“Ponzi schemes are a type of fraud in which investors make payments to a business that then distributes returns to these investors from their own money or from money paid by subsequent investors, rather than from any actual profits earned by the business” (Robb 7). The term Ponzi scheme was first introduced by a man named Charles Ponzi in the 1920s. The way that Ponzi schemes earns its profits is if the company continues to receive new investors to pay old investors. Both Ponzi and Bernard Madoff lied and robbed investors of their money by using this method. Madoff, a former stockbroker, is well known as the man who created the biggest Ponzi scheme in the history of the United States. For years he maintained his Ponzi scheme through his stock brokerage company, Bernard L. Madoff Investment Securities. He manipulated and controlled his investors by gaining their trust. The investors had no knowledge of falsified financial statements until his arrest. Most investors were left without money and others that benefited from the Ponzi scheme.
Madoff’s brokerage business was found guilty of taking investors’ money and falsifying financial statements. The total damage of his victims was $65 billion in late 2008 (Rob 7). He would falsify financial statements by creating false returns to make it seem as if the business was earning profit. In the annual reports of 2004 and 2005 the business net income increased from $34 million to $42 million (BLMI Securities). His net income increased $8 million and continued to increase until the day he was discovered. Madoff would use these statements to mislead investors and seem profitable. During his sentencing he admitted “I [also] concealed my fraud through the filing of false and misleading certified audit reports and financial statements…”(Jackall, 9). Here he admits to falsifying statements and sending them to investors. Madoff violated Section 206 of the Investment Advisers Act of 1940 prohibits misstatements or misleading omissions of material facts and other fraudulent acts and practices in connection with the conduct of an investment advisory business(SEC). The numbers he would put in the financial statements were fake and manipulated. A few of his investors earned money, but most lost money. This Ponzi scheme went on for two decades and gained 167 investors until speculation from other stockbrokers arose.
Madoff’s Ponzi scheme was investigated and then later confirmed by the Securities and Exchange Commission (SEC). He was first discovered by a hedge fund manager, Harry Markopolos who created a team of analysts to replicate Madoff’s returns. Markopolos suspected that Madoff was running a potential Ponzi scheme. Which is a violation of Section 10(b) of the Securities Exchange Act of 1934 that is the primary anti-fraud statutory and prohibits the use on any device, scheme, or artifice to defraud(LII Staff). In Markopolos’s findings he listed 29 red flags, flag one stated that Madoff had an interest rate of 16%, which is higher than any other Wall Street firms (Markopolos 4). This was a violation of 17a of the Securities Act of 1933. The act “prohibits fraud and misrepresentation in the offer or sale of securities”( Section 17(a) of the '33 Act, 860). Markopolos also discovered on June 2005, Madoff attempted to borrow money for European banks to meet investors demands. According to Markopolos this was a sign that Madoff was short on cash to give to clients. He submitted his finds to the Boston office of the Securities and Exchange Commission on May 2000 but were ignored. Markopolos believed that the SEC did not focus on Madoff because of his chairman position in the National Association of Securities Dealers Automated Quotations (NASDAQ Stock Market). After six complaints the SEC finally charged Madoff for securities fraud, violations of the anti-fraud provisions of section 17a of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Section 206 of the Investment Advisers Act of 1940 (SEC 2009, 1).
After the arrest of Madoff, his investors came forward to claim back the money they had invested, unfortunately for them complications with the Securities Investor Protection Corporation (SIPC). SIPC is a nonprofit and membership corporation where all members must be registered as brokers or dealers. Most of the investors lost money. The investors urged the SIPC to return the money they invested. “Madoff’s victims believed that they had insurance against losses. However, a court decision in 1975 ruled that the SIPC is not an insurer, nor does it guarantee that customers will recover their investments which may have diminished as a result of, among other things, market fluctuations or broker-dealer fraud” (Lewis 162). This was one of the conflicts between SIPC and the victims about the meaning of and interpretation of the Securities Investor Protection Act (SIPA) of 1970 and its 1978 amendment. “SIPA's purpose is to protect customers against certain types of loss resulting from broker-dealer failure and, thereby, to promote investor confidence in the nation’s securities markets”(SIPA). The amendment grants customers protection up to $100,000, with a ceiling of up to $40,000 for cash. The investors referred to as victims felt they had a right to protection against losses but was unfortunately dismissed by the court. The court also decided that those who directly invested with Madoff were entitled to SIPC benefits. This entitled them to $500,000 in SIPC insurance(Lewis, 165). Client #97A confess to being overwhelmed by “rage against [the] injustice” she confronted at the hands of SIPC: None of the victims are winners” and “we feel it’s immoral to again victimize people who lost their life savings by demanding back money they withdrew in good faith and which they believed was theirs”(Lewis, 166). They trusted that SIPC would reimburse the victims, but they felt used just like they did with Madoff. Those who indirectly invested through feeder funds were not considered customers and did not receive SIPC benefits. They did not receive their return of transfers of investments. Feeder funds are a type of fund where investors deposit money into a bigger fund known as a master fund. The master fund then attempts to generate profits to give to other feeders.
Very few actually benefited from the Ponzi scheme. Only those who benefited the feeder funds earned quick returns. Madoff would steal money from his investors and would profit himself and his wealthy investors. Most of his investors were people he knew well or strangers. One example is Jerry Picower who was friends with Madoff and invested with him from 1995 to 2008. Picower is said to had profited approximately $7.2 billion. He was also the biggest beneficiary of Madoff’s Ponzi scheme. On April 2006, Picower wired a check of $125 million to Madoff and in two weeks it had supposedly grown to $164 million. The reason for the massive gain was because “customer account statement reflected 57 purported purchases of securities between January 10 and January 24, 2006, almost 3 months before the account was funded”(Lewis, 73). The SIPC argued that the transfers between Madoff to Picower “were in part, false and fraudulent payments of nonexistent profits supposedly earned”(Lewis, 73). After Madoff was arrested the SIPC looked into many investor accounts and saw the Picower’s account was false and no actual real returns were earned. Another individual that benefited from the Ponzi scheme was Madoff’s brother Peter Madoff. He was the investment company’s senior managing director and chief compliance officer. The Madoff brother started working together in 1965. Peter Madoff had two accounts in which he invested $32,146 and redeemed $16.25 million over the years. Between September 2005 and April 2005, he supposedly redeemed over $3.2 million alone. Peter went even on to purchase an apartment with the money that was wired to him. It was also told that between 2001 and 2008 he was paid over $20 million in salary and bonuses. Both Peter Madoff and Picower were close to Madoff and benefited from the Ponzi scheme.