World's biggest fraudster Bernie Madoff has died – what was his scam?

Bernie Madoff, perpetrator of the world's biggest Ponzi scheme, has died in prison at the age of 82. Matthew Partridge looks at his massive fraud scheme.

Bernie Madoff
Bernie Madoff: world's biggest fraudster
(Image credit: © Mario Tama/Getty Images)

Bernie Madoff got his start in finance as a 22-year-old in 1960 when he set up a brokerage specialising in penny stocks with the assistance of his father-in-law. The firm acted as a market maker and over the years Madoff Securities would play a large role in the development of the electronic exchange Nasdaq. Madoff was briefly considered as a potential chairman of the Securities & Exchange Commission, the US regulator. From the 1980s onwards, his firm ran a large investment management division based on buying and selling options known as "split-strike conversion" instruments, which promised returns similar to that from the stockmarket, but with less volatility.

How did they work?

Madoff initially claimed his scheme was based on a legitimate strategy (others dispute this). But he admits that by the early 1990s he was running a Ponzi scheme, paying existing investors with money he raised from new ones. To maintain the illusion of profits, he shuffled money between various accounts and used a tiny accounting firm to perform the fund's annual audit. He refused to outline his exact strategy in detail, and barred investors that he felt were too inquisitive.

What happened next?

As the promised returns from Madoff's scam were much smaller than is typical with Ponzi schemes, his fund was able to survive for longer, helped by the fact that Madoff targeted long-term investors, such as charities. Ironically, it was this very stability that led to his downfall during the 2008 financial crisis, as investors withdrew money from his fund to cover losses elsewhere. In December, with only $200m left to cover $64bn worth of fictitious client assets, he confessed to his sons, who turned him into the authorities.

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Lessons for investors

The seizure of Madoff's assets as well as various lawsuits have resulted in the return of some of the cash investors lost in the scam. As of February 2018, the two funds set up to compensate investors had paid out more than $12bn, with nearly $5bn in reserve, although $25-$30bn will be needed to cover total losses, says The Economist. Compensation has been limited to the amount originally invested and many of those who made money were forced to surrender some or all of their profits. So, while it's a good idea to withdraw money you suspect might be tied up in a scam, place it in a separate account in case you have to repay it.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri