The following essay is a discussion on how Bernie Madoff defrauded the experienced as well as the common investors. The essay looks into how one would have avoided the fraud by outlining some key internal controls that indicate the organization’s performance in the market. The second part of the essay is on how smart investors lost their money. The Bernie Madoff scandal was about the manipulation of customers’ accounts to show that they had received high returns from their investments in the company even though that was not the case. The company operated as a hedge fund entrusted to invest the clients’ funds in profitable ventures for maximum returns. The fund manager however diverted funds into personal accounts rather than investing the money leading to loss of the clients’ investments.
The first internal control that would have prevented someone from investing with Bernie Madoff is that Bernie Madoff’s company auditing reports were not available to the investors. The company had a history of not issuing audit reports to the existing as well as potential clients. That was a red flag because it was impossible to assess the financial performance and position of the company if there were no reports indicating how the company was performing. Lack of financial reports indicates that the reports of high profits from the hedge fund company were not true (Caruso 2).
The other issue of great concern is the fact that the company that did regular auditing for the firm was Friohling and Horowitz, a small accounting firm with three directors and one accountant. For a hedge fund, a company to have such a small company as its auditor is alarming because the company lacks the capacity to audit such a huge firm (Harris 290).
The other issue that would have prevented people from investing in the company is the fact that the Madoff Company was the investor as well as the broker. The company was an investment company that received funds from people and traded them to earn profit. However, Madoff was the stockbroker and the trustee of the investors’ money. This means that there was no way the investors were going to receive authentic reports of the returns earned from the stock. The individual investor had no means of proving whether the figures provided were accurate (Weiner 189).
The claims made by various financial analysts that the figures provided by Madoff’s company were incorrect served as a warning to the investors. This is because in the year 2000 the stocks were selling at low prices and it was not possible for a stock trading company to give their clients a return of over twenty-five percent as claimed by Bernie’s company (Harris 290).
The company did not file its disclosures with the Securities and Exchange Commission at the appropriate time and they only filed their returns after selling their holdings to other companies in cash. The company used to sell its holdings at the end of every financial report to pay the claims made by its clients. The trend shows that the company did not have any investment that it was managing and later the chairperson of the company confessed that all they did was to deposit clients’ money in the bank account and pay previous clients who were requesting to be given their money (Weiner 190).
The high returns promised by the company created suspicion as other investment companies were not offering such returns, especially in a bear stock market. The aspect of the deal is too good makes the deal suspicious and it was necessary for the companies and individuals to investigate the company before depositing their money in the account (Wilhelm 153).
The fund manager Bernie Madoff had little personal investment because the initial capital that he had contributed was $39,000 compared to the $40 billion that he was managing for the clients. The manager had invested his money in other accounts especially the shareholding of Chase bank (Wilhelm 160).
Close relatives of the fund manager were senior employees in the company. Madoff’s brother was the company attorney and his son Mark Madoff was a senior employee in charge of marketing. The close relatives in the company led to the scandal because the high level of confidentiality exist in such instances and the investors may not be aware (Weiner 191)
Why Smart Investors Were Conned
Other than individual investors, organizations and people investing in the business for a long period defrauded their money for a number of reasons. The first reason is that most of the investors trusted the experience of Bernard Madoff as a hedge fund manager for many years and believed that he could not engage in fraudulent activity. The fact that the company started in the year 1970 makes it appear reliable and therefore the experience developed the trust such that the investors did not even ask for auditing reports (Caruso 2).
The other factor that duped the investors was that the company had been paying previous claims to its clients with high returns, which increased investor confidence. It is argued that if it had not been for the financial recession the fraud would not be exposed. This is because the recession made the clients have claims amounting to seven billion dollars and the company was not in a position to refund that amount of money. The earlier payments hoodwinked the investors (Weiner 192).
The promise of high returns from the initial investment also made the investors commit their money. The company promised the investors returns of over twenty-five per cent on their initial investment. Failure by the investors to investigate how the company was raking in such high returns cost them their money, as they would have detected the problem earlier (Harris 290).
The other major factor that led to the fraud was the fact that the Securities and Exchange Commission approved the financial transactions of the company. It is still not clear how the company with its fraudulent schemes survived the rigorous investigations and tests. The collusion of the Chairman with some of the commission officials may have made the investigations faulty therefore duping the shareholders that the company’s operations were up to the standard even though the case was different (Undergraduate Task Force 58).
The Bernie Madoff scandal is one of the greatest hedge fund scandals that have seen the investors lose billions of dollars entrusted to the fund managers. It is imperative for the investors to investigate the company they want to invest their money in. Relying on the experience of the fund manager alone is not enough to regard the company as credible. The investors must know whether the manager of the fund has investments. This is imperative as it shows that the investment is reliable when the fund manager is also an investor because he or she will be committed to making sure all activities are carried out effectively.
The investors must demand regular audit reports of the hedge fund to ensure that they have information on the financial position of the company. Investors must also not ignore the financial analysis done by the financial analysts to establish the market trends and the financial position of various companies. The reports contain insights and information that the average investor may not have made him or her informed about the trends in the market and the financial position of the company.
The Securities and Exchange Commission needs scrutiny to establish how it was unable to foresee and detect the company’s fraudulent scheme even though it had conducted regular investigations. This is worrying to the investors who have placed their money in mutual funds as it may lower the investor confidence in mutual funds accredited by the Securities and Exchange Commission. If thorough scrutiny of the company accounts were done, the extent of the fraud would have been minimal.
The investors must scrutinize the companies in which they invest to ensure that the fund manager is not the broker and the investor. The fund managers should operate independently from the stockbrokers to avoid instances where they provide false information. The company conducting the investigations for the hedge fund must be a credible company that has the capacity to conduct a credible financial audit for companies with such amounts of money. The investors must also have independent financial advisors to investigate the companies.
Caruso, David. “Madoff Investigators Look for Partners.” Associated Press, 2008. Print
Harris, Larry. Trading and Exchanges: Market Microstructure for Practitioners. London: Oxford University Press, 2003. Print
Undergraduate Task Force. Regulation of Hedge Funds: U.S. Securities and Exchange Commission. New Jersey: Princeton University, 2005. Print
Weiner, Eric. What Goes Up: The Uncensored History of Modern Wall Street as Told by the Bankers, Brokers, CEOs, and Scoundrels who Made it Happen. New York: Little, Brown and Company, 2009. Print
Wilhelm, William. Downing Information Markets: What Businesses Can Learn from Financial Innovation? Boston: Harvard Business Press. 2001. Print