Ins and Outs of the Madoff Ponzi Scheme (2008)

Bernard Madoff

Company Background

Bernard Madoff founded Bernard L. Madoff Securities LLC, a Wall Street investment advisory firm (a hedge fund) in 1960 with $5,000. Madoff was chairman of the firm until his arrest on December 11, 2008. Madoff claimed the Ponzi scheme he ran began in the early 1990s (1991) but federal investigators believe the scheme began as early as the mid-1980s.

What Happened  

Madoff was praised by many Wall Street investors, despite the fact that his numbers didn't add up. Many Wall Street experts even qualified him as being a genius. It was easy to overlook the multiple reports to the SEC about Madoff running a Ponzi scheme because Madoff was well-versed with the financial industry. He helped launch the NASDAQ stock market and advised the Securities and Exchange Commission on trading securities. He was also a former chairman of NASDAQ's board of directors and a member of its board of governors. It seemed more logical then for investors to believe Madoff knew what he was doing. The SEC is however to be blamed for not paying attention to the questions that had started being raised about Madoff Securities since 1999. 

Harry Markopolos

Financial analyst Harry Markopolos informed the SEC in 1999 that he believed the profits Madoff claimed to deliver could not be legally and mathematically achieved. Wealth lost in Madoff's vast Ponzi scheme totaled $64.8 billion and cash losses neared $18 billion. 

Madoff set up his portfolios to look like his returns matched those of the S&P 500. As such, he wouldn't need to pay existing investors too much and his purported holdings would still look appealing to new investors. His Ponzi scheme was sustained for many years because he didn't give out large returns, he kept his paperwork up to date, and targeted specific elite groups of investors.

Bernard Madoff in 2008

Madoff made no trades at all for years, just cashing people's cheques and paying back the few who opted out. He solely relied on his ability to deceive, his investors' blind faith, the laziness of the SEC, and his henchman.

Madoff lured investors such as the owners of the New York Mets (the Wilpon family), economist Henry Kaufman, former Salomon Brothers, Steven Spielberg, broadcaster Larry King - to his firm. His clients included wealthy individuals, hedge funds, charities and universities. Madoff mainly targeted charities' money, in a bid to avoid the threat of sudden and unexpected withdrawals. The Elie Wiese Foundation for Humanity was one of Madoff's biggest clients, and they lost $15.2 million. Madoff stole from Elie Wiesel, a recipient of the Nobel Peace Prize. Madoff defrauded firms in Scotland, Austria, Spain, Switzerland, the Netherlands, France, Italy, Portugal, Singapore and Japan. He also duped schools and universities, particularly those with Jewish ties.

Steven Spielberg

Madoff also duped some of his closest friends, including two tycoons he loved as surrogate fathers: the late Norman F. Levy and the prominent philanthropist Carl J. Shapiro. Norman Levy's girlfriend, supermodel Carmen Dell'Orefice was among those who lost their life savings.

Carmen Dell'Orefice

A Ponzi scheme is an illegal, carefully orchestrated financial scam which promises investors high rates of return with little to no risk. Ponzi schemes operate on the "rob Peter to pay Paul" principle; the money from new investors is used to pay off the earlier investors.  Ponzi schemes collapse when multiple investors want to cash out or when sufficient investors can't be found.

Main Players

The main players in the Madoff Ponzi scheme were: chairman Bernard Madoff; Madoff's henchman and accountant, Frank DiPascali; Madoff's auditor, David Friehling. DiPascali was Madoff Securities' "director of options trading" and "chief financial offer". DiPascali admitted he had known for at least two decades that there was no trading going on in Madoff's investment advisory. He pled guilty to ten federal criminal charges on August 11, 2009, namely: securities fraud, investment advisor fraud, mail fraud, wire fraud, conspiracy, money laundering, income tax evasion, falsifying books and records of an investment advisor, and falsifying books and records of a broker-dealer.

DiPascali

David Friehling pleaded guilty to rubber-stamping Madoff's filings with regulators rather than fully reviewing them. Friehling's firm, Friehling & Horowitz, Friehling's firm, signed off on audits on Madoff Securities' books. In exchange, Friehling and his family withdrew the tune of over $5.5 million from accounts at the Madoff firm, from 2000 to 2008.

David Friehling

Friehling trusted in Madoff, not knowing that Madoff was running a big fraud, and placed his family's savings, including his children's college savings into Madoff Securities. One of Friehling's three children, his 23-year old son, Jeremy Friehling - who was a second-year student at the Ohio State University College of Medicine - killed himself on November 16, 2012.

How they were caught

Madoff's Ponzi scheme lost steam in late 2008 with the great depression. Most of Madoff's investors were desperate to liquidate their assets as the market kept deteriorating. They requested a total of $7 billion in returns but Madoff had only $200 million to $300 million to give. Mark and Andrew Madoff, Bernard Madoff's sons, turned in Madoff to law enforcement officials a day after he confessed his fraud to them. Madoff told his sons that the asset management unit of his firm was "one big lie". Mark and Andrew Madoff were partners in Bernard Madoff Securities. Bernard Madoff was arrested on December 11, 2008, and pleaded guilty three months later. His sons became accidental celebrities the day after his arrest.

Penalties and Consequences

Bernie Madoff was sentenced to 150 years in prison with restitution of $170 billion - for running the biggest Ponzi scheme in the history of the U.S. He was charged with 11 counts of fraud, money laundering, theft, and perjury. At his sentencing, Madoff apologized to his victims, saying, "I have left a legacy of shame, as some of my victims have pointed out, to my family and my grandchildren. This is something I will live in for the rest of my life. I'm sorry. ... I know that doesn't help you." Madoff took all the blame for the scheme and only 15 of his employees have been found guilty of aiding the scheme.

Some of Madoff's individual investors were completely ruined, especially the thousands of middle-income investors who put their trust in Madoff Securities, and had to live on the street, in cars and RVs. Madoff's fraud destroyed thousands of lives, those of his wife and sons included. 4,800 individual clients - encompassing 13,500 investors - had invested in Madoff Securities by the time the scheme collapsed.

Bernard Madoff is currently serving his 150 year prison term (the maximum sentence allowed) in Federal Correctional Complex, Butner, outside Durham, North Carolina. Madoff's life in prison hasn't been as tough as one may expect. He's a well-respected "financial guru". He's particularly respected for being the biggest white-collar offender in the U.S. He lives a simple life in prison and is in charge of running the commissary - a kind of prison store. However, when he began his sentence, his stress levels were so severe that he broke out in hives and other skin diseases soon after.

Bernard Madoff in prison

DiPascali spent only two weeks in jail in 2009 then was released. He was free till 2015 when he died, as a result of delayed sentencing. He cooperated with prosecutors within this time frame. DiPascali died of lung cancer, at the age of 58, on May 7, 2015. 

Friehling pleaded guilty to one count of securities fraud and three federal tax violations in 2009. His guilty plea ended his career as an accountant, and he lost his CPA license on July 19, 2010. In 2015, at 55, he was sentenced to a year of home detention and another of supervised release. His rather light sentence was given due to his ignorance of the extent of Madoff's crimes and his full cooperation with federal prosecutors. His crime was his failure to do his job (audit), which is all that Madoff required of him. Friehling was also asked to forfeit $3.18 million that could be traced to his work for Madoff.

Irony of the Scandal

U.S. President, Donald Trump

Donald Trump, business mogul and now president of the United States of America had the chance to invest with Madoff, but didn't. In his book, Think Like a Champion, he explains why he rejected Madoff''s invitation to invest in Madoff Securities. "He'd say, 'Why don't you invest in my fund?' I didn't know much about him and I'm not a fund guy so I said no. I had enough going on in my own businesses that I didn't need to be associated or involved with his," Trump recollected. Turns out he was right to trust his instincts and not invest with someone he didn't know well. He knows how bad investing in Madoff Securities turned out to be for many defrauded of their life savings. Trump writes, "He is without a doubt a sleazebag and a scoundrel without par." Trump gives readers a sound lesson about investment, saying, "I think we would all do well to pay heed to all of our transactions no matter how much we might respect or like someone. But the main lesson is never to invest 100 percent of your money with one person or one entity."

Impact and Aftermath

Bernard Madoff, Ruth Madoff, and Mark Madoff

Bernard Madoff and his wife, Ruth both attempted suicide in their Manhattan penthouse two weeks after Bernard Madoff had confessed to running history's largest Ponzi scheme. They both swallowed handfuls of Ambien sleeping pills and Klonopin anti-anxiety pills in their suicide attempt. Particularly destroyed by Bernard Madoff's fraud was one of his two sons, Mark Madoff. Mark attempted suicide in October 2009, and addressed a suicide note to his father. It read, "Now you know how you have destroyed the lives of your sons by your life of deceit. Fuck you." He tried to kill himself by drinking handfuls of sedatives but survived and underwent therapy. Unfortunately, Mark Madoff hanged himself on December 11, 2010, the second anniversary of his father's arrest. He killed himself while his 22-month old son Nicholas, slept in his room. His wife Stephanie and daughter were on vacation. Mark was burdened by anger and grief, disgusted and exhausted from the continuing suspicion from the public. Mark had been named in at least nine lawsuits that sought to recover millions of dollars in damages. He was troubled by articles that repeatedly muddied his professional reputation. Mark Madoff was mourned by his four children - two from his previous marriage - his wife, relatives and friends.

Mark Madoff, wife and kids 

 Madoff's wife, Ruth, regularly visited Madoff in jail but stopped in 2012. Her son Andrew gave her an ultimatum to stop visiting his father if she wanted to have a relationship with him and her grandchildren. 

Andrew Madoff - 60 Minutes interview in 2011

Andrew Madoff died less than four years after his elder brother, Mark. He died on September 3, 2014, from cancer (lymphoma), at the age of 48. He and Mark became estranged from their father and mother in 2009. Andrew reconciled with his father prior to his death, but was still estranged from his father.

Andrew Madoff's partner, Andrew Madoff, and Ruth Madoff on 60 Minutes set

Three investors committed suicide following the revelation of Madoff's Ponzi scheme: French banker Rene-Thierry Magon de la Villehuchet, British soldier William Foxton, and Charles Murphy, a hedge fund executive. Charles Murphy's suicide is the most recent. He leapt from the 24th floor of the Sofitel New York Hotel on March 27, 2017.

The five Madoff grandchildren have all changed their last name in a bid to cut ties with the family shame.

Ruth Mardoff now maintains a low profile, ostracized by her former social circle - which included many who were defrauded by her husband. She was allowed to keep $2.5 million of the Madoff family's assets thanks to a deal her husband struck with prosecutors in 2009. The remaining $80 million fortune was seized to assist in repaying victims of the Madoff fraud. Ruth took the cash and skipped town, now residing in Old Greenwich, Connecticut.

Ruth Madoff in 2017

 Lessons Learned

1. Dumb questions are better than dumb mistakes. Madoff's investors assumed they would be protected were an embezzlement scandal to break out, given that most securities professionals carry insurance to cover clients from such risk. As an investor, you have to ask questions to make sure the hedge fund you want to invest in is operating like it should. Never assume someone else will protect your interest.

2. A good reputation should not replace due diligence. Bernard Madoff was a reputable and powerful man in the finance industry, so his power and reputation shielded him from legitimate due diligence efforts. Most of the SEC investigations carried out to verify the legitimacy of Madoff's operations and corroborate his earnings were done by junior SEC agents. Madoff would make these impressionable young professionals feel part of an exclusive crowd and send them on their way, hiding his mega huge fraud.

3. Don't fall for unbelievable deals. If it's too good to be true, then it most likely is. Madoff's returns lacked volatility similar to markets, which was a major red flag. The probability of falling on a low-risk investment that guarantees high returns is extremely low. Investment returns must vary; they can't continuously rise in a straight line. Madoff's returns never varied and progressed in a straight line for years, regardless of the markets' volatility. Madoff reported losses in only 7 months over a 14-year period, which was statistically impossible.

4. Do not invest all your money with one securities professional. If they happen to be involved in some sort of financial scandal, you are in for disaster. It is safer to diversify your holdings across several hedge funds or other types of investment pools.

5.  Too much secrecy could be a red flag on its own. Madoff generated an intriguing level of mystery and secrecy among employees and clients of Madoff Securities. It is true that firms always try to protect information related to their proprietary methods and strategies but clients should not be kept in the dark. They ought to know how their money is invested, the risks involved, and how the returns are generated. Clients were blinded by Madoff's charisma, industry experience and qualifications.

6. Rely on your instincts. If you are skeptical about an investment because something seems amiss, walk away. If the investment is even borderline illegal, walk way. If your securities professional doesn't charge fees, walk away.