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“In today’s regulatory environment, it’s virtually impossible to violate rules […] it’s impossible for a violation to go undetected, especially for a considerable period of time” was Bernard Madoff’s opinion on how “wrong” people misjudged Wall Street, in October 2007, one year before being considered the greatest scammer of Wall Street history for having ran, more than 15 years, the largest Ponzi Scheme the world had ever seen. Madoff has passed away on the 14th of April 2021, at the age of 82, due to health complications, in the Federal Medical Center, in North Carolina.

Bernard Madoff: The Rise

Bernard Lawrence, known as “Bernie” Madoff, was an American hedge-fund investment manager and former chairman of the NASDAQ stock market (in early 1990s), who executed the largest Ponzi scheme in history. This scheme translates into a financial fraud in which the first investors are reimbursed with money acquired from subsequent investors, instead of the real return on investment. He defrauded thousands of investors by tens of billions of dollars over at least 17 years, and possibly more.

Bernie Madoff started his career as a penny-stock trader in Wall Street. At age 22, in 1960, he created “Bernard L. Madoff Investment Securities, LLC”. He started by trading penny stocks with $5,000 earned by working as a lifeguard, and then persuaded family friends and others to invest with him.

The success of the company began when Madoff and his brother Peter started developing electronic capabilities that attracted a large flow of orders and boosted the business by providing insights into market activity. By the 1990s, Madoff’s broker was processing 10% to 15% of all trading orders for the New York Stock Exchange (NYSE).

Madoff was so well-respected on Wall Street that he also served three terms as chairman of NASDAQ stock exchange board of directors. This would later provide him the reputation and networking he needed to create a Wealth Management unit within his investment firm. It was in this department that Madoff pulled off the largest Ponzi scheme in history.

The Scheme

It is hard to comprehend the reason why Madoff started his Ponzi scheme, in the first place. Equally shrouded in mystery is the time at which it all started.

Madoff claimed in court that his scheme started in 1991. However, one of his closest associates, Frank DiPascali, who had worked at his firm since 1975, said the fraud had been occurring “for as long as he remembered”.

Madoff’s Ponzi scheme story is, in many ways, a story of successful marketing. Indeed, one of the reasons why Madoff was able to sustain the operation for so long was his great ability to bring in new investors. He started off by introducing a brand-new investment approach that would involve a highly complex derivatives trading strategy. He named it the Split-Strike Conversionstrategy, and began pitching it to his investors, stating that it was able to provide them with steady returns, alongside low-risk.

Madoff would sometimes reject new clients at first, to create a feeling of exclusivity around his money-management services.  Overall, his reputation in wealthy social circles grew and the steady and high annual returns, always between 10 and 20%, made it so that he did not have any shortage of new people wanting to invest their capital. Madoff did not attract wealthy investors from the social elites only. His scheme also affected many people who were not very wealthy and that entrusted him with their life’s savings. Among his clients were also several non-profit organizations and major banks and corporations, such as BNP Paribas, Banco Santander, and Bank Medici.

Madoff mostly kept his investor’s funds at an account in Chase Manhattan Bank and would pay out their supposed “returns” from the capital acquired from other investors. The great complexity of the whole operation was in forging the return statements and other documents that might come under scrutiny from clients or from the SEC (U.S. Securities and Exchange Commission). Madoff would work from his returns backwards, that is, he would start off from a certain return and then see how to forge a trading record that could justify that return. So, Madoff and his associates would look at previous price changes in stocks and other assets and would create an investment strategy that would have corresponded to the paid returns.

Overall, Madoff’s great attention to detail when forging all the required documents, and his intelligence to lay low, sometimes fake negative returns, either during stock market rallies or crashes, allowed him to go under the radar for so many years.

Madoff’s Fund returns vs the Benchmark (Sentry was Madoff’s largest investor). Madoff’s scheme almost always provided the same results, even laying low when the market spiked in the Dotcom bubble (1994-2000). Source: Investing Per Excellence

There were also some special clients, the so-called Big 4 (not the ones you are thinking about, but unknown multimillionaires), whose accounts stood out and were handled differently from the other clients’. There were instances when some of these clients would send back their forged trading statements to Madoff and his accountants, when they thought that their returns were too low. Miraculously, the amended accounts would then show higher returns. Indeed, this proves that there was some pressure on Madoff for higher returns from clients who knew about the fraud that was occurring.

The Fall

Well, as the old saying goes, “if something seems too good to be true, it probably is”, and, even though the collapse of Madoff’s wealth management division surprised the financial system, it was not by lack of warnings.

Harry Markopolos, known today as “Madoff’s whistle-blower” was a portfolio-manager at a Boston trading investment firm that first spotted the fraud in 1999. Back then, his boss informed him of a hugely profitable hedge fund, ran by Bernie, that was delivering steady 1 to 2% returns a month, and would latter ask him to recreate his “Split-Strike Conversion” strategy to try and duplicate Madoff’s results for their own firm. In Markopolos’ words: “It took me 5 minutes to know that it was a fraud, it took me another 4 hours of mathematical modelling to prove that it was a fraud”. For Madoff to be executing his trading strategy and perform the way he was, he would have had to buy more options on the Chicago Options Exchange than actually existed. For Markopolos, there were only two plausible explanations for the outstanding performance: either Madoff was insider trading or he was running a huge Ponzi scheme. He later took his suspicions 5 times to the Securities Exchange Commission (SEC), to which they replied that “there was no evidence of fraud”.

Harry Markopolos, Madoff’s whistle-blower, testifying in the senate how he was ignored by the SEC. Source: CNBC

Despite numerous warnings concerning Madoff’s activities, the suspicions of fraud did not themselves led to the collapse of his investment firm. Amidst the 2008 subprime mortgage crisis, multiple investors tried to withdraw their money from the fund only to realize that, from the supposed $20bn he was holding, only $200mn were left. On December 11, 2008, Bernard Madoff was arrested and charged with securities fraud, one day after revealing his scheme to his two sons, Mark and Andrew Madoff.

The End

Following Madoff’s arrest, the case was publicized around the world and was talked about in the news 24/7: it was the largest Ponzi scheme in history. Madoff plead guilty to all charges brought against him in court. The judge sentenced him to 150 years in prison, the maximum for his crimes, and a symbolic sentence for what the judge considered was “extraordinarily evil” conduct by Madoff.

Bernard Madoff arrest. Source: nypost

Following Madoff’s arrest and incarceration, efforts began to try to help victims recover their lost funds. The Madoff Victim Fund was created to try to restore funds to victims of the scheme, many of whom were thrown into financial instability with the collapse of the scheme. People who benefited from Madoff’s scheme had to forfeit their gains and, through this fund, this money is being returned to those who were affected by the scheme. So far, Madoff’s victims have been able to recover about 80% of their losses.

On April 14, 2021, Bernard Madoff passed away at the age of 82, in the Federal Medical Center in North Carolina, due to kidney disease.

Sources: Encyclopedia Britannica, Fortune, Investopedia, The Motley Fool, Wikipedia

Francisco Nunes

Raquel Novo

João Baptista

João Correia

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