Understanding Ponzi Schemes

This assignment delves into the intricate world of Ponzi schemes. It examines their structure, common characteristics, historical examples like Bernard Madoff's fraud, and the factors that contribute to their sustainability. The document also analyzes the impact of Ponzi schemes on individuals, businesses, and the financial system. Students are encouraged to research various case studies and understand the legal and ethical implications associated with these fraudulent investment operations.

Running head: ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
Analyzing Bernard Madoff Ponzi scheme scandal
Name of the student
Name of the University
Author note

1ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
Executive summary:
The report is a measurement of the Bernard Madoff Ponzi scheme that took place during the
1990 to 2006. In 2008, owing to the recession and clarification by the sons of Madoff the Ponzi
scheme scandal came out into the light. The report has analyzed the background of the case with
the basic ideas and structure of the Ponzi schemes. Besides this, the report has recommended
various steps to overcome any situation like this in future and SEC recommendations have been
mentioned in the report. The report has also discussed how the business of Madoff reaches to the
zenith of success from the scratch. To conclude, the report has outlined how SEC can modernize
its structure to overcome the rise of Ponzi scheme.

2ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
Table of Contents
Introduction:....................................................................................................................................3
Analysis of Ponzi scheme:...............................................................................................................3
Bernard Madoff case details:...........................................................................................................6
Gantt chart:......................................................................................................................................8
Outcome of the fraud and affected investors:..................................................................................8
Outcome of the case and future implication:...................................................................................9
Recommendation:..........................................................................................................................10
Steps taken by the authority to stop case like this:........................................................................10
Conclusion:....................................................................................................................................11
Reference:......................................................................................................................................12

3ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
Introduction:
Earning money is essential for everyone because it aids to fulfil the necessary
requirements of living. People try to earn more and the lust to earn more let them towards the
trap of Ponzi schemes, which is acknowledged as a financial trap (Crey & Webb, 2016). Since
the 1919, there have been various Ponzi schemes around the world but some of them made
headlines owing to their magnitude of fraud and loss to the financial stability of the economy
(Cortes, Santamaria & Vargas, 2016). Among many, one of such rarest case is Bernard Madoff
Ponzi scheme, which lead him loot approximately $65 billion from the market and ending up
with 150 years of imprisonment (Gibson, 2016). Due to the lack of researches and academic
journals on the Ponzi schemes, this are still treated as the loopholes of the existing financial
system of the economy, however recent trend has highlighted various researches is going on the
financial traps like Ponzi schemes. This paper is aimed to provide a detailed description of the
Ponzi schemes and explain the case of Bernard Madoff. Besides this, the report will discuss the
outcome of the Bernard’s case and the repercussion effect on the shareholders. Moreover, the
research is aimed to provide recommendations to avoid any cases like this in future.
Analysis of Ponzi scheme:
Ponzi scheme, which is also acknowledged as the pyramid scheme is one of the illegal
financial activities that loots money from the investors. Generally, Ponzi schemes lures the
investors to save more amount of money into the scheme highlighting higher amount of return
compared to the authorised financial institutions for the same amount of investment (Zhu et al.,
2017). In general banking structure, bank as a mediator provides loan from the money that has
been saved by the depositors. However, when it comes to Ponzi schemes, then the fraudsters do

4ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
not invest their money that they gain from the investment. Rather, during the initial days, they
pay the return with that money and after few days when a desired lump sum amount has been
collected, they run away from the business leading to a huge loss in front of the investors who
invested with an eager to earn more (Deason, Rajgopal & Waymire, 2015).
The name ‘Ponzi scheme’ came after the name of Charles Ponzi who led the investors
accept that it is possible to earn 50% return from a said amount of investment within 90 days
period (Albrecht et al., 2017). Since 1919, there have been various Ponzi schemes, which rocked
the financial stability of the economy, where it had taken place and among them, the case of
Bernard Madoff is notable (Reis, 2015). Ponzi schemes are structured in a pyramidal shape,
where more amount of money is required in each level as the business grows to provide the
payment toward the existing investors (Cortes, Santamaria & Vargas, 2016). Figure 1 shows a
hypothetical scenario of a Ponzi scheme, where the number of participants is higher at the lower
level and the highest level has the lowest amount of participants, who are mainly business
owners or the stakeholders of the business.
Figure 1: Ponzi pyramid

5ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
Investor 1
Investor 2
Investor 3
$100,000
$120,000
$144,000
As the number of investor rises, amount of investment rising
Source: (Roden, 2018)
In order to understand the Ponzi schemes more well an example can be taken into
consideration. For instance, consider the figure 2, where a Ponzi perpetrator creates a Ponzi
scheme and approaches to an investor to invest $100,000 for a year with an interest rate of 20%.
The investor agrees to invest in the scheme with a desire to earn $120,000 at the end of one year.
Once the time of payment arrives, the scammer approaches to a new investor with a same policy
and manages him to invest $120,000 in the business. The perpetrator now has the $120,000 to
repay the first investor and he continues the cycle until the flow of investment falls. In this
cyclical way, the Ponzi scheme perpetrator pockets the initial $100,000 and once there is any fall
in investment, he will run out of the operation looting all the money of the investors.
Figure 2: Investment pyramid of Ponzi scheme
Source: (Created by Author)

6ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
With geometrical expansion of funding requirements Ponzi schemes are dooms and the
weak strategies to maintain the business of the Ponzi scheme perpetrator makes it breakable in
front of the ever growing demand of returns (Keep & Vander Nat, 2014). There are various types
of Ponzi schemes; however, most of them have same characteristics. Common characteristics of
Ponzi schemes are as follows (Springer, 2017):
High return with little amount of risk: Legalised investment caries some amount of
risks and investments with higher risks earn higher amount of return. When it comes to Ponzi
schemes, then the risk factor is very high, however the perpetrators are potent enough to make it
look like a risk free investment with guaranteed highest return.
Unlicensed and unregistered: If the Ponzi schemes are not issued by the government
and are not rational Ponzi game, then they do not have any license and registration to curtail
investment and return of the investors (Carey & Webb, 2016).
Free entry no free exit: It is a common phenomenon of every Ponzi scheme is that they
allow free entry but they try to retain the investment by highlighting the new schemes with better
return.
Bernard Madoff case details:
Ponzi schemes are one of the forms of financial fraud that lead to curtailing the share
market and investment of investors. There have been many cases of Ponzi schemes around the
world since 1921, but when it comes to the biggest one, and then the case of Bernard Madoff is
the second largest after the Ponzi case of 1919 (Jain, 2015). During the 1960, Bernard Madoff
founded Bernard Madoff Investment Securities and one of its extensive hand used to promote
Ponzi schemes (Stolowy et al., 2014). During 1960, he started his company as a Penny Stock
traded with a amount of $5,000 and since then the business fledged to a great extent to become

7ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
where it was during the 2008 (Azim & Azam, 2016). With the help of his father in law, Madoff
made his business wider and employed his various family members into his business. For
instance, he had employed his brother Peter as the senior managing director and his sons worked
in the trading section. It is estimated that there were more than 25 family members of Madoff’s
business who were positioned in the directorate of the operation (Lewis, 2016). During 1980,
Madoff’s company was one of the highest market maker and it was contained about 5% of New
York Stock Exchange transaction volume. One decade later, during 1990, the business reached to
its zenith and it has almost 15% market capitalisation of the NYSE making it one of the largest
NYSE listed broker (Eren, 2017). During the 1992 to 2006, there were various charges against
the Madoff and his business house and on December 11 of 2008, he was charged for running
Ponzi schemes. Madoff took a strategy to shape his portfolios look like that it was aligned with
the S&P 500 rules of returns that constrained him to pay large amount of return to the existing
investors. Besides this, he chose elite customers who are close to him and kept his action less
aroused to look it less suspicious in front of the Securities and Exchange Commission (SEC).
Though the business was running good until 2006 with the flood of investment, it started to fall
apart during the 2008. With the rise of recession during the 2008, there was huge demand to
liquidate the assets saved as the securities that forced Madoff to borrow more from the market
and return it to the existing stockholders (Bruin, 2014). However, with higher amount of
recession fund was not available and Madoff failed to cope up with the demand of the investors.
In 2009, his son Andrew and Mark disclosed their father’s business to FBI and the court
convicted him with an imprisonment of 150 years.

8ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
Gantt chart:
Figure 3: Timeline of Madoff’s fraud
Source: ("After the Fraud", 2018)
The timeline shows that ponzi business of Madoff became fully fledged since 1995 and it
ran successfully until the 2006 and since then the business started to fall.
Outcome of the fraud and affected investors:
While the business of the Madoff was going well, the investors were rewarded well;
however, once the Ponzi business was busted, many people get affected to a great amount. For
instance, it is estimated that there were more than 4,500 investors who were affected by the
Ponzi scheme of the Madoff and the amount of loss is estimated at $64.8 billion (Brody et al.,
2016). People who were highly affected by this Ponzi scheme were the investors, which include

9ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
the citizen of USA, other countries and political leaders of the USA. Owing to the fact of this
financial disaster on average investors, lose 12 to 20 million dollars. In this fraud, investor
invested almost $36 billion, $18 billion were returned, and there were no trace of other $18
billion (Eren, 2017). In the pyramidal structure of Ponzi scheme, Madoff enjoyed almost half of
the investment and once the fraud was busted, the amount of embracement for the family is
beyond imagination. Later, there were several legal actions were also taken by the FBI and the
SEC against the Madoff family with the charges of breaching fiduciary duty, negligence, theft,
trust fraud and mail fraud. Besides this, their bank account has been frozen and it has been
inevitable for the family to live in the country (Azim & Azam, 2016).
Outcome of the case and future implication:
Once the Ponzi scheme of the Madoff has been busted, several cases were lodged against
the Aurelia Finance and the assets of the director are also frozen. Besides this, on December
2008, International Advisors LLC René-Thierry Magon de la Villehuchet found dead owing to
the fact he has invested all of his money and 20% money of his brother, which is accounted more
than $1.2 billion (Brody et al., 2016). Following the magnitude and the vastness of the Ponzi
scheme circulated by the Madoff, SEC conducted an internal investigation under its inspector
general. During the 2009 September, SEC found its eight employees guilty for misuse of their
posts and negligence of their duty. SEC released a report of 477 pages and there they mentioned
how the organisation has missed the scope of to identify the Ponzi scheme running since 1990
and depending upon the result there has been various steps taken by the organisation (Stolowy et
al., 2014).

10ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
Recommendation:
It is a common practice with the SEC that they do not pay much amount of attention to
the hedge fund of the financial institution like bank compared to the hedge funding industry
making it one of the soft point to penetrate for the Ponzi scheme makers. Using this loop hole
Madoff operate his business of Ponzi scheme and it aided the fraudster to transfer investor’s
money to his account. In order to overcome this situation following measures can be taken:
 Proper auditing of the financial institution
 Diversification of risk by investing in various portfolios
 Refraining from greed and invest into such schemes that has lower amount of risk and
legalised
 Judging the broker or the organisation before investing into its shares
Steps taken by the authority to stop case like this:
Madoff’s case of financial fraud is one of the large one around the world that has ever-
lasting effect on its investors. SEC in his report found various loopholes in its system that leads
to this devastating situation. After the massacre, SEC has taken various corrective measures and
these are aimed to reduce the scope of any Ponzi scheme in future. SEC has mentioned five
questions before investing into any new stock to avoid the scope of fraud. The questions are as
follows (Nashat, Abdullah & Abdullah, 2014):
 Is the seller is license?
 Registration information of the investment
 How well I understand the investment
 What is the comparison of potential awards with the risks?

11ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
 Where to ask for help?
Conclusion:
The report has analyzed the Bernard Madoff Ponzi scheme and it has been found that the
mastermind used various loopholes in the system to make his business grow. The report has
stated various recommendations to overcome any situation like this in future that lead to suicide,
death and loss of almost 16 billion dollars. To conclude the report has stated various steps taken
by the SEC to correct the financial structure of the scheme making it strong enough to crowd out
Ponzi schemes from the US economy.

12ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
Reference:
Roden, B. (2018). Classic 'gifting circle' pyramid scheme is back - Abbotsford News. Abbotsford
News. Retrieved 6 January 2018, from https://www.abbynews.com/our-town/classic-gifting-
circle-pyramid-scheme-is-back/
Carey, C., & Webb, J. K. (2016). Trust, but Verify? The Roles of Trust and Deceit in the
Sustainability of Illegal Ponzi Schemes.
Cortés, D., Santamaría, J., & Vargas, J. F. (2016). Economic shocks and crime: Evidence from
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Gibson, D. R. (2016). Ignorance at Risk: Interaction at the Epistemic Boundary of Bernard
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Zhu, A., Fu, P., Zhang, Q., & Chen, Z. (2017). Ponzi scheme diffusion in complex
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13ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
W. Keep, W., & J. Vander Nat, P. (2014). Multilevel marketing and pyramid schemes in the
United States: An historical analysis. Journal of Historical Research in Marketing, 6(2), 188-
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Carey, C., & Webb, J. K. (2016). Trust, but Verify? The Roles of Trust and Deceit in the
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14ANALYZING BERNARD MADOFF PONZI SCHEME SCANDAL
Stolowy, H., Messner, M., Jeanjean, T., & Richard Baker, C. (2014). The construction of a
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