MADOFF CASE STUDY

RBUS3904

Nethmi Ranaweera
43232219
Madoff Case Study RBUS3904
Nethmi Ranaweera (43232219)
Q1. Provide a summary of the case. Explain the type of scheme operated
by Madoff. Compare and contrast the scheme operated by Madoff with
Bitcoins and other financial bubbles.

Bernie Madoff is an American financier, infamous for defrauding thousands of
investors of tens of billions of dollars over decades until his arrest in December 2008.
Madoff executed what is known as the Ponzi scheme, a fraudulent investing scam that
generates returns for older investors by acquiring new investors (Azam, S. 2016). His
fraud resulted in the financial downfall of many and is considered to be the largest
and most high profile Ponzi scheme in history.

A Ponzi scheme, named after Charles Ponzi, a swindler in the 1920’s, promises high
rates of return with little risk to investors, however the claims of underlying
investments are false. The operator does not invest the money, but in turn acquires
new investors in order to obtain funds to provide returns of older investors to maintain
the illusion that real profits are being earned. When the supply of potential new
investors diminishes, there is not enough money to pay off promised returns and
cover investors who try to cash out. All Ponzi schemes eventually collapse when the
perpetrator simply cannot keep up with the required payments.

It is not often that Ponzi schemes survive for decades like in the case of Bernie
Madoff. One of the reasons why Madoff was so successful was because unlike other
Ponzi schemers, he didn't entice investors with implausible returns. For decades,
investors received consistent and steady annual returns with a 10-12% gain per year
despite market volatility. Elaborate, falsified account statements and other documents
were provided to investors to verify that the money had been placed in legitimate
investments. However, in reality, there were no actual investments and no actual
returns. Madoff paid the initial investors returns with money provided him by a steady
flow of new investors. His modest returns, usually in the low double-digit range, kept
him under the SEC radar just enough to continue his operation. Madoff set up his
portfolios to look like he was matching the returns of the S&P 500. This strategy
prevented him from needing to pay too much to existing investors, but it still made his
purported holdings appeal to new targets. (Kalen. S, 2012)
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Furthermore, Madoff was a highly respected, well-established and esteemed financial
expert. His role in establishing the NASDAQ stock exchange as well as serving as a
term as its non-executive chair boosted his reputation amongst the financial industry.
He earned his investors' trust because whenever they requested a withdrawal,
Madoff's investment company got their money to them promptly. Word of Madoff’s
investment success spread throughout and it became a privilege if people had their
money investment through him.

In 2008, as the global economy began to decline, large numbers of Madoff investors
needed money and began asking to cash in their investments. As a result of this,
Madoff’s Ponzi scheme came crashing down. New investors were scarce during the
economic downturn and Madoff struggled to cover his investors’ requests. In
December 2008, Bernie Madoff confessed to his crimes and was sentenced to 150
years in prison.

Ponzi schemes, like the one Madoff orchestrated, works in similar fashion to a stock
market bubble, as both rely on new investors to stay afloat. However, unlike Ponzi
schemes, bubbles exist in the open market and can arise without any fraud. Bubbles
also arise without schemers, as they do not have one single agent organizing it. The
price of a stock increases with demand, which causes more people to invest, resulting
in growth irrespective of any underlying value.

For a bubble to exist, the price of an asset must be detached from its intrinsic value.
Sally Auld, chief economist at JP Morgan, says bubbles can occur in just about any
asset, though they're more likely to occur when the asset itself is novel or poorly
understood. For example the dot.com bubble in the 1990’s started as people were
unsure what would happen in the future with the new technology that was emerging
that caused the rules surrounding valuation to be disregarded (Webb. T, 2017).

More recently, the topic of crypto currencies such as Bitcoin which has become a
speculative mania, has caused wide spread debate within the investing community.
Bitcoin has been labeled “a combination of a bubble, a Ponzi scheme and an
environmental disaster”, whereas others have argued that it is none of these. Although
Bitcoin may have certain properties of a Ponzi scheme, as it relies on what is known
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Nethmi Ranaweera (43232219)
as the “greater fool” theory, where they are counting on new investors to pay an even
higher price in order to realize a profit (Felder. J, 2017). Ponzi schemes promise a
profit and once it collapses does not reemerge, whereas bitcoin does not guarantee
that investors will make a profit and over the past year has proved to be rather
volatile. However, though bitcoin has the key characteristic of a Ponzi scheme of
relying on attracting a continuing stream of new investors, similar to a bubble it lacks
the element of fraud.

The similarities between Ponzi schemes like Madoff’s, bubbles and crypto currencies
is that they share the characteristic that in order for operations to run smoothly, the
system relies on continued inflows from participants. Although there are no schemers
or illegal activities associated with economic bubbles or bitcoin, the consequences
from the lack of new investors results in an eventual downfall (Huang, G, 2008).
Madoff Case Study RBUS3904
Nethmi Ranaweera (43232219)
Q2. The Ponzi scheme that was implemented by Bernie Madoff was the largest in
history. What do you believe to be the contributing factors in allowing this scheme to
survive and what was the ultimate factor in causing it to be exposed and fail. In your
answer list out ALL the contributing factors but make a decision on what you believe
as the single most contributing factor. Explain in detail.

The Bernie Madoff scandal was the largest Ponzi scheme in history. However, it was
not the scale of Madoff’s greed and deception that was most remarkable, but how he
managed to get away with it for several decades. The Telegraph, 2017 states that it
states that investigations by US regulators found evidence of misconduct stretching
back to the 1970s.

There are several contributing factors that allowed Madoff’s scheme to survive for as
long as it did. Madoff was a favourite choice amongst wealthy investors as well as
celebrities as he proved to be a consistent performer. His popularity led to him
becoming a household name and eventually it became a privilege to invest your
money through Madoff. It was an exclusive club in a sense that not everyone was
accepted into. Yang 2014 states, that in order to avoid too many investors trying to
reclaim their profit, a Ponzi schemes encourage them to stay in the game and earn
even more money. The consistent performance that Madoff showed through
fabricated documents meant existing investors continued to invest, while new
investors were drawn in.

Reports suggested that everyone including his family and most employees were
blindsided by Madoff’s fraudulent activities. This implies that Madoff would have
had a handful of loyal employees who were aware of what he was doing. Therefore,
this limited the chance of his scheme being revealed through a leak of information.

Another reason, why Madoff managed to fly under the radar of regulators such as the
SEC, as well as investors is that he was an active member in the financial industry. He
helped launched the NASDAQ and since he was 70-year old veteran who had been in
the industry for decades, it was assumed could be trusted and knew what he was
doing. Although there were numerous factors that contributed to the survival of
Madoff’s scheme it was his status in society that was the overruling factor.
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Experts were unsure whether Madoff had intentions to eventually turn his scheme into
a legitimate investment company. It is rather evident that a Ponzi scheme will
eventually collapse. This cycle comes crashing down when redemptions exceed
assets. This is what led to Madoff’s demise and eventually his confession and arrest.
During the 2008 economic downturn, more investors who had invested their money
through Madoff wanted to take their money out, while inflows decreased. This
resulted more redemptions than his firm could afford to pay out. Clients requested a
total of $US7 billion back in returns, however unfortunately for Madoff, he only had
between $US200 million to $US300 million remaining to give back, exposing the
fraud that had been committed over decades.
Madoff Case Study RBUS3904
Nethmi Ranaweera (43232219)
Q3. Provide a summary of the ethical issues that the case raises. In your answer take
the perspective of the investor, the investment manager and the regulator. That is,
consider the ethical issues from all three parties involved.

The case of Bernie Madoff’s large scale Ponzi scheme, symbolizes the strong concern
for ethical practise in business. There are numerous ethical issues that are presented in
this case which question the ethics and integrities of not only Bernie Madoff and his
employees, but regulators such as the SEC as well as the victims of Madoff’s
fraudulent actions.

However, it is evidently clear that the biggest ethical issue uncovered in this case is
the actions of Madoff himself. Madoff essentially robbed the company’s investors of
their good fortune without them knowing and although he is now serving time for his
unethical actions, because of Madoff many investors suffered a great deal; and as a
result, lives were taken and fortunes were lost.

Those who knew Madoff at the time would have said that he was a class act. New
Internationalist, 2009, describes Madoff as a highly respected champion of such noble
corporate practices as good governance, transparency and responsible regulation. He
was generous in his donations, particularly to the cause of lymphoma research,
inspired by his son Andrew, who suffered from the disease.

What his victims were not aware of was that Bernie Madoff exploited ethical theories
much like a hawk swooping down to kill its prey. Not only did Madoff manage to
manipulate his investors but his twisted moral philosophy led to the manipulation of
prominent social groups, banks, successful foundations as well as charities. He
wielded his genius in investments and securities tantalizing those who could not spot
his cabal.

Madoff’s ethical actions are undoubtedly far worse than the actions of any other
parties involved. However, that it is not to say that the magnitude of damages
resulting from his actions could not have been minimised by regulators such as the
SEC. In fact, the Ponzi scheme could have been uncovered years prior if the SEC had
conducted a detailed investigation surrounding the numerous red flags that were
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raised by Madoff’s investment success. The SEC turned a blind eye even though they
knew the returns Madoff claimed to be generating were suspicious. Kramer. B and
Buckhoff. T, 2012, states that the SEC had received detailed evidence of a Ponzi
scheme on at least five occasions over 10 years from Harry Markopolos, the Certified
Fraud Examiner (CFE) and Chartered Financial Analyst (CFA) who discovered
Madoff’s fraud years before it collapsed. This is a painful reminder that organizations
and individual investors can’t always rely on government regulators to protect them
from Ponzi schemes. The SEC had several opportunities to expose Madoff before he
surrendered to authorities on December 10, 2008, which could have potentially saved
investors billions of dollars.

As society tends to have ideological and cultural tendencies to attribute blame to

individuals, in this case, Madoff, rightfully so, the ethical actions of the victims are
usually overlooked. However, turning the mirror back onto society it could be said
that investors and other chair people leading the investing firms that invested through
Madoff failed to recognize what was actually taking place due to their own personal
greed, failure to maintain adequate financial records or inexperience.

Given that Bernie Madoff had been an investment manager since 1960 and that his
Ponzi scheme seems to have been ongoing for some 20 years, a few experts have
guessed that he may have held out hope to return it to a legitimate business at some
point. In cases like these it is hard to pin point whether the executor is overly
optimistic, in deep psychological denial or simply delusional. Regardless, uncovering
a Ponzi scheme of this magnitude has transformed the investment industry. The SEC
has adopted additional reporting requirements to prevent future Madoff’s from
arising. In July 2013, the SEC voted to approve a rule requiring brokers to file
quarterly reports detailing how they maintain customer securities and cash
(Alessandro. K, 2013).

Lastly, according to Forbes, the SEC has continued to file record numbers of
investigations and enforcement actions against advisors and other investment firms,
making good on their promise to pay closer attention to the actions of those in the
investment world. In the aftermath of Madoff ‘s scheme, investors have come a long
way by demanding greater transparency and reporting standards from firms.
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REFERENCES
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Azam, S. (2016), Bernard Madoff’s ‘Ponzi Scheme’: Fraudulent behaviour and the
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Felder, J. (2017, June 26). There are good reasons to believe bitcoin is in a bubble.
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