerable proportion of investors made investments indirectly through other individuals or firms. Though the direct investors retain the hope of getting compensation, though minor, the indirect investors may not be eligible for this. 4) Madoff’s scheme in the light of Utilitarianism theory John Stuart Mill’s Utilitarianism theory is basically a consequential theory and hence it points out basically that the rightness or wrongness of any action is solely decided by the consequences of the action (Utilitarianism). According to this theory, a business policy can be considered good only if it is the best option to promote the general welfare of the organization. Analyzing Madoff’s actions in the light of this theory, it is very evident that his intentions, from the development of the plan, were in total contradiction with the interests of the investors and was never benevolent in nature, and thus, a blatant violation of the utilitarian concept. 5) Analysis based on Justice Theory John Rawls define the principles of justice as “the principles that free and rational persons concerned to further their own interests would accept in an initial position of equality as defining the fundamental terms of their association. These principles are to regulate all further agreements.” (Rawls, 3). According to this concept, all further steps to be taken will be purely based on the understanding and this can be termed fairness. In the case of Madoff, he moved away from what he promised to the clients initially and, in simple words, violated all the concepts of business ethics. Assuming Madoff had an investment strategy that failed, forcing him to convert his scheme into a Ponzi one, what he had to do according to the principles of justice was to reveal the loss so that no more investors would lose their money. 6) Deontological concept of ethics and Madoff’s scheme The basic principle behind the deontological theory is that while fulfilling ones moral duty, the consequences of that action should not be considered (Ethical Theory – deontology). In other words, it is ultimate to do ones moral duty whatever its consequence may be; good or bad. No one can argue that Madoff’s way of management had any connection with the deontological thinking. He considered neither moral obligations nor consequences. II. Do you think Bernard Madoff worked alone, or do you think he had help in creating and sustaining his Ponzi scheme? Would this represent a conflict of interest? Bernard Madoff epitomizes the concept of white-collar crime. However, it will be baseless to believe that Madoff alone managed to defraud both the public and the authorities for nearly two decades using a Ponzi scheme, especially when there were serious allegations and doubts regarding his trading practices from the very beginning. The first deceptive step is the full-time involvement of his all family members in the business. As these people all were successful financial experts themselves, it would be foolish to believe that they had no knowledge about Madoff’s fraudulent motives. There is no ground in the theory that Madoff alone managed all the details of investment, including transfer of money and the detailed statements sent to his large number of clients. In addition, making Madoff Securities a separate entity from his all other business including proprietary trading and market making can only be considered as a calculated move. The most amazing fact is that though all other members were active in this family business, none had a responsible role in Madoff Securities; Madoff all alone is considered responsible for the treachery. It seems rational to believe that Madoff had an investment strategy when he attracted investors which, unfortunately, went wrong. The only strategy he could adopt might have been to convert his scheme into a Ponzi one, thus covering up the loss by paying the withdrawals with the investment of the new. To save the family business from total collapse, he made Madoff Securities a separate entity, thus saving their future. In addition, there is probability that he might have transferred money to foreign accounts before turning himself in. It is worth pointing here that Shana Madoff was married to a former SEC compliance lawyer and still had no idea, or no interest in knowing, about the dealings of Madoff money management. The active participation of Madoff’s staff in the scheme is very evident from the evasive reply of Frank DiPascilli, who dealt with client accounts in the firm. It is surprising that he served the company for twenty-two years in a very responsible position and knew nothing about it. In addition, such a fraud requires active participation of auditors, that too, for long terms. The most amazing fact is that though Securities and Exchange Commission had been investigating the trade practices of Madoff, it cold not find any irregularity in trade practices. SEC should be held responsible to explain what trade activities they investigated especially when Madoff admits that there was no trade or investment at all. Though enforcement investigation found misleading behavior in 2006, no further action was taken in that connection. One has to remember the fact that Harry Markopolos, an independent financial fraud investigator, managed to unearth the treachery behind the scheme of Madoff but it is unbelievable that despite his repeated tips, SEC authorities did little to, or failed to, stop Madoff from cheating many off their lifetime savings. From the above, the influence of Madoff on the regulatory authorities is very evident. This fraud represents a conflict of interest in the fact that Madoff demonstrated ethical breach. This is a classic example of COI because the interest of Madoff, from the very beginning, was to exploit the money of people misusing his position of power and trust. Though it is doubtful whether he wanted to take the money of people by defrauding them, it still can be called conflict of interest in the fact that he did not disclose to his clients that he was not investing their money. Thus, his interest becomes totally inconsistent with the interest of his clients. Yet another point is that he diverted the money of new investors to pay the withdrawals. In other words, Madoff devised the entire system for a purpose that was contradictory to what he informed the investors. Thus, it can be said that Madoff’s dealings exhibited conflict of interest though it can also be termed fraud. III. What should be done to help ensure that Ponzi schemes like this one do not happen in the future? To devise a strategy to prevent such Ponzi schemes, firstly, one has to analyze the factors that helped Madoff carry out his fraudulent scheme. There were many favorable factors that enabled Madoff to implement his Ponzi scheme. The first one was his track record as a successful investment adviser who had a stain-free public portfolio. He had a number of clients who were prominent figures in the society. In addition, there was total lack of efficiency in auditing or the auditors were corrupt well beyond limits. It is totally irrational to believe that the auditors did not notice any discrepancy or lack of coherence in the accounts and statements. One has to assume that the auditors were lured enough to turn a blind eye towards the issues. Thirdly, the authorities had a lukewarm approach towards the allegations against Madoff’s practices. It is ironic to see that the government had to take nearly two decades to find that it was a Ponzi scheme and that too, only after an independent financial investigator Harry Markopolos tipped the authorities. This shows the grave inefficiency in the government monitoring system. So, the solutions which are put forward here are categorized into two groups; for independent investors and for the authorities. For the investors Ponzi schemes such as the one devised by Madoff should act as eye-openers for the investors and the government. In fact, investors can do a lot to ensure that they are not wasting their money believing the glossy brochures and promises of improbable profits. There are certain broad ideologies that every investor should know. First of all, investment returns are always influenced by market fluctuations and hence there is risk. So, never invest such huge money that you cannot afford losing. Always try to get advice from a third party before falling prey to any high-return promise. Thirdly, never invest money in anything only because one of your relatives suggested so. Ponzi schemes always run on this trick. Moreover, it is highly necessary to make sure that you are not engaging a single financial adviser. Rather, spread the money and work with different investment advisers, thus reducing the risk. Another vital thing is to beware of uncorroborated claims about performance; it is highly unlikely for them to have any miracle that is not seen by others. The last but the most important thing is to be doubtful and to look for substantiating proofs of any claim made by anyone. Once you have decided to invest with a particular investor, there is need of a closer and deeper observation. In this case, first of all, the investors should check the transparency of operations and make sure that they are getting clear idea about payroll and overhead. In addition, the presence of annual reports and audited financial statements will prove the credibility of the institution. Lack of such things presents inappropriate management or lack of transparency, thus increasing the risk of fraud. In addition, the clients should enquire about the way the charity invests the money and should check how much money is being invested. Yet another thing to be assessed is the person who is managing the fund. It is always vital to have a committee managing the money as the presence of more than one individual, if possible not from the same family, will increase the possibility of having a fair management of the company’s interests. Another thing is the diversification of the investment portfolio. It is for the benefit of investors to have an adequately diversified investment that will reduce the possibility of loss. The credibility of the auditing authority is another concern. The last thing to be checked is the presence of conflict of interest among the board members. There are some more ridiculously simple things that go unnoticed most often which, often, are adopted by Ponzi scheme perpetrators. One such thing is the expensive lifestyle of the scheme operators. If they live an expensive life, check out when and where they earned it. However, it is painful to note that in the case of Madoff, most of these things were done intact and was a cleverly devised plan. Anyway, being careful about these facts can reduce the risk of falling prey to Ponzi schemes. For the authorities Now let us see what the government can do to prevent such incidents. The first thing is tightening the grip of SEC which was totally unfocused in Madoff case. Yet another thing that normally allows institutions to continue with financial discrepancies is their long-term relationships with auditing firms. Such relations may motivate auditors to overlook discrepancies than loosing their contract. This tendency can be prevented by making it mandatory for firms to change their auditors after a stipulated period. As there is a possibility of a new auditor finding their mistakes after some time, auditors will be thorough in their work, making their work self-regulatory (Champagne). The suggestions made by Sarah Peck in ‘Investment Ethics’ also seem similar. She even suggests that the accounting firm should be held liable to report any discrepancies they find in the financial statements. In addition, audit committee employees should be the members of director board too (Peck, 12). Yet another way to prevent such frauds is to make it mandatory for every firm to submit the profit details and investment details of their proposed plan in advance and get governmental license for the plan after thorough scrutiny. In addition, it helps if there is a registry of investment advisors and those who have registered should have each of their plans verified and licensed by authorities. Finally, there should be a disclosure policy that forces investment managers to be transparent about their investment plans. The last suggestion is the incorporation of ethical content into business curriculum. The general belief is that this will prevent a considerable proportion of business executives of future from engaging in unethical or at least unlawful behavior. In total, it is evident that Madoff did this unethical activity with full knowledge about its consequences and as he admits, he knew well that the plot would crumble one day. So, only diligence from the part of investors and authorities can prevent such fraudulent people from usurping people’s hard earned money. Works Cited Frank, Robert and Efrati, Amir. Madoff tried to save off firm’s crash before arrest. The Wall Street Journal. Jan 7, 2009. Web. 2 Jan 2011 Peck, Sarah. Investment Ethics. John Wiley & Sons, 2010. Mill, John Stuart. ‘Utilitarianism’. BLTC. web. 2 Feb 2011 Rawls, John. A Theory of Justice. US: Harvard University Press, 1971. Print. ‘Ethical Theory – deontology’. web. 2 Feb 2011 Champagne, Par Julien. ‘Preventing Madoff-type Ponzi schemes and corporate scandals’. Le Panoptique. Web 2 Feb 2011 Read More