Largest Ponzi Scheme in history
Bernie Madoff began his brokerage firm in 1960 and grew it into one of the largest on wall street.
While doing so, he began investing money as a favor to family and friends, though he was not licensed to do so.
Over 5 years, these side investments became Investment fund that mushroomed into $50 million Ponzi scheme.
Bernie pled guilty without a trial on March, 2009, and was sentenced to 150 years in prison.
Thousands of wealthy clients, organizations and middle class people whose pension funds found their way into Bernie's investment fund lost their life savings.
What to do?
Bernie Madoff, at ages of 69, owned 3 successful financial companies
1- Brokerage firm2 Trading firm3 Investment advisory firm
On Dec. 2008, brokerage and trading firms managed by his brother and 2 sons, were performing as well as could be expected in deep recession it is investment advisory firm was on verge of collapse!!
Investors in Bernie's investment fund had requested $7 billions in withdrawals; and he did not have the cash to pay them.
Investment fund was a $50 billion Ponzi scheme in operation for at least 20 years.
Bernie met with his sons, Mark (44) and Andrew (42) to discuss his contentions plan. Bernie broke down and confessed that he's finished. The Ponzi scheme consisted of tens of thousands of falsified balance sheets. Brothers were shocked.
Question: Should they grant their father the one week he requested or should they immediately notify the government officials about their father's criminal activities
Answer: they decided to notify govern friends.
Beginning of Madoff
Bernie was born in 1938, son of Ralph and Sylvia. The Family lived in a small lower eastern Manhattan apartment, then bought a small house in a working class jewish community (Laurelton) near knennedy Airport Bernie's father was a plumber mostly off-the-books.
Bernie married Ruth, moved to inexpensive one bedroom apartment
He started his Brokerage Firm, he had $5000 capital Growing the Business through Some Illegal Trading on the side.
Bernie was 22 years old, his wife's father (Alpern) helped him established some legitimacy by giving him office space in his mid-town Manhattan according firm.
A publicly traded company listed on the New York Stock Exchange and American Stock Exchange (AMEX) had to meet size requirements and pay substantial fees. Bernie focused on trading "Over the Counter" Penny Stocks, Volved less than $1.00, that were traded outside NYSE and AMEX. An investor would telephone Bernie wanting to buy or sell penny stock. Bernie would then contact other investor or stockbrokers to make the trade at best price for Bernie client.
In Short time, Bernie got several big breaks.
Alpern, impressed by his son-in-law work, loaned him $50.000 ($364,000in 2010 dollars) to invest.
Then a----- acquaintance introduced Bernie wanting Carl Shapiro, worth more than $22 million ($3 billion in 2010 at age of 45, was intrigued by Bernie's ability to complete trades in 3 days; most stockbrokers took 3 weeks.
Shapiro gave him $100.000 to invest on his behalf.
Bernie used the money he made trading for Alpern as Shapiro to subsidize his penny stock brokerage firm.
Bernie earned substantial fees by investing Alpern + Shapiro Funds and sought to increase business by offer by to pay his father-in-law for each new client he recruited.
Alpern told everyone that Bernie could get them 18% return of their investments SEC had a rule that exempted investment advises with less than 15 clients from being licensed.
Bernie exceeded this limit and was required to obtain a license, this meant passing an examination, paying fees and filing statements with SEC. Instead, Bernie joined the ranks of illegal unlicensed investment advisors-including his parents, who escaped the scrutiny of the SEC and state securities regulators.
By 1962, after 2 years of operation, Bernie was overwhelmed by paperwork required for managing his growing number of small investments. Bernie told his father-in-law to do him a favor by collecting money from various investors and then give the total amount to Bernie as one account to invest.
This also made it appear to SEC as though he had fewer clients.
Soon Alpern's accounting business unofficially merged with Bernie's investment business. Alpern assigned one of his accountants as Bernie's personal accountant.
Another Alpern accountant, Avellino, not only invested with Bernie for a guaranteed 20 percent return rate, but also earned a commission for recruiting other clients.
Both Alpern and Avellino were, like Bernie, unlicensed investment advisers.
In 1963, Bernie focused on growing his brokerage clients. That year, the SEC investigated 48 brokerage firms, including Bernie's mother's business, for not filing financial reports.
His mother though not fired, lost her business license and was banned from the securities industry. Bernie's father continued to earn money as an investment advisor.
As for Bernie, he could have obtained an investment advisory license then to avoided what happened to his mother. But if he did, the SEC or other securities regulators might audit his financial books and discover that Bernie also had been violating SEC licensing laws. He feared that, just like his mother, this could result is being banned forever from securities industry.
More Growth and illegalities.
Business borrow money from banks to pay for expansion.
Bernie didnt have to do this because he had a bank account with money flowing in and out from his illegal investment advisory business.
He used some of this money, without this client's permission , to avoid interest payments.
Bernie moved money between his Bank of New York brokerage bank account and his chase investment adviser bank account as needed.
Whenever he fell short of the guaranteed 20 percent investment advisory returns, he made up the difference by taking money out of his brokerage bank account.
If he needed income to grow the brokerage firm, he took money from the investment advisory bank account.
Bernie got another big break when his father in law hired Michael Bienes as an accountant in 1968. Biene's brother-in-law was Jeffrey Picower, a wealthy wall street investor Bienes earned hundreds of thousands of dollars in commissions from money Picower invested with Bernie over the next 40 years.
Question
How did Bernie explain his remarkable results to sophisticated investors like Picower? Bernie now sold blue-chip stocks and claimed he invested client money using a complicated three past split strike conversion investment strategy.
Note:
Key to Bernie's success was the efficiency and speed of his trading operations. Bernie was one of the first brokers to recognize the role computers could play in the financial Industry.
In 1970, he tired his younger brother Peter to help computerize operations. The speed of their trading transactions attracted a growing number of clients, such as other brokerage firms and investment advisers, to do business through Bernie's operations.
Investment advisers were also intrigued by Bernie's unique one or 2 pennies commission for each share invested with his company.
SEC was drying to break up the virtual trading monopoly the NYSE and AMEX had in the investment community, that's why the SEC encouraged Bernie and others to create a "third marked for trading over-the-counter stocks of small public companies.
Bernie's Ponzi Scheme
Ponzi schemes are named after a scheme developed by Charles Ponzi. In 1920, Ponzi promised to double the money of investors within 45 or 90 days if they invested in a complicated security the only he knew how to manage. However, he never invested the money, instead he deposited their money into his bank account and paid investors the promised return using new investor income. His scan was uncovered within a year. Investors who withdrew their funds early earned a large profit, while those who had not withdrawn money lost their investment.
A successful Ponzi scheme requires a network of trusted co-conspirators. In 1975, Annette Bongiorno, hired 10 years earlier at age 19 as Bernie's secretary, recommended her neighbor, Frank Dipascali, an 18-year old recent high school graduate, for a job assisting Bernie's investment advisory business.
Frank quickly advanced to managing Bernie's computer systems. Frank and Daniel (hired 7 years earlier as Bernie's auditor created fraudulent records to verify trades that never occurred.
Unlike Ponzi, Bernie owned a successful and legitimate brokerage firm. He used the activities of his booming brokerage business to shield his fraudulent activities.
The computer software program developed by Bernie's brother determined optimal trades within 4 seconds. Clients visiting the brokerage company observed a great deal of trading that generated tremendous profits.
Bernie's Fraud was a simple scheme. Assume a client, promised a 20% annual return, gave Bernie $1 million to invest on January Bernie deposited the client's money in his own bank account. As more clients invested over the course of the year, the amount in Bennie's bank account grew. If the client decided to redeem (save himself) the entire investment on Dec 31, Bennie wrote a check for $1.2 million from the company's bank account.
Questions: Why would potential clients trust Bernie?
Bernie had a long track record of successful investing, and was at the forefront of computerization of stock trading.
He served on SEC advisor committees, held a 4 year elected term on the NASD Adviser council, and was elected as non-executive chairman of NASDAQ.
People were drawn in by Bernie's personality. He was a quiet yet charismatic. A family man, loyal, honest, did not drink alcohol. Elderly clients treated Bernie as a son.
Flush with cash, Bernie opened a London office in 1983 to attract European investors. This office would play a key role in his money laundering operation.
Almost Caught: by a client who found out it was unregistered invest advisory company so he filed a complaint with SEC.
Bernie who was dealing with Avellino and Bienes told SEC that he had assumed they were a registered investment advisory business which was a lie, so they were filed $350,000 + return of $441 million to victims.
This scandal affected Bernie's reputation in wall street Journal.
Another red flag noted by Markopolos (highly skilled Rampart hedge fund manager) who submitted a complaint to SEC against Bernie.
Question: Why did the SEC dismiss complaints filed against Bernie?
1- SEC annually receives more than 10,000 complaints against brokers so they focused on the more familiar front running that Bernie wasn't doing
2- SEC had difficult to understand complexity of Bernie operation.
3- They gave Bernie the benefit of the doubt because he had an impressive track record with NASDAQ and had assisted the SEC on complex issues.
4- Bernie never requested presence of a lawyer when speaking with SEC
5- When questioned about his high returns, he said he had personal feel for marked.
6- Markopolos unsuccessfully competed against Bernie, thus leaving himself vulnerable to the "sourg rapes" accusation
7- SEC managers and Markopolos had an adversarial relationship
8- The SEC believed Markopolos was motivated by a desire for the whistleblowing reward windfall.
