A charismatic man
Bernie Madoff was a well-respected financier and former non-executive chairman of the NASDAQ stock market. An affable man who could be charming and very charismatic with people. He was an exceptional marketer who managed to cultivate an image of exclusivity, often initially turning clients away. These qualities enabled him to run the largest Ponzi scheme in history for several decades.
Staying under the radar
Bernie knew perfectly well the rules of the game. In order for his Ponzi scheme not to collapse he needed constant cash inflows. His fixed returns, no matter what the weather was, would ensure cash flowing on the one hand, but would act as a red flag on the other. Therefore, staying under the radar was crucial. In achieving this, he had one condition he imposed on everyone: his name was not to be mentioned on any marketing material.
He was also aware of the universal truth that people are greedy and when they make money they often turn a blind eye to irregularities. That’s why he had an unusual fee arrangement with his feeder funds; he didn’t charge any fees. For a major feeder fund the benefit could be up to $100m per annum.
His bankers were also incentivized not to pose any difficult questions. Madoff simply deposited the funds received in an account and let it sit. The bank approximately made close to $480m from those deposits, so it was not inclined to dig deeper and inquire about the origin of the funds.
As a final layer of protection, he stayed very close to regulators. He was smart enough to know that if you stay close you will be protected in case of any potential investigations.
The beginning of the end
When Bernie Madoff was asked about his investing model he replied that he was following a split-strike conversion strategy, which is sometimes called a collar. The good thing with this strategy is that is a bit complex for the average investor to actually understand it and raise any questions. On the other hand, any sophisticated investor would try to duplicate it so as to generate similar returns.
In 1999 Harry Markopolos CFA, CFE was asked by his employer to try to design a product similar to Madoff’s split-strike conversion. As soon as he obtained a copy of Madoff’s revenue stream, he concluded that there was no legal way for Madoff to deliver his returns. It took him 5 minutes figure out it was a fraud and another 4 hours to prove it mathematically. What caught his attention was the performance line of Madoff’s investment model, as only 4% of the months were down months. Markopolos concluded there were only 2 plausible explanations; either Madoff was using insider information or his was running a huge Ponzi scheme.
On several occasions, 2000, 2001, 2005, 2007 and 2008 Markopolos informed the U.S. Securities and Exchange Commission (SEC) of the potential fraud, supplying supporting documents. Each time, the SEC failed to investigate it properly. Markopolos later in his Congressional Testimony, criticized SEC for failing to discover the Madoff fraud despite his repeated tips.
Below you may find a link to Harry Markopolos Congressional Testimony:
Eventually the financial meltdown in 2008 lead to the collapse of Madoff’s Ponzi scheme, since his investors wanted their money back and he couldn’t secure any new cash inflows to meet the demand. He was finally uncovered as a fraud in December 2008, when his sons contacted the FBI.
After admitting to operating the largest private Ponzi scheme in history, Madoff was sentenced in 2009 to 150 years in prison.
His son Mark committed suicide in 2010. Mark’s lawyer stated “…he succumbed to two years of unrelenting pressure from false accusations and innuendo.” Mark wasn’t the only man who killed himself after the collapse of Madoff’s Ponzi scheme; overall at least 4 suicides are linked to Madoff’s case.
As a final note, I leave you with the words of Harry Markopolos “…it’s not the armed robbers or drug dealers who cause the most economic harm, it’s the white-collar criminals living in the most expensive homes who have the most impressive resumes who harm us the most. They steal our pensions, bankrupt our companies, and destroy thousands of jobs, ruining countless lives.”