As a trader the story of the Madoff Fraud is compelling reading, never forgeting for a moment the huge pain and hurt it has caused to thousands of innocent investors.
It took me a while to really understand how the fraud worked, but I think I’ve got the guts of it, and I’ll try and give my simple understanding of it here:
Madoff founded the Wall Street firm Bernard L. Madoff Investment Securities LLC in 1960, and was its chairman until his arrest on December 11, 2008. The firm was one of the top market maker businesses on Wall Street,which bypassed “specialist” firms, by directly executing orders over the counter from retail brokers.
This obviously gave him a lot of credibility as this was a real legitimate business and well respected.
Fast forward to 1991, Madoff started a number of mutual type investment funds in which clients, if they qualified, could invest their cash. Madoff has confessed that he began his Ponzi scheme in 1991. He admitted he had never made any legitimate stock trading investments with his clients money during this time.
Instead of trading the money he simply deposited the client cash into his Chase Manhattan Bank business account. He was committed to satisfying his clients expectations of high returns, despite an economic recession. He admitted to false trading activities masked by foreign transfers and false SEC filings.
So clients gave him money to trade which he just put into a bank account, earning maybe 3-5% return per year, yet he claimed gains of maybe 12-15% per year. This was easy to do until someone wanted their investment back along with the returns it had made over the time it was in the funds.
So early investors who closed their accounts actually could have done quite well making 12-15% year. The problem was that their returns were paid for by the new cash being invested by new clients.
Of course Madoff took his cut by charging management fee’s just like any regular mutual fund, and Madoff also paid out large fee’s to other investment companies for reffering clients to him.
The net result of all this was that Madoff was making big money, people who withdrew early made good money and a network of refers also made good money. This fraud, scam, ponzi scheme worked well as long as there was enough new money flowing in to pay off people who wanted to close their investments. Incredibily it seems this went on from 1991 to 2008!.
The problem of course was that the real value of the fund was massively less than the stated value, I have read reports that the funds claimed assets of about $65 Billion at the time of the fraud exposure yet really only had less than $1 Billion, if that, in cash in the bank account.
In total about $170 Billion was deposited into the the funds over the during of the fraud, exactly how much was paid out to those who quit is not clear, but what is clear is that a huge amount of money is still unaccounted for.
So I can only assume that about $65 Billion is the amount that has been lost by the investors holding the bag at the end, that is one big bag!.
Technorati Tags: madoff fraud, ponzi scheme, Chase Manhattan Bank, Bernard L. Madoff , Investment Securities LLC
