IntroductionBernard Lawrence "Bernie" Madoff; (born April 29, 1938) is an American former financier and convicted felon. Madoff, who once served as a non-executive chairman of the NASDAQ stock exchange, pled guilty to an 11-count criminal complaint, admitting to defrauding thousands of investors of billions of dollars. He was convicted of operating a Ponzi scheme that has been called the largest investor fraud ever committed by a single person.Federal prosecutors estimated client losses, which included fabricated gains, of almost $65 billion. Other estimates of the fraud, excluding the fabricated gains, are $14-21 billion. On June 29, 2009, he was sentenced to 150 years in prison, the maximum allowed

Madoff founded the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960, and was its chairman until his arrest on December 11, 2008. The firm started as a penny stock trader with $5,000 (about $35,000 in 2008 dollars) that Madoff earned from working as a lifeguard and sprinkler installer. His business grew with the assistance of his father-in-law, accountant Saul Alpern, who referred a circle of friends and their families. Initially, the firm made markets via the National Quotation Bureau's Pink Sheets. In order to compete with firms that were members of the New York Stock Exchange trading on the stock exchange's floor, his firm began using innovative computer information technology to disseminate its quotes. After a trial run, the technology that the firm helped develop became the NASDAQ

Madoff founded the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960, and was its chairman until his arrest on December 11, 2008. The firm was one of the top market maker businesses on Wall Street, which bypassed "specialist" firms, by directly executing orders over the counter from retail brokers.

Madoff was a prominent philanthropist, who served on boards of nonprofit institutions — many of which entrusted his firm with their endowments. The collapse and freeze of his personal assets and those of his firm affected businesses, charities, and foundations around the world, including the Robert I. Lappin Charitable Foundation, the Picower Foundation, and the JEHT Foundation which were forced to close.

Ponzi SchemePonzi scheme is a scam investment designed to separate investors from their money. It is named after Charles Ponzi, who constructed one such scheme at the beginning of the 20th century, though the concept was well known prior to Ponzi.

The scheme is designed to convince the public to place their money into a fraudulent investment. Once the scam artist feels that enough money has been collected, he disappears - taking all the money with him.

Features of Ponzi Scheme The Benefit: A promise that the investment will

achieve an above normal rate of return. The rate of return is often specified. The promised rate of return has to be high enough to be worthwhile to the investor but not so high as to be unbelievable.

The Setup: A relatively plausible explanation of how the investment can achieve these above normal rates of return. One often-used explanation is that the investor is skilled and/or has some inside information. Another possible explanation is that the investor has access to an investment opportunity not otherwise available to the general public.

Features of Ponzi Scheme (Contd.)Initial Credibility: The person running the

scheme needs to be believable enough to convince the initial investors to leave their money with him.

 Initial Investors Paid Off: For at least a few

periods the investors need to make at least the promised rate of return - if not better.

 Communicated Successes: Other investors need

to hear about the payoffs, such that their numbers grow exponentially. At the very least more money needs to be coming in than is being paid back to investors.

Steps in the Ponzi Scheme1. Convince a few investors to place money into the

investment.

2. After the specified time return the investment money to the investors plus the specified interest rate or return.

3. Pointing to the historical success of the investment, convince more investors to place their money into the system. Typically the vast majority of the earlier investors will return. Why would they not? The system has been providing them with great benefits.

4. Repeat steps 1 through 3 a number of times. During step 2 at one of the cycles, break the pattern. Instead of returning the investment money and paying the promised return, escape with the money and start a new life.

The investors give money to the Firm

The Firm gives back money to the investors with returns

Firm

Investors

This way the firm makes its first set of customers

These customers spread the word to other potential investors

These new investors invest in the firm and receive returns

Newer set of customers is made

The investors again refer a newer set of investors

This is how the funds of the firm increase

The complete events of the Company can be broken down into 2 main Phases,

• Phase I (1960-1992)• Phase II (1992-2008)

Phase I1960

Madoff started career in his father's accounting firm in NY as a market maker

He Also had a side business as an investment advisor

It was completely off the radar, that is it wasn't registered

He basically started small, with a handful of closely known people, promising a return of around 14-20%, depending on the investment

Brought In two accountants from his father-in-law’s firm, Frank Avellino & Michael Bienes

They handled the funding part, taking small percentage of the total funds

Interestingly, the firm had their name. That is it was called Avellino & Bienes Co.

The initial investors had not heard of Madoff at all

Mid 80s

Avellino & Bienes’ share reached $10 million per year

1992

• SEC (Securities and Exchange Commission )

Launched an investigation after a complaint from an

Investment advisor, suspecting a Ponzi scheme

• Above 3000 clients were being served

• By November 1992, SEC ordered shutting doing the

Co.

• Avellino and Bienes paid back all the investors

money

End of Phase I

Phase II1992

Madoff took over the company in publicMichael D Sullivan took 30 accounts of

Avellino and Bienes in the firmAvellino & Bienes themselves invested their

personal money with Madoff

Mid 90s

By now Madoff had Bigger players in his scheme, Private banks had started to pool in money

The family of the investors did the marketingIt had started being marketed to the wealthiest

and famous people all around the worldConditions implied to customersi. Funds were forbidden from Listing Madoff as

investment advisorii. Madoff’s firm was still unregistered with SEC,

although serving thousands of investors

Marketing:

Madoff showed his investors his office

The office had a nice ethical working standard

Madoff also used his name as part of marketing as

he was one of the most respected and influential

people on Wall Street

Madoff did well till 2008. In 2008, almost 1/3rd of all

Geneva fund managers had invested with Madoff

How did it collapse?In 2007 after the Housing bubble burst, most of

the companies in the market allowed it’s investors to withdraw money or were simply shut down

By December of the same year, There were more requests of withdrawals in the firm than depositsThis was because most of the investors needed money to pay their own customers and/or to run their own business

The firm was unable to pay the customers and the scheme came to light

The 2 main rules of Ponzi scheme are:

To have newer customers &There is no sudden outflow of customers

These rules are put to a shock test whenever there is a downfall in the market

Finally on December 10 2008 Madoff confessed to his 2 sons about his funds being a Ponzi scheme and the next morning the FBI were at his doorstepHe was later granted a sentencing of 150 years, being accused of Fraud and 8 other cases

CatchesEven before the SEC busted the scheme, there were a lot of obvious catches which, if had been taken into consideration at the right time by the SEC, could have prevented this from happening. They are as follows:

The company being Unregistered although serving thousands of customers

There was always a steady rate of return even if the market goes up or down

The statements sent to customers was always given in printed form and were never available online

Catches (Contd.)Statements were set to customers 3-5 days

AFTER a deal in the market was made, resulting in foresightedness. e.g.: Betting on a horse race AFTER it has begun

Statements showed names of firms whose names had changed and were not open to new investors

If customers complained on any of the above issues, the firm would threaten to return back the money

Catches (Contd.)The 3rd party Due Diligence (Auditor) officer

had his office in Bermuda, a place not known for having such offices

Whistle Blowers Like Marco Polo published these facts in 2001 but SEC did not act accordingly

Steady flow of letters were doing the rounds to SEC office regarding Madoff

In 2006 SEC finally launched an investigation into the matter

Following are SEC’s responsibilities which should have been checked:

SEC should have checked if the firm was registered or not

Should have proactively taken the initiative to check on the firm of its funds

Even after the warnings from whistleblowers, the SEC should have swiftly acted on the situation

SourcesWebsites:http://economics.about.com/od/financialmark

ets/f/ponzi_scheme.htmhttp://en.wikipedia.org/wiki/MadoffDocumentary:PBS Frontline - The Madoff Affair