Bernie Madoff's Elaborate Fraud Case

By 2008, Bernie Madoff had grown Bernard L. Madoff Investment Securities to 200 employees and commanded tremendous respect on Wall Street (Gregoriou & Lhabitant, 2009, p. 90). His lines of business included market making, proprietary trading, and investment advisory services. Madoff used the investment advisory services sector to perpetrate his Ponzi scheme. More than $750 million dollars of stolen funds were transferred to the market making and proprietary trading operations, keeping those portions of the business afloat. Madoff needed to support these failing portions of the business to maintain the appearance of a legitimate business operation (Lewis, 2013, pp. 283-284). Madoff was a legend in the investment community, and he generated
astonishment, admiration, and curiosity with his track record of high returns and low volatility. Madoff even served as a member of the board of governors of the NASDAQ Stock Market in the 1980s and as a chairman of the board of directors (Gregoriou & Lhabitant, 2009, p. 90). According to Gregoriou and Lhabitant (2009, p. 89), “few dared criticizing him without risking their careers.” Investing with Bernard L. Madoff Investment Securities was an exclusive and lucrative opportunity.
Lewis (2013, pp. 283-284) noted that investment advisory customers, mostly large feeder funds, were led to believe their funds were invested in common stock, options, and other securities of well-known corporations within the Standard & Poor’s 100 Index; however, they were simply deposited into a bank account. False account statements showing the stocks and securities that had allegedly been purchased were provided periodically, and Madoff issued “returns” to early investors using funds collected by subsequent investors. Per Gregoriou and Lhabitant (2009, pp. 90-91), Madoff attributed value appreciation in these fictional securities to his split-strike conversion strategy, which was a complex combination of options designed to protect the investment from losing value. Madoff claimed to use this strategy over short periods of time, typically one month or less, and he promised a yield of 8-12% per year without regard to the condition of the overall market. Alleged returns were comparable to the S&P 100 but far less volatile.
Lewis (2013) writes that when a customer requested their investment to be returned, the funds were withdrawn from the company’s bank account and promptly returned to conceal any fraud (p.
283). Stolen funds were used to support Madoff’s luxurious lifestyle and to bribe employees to conceal the fraud (p. 284). Elaborate falsifications were also created to hide the fraud (p. 289). However, Madoff finally confessed to his family on December 10, 2008 (Gregoriou & Lhabitant, 2009, p. 91), due to the steady flow of redemptions following the financial crisis (Rhee, 2009, p. 365). Madoff knew that the scheme could not continue indefinitely. Henriques (2011, p. XXIII) quotes Mr. Madoff saying, “By 1998, I realized I was never going to get out of this. That’s when I acknowledged the fact to myself that the ax was going to fall on me eventually.” The “ax” fell when Madoff’s sons turned him in to the U.S. authorities for securities fraud the evening of his alleged confession (Gregoriou & Lhabitant, 2009, p. 91). He was arrested the next day and sentenced to 150 years in prison on June 29, 2009, after pleading guilty to eleven felony charges (Lewis, 2013, pp.
283-284).
Victims were comprised of investment professionals, reputable banks (Gregoriou & Lhabitant, 2009, p. 89), individuals, trusts, pension funds, hedge funds, and even charitable organizations (Lewis, 2013, p. 292). Over 8,000 claims seeking protection under the Securities Investor Protection Act had been mailed to Madoff customers as of January 6, 2009 (Gregoriou & Lhabitant, 2009, p. 89). Not everyone believed the stories told by Bernie Madoff. After looking into Madoff’s reported returns, Harry Markopolis, a chartered financial analyst with a background in quantitative analysis, reported to the SEC that Bernard L. Madoff Investment Securities returns could not be legitimate in May 2000 (Henriques, 2011, pp. 122-123). The SEC paid little attention, but Markopolis continued his efforts. Finally, in November 2005, the SEC’s New York Office followed up on Markopolis’s tips. Their investigation found only a few technical violations and no evidence of the Ponzi scheme. The case was closed because the violations were quickly corrected and not considered serious (Gregoriou & Lhabitant, 2009, p. 96).
Gregoroiu and Lhabitant (2009, pp.
93-94) describe several warning signs of something amiss with Bernard L. Madoff Investment Securities. Because all services were handled internally, without an independent third-party to oversee operations, BMIS had a lack of segregation of duties, an anomaly in the industry. This weakness increases the risk for misappropriation of assets and allows for performance manipulation. BMIS was audited by Friehling and Horowitz, a virtually unknown accounting firm comprised of one partner in his late 70s, a secretary, and a single active accountant. The firm was not peer reviewed and since 1993 had claimed in writing to the American Institute of Certified Public Accountants that it was not conducting any audits. Meanwhile, feeder funds were audited by large, reputable accounting firms such as KPMG, PricewaterhouseCoopers, BDO Seidman, and McGladrey & Pullen, instilling confidence to investors in the legitimacy of the operations. Madoff allowed little transparency regarding his investing decisions with his funds. Access to BMIS offices in either New York or London for due diligence was limited, and Madoff was evasive regarding questions concerning his investment strategies and general business
decisions.