Introduction and Background

INTRODUCTION

Bernard Lawrence Madoff was a former financial advisor and non-executive chairman of the NASDAQ stock market. Madoff was born on April 29, 1938, in Queens, New York. His family had a tough time after the closure of their company by the SEC due to failure to file required documents. Afterwards, with his accumulated savings of $5,000 and a further $50,000 borrowed from his father-in-law, he set up his investment company called Bernard L. Madoff Investment Securities (The Infographics Show, 2018). The company was supposedly operating a hedge fund which promised investors high and consistent return of around 12%. With these promising returns, Madoff would be portrayed as an investment genius in the years to come.

However, on 29^th June 2009, this Wall Street trader plead guilty to Ponzi scheme fraud; and was consequently sentenced to 150 years in prison. To the shock and bemusement of many, his conspiracy allegedly spanned across approximately two decades; with federal prosecutors estimating $64.8 billion worth of financial fraud based on the amounts missing from 4,800 clients' accounts (Graybow, 2009). As of November 30, 2008, the U.S. Securities and Exchange Commission (SEC) claims the scam to be “one of the biggest fraudulent schemes in history.”

PONZI SCHEME

Madoff first created Madoff Securities in 1960 as a penny stock trader. This meant that the firm traded at a low price, which allowed the company low market capitalization (B. Murphy 2019). Normally, this infamous firm was a brokerage house which would undertake buying and selling of securities in financial instruments. In order to make profit, its ask price would be higher than the bid price of a market asset; which was usually known as bid-ask spread (Ganti, 2019). Nonetheless, after a period of time, the activities that Madoff dealt in were far different as he would eventually operate a Ponzi scheme.

According to Investopedia, a Ponzi scheme is “a fraudulent investing scam promising high rates of return with little risk to investors” (Chen, 2020). To illustrate from the Ponzi scheme diagram, the red man at the top would be Madoff and the first investors he had would be the orange group below of him. All the money that he received from these investors would go straight into his bank account while in order to pay off these investors their proclaimed returns of 12%, he would find another group of investors (the blue group in the diagram) and utilize their investment to do so. In simple terms, Madoff simply put the money into a bank account and withdrew from this account to pay off the returns that he promised - instead of investing it into securities, like he claimed. And as long as he kept taking money from a new group of investors and the amount received was more than he was returning, this scheme would have gone on indefinitely.

Yet, this type of scheme is not sustainable. As long as investor's claims were more than what was available, the business will be in trouble as there would not be enough to pay out such claims. Such a situation occurred during the financial crisis in 2008, when every stock was going down. It was such a concern to stock market investors to the point that people were pulling their money out of the market at such a large volume and speed that Madoff realized that his scheme was over. In the end, he was reported by his two sons Andrew and Mark after he confessed and was arrested (The Infographics Show, 2018).

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