Bernie Maddoff and his Ponzi Scheme

Scheming, Scandals and Crime: The Biggest Fraudster in Wall Street History

Bernard Lawrence Madoff – aka: Bernie Madoff – executed the largest Ponzi scheme in history, defrauding thousands of investors out of billions of dollars over the course of nearly 20 years, possibly longer.

Early life:

Madoff was born in Brooklyn, NY in 1938 to working-class parents. He attended a local Long Island University, majoring in Political Science, and afterward took classes at Brooklyn Law School for a brief period. He founded Bernard L. Madoff Investment Securities LLC in 1960. According to Madoff, he began to make a name for himself as a scrappy market maker (a market maker is an individual firm of an exchange that buys and sells securities for its own account. Market makers provide the market with liquidity while profiting from the difference in the bid-ask spread.) "I was perfectly happy to take the crumbs," Madoff said in a 2017 interview from prison. "We were a small firm, we weren't a member of the New York Stock Exchange. It was very obvious."

Success finally came when he and his brother Peter began to build electronic trading capabilities—"artificial intelligence" in Madoff's words—that attracted massive order flow and boosted the business by providing insights into market activity.

His and four other Wall Street companies processed half of the NYSE’s order flow (brokerage firm directing orders for trade execution to a particular market maker or exchange) —and by the late 1980s, Madoff was making in the vicinity of $100 million a year.

He was a pioneer in electronic trading and served as chair of the Nasdaq in 1990, 1991, and 1993.

The Scheme

A Ponzi Scheme is a fraudulent investing scam promising high rates of return with little risk to investors.  It is very similar to a Pyramid Scheme; both are based on using new investors' funds to pay the earlier backers.  Imagine a pyramid: the point at the top is where the initial investors sit, above the lower layers of subsequent participating investors. Investors’ money is never actually spent on legitimate investments. Instead, money flowing into Madoff’s company was deposited in the bank, for his and his family’s personal use. Some of that money would be used to pay off the initial investors, or for some other selective payouts, to avoid suspicion that would unravel the lucrative scheme.

Both schemes eventually bottom out when the flood of new investors dries up and there isn't enough money to go around. At that point, the schemes fall apart.

Madoff’s private investing firm boasted a huge return on investment – typically 15 – 18% returns – which often outperformed the market index. Madoff had a team of insider clients, often referred to as “The Big Four”, who recommended the brokerage firm and vouched for their integrity. (These Big Four netted hundreds of millions each for helping to defraud future investors in the scheme).

The Unraveling

Madoff was unable to maintain the fraud when the market turned sharply lower in late 2008.

In November of that year, Bernard L. Madoff Investment Securities LLC reported year-to-date returns of 5.6% during the same period when the S&P 500 dropped 39%. Clients were asking to withdraw their funds. As the selling continued, Madoff became unable to keep up with the onslaught of client redemption requests.

On Dec. 10, 2008, he confessed his wrongdoing to his sons—who worked at his firm. The following day, his sons procured lawyers for their defense, and they turned their father over to the authorities. Bernie remained adamant that his sons were not aware of his scheme.

The fund's last statements indicated it had $64.8 billion in client assets.

Madoff’s massive Ponzi scheme was tied to at least four suicides, including that of his elder son, Mark, who hung himself on the second anniversary of the Bernie Madoff’s 2008 arrest. His other son, Andrew, died of cancer in 2014.

Madoff was sentenced to 150 years in prison and forced to forfeit $170 billion in 2009. His three homes and four boats were auctioned off by the U.S. Marshals. On Feb. 5, 2020, during the early and oppressive days of the Coronavirus pandemic, Madoff's lawyers requested that Madoff be released early from prison, claiming that he was suffering from a terminal kidney disease that may kill him within 18 months. The request was denied.

Madoff remained at the Butner Federal Correctional Institution in North Carolina until he died on April 14, 2021 at the age of 82.

In the wake of Madoff’s death, he left behind his widow, grandchildren, and siblings —and tens of thousands of victims, many of whom were scammed out of their life savings. 

The Regulators – Not enough resources?

The Securities and Exchange Commission (SEC) had been investigating Madoff’s firm (on and off) since 1992.

Financial analyst Harry Markopolos was one of the earliest whistleblowers. In 1999, he calculated that Madoff had to be lying. He filed his first SEC complaint against Madoff in May 2000, but his complaint seemed to be largely ignored by regulators.

It was not until 2005—shortly after Madoff nearly went belly-up due to a wave of redemptions—that the SEC asked Madoff for documentation on his trading accounts. He made up a six-page list, the SEC drafted letters to two of the firms listed but didn't send them, and that was that. "The lie was simply too large to fit into the agency's limited imagination," writes Diana Henriques, author of the book "The Wizard of Lies: Bernie Madoff and the Death of Trust," which documents the episode.

The SEC was excoriated in 2008 following the revelation of Madoff's fraud and their slow response to act on it.

A Lawyer’s role in this whole situation

Lawyers needed to be involved on every level of this scandal – from the roles of protecting the victims to representing the clients, to drafting bankruptcy settlements, to working in the regulatory agencies to providing the roles of corporate governance (aka compliance)

In 2003 – five years before the Madoff fraud rocked Wall Street – then SEC Commissioner Harvey J Goldschmid said this: “The corporate and financial scandals of the 1990s and early 2000s are the most serious that has occurred in this country since the scandals of the Great Depression. We have witnessed a systemic failure. The checks and balances that we thought would be provided by independent directors (acting pursuant to the monitoring model), independent auditors, securities analysts, investment and commercial bankers, rating agencies, and lawyers too often failed. The regulatory checks represented by the SEC, and by federal and state legal constraints, also proved inadequate because, in meaningful part, of scarce resources and overly protective case law and legislation.”

In a reputable company, a lawyer would have protected both the client and the company from potential harm and wrongdoing. As Goldschmid says: “There is a broad consensus that lawyers should play a critical gatekeeping role in large public corporations. The term "gatekeeper" suggests a guardian with independent professional responsibilities, including responsibility for protecting the institution. Certainly, this was a virtually unanimous view of Congress when, in Section 307 of Sarbanes-Oxley, it required the SEC to establish a system for lawyers to report wrongdoing up the corporate chain of command or ladder and to establish other ‘minimum standards of professional conduct.’ “

According to US law (Sarbanes-Oxley, passed in response to scandals such as Enron and The Dot Com Crisis), corporate lawyers have a duty and are clearly required to Report Up to the corporation’s highest authority (board and executive leaders) any violations or wrongdoings occurring within that company or among its employees.

Additionally, Lawyers have a responsibility and requirement to Report Out any issues to a regulatory authority outside the corporation when its board has failed to stop ongoing financial fraud or other serious violations occurring within the company or among its employees or representatives.

Wall Street Lawyers

Even if one does not want to be a lawyer, studying the law can provide a beneficial edge on so many career paths (politics, finance, non-profits, etc.) Conversely, studying finance and financial history can give those wishing to pursue a career as a lawyer an unmistakable advantage – a knowledge of the fields in finance where lawyers are needed and useful, and a clear understanding of the depth of those fields, the necessity and value of lawyers, and the myriad ways a law degree can be advantageous in a financial legal speciality.