Bernard Madoff: The Ponzi Schemer

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On June 29, 2009, Bernard Madoff, then 71, was sentenced to 150 years in prison, for the perpetration of the most elaborate Ponzi scheme ever conducted in United States history (“Bernard Madoff”). Madoff, who actually swindled investors out of $17.3 billion, conveyed to his clients that they had collectively amassed over $64 billion in what amounted to fictitious earnings (Lattman and Henriques). Madoff, who ran a supposedly legitimate business for years called Bernard L. Madoff Securities, was well respected in the securities industry, and is the former Chairman of National Association of Securities Dealers Automated Quotations (NASDAQ) (Velshi), an electronic marketplace and stock exchange, where traders can buy and sell securities operating on the world’s stage, similar to the New York Stock Exchange (NYSE) ("New York Stock Exchange”). During his long career, Madoff was a member on a variety of NASD committees, acting as chairmen on several ("The Madoff Affair: Timeline"). In the early days of the NASDAQ, Madoff was a boisterous proponent of the automation of stock exchanges, creating a less expensive environment for customers and institutional investors, and creating a more transparent approach to trading, versus for example the face to face, behind closed doors trading on the NYSE. Madoff also acted as a consultant to the Securities and Exchange Commission (SEC) on trading matters (Yang).

So How Did Things Go Awry?

Madoff started his firm with just $5,000 that he had saved up after graduating from college and marrying his high school sweetheart, Ruth Alpern. He initially traded small unlisted stocks by telephone as a dealer, often referred to as over-the-counter stocks. The company’s trading operations grew quickly (Lattman and Henriques). There were two main components to the Madoff business. The first component, the trading operation, was his initial foray into the securities industry, he later began the second, corrupt component of Bernard L. Madoff Securities, the money management business. The money management portion of the firm was the section that facilitated the vast Ponzi scheme. In 1965, Peter Madoff, Bernard’s brother, joined the firm as its compliance officer. Geographically speaking, the trading element was located two floors above the money management portion, and was locked by a separate key card preventing Madoff’s brother Peter and his sons, Andrew and Mark, from entering (Lattman and Henriques).

Madoff ran the money management section of his firm, while Peter ran the legitimate trading operations (Seal and Squillari). The nefarious investment advisory portion started about 1962, although it is not clear that he started engaging in illicit behavior immediately ("The Madoff Affair: Timeline"). Madoff initially received clients through his father-in-law, Saul Alpern, and Alpern’s partner Frank Avellino. The first investors were primarily friends and affiliates. Madoff did not like handling the individual accounts, so Alpern suggested that he lump them together, and that Alpern would handle the details for him. During these years, investment advisories, other than mutual funds, were not under the duress of regulation and scrutiny that they are now ("The Madoff Affair: Timeline").

The trading operations continued to grow ("The Madoff Affair: Timeline"). Madoff engaged in a methodology called pay for order flow, which was both controversial and drew the ire of the stock exchanges, although it was considered legal. The process has the ring of the illegal payola practices of the 50s music industry, but again, was not considered illegitimate within the securities industry. Pay for order flow is money received by a brokerage, usually pennies for a share, in payment for ensuring that the order goes to a certain party. In the case of Madoff, he paid a company like Charles Schwab, a few pennies per share to gain their business. He was able to make up for the payment as a result of the profit he made on the spread, or difference between buy trade prices and sell trade prices. In 1983, Avellino and Michael Bienes, an accountant in the Alpern firm, decided to stop accounting and started soliciting clients for Madoff full time. Bienes, in describing what it was like for him at that time, said the process was "easy-peasy” ("The Madoff Affair: Timeline"). Recruiting clients to become part of the Madoff feeder fund was simple, for which he and Avellino were generously compensated. The effort was so elementary, Bienes opened a second office in Fort Lauderdale, Florida.

Madoff fed the charade by becoming a prominent fixture in the industry, through enhancing his visibility on the regulatory body, and to gain exposure in all aspects of the securities industry ("The Madoff Affair: Timeline"). In 1989, Madoff’s popularity skyrocketed. He met Fairfield Greenwich Group partners, Jeffrey Tucker and Walter Noel. They initially invested $1.5 million and the next year added $1 million. Toward the end of 1990, they created the Fairfield Sentry Limited Fund, and invested a full $4 million in Madoff’s firm.  Also in 1990, Madoff met the notable Ezra Merkin, who was both a philanthropist and money fund manager. Merkin gave Madoff assets from his Ariel and Gabriel funds. Madoff managed those funds up until 1992. Merkin then continued with Madoff after creating the Ascot Fund Limited and the Ascot Partners LP, giving Madoff exclusive control of both funds ("The Madoff Affair: Timeline"). Sandra Manzke, the well known executive founder of Tremont and Maxam Capital, managed both hedge funds that became feeder funds to Madoff’s company. Madoff’s investment business was not a registered SEC business, so he requested that she not use his name in her prospectus. Hedge fund managers like Manzke liked Madoff’s fee structure pay out. He did not charge the fund any fees, but said that he gained his earnings through commissions ("The Madoff Affair: Timeline"). 

Madoff stated that the Ponzi scheme started in early 1990, as specified in his confession plea allocution, though many question the honesty of that estimation ("The Madoff Affair: Timeline"). The recession was in play and Madoff wanted his clients to believe that he was doing what he had said he would do, provide consistent returns. Yet, the fact of the matter is that he was not investing the money as he had claimed. It is during this period that Madoff became the chairman of NASDAQ (1990-1993), a fact that surely boosted his prestige in the securities industry. Though, the pay for order flow controversy was still front and center and created a continued issue, casting a negative light on Madoff that he simply could not shake. In 1997, the 12.5 per share spread that he had enjoyed previously (difference between buy trade prices and sell trade prices), shrank to 6.5 and then in 2001 to one penny ("The Madoff Affair: Timeline").

In November 1992, the Avellino & Bienes fund feeder firm was shuttered (Seal and Squillari). There were suspicions that the firm was conducting a Ponzi scheme since they were promising investors a consistent 18 percent return and advising clients to invest in a prosperous, yet controversial mystery man. The partners never obtained their license to become investment advisors. Michael Bienes stated that Madoff did not want them to get their licenses because he did not want the information disclosed to the SEC. When the SEC conducted their probe against the partnership, Madoff suggested that they hire attorney Ira Sorkin, who formerly oversaw the New York SEC’s office, but Sorkin was not able to come up with a plan to keep Avellino & Bienes open in time, and the firm was forced to close. Some suggest that the partners continued to feed investment funds to Madoff through intermediaries after they were shut down, a claim Bienes vigorously denies (Seal and Squillari).

The Madoff House of Cards Begins to Fall

Frank Casey, of Rampart Investment Management, appears to be the true fly in the Madoff red flag ointment (Lopez). He wondered how a particular manager was getting 1 percent per month with absolute consistency. He discussed this with Harry Markopolos, a Rampart portfolio manager (Markopolos). After some back and forth, Casey met with Thierry de la Villehuchet, principal of Access International Advisors and investor in the Madoff investment advisory component. Casey asked de la Villehuchet lots of questions about his investments and eventually disclosed to Casey that the mystery man was Bernard Madoff. Madoff did not want his investors to disclose who he was, and insisted upon their complicity in this, but de la Villehuchet probably felt comfortable with Casey since they were both former sailors and also options guys, there was some modicum of accord and common ground. Thierry de la Villehuchet did not know it then, but this information represented the beginning of the end for Bernard Madoff. Thierry continued to disclose information, including Madoffs investment strategy, called split-strike conversion work. Casey knew that this might be a good strategy in a bull market, but in a negative or bear market, he knew that this could not work to deliver consistent percentages. He discussed this with Markopolos and they both knew that further investigation was required (Moreschi).

Casey met with de la Villehuchet at the Access offices and looked at his return streams which he later brought back and gave to Markopolos requesting that he reverse engineer the numbers to assure that they were consistent with the market (Moreschi). After about four hours, Markopolos came back and told Casey, “this is a Ponzi scheme” (Moreschi). Not too long thereafter, Casey met Michael Ocrant, a securities reporter, and shared his thoughts. He suggested that Ocrant do some investigating and write a story on the subject, which he did. Madoff heard through the grapevine that Ocrant was sniffing around and told him, if you are going to do a story on me, you better get it right. Ocrant met with Madoff and was amazed at how cool he was, he never blinked and did not appear threatened that his house of card might come falling down. Ocrant reported the meeting back to Casey with utter surprise at Madoff’s unflappability. Madoff basically said that he had a secret sauce and did not want to disclose it. Markopolos was not convinced. He was certain that it was a Ponzi scheme and spoke to an SEC contact that he knew in early 2000. Markopolos wrote up his theory for the SEC, and MARHedge and Barron’s both picked it up, but the SEC did nothing. Markopolos wrote things up again, but nothing. By 2005, he was quite frustrated. But in the interim, Madoff saw the cards beginning to collapse, and admitted his actions to his family in 2008. It was his sons, Andrew and Mark, who gave Madoff up to the feds. Finally, in December of that year, Madoff was arrested and admitted he was running a Ponzi scheme (Honan and Wilchins). Sadly, Thierry de la Villehuchet committed suicide when the scandal broke. He sent a note to his brother stating that he felt fully responsible for the losses suffered by his clients (Berenson and Saltmarsh). Exactly two years after Madoff’s arrest, his son Mark also committed suicide. His son Andrew died of cancer. 

Madoff’s Plea Allocution Confession

Madoff offered up a six page confession of his crime. He gave an apology to all those he hurt, and then went on to detail his efforts to conceal his actions.

I am actually grateful for this first opportunity to publicly speak about my crimes, for which I am so deeply sorry and ashamed. As I engaged in my fraud, I knew what I was doing was wrong, indeed criminal. When I began the Ponzi scheme I believed it would end shortly and I would be able to extricate myself and my clients from the scheme. However, this proved difficult, and ultimately impossible, and as the years went by I realized that my arrest and this day would inevitably come ("Plea Allocution of Bernard L. Madoff").

What is so stunning about Madoff and his Ponzi scheme is he did not need to do it. He was well respected for the success of his legitimate trading division and was viewed by his colleagues as accomplished. He was already living in the lap of luxury and making boat loads of money, which begs the question, exactly what kind of evil is this?

Works Cited

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Honan, Edith and Wilchins, Dan. "Bernard Madoff arrested over alleged $50 billion fraud." Reuters. Thomson Reuters. 12 December 2008. Web.  20 July 2016. <>.

Lattman,  Peter and Henriques, Diana, B. "Peter Madoff Is Sentenced to 10 Years for His Role in Fraud." The New York Times. The New York Times Company. 20 December 2012. Web. 20 July 2016. <>.

Lopez, Linette. "One Of The Madoff Whistle-Blowers Has One Piece Of Advice For People Looking For A Money Manager." The Business Insider. Business Insider, Inc. 17 August 2012. Web. 20 July 2016. <>.

Margolick, David. "Did the Madoff Sons Know?" Vanity Fair. Conde Nast. 3 June 2009. Web. 20 July 2016. <>.

Markopolos, Harry. "Madoff Whistleblower: SEC Failed To Do The Math." NPR. 2 March 2010. Web. 20 July 2016. <>.

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"New York Stock Exchange - NYSE." Investopedia. Investopedia, LLC. n. d. Web. 20 July 2016. <>.

Seal, Mark and Squillari, Eleanor. "Hello, Madoff." Vanity Fair. Conde Nast. 22 May 2009. Web. 20 July 2016. <>.

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Velshi, Ali. "Ex-Nasdaq chair arrested for securities fraud." CNN Money. Cable News Network. A Time Warner Company.  12 December 2008. Web. 20 July 2016. <>.

Yang, Stephanie. "5 Years Ago Bernie Madoff Was Sentenced to 150 Years In Prison – Here's How His Scheme Worked." The Business Insider. Business Insider, Inc. 1 July 2014. Web. 20 July 2016. <>.