NAVARRO, Bea Czarina B.

Legal Accounting
17-334 Atty. Anderson

Doomed to Fail: The Bernie Madoff’s Ponzi Scheme

I. Introduction

It was December 11, 2008 when FBI agents in Manhattan, New York arrested Bernard L.
Madoff who was the founder and sole proprietor of Bernard L. Madoff Investment Securities
which was a wholesale securities trading firm with a pristine regulatory history.1 The sons of
Bernie Madoff, Mark and Andrew reported the federal law enforcement agencies about their
father running a Ponzi scheme owing investors approximately $64.8 billion.2 The agents had no
evidence gathered beyond such report, but to their shock, Bernie Madoff admitted the
commission of such fraud.3 In March 2009, Bernie Madoff pleaded guilty to various securities
and tax law violations such as fraud, money laundering, perjury and theft.4 His sentences were
to serve 150 years in federal prison in North Carolina and to pay $170 billion in restitution.

Madoff’s scheme was the most high profile scandal in history which caused a rippling
effect to a lot of people around the world. Investors lost billions of dollars. Employees and
associates were put into investigation and arrest. At least three involved committed suicide,
including Madoff’s son, Mark.5

This paper discusses the Bernie Madoff scandal, how it was able to thrive for so long
and what needs to be done to avoid another fraudulent scheme for the protection of the public.

II. Bernie Madoff’s Ponzi Scheme

1
Diana Henriques. A Case Study of A Con Man: Bernie Madoff and The Timeless Lessons of History’s Biggest Ponzi
Scheme, 85 Social Research: An International Quarterly. Johns Hopkins University Press 745, 766 (2018).
2
Id.
3
Id.
4
Stephanie Yang. 5 Years Ago Bernie Madoff Was Sentenced to 150 Years in Prison – Here’s How His Scheme
Worked, available at https://www.businessinsider.com/how-bernie-madoffs-ponzi-scheme-worked-2014-7 (last
accessed December 20, 2019).
5
Kalen Smith. What Is A Ponzi Scheme – Bernie Madoff Ponzi Scheme and Scandal Explained, available at
https://www.moneycrashers.com/bernie-madoff-ponzi-scheme-explained/ (last accessed December 20, 2019).
 The Bernie Madoff scandal was the largest Ponzi scheme being a global one as victims
of such scandal were reportedly from different parts of the world like Canada, Brazil, South
Korea and Israel.

Ponzi schemes are fraudulent methods that work by getting investors by assuring high
returns. They are run through a central operator, whether a single person or a group, who
gathers new investors to pay off the returns to older ones, although no actual profit is being
generated.6 Of all the business frauds, the Ponzi scheme is one of the more notorious. The
name originated in the 1920s with the infamous Charles Ponzi, whose scheme assured 50%
returns on investments in 90 days.7

Bernie’s Ponzi scheme happened through creating a hedge fund that guaranteed
investors a double digit investment returns despite market fluctuations. He issued false
statements. His friend who is an accountant verified such. To convince investors, Madoff sold
the idea of combining blue chip securities with derivatives to hedge risk.8 However, Bernie
never really explained how his methods work to investors and claimed that they are too
complicated to understand. In truth, however, it was just Bernie Madoff’s massive personal
bank account receiving new investments and paying off older ones. He created false brokerage
statements and trade confirmations to support this fraud.

Ponzi schemes, however, are doomed to fail. They fall apart when (1) there aren’t
enough new investors to keep the cash flow going, (2) the operator decides to take the
remaining investment money and runs and (3) too many investors decide to bail and pull out
their returns.9 Thus, when the financial crises began, as the market deteriorated, which later
worsened to become the Great Recession, people began asking for money from Madoff’s
account. Such requests became as big as $7 billion but Madoff’s account only had $200 to 300
million to pay them off, hence, the collapse. Eventually, Madoff realized he couldn’t keep up

6
Yang, supra note 4.
7
Id.
8
Paul Volker. Disclosure: The Bernie Madoff Case, available at https://sevenpillarsinstitute.org/case-
studies/disclosure-the-bernie-madoff-case/ (last accessed December 20, 2019).
9
Yang, supra note 4.
with all the investors who wanted to liquidate their assets due to the recession and confessed
to his sons the fraud he committed, who thereby turned him up to the FBI.10

III. What factors contributed to the thriving of Bernie Madoff’s Ponzi Scheme

a. Establishment of trust

Earlier in his life, Madoff was a legitimately successful and respected Wall Street
entrepreneur. He built up his reputation as an honest businessman over years to reach the top
of the financial industry.11 He was the owner of one of the most successful investment firms in
America the Bernard L. Madoff Securities, LLC, the former chairman of National Association of
Securities Dealers, and he advised the Securities and Exchange Commission on trading
securities.12 Madoff was able to trade on his good reputation to convince sophisticated and
knowledgeable financial professionals to invest in his fraudulent scheme.13

Aside from using his good reputation, Bernie was also an affinity fraudster. He was able
to pull off such scheme because most of the sources of investment were from Jews and he
himself is Jewish. He basically victimized fellow Jews and Jewish charities.14

Lastly, Madoff created a huge, complex mountain of truth in order to mask his lie. He
used the truth in his reports that made such scheme work for so long and deceive many
sophisticated financial professionals.

b. The Rumsfeld Rule

The Rumsfeld Rule, advanced by Donald Rumsfeld, one of the most skilled bureaucratic
infighters in contemporary American political history, is to stymie an opponent through burying

10
Smith, supra note 5.
11
Michael Heydenburg. The Ponzi Scheme As A Deception Operation: The Bernie Madoff Case Study, 32 American
Intelligence Journal 27, 34 (2015).
12
Yang, supra note 4.
13
Heydenburg, supra note 12 at 29.
14
Id.
him in paper. 15
Bernie Madoff utilized such rule to conceal his fraudulent act and met all the
reporting obligations so as not to raise the proverbial red flag. Madoff provided his clients
financial statements which indicated that they earned the amount of returns promised. To
them, it looked authentic as long as it indicated income. Madoff’s meeting his statutory and
regulatory reporting requirements showed his clients a false world in which they were making
profits although in fact, the only person profited by such transactions was Madoff himself.16

c. The failure of the bureaucracy

The public directed fault against the state and regulatory agencies such as the Securities
and Exchange Commission for failing to detect such fraudulent scheme. But state agencies are
limited in their ability to identify fraud having to oversee local financial markets valued in
trillions of dollars and involving billions of transactions in one business day and foreign markets
with their interconnections to the US financial market.17 Such significant responsibility but with
limited resources forces bureaucracies to prioritize tasks over the others. Additionally, the Wall
Street corporate culture holds the strong belief that if a person makes money, let it.18 Hence,
it’s not surprising that a Bernie Madoff would flourish in this kind of setup.

IV. Key Takeaway

Among the many recurring themes of the financial crisis is the failure of lawyers as
regulators and gatekeepers. It cultivated in a medium of recklessness across the entire financial
industry and the inability of government to regulate bad behaviour. Most importantly, this
scandal shows how the SEC, a principal market regulatory agency mostly operated by lawyers
failed to regulate complexities surrounding their work.19

The SEC had several opportunities to uncover Madoff’s fraud. The first was when
Markopolos, who was initially instructed to deconstruct Madoff’s trading strategy so he could

15
Id.
16
Id.
17
Id.
18
Id.
19
Robert Rhee. The Madoff Scandal, Market Regulatory Failure and The Business Education of Lawyers, 35 J. Corp.
L. 363, 391 (2009).
replicate such, in 2005 sent a detailed financial memorandum showing strong evidence that
Madoff was running a Ponzi scheme but the SEC responded saying that the staff found no
evidence of fraud. Robert Rhee found that with such memo, SEC and its highly qualified
attorneys couldn’t have missed seeing a fraud spelled out in detail.20 And there are only two
plausible explanations this which is either: (1) the SEC was influenced by Madoff’s stature, a
form of corruption, or (2) its attorneys were too ignorant to understand such memo.21 Both the
SEC and Markopolos agree that the most probable answer is SEC lawyers’ incompetency.

The point here is not that the SEC on its own could have detected the fraud but that
accounting and financial training are necessary to detect sophisticated market fraud. The SEC
was already presented how the crime was committed but was unable to comprehend what
happened because they lacked business literacy. Hence, more training and experience should
be required of the lawyers of the SEC who are tasked to regulate the market.

20
Id.
21
Id.