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Bernard Madhoff - The W1nners' Club

Bernard Madhoff ran the largest fraudulent pyramid scheme in history.

The former Chairman of NASDAQ and founder of the Wall Street firm Bernard L. Madoff Investment Securities LLC, admitted that the wealth management arm of his business was an elaborate Ponzi scheme when he was apprehended by federal authorities on 11th December 2008.

He was arrested at his $7 million penthouse and the man who had been running what Securities and Exchange Commission (SEC) investigators referred to as, “a stunning fraud that appears to be of epic proportions,” finally made an emotional confession to his sons that “it’s all just one big lie.”

Ponzi schemes are a type of pyramid scam and with the promise of large returns being used as bait, a fraudster will take money from unsuspecting new investors and then use these funds to pay off people that have been in the scheme for longer until no more new recruits can be found. This scenario inevitably results in the whole scheme collapsing and the newest investors are the ones that are set to lose everything.

The ruse is named after a certain Charles Ponzi, a 1920s criminal who promised investors a 50% return on their investments over just 45 days – compare this to the 5% annual return delivered in a contemporary savings account.

Ponzi would say to new investors that his scheme was able to take advantage of the differences in exchange rates between the dollar and other currencies to buy and sell international mail coupons at profit. The scheme was a roaring success and during a single three-hour period in 1921, he brought in $1m (£12.5 million in 2017 money) from investors. When his suspect scheme eventually collapsed, it turned out that Ponzi had only ever purchased about $30 worth of mail coupons upon which the scheme was based.

Bernard Madoff eventually stole as much as $17.5bn (£11.4bn) from more than 4,000 account holders with his company as well as thousands more third-party investors who were exposed to his crimes through feeder funds.

Madoff managed to avoid detection for so long despite numerous reports to the SEC that he may have been running a Ponzi scheme because he was a well respected member of the finance industry. He started up his own firm in 1960 and helped to launch the Nasdaq stock market. He also sat on the board of National Association of Securities Dealers and advised the SEC on trading securities. It was therefore relatively easy for the authorities to believe that the industry veteran knew exactly what he was doing.

Master Salesman

 

Madoff was a master salesman and he pitched his fund to investors as an exclusive club for VIPs. He would usually refuse to meet with people in person which in turn gave him a “Wizard of Oz” type aura and increased the allure of his fund. Madoff investors were so taken in by his sales tactics that many were wary of removing money from his fund for fear of not being allowed back in further down the road.

Madoff’s annual returns were considered “unusually consistent,” at around 10% and this played a key role in perpetuating the fraud. Ponzi schemes typically pay out returns of 20% or higher before swiftly collapsing. One of Madoff’s funds that described its “strategy” as investing in shares on the Standard & Poor 100-stock index, reported a 10.5% annual return during the previous 17 years of trading. Even after the 2008 financial crisis, the same fund was reporting increases of 5.6%, whilst the S&P 500-stock index was experiencing 38% decreases.

An unnamed investor once remarked of Madoff’s fund, “The returns were just amazing and we trusted this guy for decades — if you wanted to take money out, you always got your cheque in a few days. That’s why we were all so stunned.”

Unravelling

 

The scam had begun to unravel by December 2008 as the credit crunch bit hard into the resources of financial institutions worldwide. Two of the major banks were no longer prepared to lend money to customers if it meant investing with Madoff. In June 2008, a good six months before the scam imploded, Madoff was accepting leveraged (borrowed with a view to profits exceeding the cost of borrowing) money. Madoff was quickly running out of cash and therefore needed to increase his promised returns to keep the scheme afloat.

As the market downturn continued, investors attempted to withdraw a total of $7 billion from the fund. In order to pay off those investors, Madoff needed to acquire new funds from other investors. Even with the rush of new investors who still believed that Madoff had somehow managed to thwart the economic crisis, it wasn’t enough to keep up with the torrent of withdrawals.

Confession

 

On 10th December 2008, Madoff suggested to his sons Mark and Andrew that the firm should pay out $170 million in bonuses two months ahead of schedule, from the remaining $200 million in assets that the firm still had. The Madoff boys confronted their father to ask him how the firm could pay out bonuses to employees if it could not pay its investors. It was at this point that Madoff finally admitted that he was “finished,” and that the asset management arm of the firm was in reality nothing more than a Ponzi scheme. Mark and Andrew subsequently reported him to the authorities.

On March 10th 2009, Madoff was charged with securities fraud, investment adviser fraud, mail fraud, wire fraud, three counts of money laundering, false statements, perjury, making false filings with the SEC and theft from an employee benefit plan. His charge sheet stated that Madoff had defrauded his clients out of almost $65 billion – thus creating the largest Ponzi scheme in history, as well as the largest ever investor fraud committed by a single person.

On June 29th, Madoff was sentenced to 150 years in prison whilst having to forfeit combined assets worth about $826 million.

In our opinion Bernard Madoff should be grateful that he’ll likely never experience freedom in the outside world ever again. Our publisher Darcus White once didn’t pay his ex-girlfriend back the £20 she lent him after losing his wallet. It’s unlikely that he’ll ever hear the end of it – a much worse sentence than spending the rest of your life in a federal penitentiary!

 

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