1. The three types of illegal business behavior alleged against Bernie Madoff include fraud, money laundering and theft. The first, fraud, involves coercing investors to decide whether or not to invest by giving them information that does not correspond to the reality of their situation. Madoff did this by This is meant to provide a short term gain for the defrauder, but significant losses for investors – the person committing the fraud gets the investment money while providing no return on that investment back to the investors. This is an unethical business practice, due to the fact that it is an intentional breach of trust at the expense of the investor, knowingly giving them bad investments in order to pocket the difference. Also, it is illegal as per regulations set by the Securities and Exchange Commission.
The second, money laundering, involves hiding money acquired illegally by funneling it through ostensibly legal sources. Madoff performed money laundering by using his securities office, Madoff Securities International Ltd., to launder millions of dollars of his client’s money, disguising it as trading for said clients in Europe. Because the practice allows for illegally gained money to be masked as legitimately earned money, it is an illegal business practice; what’s more, financial institutions can lose their reputations as a result of handling laundered money, making it even more dangerous a practice for businesses overall.
The third crime is theft, or larceny; Madoff allegedly stole from an employee benefit plan, funneling money from that to his own personal accounts. Theft, being the outright stealing of money from one person by another, is most certainly an illegal action, and it is unethical because the money was not received through honest means. In the case of Madoff’s crime of theft, over $10 million in assets from the pension fund was taken by Madoff, when it was meant for several dozen labor union pension plans for his securities firm. As opposed to the securities fraud he committed when he took money from investors, the recipients of the pension fund were merely expected to get that money, while Madoff stole a large portion of it and kept it to himself.
2. The impact of Bernie Madoff’s Ponzi scheme was far reaching and disastrous for many people, including investors, employees and business partners. In the case of investors, they lost substantial amounts of money taking the risk in investing with Bernie Madoff – almost $65 billion in investment money was taken from nearly 5,000 clients, which was then invested in more and more securities. When the economic downturn occurred, Madoff lost the money he got from investors and continued the scheme to get more. As a result of the continually lost money, in addition to the assets frozen by the SEC, many of these investors cannot get their money back. There is more than $800 million that has been frozen by the SEC, many of it intended to go to nonprofit organizations and individuals who invested their entire fortunes into the trading system Madoff purported to have (Lenzner, 2008). Many hedge funds and banks had invested substantial amounts of money, as well as other investment firms, all of whom lost millions of dollars when the Ponzi scheme fell through (Wall Street Journal, 2009).
As a result of Madoff’s securities fraud, the firm faced insolvency. Consequently, employees of his investment firm lost their jobs due to the bad investments and the lack of actual financing. What’s more, Madoff actually stole from employee pension funds, thus directly robbing them of retirement money. This left them without jobs and the proper means to support themselves in light of the pension fund theft. Also, some of the employees of Bernie Madoff are accused with conspiracy, as accessories to the Ponzi scheme – therefore, the scheme itself ruined their careers and made them subject to criminal charges and sentencing.
Business partners who worked with Bernie Madoff also lost their reputations – as people who were knowingly or unknowingly complicit in the million-dollar fraud that he committed, it is unlikely that many clients would be able to trust these business partners again. Much like the employees of Madoff, they are less likely to be trusted in the future, but they were not directly let go as a consequence of the Madoff firm entering insolvency. Not only that, but the insolvency of Madoff’s business affected all of the investors and stockholders who had invested heavily in him. Independent of the scheme, these people lost their investment in the company itself, and many recipients of Madoff’s philanthropy, including nonprofit organizations, have had to close in light of the asset forfeiture.
3. Bernie Madoff’s scheme may have done less damage if certain risk management practices were put in place to minimize the likelihood of bring defrauded. First, additional regulation of the hedge fund industry would provide greater oversight and more stringent controls of hedge funds. Greater laws regarding transparency and accountability could be put in place in order to anticipate future instances of fraud; this would make it more difficult for people like Madoff to let money slip through the cracks, and prevent laundering (Clauss et al., 2009).
Secondly, due diligence in hedge funds needed to be practiced more thoroughly, with investors monitoring the operation in order to find out which managers would be best to invest with. Once they are selected, steps are also taken to monitor the managers chosen in order to make sure they are acting in the best interests of one’s investment. If proper due diligence had been performed on Mr. Madoff, it is possible that his scheme would have been found out much sooner. However, he had found a way to maintain a veil of secrecy and exclusivity regarding the scheme, by elevating his reputation to a point where he was painted as ‘too important’ to meet personally with investors, all of whom trusted Madoff as a busy authority (Clauss et al., 2009).
Lastly, steps to increase transparency needed to be implemented in order to make Madoff’s firm less shadowy and mysterious to investors. The ‘retailization’ of the hedge fund industry has made it necessary to create stronger standards that “would fill the regulatory gap which exists between hedge funds and their more regulated competitors” (Clauss et al., 2009). These standards would allow an investment strategy to be dependent on more than merely a high reputation in the world of investments, as Madoff had and used in his scheme. With new rules to allow investors to learn more about the securities firm they are entrusting their money to, and greater access to executives like Madoff, they would be able to determine exactly what the intentions are for their money, and calculate the legitimacy of the rates of return.
4. In order to protect themselves, there are a number of risk management practices that private investors could employ to prevent themselves from enduring such a disastrous situation again. First, investors could “deploy more time toward, and employ more diligence in, assuring themselves that the funds in which they have invested or may invest use independent custodians and other service providers” (Krug, p. 6). One of the biggest red flags for Madoff’s investment scheme was the lack of an independent accounting firm to keep track of the investments; as it stood, Madoff kept the accounting in-house and small (only one individual person was in charge of auditing Madoff’s entire empire), making it much easier to hide the true nature of the investments (Fitzgerald, 2008). However, a neutral accounting auditor would have been able to see the discrepancies put forth by Madoff and his team; therefore, hiring on independent custodians would have been a wise move to make sure that Madoff’s investment plan was legitimate.
Secondly, they could learn more about investment strategies involved and utilized by their investment firms, so as to determine exactly how capital management will occur. In the case of Bernie Madoff, investigation of his risk profile and his “split strike conversion” strategy would have helped to show just how inflated his performance estimates were, and that a realistic replication of returns would not match his estimates by a wide margin. With the help of quantitative risk systems, it is easy to see just how these funds would actually behave, which is far lower than how Madoff would make it seem. By using these strategies, it would be much easier to sniff out fraudulent deals by shady firms like Madoff’s (Douady et al., 2009).
Lastly, private investors could have avoided the risk by not just relying on the cult of personality to dictate their investment strategies. Many investors did not look closely enough at the actual plan that Madoff put forward, instead merely wishing to get close to the person they believed “knew what they were doing.” By virtue of his reputation, Madoff lured in private investors who did not know about the investment market by assuring them that he was an expert; since his name was well known, being the former chief executive of NASDAQ, novices to the game trusted him to handle their finances well. The best strategy for private investors, however, is to look at an investment from an objective viewpoint, foregoing the big name in front of it and looking at how the investment would affect them (Huddleston, 2011).
5. As a result of the disastrous Ponzi scheme he oversaw, Bernie Madoff is subject to a great variety of civil and criminal actions that could be (and were) taken. The primary action that could be (and was) made against Bernie Madoff was a class action lawsuit, wherein the investors who were adversely affected by Madoff’s actions collectively sued him to attempt to regain their funds. Thousands of investors and clients were robbed of their money by Madoff in order to pay the previous investor, leaving many without the compensation that was promised by them, or even the money that they had originally invested. With the help of a class action lawsuit, a civil case can be filed against Madoff that will force him to return the funds to them by any means necessary. The use of such a lawsuit permits a larger number of the individuals to get their money back more quickly by filing a joint case against Madoff, instead of specific cases to get their individual amount of money back.
Madoff also could be arrested and imprisoned as a result of the securities fraud that he committed. Indeed, Madoff was arrested and brought up on criminal charges, where he was sentenced to 150 years in prison; this was the maximum sentence allowed for the eleven charges that he pled guilty to. The crimes that he committed were federal felonies, and as such he is subject to the letter of the law, which can include sentencing of prison time. The eleven charges he was charged with include securities fraud, mail and wire fraud, perjury, and filing false documents with the Securities and Exchange Commission, among others (United States v. Bernard L. Madoff, 2009).
The Securities and Exchange Commission was granted the right to freeze Bernie Madoff’s assets. This is known as asset forfeiture, wherein the United States carries the right to confiscate assets that were acquired illegally or through fraud. At the same time, Madoff’s forfeiture is civil, not criminal; this is due to the lack of specific evidence supporting a case that Madoff used tainted funds. However, in the case of civil assets forfeiture, it is possible for probable cause to be sufficient for the freezing of Madoff’s funds (Henning, 2010). During the freezing of these funds, they are not permitted to be spent by Madoff or any other party in its name pending investigation; this permits investigators to at least attempt to track down the source of the money and potentially return it to the parties it was stolen from, eventually.
Clauss, P., Roncalli, T., & Weisang, G. (2009). Risk Management Lessons from Madoff Fraud. International Finance Review, 10(17), 1-28.
Douady, R., Abdulali, A., & Adlerberg, I. (2009). The Madoff Case: Quantitative Beats Qualitative!. Riskdata, 2, 1-6.
FITZGERALD, J. (2008, December 18). Madoff’s financial empire audited by tiny firm: one guy. The Seattle Times. Retrieved August 17, 2011, from http://seattletimes.nwsource.com/html/businesstechnology/2008533585_madoff18.html
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Krug, A. (2009). The Regulatory Response to Madoff. Berkeley Center for Law, 6, 1-6.
Lenzner, R. (2008, December 12). Bernie Madoff's $50 Billion Ponzi Scheme. Forbes.com. Retrieved August 17, 2011, from http://www.forbes.com/2008/12/12/madoff-ponzi-hedge-pf-ii-in_rl_1212croesus_inl.html
Stanyer, P. (2009, December 7). The lessons we can all learn from Bernard Madoff. Telegraph.co.uk. Retrieved August 17, 2011, from http://www.telegraph.co.uk/finance/personalfinance/investing/6752468/The-lessons-we-can-all-learn-from-Bernard-Madoff.html
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Wall Street Journal. (2009, March 6). Madoff's Victim List. The Wall Street Journal. Retrieved August 17, 2011, from http://s.wsj.net/public/resources/documents/st_madoff_victims_20081215.html