Great frauds in history: Madoff’s scam

Matthew Partridge looks at Bernie Madoff's $64bn fraud scheme.

932_MW_P40_Profile_Bottom
56945462

Bernie Madoff (pictured) got his start in finance in 1960 when, at the age of 22, 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.

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.

Recommended

The electric-car bubble could get an awful lot bigger from here
Renewables

The electric-car bubble could get an awful lot bigger from here

The switch to electric cars is driving a huge investment bubble. But that’s not necessarily a bad thing, says John Stepek. Fortunes will be made and l…
24 Sep 2020
The rising dollar is proving bad news for most other assets – will it last?
Investment strategy

The rising dollar is proving bad news for most other assets – will it last?

Precious metals, stocks and pretty much every other asset has taken a tumble as the US dollar strengthens. Dominic Frisby looks at how long this trend…
23 Sep 2020
Great frauds in history: the Pigeon King’s Ponzi scheme
People

Great frauds in history: the Pigeon King’s Ponzi scheme

Pigeon-fancier Arlan Galbraith claimed to have created a new breed of elite racing pigeon, but his Ponzi scheme defrauded investors of over £200m.
23 Sep 2020
I wish I knew what ESG investing was, but I’m too embarrassed to ask
Too embarrassed to ask

I wish I knew what ESG investing was, but I’m too embarrassed to ask

ESG investing – investing with a focus on environmental, social and governance issues – is the latest incarnation of ethical investing. Here's what it…
23 Sep 2020

Most Popular

Oil producers are back at their Covid-19 lows – is it time to buy?
Oil

Oil producers are back at their Covid-19 lows – is it time to buy?

With demand for oil hammered by Covid-19 and talk of “peak oil demand”, there are lots of good reasons to be bearish on oil producers. So, asks John S…
22 Sep 2020
The rising dollar is proving bad news for most other assets – will it last?
Investment strategy

The rising dollar is proving bad news for most other assets – will it last?

Precious metals, stocks and pretty much every other asset has taken a tumble as the US dollar strengthens. Dominic Frisby looks at how long this trend…
23 Sep 2020
Why you should stuff your end-of-pandemic portfolio with Chinese stocks
China stockmarkets

Why you should stuff your end-of-pandemic portfolio with Chinese stocks

For an end-of-pandemic portfolio, you need assets that can cope with today’s volatility. And that, says Merryn Somerset Webb, means Chinese stocks.
14 Sep 2020