In the 1920s, Charles Ponzi introduced the “Ponzi” scheme to the American public. The scheme’s simplicity is one of its best traits. By promising above-average returns for their investment, individuals appear willing to stand in line to give you their money. The only problem is that the Ponzi scheme makes no “real” investments other than paying back previous investors. The cycle of paying one investor (and pocketing a lot for himself) by collecting from another investor should only work for a short period before the “pyramid” of investors collapses under the weight of money owed.

Almost 100 years after Charles Ponzi showed the world how the scheme worked, people are still convinced that the administrator of the investments can guarantee above market returns. The underlying reason why Ponzi schemes will continue to be tried in the future is greed. As long as some people believe they can get more money from an investment than the average investor, they will continue to line up to give their money away in return for this empty promise.

Bernard Madoff went to prison for pulling off the largest Ponzi scheme in history, a fraudulent investment scheme that lasted an estimated 20 years. The eventual downfall of Madoff’s Ponzi scheme was not caused by regulators, investors, or even his employees but, rather, was the result of a global financial recession. When the financial crisis hit, Madoff had many billions of dollars of outstanding debt. Typical of a Ponzi scheme, when Madoff’s investors made a “run on the bank” to take out the money that they invested with his firm, he did not have enough money to pay the above-average returns that he had promised. He did not even have enough to cover his clients’ initial investment money.

Furthermore, there is no evidence that Madoff even made any trades to invest the money that his clients gave him. For example, Madoff had listed transactions in Fidelity Investments’ Spartan Fund, yet Fidelity had no record of any account or transactions by Madoff’s company.

On the morning of December 11, 2008, the pyramid collapsed on Madoff when he was arrested in his apartment for criminal securities fraud. As a well-respected investor and part of New York’s social elite, Madoff pulled off the largest Ponzi scheme in the history of commerce. Estimates are that Madoff stole more than $50 billion from investors over three decades. It is also estimated that Madoff, the former chairman of the NASDAQ Stock Exchange, had defrauded thousands of people including individuals, corporations, endowments, universities, foundations, and other investment funds. Before he was arrested, he told his sons Andrew and Mark, who worked for him, that his financial operations were “all just one big lie . . . basically a giant Ponzi scheme.” The day before his arrest, his wife Ruth withdrew $10 million from a brokerage firm that was partly owned by Bernard. This followed a withdrawal made November 25, 2008, for $5.5 million.

As early as 2001, one of Barron’s staff writers interviewed financial experts who questioned how only Madoff was able to achieve these types of above-average returns regardless of the market movement. Madoff’s standard response as to how he was the only person who could create these “miracle” returns was that his business strategy was too complicated for anyone outside the company to understand how he did it.

In his response to the charges after being caught in 2008, Madoff stated, “‘there is no innocent explanation’ . . . and he ‘paid investors with money that wasn’t there.’” After his confession to his sons, the sons turned him in to federal authorities.

Madoff ran his investment department of the company on a separate floor from the other parts of the company. He would not disclose his financial reports to anyone and would not tell his employees how he was able to provide guaranteed returns for the investors. He told one of the sons that investors had asked for approximately $7 billion in redemptions of their investments, and Madoff did not have enough money to cover those demands.

The day after Madoff’s arrest, the first of many class-action lawsuits were filed against him. The lawsuit claimed that Bernard L. Madoff Investment Securities represented itself as a legitimate broker and dealer when in actuality it was a fraudulent Ponzi scheme. His impact is staggering. A total of 13,567 customer accounts were listed with Madoff Securities. Young and old, famous and rich, the listing demonstrated that the fraud Madoff committed was global and piercing in its reach....

Questions

1. Trust is extremely important in business transactions. Greed also plays a role in some business transactions. Discuss how these two concepts were intertwined in this case.

2. Describe a Ponzi scheme. Find several examples of other Ponzi schemes that have occurred in recent years.

3. In this case, it appears that Madoff had many friends and family members who were involved in the fraud.

Speculate about how likely it is that Madoff’s own sons, who were employees of the firm, knew nothing of the fraud, as they stated.

4. Explain the ethical issues associated with running a family-owned business. Were these issues present at Madoff’s firm?