Madoff Ponzi Scheme 2010

Ponzi Scheme is the name often applied to any fraudulent financial scheme that uses money from a steady stream of new investors to pay off old investors seeking to redeem their investments. Since in the framework of this scheme, no assets are really purchased, but dividends are paid out, the scheme will inevitably collapse whenever redemptions outstrip new investments (Sarna, 2010,p.28).

A technical explanation of a Ponzi scheme is provided by Culp and Heaton, (2010,p.92).According to Culp and Heaton (2010,p.92), in a Ponzi scheme, the promoter solicits funds from customers for investments in some portfolio or strategy, but little or no investing actually occurs. Redemption requests and distributions are financed by cash received from new participants in the scheme.

Bernard L. Madoff, the president and the 75% owner of Bernard L. Madoff Investment Securities confessed to the FBI and finally in open court that he had organized what was arguably the longest-running and the most extensive Ponzi scheme in history run by an individual, involving cash flowing through the accounts of USD170 billion (Sarna, 2010,p.147).

The following account from Culp and Heaton, (2010,p.92) recounts Madoff tangled web of deceit to investors. According to Culp and Heaton, Madoff Ponzi scheme scandal is the largest fraud done on investors by a single individual in history. In his Ponzi scheme framework, Madoff primarily marketed a single investment strategy, known as 'split strike conversion', in which he claimed to be purchasing blue-chip stocks in the S&P100 index and simultaneously selling 'call options' and buying 'put options' on the S&P100 Index. A split strike conversion strategy is essentially just a stock index arbitrage program and as such should have relatively low risk and generate modest returns. However, for the 17 years during which his Ponzi scheme went undetected, Madoff boasted average returns of nearly 10.5 percent per annum even at time when the stock market fell nearly 40 percent in November 2008.

As stated above, Ponzi scheme generally collapse when unexpected larger redemptions occurs. If not for the credit crisis which originated from the 2008 subprime crisis, Madoff might have been able to perpetuate his fraud more a couple more years. One of the reason why Madoff's Ponzi scheme went undetected for so long was because it was an 'affinity fraud' which was aimed at the effluent Jewish community in New York and Palm Beach, Florida. Within that community, Madoff was a respected figure and gained his investors trust. Adding to his appeal was his practice of sometime turning away investors who want to invest with him. Apart from that, the returns in Madoff's Ponzi scheme were generally not so high as to be completely ridiculous on the face of it (Culp and Heaton, 2010,p.93).

Most of Madoff's money came from feeder funds that gathered investments from customers and then used Madoff as either the investment manager or broker.Managers of feeder funds earned high fees for providing fresh investors for Madoff (Peck,2011,p.5).In 2008, as the securities market began in downward spiral in 2008, investors redemptions outstripped new funds. Madoff, sensing the impending collapse of his scheme turened himself in to the federal Bureau of Investigation (FBI) (Peck,2011,p.5).

Thus when Madoff's ponzi scheme was uncovered. Madoff was held retrospectively accountable for years of deceitful, exploitative, criminal behaviour. Consequences naturally follow, Madoff's retrospective accountability involved arrest ,trial, testimony and jail (Johnson,2011,p.69).