The Fraud of the Century: The Case of Bernard Madoff
CASE NOTES FOR INSTRUCTORS
This case will provide students with details of the Bernard Madoff scandal, as well as how it affected a variety of stakeholder groups. Because of its magnitude and the high-profile nature of Madoff and many of his victims, the Bernie Madoff case is destined to be a white-collar crime classic. The fraud perpetrated by Madoff is what is known as a Ponzi scheme. A Ponzi scheme works similarly to a pyramid scheme in that a person takes money from new investors to pay back older investors. The scheme continues to work as long as new investors keep joining. As soon as new cash stops flowing in, however, the scheme falls apart. While this arrangement is known as a Ponzi scheme, it should well be called a Madoff scheme now because Madoff’s crime was unusually large and long-running. Most Ponzi schemes fall apart in a short time, but Madoff sustained his for decades. After reading this case, students should be able to identify some of the major lapses in oversight that enabled Madoff’s Ponzi scheme to go on for so long.
Madoff began his career as a highly successful, highly respected businessman. He started a legal investment business in 1960 by buying and selling over-the-counter stocks that were not listed on the New York Stock Exchange (NYSE). In the 1990s, Madoff Securities was trading up to 10 percent of NASDAQ shares on certain days. He used his legitimate success to start another, illegitimate money-management business that promised his investors consistent returns of 10 to12 percent. Such returns are so high that investors should not have believed him, yet many thousands of people invested because they trusted Madoff, liked the sense of exclusivity he imparted, and were swayed by the promise of high returns. Madoff told his investors that his strategy was to buy stocks while also trading options on those stocks as a way to limit the potential losses. His market timing strategy was called the “split-strike conversion.” While this is a legitimate means of managing money, it would have been impossible to earn the returns Madoff claimed. Additionally, it came out in the trial that Madoff had not invested a single cent of the money he took in as part of his illegal business.
In 2008 Madoff grew desperate for new funds while, at the same time, cash-strapped investors were asking for their investments back in record numbers because of the financial crisis. Madoff’s Ponzi scheme began to unravel quickly. He confessed his crime to his sons in December 2008, who then reported it to the authorities. In March 2009, Madoff stated his guilt in court but refused to affirm whether any other company employees or family members were involved. Although it is unlikely that Madoff worked alone, there is no evidence that even his sons knew about his illegal dealings, involved as they were with the legal portion of the business. Madoff chose to hire inexperienced, sometimes uneducated individuals with no background in finance to work in his investment management business. Some speculate that he did this so as to surround himself with unknowing participants. Madoff was eventually sentenced to 150 years in prison.
So far, thousands of people have submitted claims for restitution. However, paying back all of these investors will be a difficult task. Although Madoff’s fraud is being billed as a $65 billion Ponzi scheme, Madoff never had anywhere near that amount of money. This amount is what Madoff told people they had invested and earned with him. The actual amount may have been well below $10 billion.
The Madoff family, in particular, has been forced to deal with the consequences of Madoff’s wrongdoing. Members of the Madoff family are fighting a $200 million lawsuit filed by Madoff bankruptcy trustee Irving Picard. Madoff’s wife, Ruth, gave up claims to $80 million in assets to federal prosecutors. Perhaps most tragic, his son Mark Madoff