Bernard Madoff – A $50 billion fraud

Dec 13, 2008 Scams

Bernard Madoff, former NASDAQ chairman, market maker for over 350 companies on the exchange and supposedly a man with a midas touch, has been arrested on account of running a giant $50 billion “Ponzi scheme”, which is likely to see a number of corporate entities and well heeled individuals part ways with their millions / billions.

Founder of Bernard L. Madoff Investment Securities LLC, Madoff told his employees that ”it’s all just one big lie” and also told investigators it was entirely his fault. For the past so many years, he had maintained an aura of exclusivity around his fund, refusing to share or divulge details of his operations and investments, and even refusing new entrants or chucking out those that got too nosy. He told investors that his fund followed a ”split strike conversion” strategy, which meant owning stock and buying and selling options to limit downside risk. However, other fund managers and traders seemed unable to generate similar unnaturally consistent returns after following his method, and started getting more and more curious.

In fact, as early as 1999, analyst Harry Markopolos tipped off the SEC that it was just not possible to legally generate the kind of returns Madoff’s firm was, given his so-called investment strategy. In November 2005, Markopolos sent a 19 page document to the SEC, entitled “The World’s Largest Hedge Fund is a Fraud”, in which he stated,

Bernie Madoff is running the world’s largest unregistered hedge fund. He’s organized this business as a hedge fund of funds privately labeling their own hedge funds which Bernie Madoff secretly runs for them using a split-strike conversion strategy getting paid only trading commissions which are not disclosed. If this isn’t a regulatory dodge, I don’t know what is.

Madoff was also in the habit of liquidating his holdings every quarter, thereby avoiding the need to file disclosures with the SEC. Incredibly, he even disallowed clients access to their own accounts, cleared his own trades, and was audited by a small firm that had three employees !!

Finally, in the face of the financial crisis this year, as clients lined up to withdraw their funds, Madoff found himself unable to raise the $7 billion needed to cover the redemptions. Even his own sons seemed unaware about the magnitude of the scam, and finally turned their father in. If convicted, he will face upto 20 years in prison along with a $5 million fine. He is presently out on bail after posting $10 million bail.

Some of his largest clients were Swiss bank Union Bancaire Privée ($700 mn), Abu Dhabi Investment Authority ($400 mn), clothing magnate Carl Shapiro ($ 545 mn), and others like Steven Spielberg, Royal Bank of Scotland, BNP Paribas, Man Group, Nomura Holdings et al.

It is amazing to see the number of times all the red flags were overlooked as well as the complete failure of due diligence. All along, Madoff’s reputation and credentials seem to have put a blanket over the regulator’s eyes. It is also amazing to see that in this day and age, people are still willing to fall prey to such scamsters. All these institutional and individual investors just got plain greedy and should have paid heed to that adage, “If something is too good to be true, it probably is”, and another one, “Do NOT put all your eggs in one basket”.