Madoff: Profile of a Ponzi Scheme

According to the U.S. Securities and Exchange Commission, the lead agency in the United States for protecting investors and financial securities, a Ponzi scheme is a type of investment fraud in which investors/victims are paid returns on investments from funds which they initially contributed, or from funds collected from other investors/victims. New investors are attracted to Ponzi schemes with promises of high rates of return in little time. Instead of using their resources to actually invest their client's money, Ponzi scheme orchestrators instead focus on recruiting as many victims as possible in order to keep early investors satisfied. Due to the fact that a near constant stream of cash is needed to keep the scheme alive, Ponzi schemes almost always collapse as soon as a large number of investors decide to cash out or when the person orchestrating the scheme is unable to recruit more patsies.

For Bernie Madoff, orchestrator of one of the largest Ponzi schemes in America, if not the world, the cat was let out of the bag when he confided in his sons that a majority of his investment management business was nothing more than a Ponzi scheme. Madoff, who once served as a member of the NASDAQ Stock Market's board of governors and chairman of the NASDAQ trading committee, used his investment firm, Bernard L. Madoff Investment Securities LLC, to scam thousands of investors out of billions of dollars around the globe. According to the Wall Street Journal, Madoff's victims included such high profile individuals as John Malkovich, Larry King, and Zsa Zsa Gabor, to name a few.

The intricacy of Bernie Madoff's Ponzi scheme was so well concealed that he even managed to swindle some of the world's largest financial institutions, like Banco Santander of Spain, Bank Medici of Austria, and HSBC of Great Britain. In many cases, individuals and businesses who supplied Madoff with cash to keep his scheme alive didn't even know they were funding the fraudster, as was the case with British Virgin Islands company Repex Ventures, which sued Bank Medici for not disclosing that cash in Repex Ventures' account was being funneled to Madoff without the company's knowledge.

Despite the fact that several industry insiders, like financial analyst and fraud investigator Harry Markopolos, were suspicious of Madoff as far back as the year 2000, the SEC was unable to make a case against Madoff until 2008. Markopolos, who contacted the SEC on five different occasions in regards to Madoff and his organization, partly blames SEC investigators for being "untrained in finance", "unschooled", and "un-credentialed", describing them as " -- just merely lawyers without any financial industry experience." While SEC investigators, he explained, were good at reviewing documents to uncover misdemeanors, would often miss financial felonies like those committed by Madoff.

Perhaps most unsettling about the lack of attention which the SEC paid to the red flags surrounding Madoff, of which Markopolos says there were many, was a statement made by Madoff himself in 2007, during a roundtable discussion about the future of the stock market hosted by non-profit group The Philoctetes Center:

"In today's regulatory environment, it's virtually impossible to violate rules. This is something that the public really doesn't understand. But it's impossible for a violation to go undetected, certainly not for a considerable period of time."

It was approximately one year after he made this statement that Madoff was uncovered and arrested, this time with a mountain of evidence that eventually secured a 150 year prison sentence.

In 2009, the Securities and Exchange Commission's Office of the Inspector General released a report entitled "Investigation of Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme", which is available online (see sources), that has led to several changes in SEC policies and investigation practices.

Sources:

Madoff's Victims. The Wall Street Journal.

David Voreacos and David Glovin. Madoff Turned in by Sons After Confessing $50 Billion Fraud. Bloomberg.

Daniel Schorn. The Man Who Figured Out Madoff's Scheme. 60 Minutes.

Ponzi Schemes'"Frequently Asked Questions. U.S. Securities and Exchange Commission.

Investigation of Failure of the SEC to Uncover Bernard Madoff's Ponzi Scheme, Public Version. U.S. Securities and Exchange Commission.