The business world has witnessed several massive frauds during the 21st century. Foremost among them is the Enron debacle of 2001 {which resulted in one of the Big Five world auditors, Arthur Andersen LLP, being obliterated from the world scenario}, the WorldCom scandal of 2005, and the recent sensational collapse of Lehman Brothers last year. The latest to join the list is Bernard L. Madoff Investment Securities LLC, with its founder Bernard Madoff earning the dubious distinction of being the perpetrator of one of the largest financial frauds in history.
Madoff’s rise to fame and fortune
Bernard {‘Bernie’} Lawrence Madoff was born on April 29, 1938, in New York to East European immigrants Ralph and Sylvia Madoff (Biography.com, 2009, page 1, para.1). Bernie’s maiden venture into the business world began when he discontinued studying at law school and joined his wife Ruth in establishing an investment firm named Bernard L. Madoff Investment Securities LLC in 1960. The business started well due to active assistance from Ruth’s father, who was a retired Certified Public Accountant {C.P.A}.
People were enticed to invest in the business through the word-of-mouth technique. The Madoffs employed an unusual method of attracting investors – they offered yearly returns of at least 10 percent on the money invested with them. This tactic was so successful, that by the end of the next two decades, Madoff Investment Securities appropriated nearly 5 percent of all the trading transactions carried out on the New York Stock Exchange besides also garnering a large clientele that featured several famous Hollywood personalities like Kevin Bacon, Kyra Sedgwick and Steven Spielberg (Biography.com, 2009, page 1, para.5&6).
As the expanding business necessitated the presence of reliable people to supervise and manage lower-level employees, Bernie shrewdly employed many from within his family for such posts. These included his sons Andrew and Mark, his brother Peter and niece Shana. The widespread acclaim of Bernie’s success as an investor with the golden touch began to accelerate when Madoff Investment Securities capitalized on the influx of electronic trade by introducing computerization in their operations.
The fact that the computer program that was tested and used by them went on to become the National Association of Securities Dealers Automated Quotations {NASDAQ}, plus the additional accolade that followed when Bernie became president of the NASDAQ stock exchange board of directors (Biography.com, 2009, page 1, para.7&8), as well as its first Chairman and member of the National Association of Securities Dealers board of governors (Damon, 2009, para.4), served to greatly enhance the fame of the stockbroker and his investment firm. Bernie soon acquired the status of an important individual on Wall Street. At the height of his fame, Bernie’s investment firm was maintaining an impressive record of allocating a huge 12 percent {minimum} rate of returns to investors regularly (Damon, 2009, para.2).
The Madoff Ponzi Scheme is revealed
Bernie’s infamous Ponzi Scheme was exposed on December 10, 2008, when he told his sons about his intention to distribute many millions as bonuses 60 days ahead of schedule. The unusualness of this information prompted his sons to enquire about the origin of such an amount. They were flabbergasted when their father confessed that one of Madoff Investment Securities’ branches was a complex, extravagantly ornamented Ponzi Scheme. Bernie’s sons lost no time in complaining to the federal authorities, as a result of which their father was arrested the following day on charges of securities fraud (Biography.com, 2009, page 2, para.1).
The Ponzi Scheme takes its name from an Italian immigrant named Carlos Ponzi, who ran a similar operation in the 1920s in the United States over more than 20 years. The modus operandi of Bernie’s Ponzi Scheme involved the following 4 stages (Hinton, 2009, para.6&7):
- The stockbroker entices the first client by promising a healthy return on investment.
- The stockbroker invests very little or nothing of the client’s money, instead of utilizing it for himself or putting it to some other use.
- When the time comes for the first investor’s money to be returned, the stockbroker entices other clients and pays off the first investment with the money obtained from the new clients.
- This process goes on in a $ 50 billion pyramid plot involving no real money in the business – the money was just shifted from one investor to another.
Complicity of SEC in the Madoff Scandal
On November 9, 2009, Federal investigators presented documents that clearly show the involvement of the United States Securities and Exchange Commission {SEC} in the Madoff Scandal. The documents reveal that SEC regulators carried out at least 5 investigations of Madoff Investment Securities, during each of which they failed to take basic steps that would have exposed Bernie’s fraud. Instead, their gross negligence resulted in the SEC granting Bernie’s firm a clean bill of health again and again. To add insult to injury, the daring Bernie showcased the SEC approval to existing and potential investors as a sign that his business was fully compliant with the law (Damon, 2009, para.5).
Bernie even boasted about his close friendship with SEC bigwigs like Mary Shapiro, the present chief of SEC, whom he called his ‘dear friend,’ and Arthur Levitt, former Chairman of SEC who he claimed to know ‘very well and with whom he had lunch on several occasions (Damon, 2009, para.13). Bernie also pointed out that Levitt had appointed him in the year 2000 to a learned group panel set up to impart advice to the SEC on new stock market regulations as a reaction to the increase in electronic trading (Damon, 2009, para.4).
The SEC regulators checking Madoff Investment Securities blundered by relying fully on Bernie’s records and did not bother to do a third party check either with the firm’s counterparts or the Wall Street clearing house that maintained records of the firm’s operations, or the absence of such records (Damon, 2009, para.6&7). The incompetence shown by SEC regulators becomes inexplicable in the light of 3 facts. Firstly, it was well known that Bernie’s dealings were viewed with suspicion by competent investors and dealers.
Secondly, a securities industry executive named Harry Markopolos had sent official letters to the SEC from as far back as 1999 urging it to thoroughly investigate Bernie’s firm which ‘is the world’s largest Ponzi Scheme.’ Thirdly, the SEC regulators deliberately overlooked evidence in the firm’s records that reveal it regularly imparted investment advice {this is a prosecutable offense} to investors (Damon, 2009, para.10&11).
The incompetence exhibited by SEC investigators takes on sinister implications due to the well-known fact that they are usually repaid for their ‘oversight’ by people like Bernie in the form of lucrative jobs on Wall Street that can transform them into overnight multimillionaires (Damon, 2009, para.20).
Culpability of auditors in the Madoff Scandal
Friehling & Horowitz, an auditing firm based in New York, like 33,000 other auditing firms, had enrolled in the American Institute of Certified Public Accountant {AICPA} peer review scheme under which professional auditors annually examine the standard or grade of every firm’s audit. However, Friehling & Horowitz not only didn’t hand in any review from 1993, but it also confirmed in writing each year to the AICPA that it does not carry out auditing functions (Abkowitz, 2008, para.5&6).
In reality, Friehling & Horowitz have been performing audits for Madoff Investment Securities. This is confirmed by the firm’s name and signature which appears on the Madoff Investment Securities’ Statement of Financial Condition dated 31 October 2006. This points to Friehling & Horowitz being in cahoots with Bernie because it not only deliberately hid the fact that it conducted audits for Bernie’s firm, but it also deliberately did not submit any such audit for peer view as required. The AICPA is presently conducting a thorough ‘ethics investigation’ into Friehling & Horowitz (Abkowitz, 2008, para.7).
Bernie’s investors did not know Friehling & Horowitz’s status as a tiny firm staffed with only a partner over 70 years old who resided in Florida, an accountant and a secretary, with a small office in a strip mall in New York. The investors put their money in feeder funds established by third-party firms which then channeled the money received to Bernie’s firm. A prime example of such a Madoff feeder fund is the Rye Select Broad Market fund (Gandel, 2008, para.7&8).
While the Madoff feeder funds that invested with Bernie were audited by eminent firms like KPMG, Pricewaterhouse Coopers, and BDO Seidman, these auditors hardly did anything to protect their clients from Bernie’s fraud, such as independently reviewing Bernie’s firm statements thoroughly {especially because the firm was using an unknown auditor to check its accounts}, instead just being content with taking at face value the statements of Bernie’s firm that Bernie himself created. The ones who suffered the most were the investors who knew that the feeder fund’s statements were audited by well-known auditors {for example, KPMG audited Rye Select Broad Market fund} primarily due to which were satisfied and assured that their money was safe (Gandel, 2008, para.7&8).
Following news that auditor BDO Seidman and its Madoff feeder fund client Ascot Partners have been sued on 16 December 2008 by New York Law School, the law circle ominously predicts that lawsuits will soon be instigated against other auditors of Madoff feeder funds. This point is well elucidated by Scott Berman, a lawyer with Friedman Kaplan Seiler & Adelman who has tackled auditors in several similar cases in the past: “The fact that they [Madoff feeder firm auditors] didn’t catch the fraud leads me to believe that they blew it. I am going to look hard at whether there is a liability here” (Gandel, 2008, para.4&5).
Losses that accrued from the Madoff Scandal
A massive $ 61 billion in investments was obliterated due to Bernie’s fraudulent activities (Damon, 2009, para.2) that included 11 counts of felony, the first count being securities fraud (Biography.com, 2009, page 2, para.2) which accounted for the major part – over $ 50 billion (Hinton, 2009, para.5). A wide range of investors was adversely affected. Rich and eminent individuals lost millions of dollars. Losses incurred by international banks and hedge funds ran into billions of dollars. Organizations like university endowments and charities sustained huge losses with several of the latter having no option but to close. A large number of retired individuals who had invested their entire life savings in Bernie’s firm lost the full amount (Damon, 2009, para.3).
Madoff is imprisoned and sentenced
In a significant development following Bernie’s arrest on 11 December 2008, Federal investigators revealed on 12 March 2009 that Madoff admitted to guilt on 11 grounds of a felony that included 4 counts of fraud relating to securities, investment adviser, mail, and wire; 3 counts of legitimizing illegal money; 3 counts of falsification relating to statements, perjury, and filings with the SEC; and 1 count of theft from a worker benefit scheme. The 71-year-old disgraced stockbroker was handed a sentence of 150 years in prison on June 29, 2009 (Biography.com, 2009, page 2, para.2&3).
Conclusion
While Bernie and his puppet auditors are the prime culprits, and part of the blame for the Madoff Scandal has to be placed on the well-known auditors of the Madoff feeder funds, it is the SEC that should also be heavily blamed. It is unacceptable that an organization of such vital and elevated stature as an independent agency of the United States government which has been entrusted with the responsibility of administering federal securities laws should be hampered by investigators that are blatantly exploiting their responsible positions by shirking their responsibility in the hope of material gain {this practice is well exemplified by an SEC investigator’s 2006 email: “I don’t think we should worry about Bernie finding out to whom we speak…..[We] are not telling anybody that we found anything improper [except his lies to us, of course]” (Damon, 2009, para.11).
Last, but certainly not least, a sizeable part of the blame for the Madoff Scandal falls on the laps of the United States administration. It is widely perceived that Wall Street continues to be well protected because individuals like SEC chief Mary Shapiro and Lawrence Summers (Damon, 2009, para.25) the former Clinton administration official who was instrumental in the ousting of Brooksley Born, Chief of Commodities Future Trading Commission, when the lady urged reform of the derivatives market (Damon, 2009, para.21}, continue to feature prominently in the United States President Barrack Obama’s administration’s financial bureaucratic system.
References
Abkowitz, A. (2008). Madoff’s Auditor…Doesn’t Audit?. Web.
Bernard Madoff Biography. (2009). Web.
Damon, A. (2009) Documents Reveal SEC Complicity in Madoff Ponzi Scheme. Web.
Gandel, S. (2008). The Madoff Fraud: How Culpable Were the Auditors? Web.
Hinton, P. (2009). A Biography of Bernard L. Madoff and His Scam. Web.