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

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.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

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.