The Madoff Scheme Tsunami

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1. Introduction

Carlo Ponzi made selling to new customer Peter in order to pay old customer Paul the standard fraud which became known as a Ponzi scheme.  It is actually little or no business, but rather old customers are paid returns from the funds received from new customers. It is a system designed for disaster.  Usually, the person who runs the Ponzi scheme disappears before anyone finds out. Ponzi was not so lucky and spent time in prison.  Bernard Madoff didn’t learn anything from Ponzi except how to cause misfortune and go to jail. The trouble is that the fraud was like a giant tsunami, and the initial jolt was only the beginning of the pain.

2. Madoff’s Business, Its Failure, and the Aftermath

Bernard Madoff was born in 1938. He had a degree from Hofstra University in Political Science.  He attended one year of law school before dropping out. He began his own investment firm using his own savings. His father-in-law helped him get many business contacts, some of the famous people in the film and other industries. One of the attractions of his company was the regular returns on investment of more than ten percent. Many of the employees of his family-run business were members of his immediate family. The 20-year scheme run by Madoff involved the movement of $170 billion, and Madoff’s accounts had around $65 billion in them. 

Madoff told his family members he would be distributing $2 million each to them earlier than anticipated as bonuses.  They were suspicious, and when they pressed him about the money, he admitted the scheme. Madoff’s son turned him into the federal authorities, and Madoff confessed that his business was a giant Ponzi scheme. Madoff was arrested and convicted of securities fraud among other things, and sentenced to 150 years in prison. (“Bernie Madoff Biography”)

The simple fact is that thousands of people, some ordinary and some famous, lost around $18 billion.  There are ordinary investors with little sophistication, and funds managed by highly sophisticated managers. All claim to have been duped and probably were to some extent. Madoff went to jail, his family suffered incredible humiliation, though many people will say it was well deserved considering how they lived, and whose money they were using.  

Mark Madoff, Bernie’s son hanged himself. The family has cut off contact with Bernie Madoff since then. Mark’s widow published an intimate book about the dysfunctional family. Some books have said that Bernard and his wife, Ruth tried to commit suicide a few weeks after the arrest. The trustee for the company, trying to recover money for the investment victims have been pursuing every dollar the family received from the company.  The family is fighting against the trustee contending they are innocent having known nothing of the fraud.  Many people disagree, arguing that they profited from the fraud, and therefore should pay it all back. (Henriquez)

3. The Impact of the Scheme

Given the breadth of the fraud and the list of victims, from housewives and pensioners to the New York Mets and Steven Spielberg, it is hard to calculate or even begin to understand the full impact of Madoff’s Ponzi scheme.  Small investors were wiped out. Even large investors lost substantial sums. According to the New York Times the trustee “approved 2,245 claims totaling almost $7.3 billion” (Henriquez). But for these people, the impact is likely not as shattering as for some of the remaining claimants. The New York Times article goes on to say “But two-thirds of the 16,519 claims originally filed have been denied, either because claimants took out more cash from the Madoff firm than they paid in over the years or did not have an account directly with the firm” (Henriquez). Many claimants who were denied actually might have lost their entire retirement savings.

As in any Ponzi scheme, there are some lucky early investors who get paid, and then the thousands of late investors, who lose everything.  Should the early investors pay back what they got to make everyone as whole as possible? This is just one of the many legal issues to be finally determined, possibly in the U.S. Supreme Court, though it is not likely to get all the way up there. For the day to day impact, we might just look at what Alexandra Penney, who lost her entire life savings and has so far recovered only a small fraction of what she lost, had to say “’ I don’t think about Madoff at all, at all,’ she said. ‘However, I have to think about the impact of what happened every day — whenever I stop to consider ‘Do I take a bus or walk?’ It is ever-present and it will always be’” (Henriquez). Perhaps these are the best images of the true impact of the fraud upon almost twenty thousand investors.

The Mets were affected since the trustee sued the Mets to recover over $300 million the Mets received from Madoff. The Mets settled with the trustee to put a ceiling of $162 million on how much they will have to pay, and that has affected the team’s resources. (“Mets Owner Reach…”). 

According to the New York Times article, there is another category of investors who have been impacted. They are called “indirect investors” and that means that they invested with firms that then invested with Madoff. Since they were not direct customers of Madoff, the bankruptcy court has said they do not have the standing to submit claims there. Their money was used by Madoff, it flowed into Madoff’s firm, but they may be locked out of any recovery. These people also include small investors who feel the pain and might have lost their life savings. (Henrique).

4. The Government Regulator’s Role

Bernard Madoff himself accused the Government regulators of not so much failing to find his scheme, as focusing on small firms who do not have the resources to fight them, instead of the big fish (e.g. large investment banks) who are responsible for far greater losses but have the resources to make the regulators’ lives miserable with high priced lawyers and accountants, and key relationships with people in high places.  It may be unfair to fault the Government for not uncovering the scheme – after all, it was a lengthy scheme that could have lasted as long as fifteen or twenty years.  With interest rates hovering around one percent, anything offering ten was attractive, and Madoff, on the board of NASDAQ, was hiding among the regulators. In Senate hearings, a top regulator, Stephen Luparello, the interim chief financial officer of Financial Industry Regulatory Authority, complained about a lack of resources:

“Our current fragmented regulatory system can allow bad actors to engage in misconduct outside the view and reach of some regulators…It is undeniable that, in this instance, the system failed to protect investors." (Moyer par. 4)

According to Moyer, the Securities Exchange Commission was told about something fishy at Madoff’s firm in 1999. The SEC even conducted an investigation and didn’t find anything. Linda Chatman Thomsen, the SEC’s enforcement chief, also complained about a lack of resources. (Moyer)

5. Conclusion

In some respects, Bernard Madoff’s life now at 74 years old is more routine with an address at a jail in North Carolina than possibly any of his victims. He knows where his next meal is coming from; he knows where he will be safe from storms and cold for the rest of his life, with medical care and probably books and television and other distractions. Probably most of his victims are not so lucky.

Works Cited

“Bernard Madoff Biography” A&E Network, 2012, http://www.biography.com/people/bernard-madoff-466366

Henriquez, D. “The Lasting Shadow of Bernie Madoff” The New York Times, 2011, http://www.nytimes.com/2011/12/11/business/bernie-madoffs-lasting-shadow-3-years-after-his-arrest.html?pagewanted=all

“Mets owners reach settlement in Bernie Madoff-related case.” USA Today, 2012, usatoday30.usatoday.com/sports/baseball/nl/mets/story/2012-03-19/bernie-madoff-ponzi-settlement/53647940/1

Moyer, Liz. “How Regulators Missed Madoff.” Forbes, 2009, http://www.forbes.com/2009/01/27/bernard-madoff-sec-business-wall-street_0127_regulators.html

Illustrations of Violations of Certain Sub-sections of the California Civil Code Section 1770 (a)

Section 1770(a)(1)

John Jones was walking down the street and saw a new shop selling sports team T-shirts.  He went inside, and saw a fantastic Kobe Bryant shirt, and was swept away by how amazing it looked, but it was $100. The salesman in the store explained to John that the shirt was an authentic Kobe Bryant shirt, and that is why it was so expensive. John bought it for $100, and later his father looked at it closely and noticed there weren’t any labels indicating the shirt was licensed under the NBA or the Lakers or Kobe Bryant.  The sale of the shirt violated Section 1770(a)(1) regarding passing off goods.

Section 1770(a)(2)

When Mary Jones was shopping in her favorite supermarket, she decided it was time to try some new toothpaste. There was a brand on the shelf she had not noticed before.  She read the box of Dental Gloss toothpaste and noticed that it said it was certified by the American Dental Association and recommended by certified Dentists. After using the toothpaste for a month or so, her family’s teeth began to turn colors, and she found that the toothpaste was manufactured in China and contained some toxic chemicals. She also learned that although the box of Dental Gloss stated that it was certified by the ADA and recommended by Dentists, both statements were false. The sale of Dental Gloss toothpaste violated Section 1770(a)(2) by misrepresenting the certification and approval.

Section 1770(a)(3)

Robert Jones answered the telephone one night, and the person on the phone said that he was from the Fireman Widow’s Fund, asking for a donation. Robert felt like it was a worthy cause, and said he would be happy to contribute. The man on the phone said he was in the area and could stop by to pick up a cash contribution. Robert was a little suspicious because the man was very insistent that the contribution is that night and in cash. Robert looked up the Fireman

Widow’s Fund, and called them, and they said there was no such fund. Robert called the police, and they said there had been complaints. They staked out his house and caught the man. Among other things, the solicitation of the contribution violated Section 1770(a)(3).

Section 1770(a)(4)

John Jones bought a computer in his favorite consumer electronics store. The advertisement placed special emphasis on the fact it was “Made in the USA”. After about two weeks, the computer started having problems, and he took it in to the store to be looked at.  The technician opened it up and saw from the inside that it was made in China, not the USA. In fact, not even the label on the outside that said “USA” was from America.  The representations by the computer company as to the geographic origin of the product violated Section 1770(4).

Section 1770(a)(5)

Mary Jones went to her favorite gas station to get gas. It was so expensive. She kept good track of her gas mileage because she wanted to get better gas mileage by driving smarter. However, no matter what she did, she always seemed to be getting less and fewer miles per gallon, even after she had her tires inflated and her engine tuned. At one point, her gas mileage dropped 6 miles per gallon. One day she went to the gas station with her husband, and he noticed that the pump seemed to go much faster than he ever remembered it. He decided to check it out. Later that day he went back to the station with a gas can and said he wanted one gallon of gas, which was marked on the can.  He went to the same pump, and sure enough, when the pump said one gallon, in fact, it was only a bit more than ¾ of a gallon. He called the authorities, and their investigation showed that all of the pumps had been fixed to give less gas than the pump indicated. Among other violations, the gas station violated Section 1770(a)(5) for misrepresenting the amount of gas actually paid for and received.

Section 1770(a)(6)

Robert Jones thought it was time to buy his son a car. Although he had always said he would buy a used car for the first time, he thought that his son John had done an excellent job in school, and wanted to reward him. He went to the dealer where he usually had his car repaired, and bought a new Vector-5000, a good starter car. It seemed he was able to negotiate a good price with the salesman.  When John got behind the wheel and saw that the odometer read 5 miles, he was so thrilled to sit in a new car. It even smelled new.  Within a month, the car started having problems, and John didn’t want his Dad to know, so he took the car to another car shop.  The mechanic told him that his spark plugs were worn down and that his air filter needed to be replaced.  When the mechanic looked at the odometer, he asked John if he had changed it.  John said no.  The mechanic told him that the car had at least 3,000 miles on it, probably more. The sale to his father violated  Section 1770(a)(6) for having represented the car as new when in fact it was used.

Section 1770(a)(7)

Robert Jones went into his favorite jewelry store to buy an anniversary gift for his wife. He had never given her that diamond ring, and he could afford one now.  The ring he liked was quite expensive, and the sales clerk told him that it was almost the highest grade diamond, and in fact, said it was almost flawless. Robert bought it and the sales clerk gave Robert a receipt, and he told her to write the grade of the diamond on the receipt, and after he gave it to his wife, she insisted on getting it appraised for insurance purposes.  Robert was busy that day, and so he took the ring to a different store next to his office. The clerk there gave Robert an appraisal that was the only ¼ of what he paid, and he found out the diamond was a much lower grade than the receipt represented. The first store violated Section 1770(a)(7) for misrepresenting the grade of the diamond.

Section 1770(a)(8)

Mary Jones was upset about her ring, and her husband wanted to sue the store for lying about the ring. He wanted to go to a lawyer and was recommended to two.  He went to the first, and had a very good conversation, and learned a lot.  He went to the second lawyer and had a lot of questions now that he could ask. The second lawyer asked who he had already talked to, and he mentioned the first lawyer.  The second lawyer told Robert that the first lawyer was not a real lawyer, and was suspended by the Bar from taking new clients.  He said Robert should retain him, and not even go back to talk to the first lawyer, to just leave it to him. Robert didn’t listen and later found out the second lawyer had lost a case to the first and held a grudge.  The second lawyer, among other things, violated Section 1770(a)(8) for disparaging the first lawyer’s services with misrepresentations.

Section 1770(a)(9)

ABC Electronics Superstore advertised a Whizzo Computer with 1 Terabyte of memory and lots of other special features for only $200.  John needed a new computer for college and decided to buy the Whizzo.  When he talked to the salesman, the salesman was happy to make the sale but handed John a bill for $700, not $200.  There were many extras that John was required to buy in order to get the $200 price for the computer, but actually the price was $700, and there was no way to get a $200 computer ABC violated Section 1770(a)(9) because they had no intention to sell the Whizzo computer as advertised.

Section 1770(a)(10)

ACME Carpets advertised a sale for certain special Oriental Rugs, 50% off. Robert still wanted to make up for the ring and took Mary to buy a nice carpet for the living room. They took the ad with them to the store in the morning on the first day of the sale and showed it to the salesperson. They were told those rugs were not in stock and would not be available for six months. He showed them another design which was twice the advertised price. Robert and Mary asked how many of the sale items were sold since 9 a.m., and the salesperson laughed and said one. ACME Carpets violated Section 1770(a)(10) because the advertisement did not mention a limited quantity, and the quantity of one was not reasonable under any circumstances.

Section 1770(a)(11)

Robert Jones helped his son move into his apartment near his college. They were looking for furniture and saw a really nice desk that had a bookcase and computer stand built-in advertised in the local newspaper. To save time, Robert ordered it over the phone, and the store agreed to deliver it. Robert paid with his credit card.  It was delivered later that same day in a huge box, unassembled. Robert was amazed. He took out the ad, and there was a picture of the assembled desk, and nowhere in the entire ad did it mention it was unassembled. The sale violated Section 1770(a)(11) because the ad failed to mention the furniture was unassembled.

Section 1770(a)(12)

Robert also purchased a bed from the same store based on an ad. The ad said it was an unassembled price, and mentioned nothing about buy it assembled. However, Robert wanted to see the bed in person and went to the store. There, the store tried to sell Robert the unassembled furniture first, but finally told him he could buy the assembled furniture for ten dollars more. The advertisement violated Section 1770(a)(12) because it failed to mention that assembled furniture could be purchased for ten dollars more.

Section 1770(a)(13)

Mary Jones went to her favorite supermarket and noticed that cooking oil spray was half the normal price.  The sign on the display said “Special Inventory clearance, this item 50% off” – she used a lot of that product so she picked up three cans.  When she put it in the cart, she noticed a little sign on the can that said “Expiration date on the bottom”, so she looked.  Sure enough, all of the cans were more than ten months expired. The store violated Section 1770(a)(13), in addition to other regulations, because the sign on the display misrepresented the reason for the markdown.

Section 1770(a)(14)

Robert saw a TV ad that said that if he called right now, he could get a membership in an exclusive club that would allow him to receive highly discounted sports tickets to see professional baseball, basketball and football games in town. He paid $500 for the membership, but when he read the material he received for the membership, he found out that he had no special rights to get any special discount, and that he had to use his credit card and spend $3,000 per month to get a 5% discount on semi-professional soccer matches only. The sale violated Section 1770(a)(14) because it misrepresented the rights conferred on Robert upon paying the membership fee.

Section 1770(a)(15)

Robert’s water heater leaked and he called the number on the heater for repair. The repairman came to his house and made all kinds of measurements and told Robert that it would cost $4,000 to repair the heater and “bring it up to code”.  Actually, the heater was already up to code, and the additional items the repairman said were required for $3,100 were not required at all. The repairman violated Section 1770(a)(15) by misrepresenting the parts and repairs that were in fact required.

Section 1770(a)(16)

Robert and Mary bought a condo in Palm Springs. In the purchase documents, the seller represented that among other things certified repairs to the roof had been made by a certified contractor. Two months after they moved into the condo, heavy rains caused the roof to leak so that the living room was flooded. They contacted the contractor only to find that his company had never visited the house because the seller had failed to pay for the repairs. The seller violated Section 1770(a)(16) because the representation that the subject of a transaction had been supplied was false.

Section 1770(a)(17)

John joined a club online per an ad that stated that if he paid $75 for a membership, within two months after that, his name would be entered into a drawing in which he could win a coupon worth $1,000 in shopping at the club’s website, and in the meantime he agreed to receive hundreds of solicitations from sellers of all kinds of products at his email address. The terms of the membership violated Section 1770(a)(17) because the benefits John would receive were contingent on an event which occurred subsequent to joining the club and paying the membership fee.

Section 1770(a)(18)

When Robert and Mary purchased a used car, the terms of the sale were all signed by Mr. I. M. Lying as the authorized agent for the seller under a power of attorney. As it turns out, Mr. Lying did not have a power of attorney, and was not the agent for the seller, and had no authority to negotiate the final price or any other terms.  The seller tried to raise the price on the day the car and their check was to be exchanged or back out of the deal on that basis. But the seller had represented to Robert that they could deal with Mr. Lying as the seller’s authorized agent. The transaction violated Section 1770(a)(18) because the seller represented Mr. Lying had authority to negotiate the final terms. 

Section 1770(a)(19)

When Robert signed his employment contract for his new job at the pet store, there was a new provision which was tucked in at the end that provided that Robert could be required to perform surgery on cats and dogs if the company required, even though Robert was not a vet, and had no such knowledge or experience.  He was told it was a standard provision, and not to worry about it. This violated Section 1770(a)(19) because it required Robert by contract to violate among other things, California law, which is unconscionable.

Section 1770(a)(22)

Mary was sleeping and answered the phone. She heard a recorded voice say, “Please hold for an important message.” Mary held on the phone and a few minutes later, she was connected to lengthy recorded messages selling supposedly lean and healthy dried swamp rat jerky at discount prices. This call violated Section 1770(a)(22) because Mary had no relationship whatsoever with Consolidated Swamp Rat Farms, and the call was not introduced by a live person stating the name of the caller or the organization represented, seeking permission for Mary to listen to the recorded message.