Question:

Bernie Madoff

Bernard Madoff and his securities firm were an operation that, for over eighteen years, managed to lose $50 billion in investors' funds. Madoff, the former chairman of NASDAQ, was able to dupe employees, regulators, and of course investors, with nothing more sophisticated than a Ponzi scheme for eighteen years. When Mr. Madoff was indicted for federal securities fraud,Madoff's lawyer offered, "We will fight to get through this unfortunate series of events."

Madoff was an iconic CEO. He was instrumental in creating NASDAQ and had served as a board member at NASD, the precursor organization to FINRA. Even Arthur Levitt Jr., the former head of the SEC for eight years, was known to consult with Madoff on market issues. In classic Ponzi fashion, when anyone questioned his operation, he gave the person money back. People clamored to get their money invested with Bernie.

Madoff kept his operations close. Madoff's direct reports were from his sons and brother. Madoff limited access to the seventeenth floor of his headquarters, the Lipstick Building, where the supposed trading computer was housed. However, the computer was terribly outdated. No one ever wondered why it was never replaced. The reason was simple: a new computer would require someone looking at the old computer and transferring files-files for nonexistent trades.

No one ever wondered why such a large investment firm employed a strip-mall accountant. No one ever wondered how Madoff was able to use only twenty people to do the work that would have required 200 in another firm. They just knew that only those twenty people ever got access to the seventeenth floor. The SEC was in to investigate at least three times, but the red flags were not obvious. Madoff even commented on how his niece had married an investigator from the SEC.

The seventeenth floor was where the money of investors such as Mort Zuckerman, Kevin Bacon, and many of Palm Beach's movers and shakers was never really invested but was funneled to Madoff and the charities he favored. Madoff contributed to his church, universities, and so many philanthropies that he was known in both New York and Florida for his generosity. Madoff followed the pattern of all Ponzi schemers. They never begin with the idea of a fraud. Indeed, Madoff was even more true to form. He offered good, but not excessive returns. He was a consistent performer with a steady 12 percent-enough to be better than the rest, but not enough to turn regulatory heads too far in the direction of the seventeenth floor.

Ponzi schemers continue to believe that they are just one dramatic trade or market move from pulling a "rabbit out of a hat" and making it all work for everyone. Generally, Ponzi schemes last no longer than one year. Mr. Ponzi himself made it for only nine months. Madoff lasted eighteen years. There were those outside the regulatory agencies as well as New York's and Palm Beach's movers and shakers who were wondering. For example, Harry Markopolos wrote in a November 7, 2005, e-mail to the SEC of his concerns about the Madoff operations and concluded, "Madoff Investment Securities LLC is likely a Ponzi scheme." The SEC investigated and closed its investigation eleven months later, writing, 'The staff found no evidence of fraud."

After entering a guilty plea, Madoff was sentenced to l50 years in prison. The federal judge who sentenced him said that Madoff's conduct was "extraordinary evil." The Ponzi scheme is the largest in history. The sentence is three times longer than what was recommended by the prosecution and ten times longer than what Madoff's lawyers proposed. Mrs. Madoff was required to vacate the couple's penthouse apartment, and U.S. Marshalls took possession of it. The Madoff's assets, including properties in the Hamptons, Palm Beach, and Switzerland, are being sold, with the funds being used to compensate victims of the fraud as well as pay the fines imposed by the judge. Madoff turned to the courtroom full of his victims and said that he was sorry but, "I know that doesn't help you." Mr. Madoff blamed his pride for his actions, stating that he could not bring himself to admit his failure as a money manager and that he created the Ponzi scheme to cover up his shortcoming in terms of the returns on investments of his clients.

Questions:

1. Mr. Markopolos was dismissed by his bosses and friends even as he provided a lot of twenty-eight red flags. What do we learn from his experience about raising questions on the accounting and returns of companies? What can we learn about the reception whistleblowers receive? Did the market, regulators, and investors not want to raise questions because of the steady returns Madoff provided? What role does a questioning attitude play in preventing company collapses?

2. Should investors have suspected the continuing higher levers of returns that never faltered?

3. The Madoff empire could not have lasted as long as it did without complicity from employees. Mr Madoff's second-in-command, Frank DiPascali, who entered a guilty plea, told the federal judge, I'm standing here to say that from the early 1990's until December 2008, i helped Bernie Madoff and other people carry out a fraud. I knew no trades were happening I knew what I was doing was criminal. But I did it anyway.

Mr. DiPascali's compensation was $2 million per year. He had not completed college at the time Mr. Madoff hired him in the early years of the firm. What might have helped Mr.DiPascali resist the temptation to participate in the fraud?