Money and Capital Market Analysis: The Bernard Madoff Ponzi Scheme

This report provides a detailed analysis of the Bernard Madoff Ponzi scheme, a major financial fraud that operated for decades. The report begins with an introduction to Ponzi schemes, defining their characteristics and mechanics, and then delves into the specifics of the Madoff case. It outlines the...Read More

Running head: MONEY AND CAPITAL MARKET ANALYSIS
MONEY AND CAPITAL MARKET ANALYSIS
Name of the Student
Name of the University
Author’s Note

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Table of Contents
Introduction......................................................................................................................................2
Ponzi Scheme...................................................................................................................................2
Background of the Bernard Madoff case.........................................................................................3
Timeline of events...........................................................................................................................4
Findings of institutions and investors affected................................................................................7
Outcome of the case in terms of recommendations and implication for future...............................7
Reducing the chance of occurring again..........................................................................................8
Conclusion.......................................................................................................................................9
References......................................................................................................................................10

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Introduction
The purpose of this report is to highlight on the Ponzi Scheme and the case on the
Bernard Madoff relating to this scheme. This study exploits the Ponzi scheme crash for
estimating the impact of negative economic shocks on the criminal result. Ponzi scheme refers to
the financial scheme created in the year 1920 and has been named after Charles Ponzi in the US.
This scheme offered high returns to the costumers with the aim “Doubling the cash within three
months”. This paper also elucidates on the findings of institutions and investors impacted. The
outcome of this case in terms of recommendation and implication for future is also discussed in
this report.
Ponzi Scheme
Ponzi Schme is basically a fraudulent investing scam that promises higher return rates
with less risk to the investors. In this scheme, the returns are usually paid to the depositor either
from their own cash or from the money paid by subsequent investors (Frankel, 2012). The
organization that is engaged in this Ponzi scheme focuses to attract new clients for making
investments. This new income has been utilized in paying returns to the investors, marked as
profit from genuine transactions. This scheme mainly relies on the constant investment flow in
order to give returns to older depositors.
There at times when these schemes commence operations in terms of rightful investment
vehicles that includes hedge funds. This hedge funds easily degenerate into Ponzi scheme if they
fail in legitimately earn expected returns (Rantala, 2012). The investors within this scheme might
face huge difficulties when they try to take money out of investment. Even the promoter’s tries

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to reduce withdrawals by providing new plans to depositors in which the cash cannot be taken
out for specific time period in exchange of higher returns.
Bernard Mandoff’s financial fraud had been one of the biggest lasting Ponzi scheme. He
implemented same strategy as that of Charles Ponzi (Aliber & Kindleberger, 2015). As former
chairman of NASDAQ stock market and founder of wall street firm, he had drawn promising
result and also guaranteed proper rate of return. He did not disclosed the origin of money that
came in business and went.
Background of the Bernard Madoff case
Bernard Madoff had started his organization in the year 1960 as stock trader with the
total amount of $5000. His business started to develop by taking assistance from accountant.
Madaff operated Ponzi scheme under the investment advisory business for near about 40 years.
He took the assets of clients, transferred their cash to his personal accounts and even mailed
fictitious statement of their account for hiding ruse. However, when his clients withdrew their
funds, he utilized obtained capital from other depositors in paying out redemptions. Madoff sold
his commodity to his clients as hedge fund (Deason, Rajgopal & Waymire, 2015). Even he did
not met with his investors and refused in divulging any data pertaining to his company’s
practices. In 1980, the market creator division of Madoff traded up to 5% of total volume that is
made on NYSE. The scheme mainly began in 1990. In the early 1990, he suffered losses with
European bank. Despite admitting this losses to his customer, he started in giving false returns.
The analysis of Madoff case was basically performed by Markopolos, before this scheme
collapsed. He started to send report to SEC in the year 2000 about the operations of Madoff. By
the year 2005, Markopolos gave detail about Madoff fund in the letter to SEC titled “The largest

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Hedge Fund is Fraud”. The red flags reflected by Markopolos showed that the Madoff fund
earned 16% average annual returns by applying strategy of spilt strike conversion (Kull, 2012).
In the year 2008, he started to receive huge redemption amount from clients. In December 2008,
the Madoff’s firm faced $7 billion in request of redemption from investment , which did not
exist. His brother and two sons engaged some of positions in Madoff organization. On 9 the
December, he told his sons and his brother about the fraud and that his business was Ponzi
scheme (Smith,, 2012). However, on 11th December 2008, he was arrested by FBI ( Federal
Bureau of Investigation). On 12th March 2009, he pleaded guilty to 11 number of securities fraud
and hence received 150 years of imprisonment.
There were several factors that kept this scheme running for long time:
Firstly, His firm aid in developing NASDAQ and was the biggest market marker. Moreover, the
investors took him on trust.
Secondly, The inspectors of SEC had conducted certain investigations, but did not check trades
with their counterparties.
Thirdly, Madoff offered 13% per annum returns in product market and told his customers that
he generated returns with split-strike conversion strategy.
Fourthly, he relied on feeder funds for steering investor funds, for which the investors were paid
1.5% per annum as management fee as well as profit share.

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Timeline of events
YEAR BACKGROUND EVENTS
1960 Bernard Madoff starts trading operation named as Bernad Madoff Investment securities
(BLMIS)
1960-1970 BLMIS had been known for creating “ third market” trades, which uses creative
computer technology as well as bypass NYSE in making markets. In fact, some of this
technology had also been used to create NASDAQ. The corporation also started
investment portfolio sector, where he managed cash for the investors.
1989 BLMIS handled 5% of the trading volume on NYSE.
1990 Bernard Madoff had been appointed non – executive chairperson of NASDAQ. In this
year, the investment accounts of the organization continued to develop and hence
reported constant positive growth returns (Mauboussin, 2012). These investors
involve hedge funds, pension plans, charitable foundations etc.
1992 Madoff’s fame as investment manager becomes widespread in the nation. Owing to
increase in his fame, Madoff had been asked to disclose his strategy that is described as
split strike conversion. He created false account records for Avelliom and Bienes (AV)
accounts reflecting profitable trade.
YEAR CENTRAL EVENTS
1999 A portfolio manager (named Harry Markopolos) at trading organization in Boston
had been asked by his manager in designing investment product, which could copy
Madoff’s success. After analyzing it, he concluded that Madoff could not earn the
returns without any fraud.
2000 Harry filed complaint with Boston office of SEC (Securities and Exchange
commission), but it does not take any action on this complaint. They was no clue

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that tip off was transmitted to SEC.
2001 Markopolos sent another report to SEC in order to undercover the evidences that
Bernard Madoff had committed fraud. The enforcement director thought that they
did not want further investigation. In May 2001, the feeder fund was called by
Madoff for inspecting his assets and hence was shown bad trading records.
2002 Harry Markpolos met with the depositors in Madoff’s fund who gave the
information about Madoff that he was usually operating a Ponzi. Still there was no
discernable effect.
2005 Another report was also sent to SEC by Markopolos that suggested that BLMIS is
the Ponzi scheme (Moore, Han & Clayton, 2012). Two SEC had spent long
time in examining his records. After investigating it, SEC does not find any proof
of fraud and hence this case wounded up in this year. In September, the bank had
asked KPMG to see operational risk of his business. This report outlined several
possibilities that include fraud. In October , SEC chief person spoke to Harry but
still was not influenced by him. In fact, SEC team thought that it might good idea
for ascertaining the counterparties to reported trade.
2008 In March, HSBC bank had asked KPMG in undertaking further risk assessment of
doing business with Bernard Madoff (Pozza Jr, Cox & Morad, 2012). In August,
risk officer of Fairfield Greenwich conceded that few aspects of his operation
remained unclear. He also told his two sons as well as his brother that his business
was a Ponzi scheme and hence was unable in fulfilling the request of his clients.
His sons also reported this revelation to the authorities. On the 11 th December,
Madoff had been arrested with securities fraud.
YEAR AFTERMATH

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Janurary, 2009 The customers of Madoff began filing claim against BLMIS
February, 2009 The customer account of Madoff had been released
12 March 2009 Madoff had been pleaded guilty to 11 federal states that he was the only person
responsible for fraud. As a result, he was sentenced prison to 150 years.
Findings of institutions and investors affected
Madoff’s fraudulent firm affected biggest international banks, charities, hedge funds,
investors and other institutions. Owing to loss of trust, the investors exposed to this scheme
moved their fund out of any risky assets into the bank accounts (Dodge & Steele, 2015). Even
the loss from this scheme was mainly felt in Jewish community and charities and hence they
were forced in cutting back operations. One of the investors who lost $1.4 billion in Madoff’s
Ponzi scheme committed suicide. In addition, several financial institutions had shut down as they
lost huge endowments. HSBC had been emerged as the biggest victim of this scheme, which lost
more than $1 billion. As a result, this bank collapsed as their client suffered from huge losses.
Thus, all the victims underwent huge trauma owing to this Madoff’s Ponzi scam.
Outcome of the case in terms of recommendations and implication for future
The outcome of the case was that Mandoff was imprisoned for 150 years and was forced
to surrender $170 billion in the year 2009. His three residents and all accessories were
auctioned off. Even the employees of Mandff’s firm, who were found culpable for their work in
Ponzi scheme also imprisoned for 30 years.
The recommendations and implication for future regarding this case are illustrated below:

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 The firm must hire ethical minded staffs, promote their core values, staff Chief
compliance officer and have good business culture for avoiding fraudulent schemes as of
Mandoff.
 The accounting practices in the company should also be transparent and all transactions
in business must be publicly revealed (Freshman, 2012).
 It is suggested that the investors must also perform detailed research before making
investment in any fund or scheme.
 The organizations must always check the credentials of the financial adviser and hence
must be sure that the adviser is legit. This can help the firm in avoiding Ponzi scheme.
 On the utilization of advanced technology in firm, the investors must carefully inquire
about these particular systems as well as infrastructure that is to be used for securing and
protecting their assets.
Reducing the chance of occurring again
The ways of reducing the chance of occurring Madoff scam again are given below:
 A well defined investment strategy should be determined when writing it to specific
clients
 The financial statement must be audited if the fund has been registered as well as
regulated by SEC
 GIPS (Global Investment Performance Standards) must be determined as it includes
accurate depiction of historical performance of clients. Each firm must adopt this
standard for receiving honest reporting as well as accountability.

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 The present prospectus and outline of company’s assets under management, risk taken
must be checked in diligence process (Levmore, 2012). However, these documents must
include details regarding investment valuations especially the investments that have been
not traded in current market.
Conclusion
From the above study, it can be concluded that Mdoff’s scam had not adversely impacted
all victims including investors, organizations, charities etc. It has been seen from this scandal
that due diligence of auditors is vital than relying on others opinions. One of lessons that this
scheme had taught the investors was that this Ponzi schemes might be legitimate. The auditors
must also make certain that the management of the company had conducted test on risk
assessment. In fact, they are also responsible for examining management risk evaluation. While
dealing with the company’s financial reports, they should be sceptical about internal control
system as well as business risk that might lead to material misstatement. They should also report
the company’s management about fraudulent action taken place in business.

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References
Aliber, R. Z., & Kindleberger, C. P. (2015). Bernie Madoff: Frauds, Swindles, and the Credit
Cycle. In Manias, Panics, and Crashes (pp. 143-182). Palgrave Macmillan, London.
Deason, S., Rajgopal, S., & Waymire, G. B. (2015). Who gets swindled in Ponzi schemes?.
Dodge, M., & Steele, S. (2015). A comprehensive framework for conceptualizing financial
frauds and victimization. The Routledge International Handbook of the Crimes of the
Powerful, 289.
Frankel, T. (2012). The Ponzi scheme puzzle: A history and analysis of con artists and victims.
Oxford University Press.
Freshman, A. (2012). Financial disaster as a risk factor for posttraumatic stress disorder: Internet
survey of trauma in victims of the Madoff Ponzi scheme. Health & social work, 37(1),
39-48.
Kull, A. (2012). Common-Law Restitution and the Madoff Liquidation. BUL Rev., 92, 939.
Levmore, S. (2012). Rethinking Ponzi-Scheme Remedies in and out of Bankruptcy. BUL
Rev., 92, 969.
Lewis, M. K. (2012, December). New dogs, old tricks. Why do Ponzi schemes succeed?.
In Accounting Forum (Vol. 36, No. 4, pp. 294-309). Elsevier.
Mauboussin, M. J. (2012). Think twice: Harnessing the power of counterintuition. Harvard
Business Review Press.