Bernie Madoff: The Story Behind One Of The Biggest Ponzi Schemes
Bernie Lawrence Madoff was born on April 29, 1938 in Queens, New York to Ralph Madoff and Silvia Munter. He attended Far Rockaway High School where he graduated in 1956 finally proceeding to the University of Alabama for a year.
He became a member of Tau Chapter of the Sigma Alpha Mu fraternity before transferring to Hofstra University in 1960 where he graduated with a Bachelor of Arts in Political Science. He co-founded the Bernard L. Madoff Investment Securities together with his wife, Ruth Madoff after a brief stint in Brooklyn Law School in 1960.
Bernie Madoff started as a penny stock trader with $5,000 only. Penny stocks were low priced shares which traded over the counter and were known to be the predecessor to NASDAQ exchange. He became friends with influential business men who signed up as investors with his firm and were paid handsome returns. This led to the recruitment of new investors leading to what is referred today as Bernie Madoff’s Ponzi scheme.
What is Ponzi scheme?
This refers to a fraudulent scam that is passed as an investment to clients where they are promised large profits within a short period of time at little to no risk. The idea behind a ponzi scheme is to attract new investors where old investors are paid off their “profits” from the new monies brought in by the new investors.
Ponzi schemes survive on a constant flow of “new investments” and when the cash flow runs out, the scheme falls apart. The difference between a ponzi scheme and a pyramid scheme is that in a pyramid scheme, members are required to recruit others and are paid an incentive for doing so.
How did Madoff’s Ponzi Scheme Work?
After Madoff established his investment securities firm, he cultivated close friendships with wealthy businessmen from Palm Beach, Florida and New York City. They signed up as investors after Bernie Madoff promised to pay them unusually high returns. He promised the investors 50% in returns after a 90 day period. He set up portfolios to look like he was matching the returns of S&P 500. Thanks to this strategy, it prevented him from paying too much to investors which resulted in making his holdings look attractive.
After paying off the first batch of investors, Bernie used his reputation to develop relationships with financial regulators. As time went by, more and more investors wanted to join the now prestigious Madoff Investment which was a ponzi scheme that began in the 1980s.
New investors remitted their investment which was used to pay off the so-called profit returns to the old investors. Furthermore, their money was used as fee payments to Madoff’s firm, his family and friends. By the end of 1980s, the investment securities firm was handling more than 5% of the trading volume on the New York Stock Exchange.
Like any other ponzi scheme, Bernie Madoff encouraged the many investors to stay on and earn more money instead of reclaiming their profits. Some of the clients he conned include Steven Spielberg, Kevin Bacon and Kyra Sedgwick among others. Did you know that his firm was one of the earliest to use computer technology for trading?
How He Remained Under The Radar
Madoff kept his ponzi scheme low key by targeting specific elite groups of investors who were not concerned about their money too much as they were earning more from the work they did. Furthermore, he kept his victims close and the SEC off his back.
In fact, members of the SEC were his close friends since Madoff had served as Chairman of NASDAQ for three consecutive terms. He kept his paper work up to date and consistent. To ensure that he was not caught early like other Ponzi scheme scammers, he paid out small returns instead of large returns.
This did not raise any suspicions with his investors/victims because he had already built a name in the financial industry as a “genius.” His victims further trusted him because they believed they could withdraw all their funds within a moment’s notice which was not actually true. During this time, other investors tried to replicate his style but ended up performing poorly.
This led to professionals in the financial industry raising red flags regarding the returns Madoff boasted. Even when these claims were made, the SEC ignored them. His ponzi scheme started to fall apart in late 2008 after he borrowed a lot of money and was unable to keep up with the payouts his investors were demanding – $7 billion.
How He Got Caught
On December 11th 2008, Bernie Madoff informed his family that he planned to pay out millions of dollars in bonuses earlier than scheduled. His sons, Mark and Andrew Madoff demanded to know where the money was coming from leading to Bernie confessing that his “investment securities firm” was an elaborate Ponzi scheme.
Before this revelation, investors had requested payouts totaling to $7 billion. In reality, Bernie had between $200 million and $300 million so he was unable to meet the demand.
After revealing to his family the truth, his sons reported him to federal authorities leading to his arrest and subsequent trial in March 2009 after pleading to 11 federal felonies. They included securities fraud, wire fraud, mail fraud, money laundering, making false statements, perjury and making false filings with the SEC among others.
He defrauded his clients $65 billion turning it into the largest Ponzi scheme ever. He was sentenced to 150 years imprisonment which means he is scheduled to be released in 2159 while aged 201 years.
Bernie Madoff’s Ponzi scheme is referred to as the highest profiled scam in the history of the financial industry. The scheme sent a rippling effect across the world and affected his family, everyone who worked with him and the investors who entrusted him with their money. It led to the death of his eldest son, Mark who committed suicide.
The one lesson that readers need to take from Bernie’s Ponzi scheme is that not everything that glitters is gold. One should think twice when offered opportunities that promise high returns within a short time.