How to Cover Wall Street

Billions Lost in Former Nasdaq Chairman's Pyramid Scheme

At the end of last week, former Nasdaq chairman and money manager Bernard L. Madoff was arrested for running a firm that lost billions of dollars through a pyramid scheme.  Although such scandal is not new to Wall Street, Madoff might hold the dubious honor of committing the largest fraud in financial history.  And the details are emerging rapidly this weekend.

The SEC orginally investigated Madoff in 1992, but ended up clearing his name, and have been caught off-guard by news of Madoff’s Ponzi scheme.  In an affadavit written for federal agents, Madoff said his fraud totaled about $50 billion.  Bernard L. Madoff Securities gave its earlier investors returns with money from later victims, rather than actually investing the money.  The scheme worked until the firm was hit with about $7 billion worth of redemptions by early December.  Similar schemes usually quickly collapse, but Madoff’s fraud looks to have gone on for years.

Madoff did not run a hedge fund, but managed accounts for investors inside of his security firm.  If the investors’ portfolio had, like hedge funds, been held at a bank or brokerage firm, outside auditors could have checked that the fund existed.  Instead, only Madoff looked at the clients’ accounts that he processed, with the exception of a tiny auditing firm in NYC.  He attracted investors through his reputation, and they put billions of dollars into funds that then invested in Madoff’s firms. According to the Wall Street Journal, the money manager tried to exude an aura of exclusivity, and marketed himself through an ‘A-list’ of prominent investors.  His emphasis on an invitation-only policy for investors, and targeting of country clubs generated new customers for his Ponzi scheme for years.  Madoff was referred to by some investors as the “Jewish bond,” who consistently paid returns of 8 to 12 percent per year, ‘no matter what.’

While Madoff was a winner for many years, there are now many losers.  They include Yeshiva University (Madoff was even chairman of their board), a Jewish charity that lost its $7 million endowment and plans to lay off its workers and shut down, as well as prominent Jewish families in Florida and New York.  

Originally, Madoff started his firm with money he made 50 years ago working as a lifeguard in Queens.  His firm was a major driver in the growth of the Nasdaq by persuading brokers who primarily traded on the NYSE to do more Nasdaq training.

How did Madoff get caught? Redemptions.  In the first week of December, Madoff’s scheme collapsed when clients asked for $7 billion in redemptions.  According to Time, Madoff met with his sons last Wednesday and told them his firm was a fraud, and called it “a giant Ponzi scheme.”  When the sons called a lawyer, the lawyer alerted federal authorities about the fraud.  By this time, Madoff was virtually bankrupt.  He had planned to give the remaining $300 million that his firm had to family members and employees, but it looks like that scheme will have to be worked on from jail.