The Bernie Madoff Scandal - Case Study Example

The Bernie Madoff Scandal The Bernie Madoff scandal is considered the largest Ponzi scheme to have occurred in history which has since damaged the reputation of the hedge-fund industry. The scandal was discovered in 2008 with estimated client losses of up to US$65 billion (Jackson 274). Madoff took advantage of the growing hedge-fund industry in which approximately 20 percent of all endowments and foundations in the United States relied on hedge funds. However, most of these firms failed to realize the interconnectivity within the industry and how a mistake by one of the players could hurt the competitiveness of the entire industry. Surprisingly, the scandal was discovered by one of the Modoffs’ son when Madoff decided to pay up to $7 billion redemptions or bonuses upfront after showing inability to pay investors (Tuttle 152). The sons demanded to know the source of the funds and father admitted that his asset management arm of his firm was actually being operated as a Ponzi scheme in which new investments covered returns from the existing or earlier investments and personal wealth. Upon discovering the fraud, the son did what the unexpected and took up the matter with the federal authorities leading to the arrest of Madoff. Madoff revealed that he had run the scheme for approximately 20 years since the early 1990s. Operation of the Scheme It was discovered that over the years Mr. Madoff was actually using money from new investors to pay returns to old investors creating a pyramid resembling a previous scheme named after Charles Ponzi. Although Mr. Madoff was operating within hedge fund industry, his fund was not a hedge fund, but endowments and foundations after the hedge funds invested heavily with his company. Madoff’s strategy to pay old investors with funds obtained from new investors enable his firm to satisfy the high returns promised to investors despite failure by the old investments to generate any returns (Tuttle 153). Investors expected that their funds were invested elsewhere by the company to generate returns, but Madoff deposited all the funds in his business account at Chase Manhattan Bank. In order to hide the reality in his company, he creatively came up with false transactions involving falsified SEC filing with the Securities and Exchange Commission and foreign transfers year after year. Modoff’s fraud dealings also most surfaced in 1999 when Harry Markopolos, a financial analyst-whistleblower alerted the securities and commission that his gains were impractical in then financial situation (Washington). However, the commission failed to investigate the truth behind the whistleblower claims until one of his son compelled him to confess about his dealings. A simple irregularity in Madoff’s filings on his firm’s liabilities which was less by $4.8 billion from reported US$ 50 billion would have been enough to reveal the giant scheme even before his confession. It is indeed interesting how Mr. Madoff managed get away with false SEC filings for approximately 20 years before someone from his family actually sensed that something was financially impractical. In this case, this scheme could be largely attributed to failure by the regulatory bodies within the banking and investment sector. People brought to Punishment Bernard Madoff was arrested and charged with securities fraud after which he pleaded guilty to eleven federal crimes in total including wire fraud, mail fraud, securities fraud, money laundering, making deliberate false fillings with the Securities and Exchange Commission and perjury. He also pleaded to operating a Ponzi scheme in which admitted defrauding thousands of investors of billions within the hedge fund industry. Surprisingly, admitted that he operated the scheme without involvement of any other individual, making it the largest investor fraud ever committed by a single person in history (Washington). Peter Madoff, brother to Bernard Madoff was also prosecuted for orchestrating other frauds within the firm such evading taxes on his tens of millions of dollar income he received from the firm, submission of false filings to the securities regulators as well as putting his wife on the firm’s payroll when she was not working for the farm. Although Bernard Madoff argued that he orchestrated the Ponzi scheme alone, his brother could not have escaped the responsibility of failing stop the fraud as the firm’s top legal and compliance officer. He deserved the prosecution, particularly for allowing his brother to continue with frauds while he was also a major beneficiary of the scheme’s money stolen from investors. In addition, despite the owner of the scheme maintaining that he did not involve other people in dealings, it was clear that his was a firm that had employed several people who would have reported any illegal transactions in the company (Miller and Jentz 637). As a result, federal prosecutors have charged additional thirteen others people found to have played a critical role carrying out the various frauds. Some of the individuals directly associated with the scheme frauds include an outside accountant and the office secretary. At least eight people have already been charged and five other still awaiting judgment in connection with the Ponzi scheme. Indeed the federal prosecutors have cast their nets wide and managed to bring into account several people who participated in propagating the scheme’s fraudulent deals including external accounts at the bank where the owner had his business accounts. In this case, the right people have been punished and others are awaiting judgment to ensure that all defaulters with firm are punished for taking part in the fraudulent investment deals. Legislations and Red Flags that That Might Have Preceded the Unethical Behavior Legislation enacted to protect investors from frauds associated with Ponzi schemes requires maintenance of a continuous disclosure system for all corporations dealing with securities exchange and companies with assets in the excess of $10 million and more than 500 shareholders (Miller and Jentz 636). Effective implementation of this law would have prevented the orchestration of the scheme for all those years it was in operation but failure by the SEC regulator failed to scrutinize the company’s SEC filing which were later discovered to have been falsified in all those years. Effective monitoring of all investment schemes through the banking sector would have prevented emergence of the scheme. Clear red flags such as the lack of a third party in the dealings of the company such as an investment firm would have been a good indication that something was wrong about the transactions. In addition, clients did not receive monthly statements from Bernie Madoff showing the value of his account. These are some of the red flags that would have alerted investors on the possible frauds that were taking place. Implication of this Situation In part because of the Madoff scandal, the amount of the hedge-fund managers in the world was cut in half and total estimated hedge-fund industry assets dropped to around US$1 trillion, down from a peak of US$ 2.8 trillion (Jackson 274). Before the discovery of Madoff, the reputation of the hedge-fund industry was a productive asset. Assets in the industry continued to increase and hedge funds, as a percentage of total assets within an investor’s portfolio, were growing significant. In the wake of the Madoff scandal , there has been widespread redemption pressure from hedge-fund allocators, or constituents. Also, hedge-fund allocators have begun to demand increased transparency on their portfolios and lower management and performance fees (Jackson 274). Firms have focused on developing transparency reports that allow investors to have a better understanding of the makeup of their portfolios. It has been suggested that Madoff impacted negatively on the competitiveness of the hedge-fund industry by making it clear that even the most respected hedge-fund managers and firms could pull of a fraud anytime. Madoff and his impact on redemptions in hedge funds significantly contributed to the economic crisis and the associated stock market performance in the year that the scandal was discovered. The unethical behavior affected investors who had invested hugely in the firm as well as the entire hedge firm industry whose competitiveness and trust was seriously undermined by the Madoff scandal. Conclusion The Madoff scandal is still recognized as one of the major Ponzi scheme ever crafted by a single individual in the history of United States. The scheme almost brought the hedge-fund industry to a complete halt as well as contributing to the financial crisis experienced in 2008. Despite the owner of the scheme maintaining that he did not involve other people in dealings, it was clear that his was a firm that had employed several people who would have reported any illegal transactions in the company. Federal prosecutors have charged additional thirteen others people found to have played a critical role carrying out the various frauds. As a result of the scandal, firms have focused on developing transparency reports that allow investors to have a better understanding of the makeup of their portfolios. Work Cited Jackson, Kevin. Virtuosity in Business: Invisible Law Guiding the Invisible Hand. Pennsylvania: University of Pennsylvania Press, 2011. Print. Miller, Roger and Gaylord, Jentz. Business Law Today: The Essentials. Cengage Learning, 2010. Print. Tuttle, Mathew. How Harvard and Yale Beat the Market: What Individual Investors Can Learn From the Investment Strategies of the Most Successful University Endowments. Stamford CT: John Wiley and Sons, 2009. Print. Washington, Ruby. Bernard L. Madoff. The New York Times, 20, 2012. Web. Accessed, March 02, 2013. Read More