Bernie Madoff

Bernie Madoff

Accounting 2600

 March 21, 2013

Bernie Madoff

“Breathes there the man with soul so dead, who never to himself hath said, this is my own, my native land!  Whose heart hath never within him burned as home his footsteps he hath turned from wandering on a foreign strand?  If such there breathe, go, mark him well!  For him no minstrel raptures swell; high though his titles, proud his name, boundless his wealth as wish can claim.  Despite those titles, power, and pelf, the wretch, concentered all in self, living, shall forfeit fair renown, and, doubly dying, shall go down to the vile dust from whence he sprung-unwept, unhonored, and unsung.”  ("John Bartlett (1820–1905). Familiar Quotations, 10th Ed. 1919”, 2013).  These words from Sir Walter Scott illustrate the kind of man the Bernie Madoff was through rise as a stock market icon to his disgraceful fall as one of history’s most infamous conmen.  From the creation of his investment company in 1959, Bernie Madoff used deceptive practices to portray himself as a stock market legend.   During his rise to fame, he continually took on investors and began what was to become the largest Ponzi scheme in United States history.  Though there were several red flags, his scheme lasted over twenty years before it was uncovered.

Bernie’s start on his path of deception, dishonesty, and secrecy began with the example of his parents.  He and his brother Peter grew up in a suburban town in a middle-class area of Queens.  His father’s occupation is little known but it is generally assumed that he was a stock broker.  The details of his business are very few but, during the years his business survived, was able to rack up an IRS bill of over $13,000, which was the 1950’s equivalent of about $100,000.  Because of this, a lien was places on the Madoff house which was not paid off until his father, Ralph, either sold or lost his house in 1963.  Ralph wasn’t the only person in the family to have problems with the law.  According to James Bandler, “Like Ralph, Sylvia had a run-in with the government. In August 1963, the Securities and Exchange Commission announced it was instituting proceedings to determine whether 48 broker-dealers, including "Sylvia R. Madoff [doing business as] Gibraltar Securities," had "failed to file reports of their financial condition ... and if so, whether their registrations should be revoked." Then, in January 1964, the SEC dismissed administrative proceedings against a number of the firms, including Madoff's, in what appeared to be a deal: No penalties if you promise to stay out of business.

What's mysterious is that Bernie Madoff's childhood friends don't recall his mother's being involved in stocks or bonds. For a woman to head her own securities firm in the early '60s was unusual. And given that the company's address was listed as the Madoff home in Laurelton, Bernie's friends would seem likely to have noticed the business. Yet they didn't and it's impossible to know why not. One could speculate that Ralph, his name tarnished by federal tax troubles, decided to put his wife's name on the application to open a stock brokerage.

Either way, one of Bernie Madoff's parents was involved in securities -- and got into trouble for it. And according to his friend Joe Kavanau, who attended law school with Madoff (before both dropped out), Madoff knew he was going to go into that line of work from a young age. "Bernie," he says, "was always going to have this business."” ("How Bernie Did It", 2013). In retrospect, it’s easy to see that his upbringing may have played a pivotal role in his life of deception.  After watching the example of his parents, it’s plain that his predisposition to seeing the law as an obstacle to work around rather than rules to follow should have been a red flag from the beginning.

In 1959, Bernie Madoff started his company Bernie L. Madoff Investment Securities, LLC.  What made his company different was that instead of trading on the New York Stock Exchange which was closely monitored and security price quotes were readily available, he traded on the over-the counter market where he was the market maker responsible for selling shares of small companies to broker-dealers.  This market was not closely regulated and market makers, like himself, took liberty with price quotes and made a large profit.  After about ten years, his company was worth over $1 million.  As the market became savvier, his company turned to take advantage of different market efficiencies.  His company used investor money to place simultaneous buys and sales of a security and because of differences of price in different markets, his company would take the risk-free profit.  During that time in the market, there was nothing like NASDAQ or any streaming price quote system, so the broker would literally pick up the phone to different dealers to place a trade.  This was very profitable for his company, though the market soon became automated and made this practice unrealistic.  The third way that the company made money was by taking advantage of market spreads.  During that time, the price that the market makers would mark up securities was 12.5%.  Bernie decided not to charge commissions and offer “free trading” to investors while taking the 12.5% profit.  He was so successful at this that his company placed 9% of all trades on the New York Stock exchange during that time.  The practices that he employed made him a huge stock market success to the extent that he was named as chairman of the board of directors of NASDAQ. ("From Prison, Madoff Says Banks ‘Had To Know’ Of Fraud", 2011).

Aside from his business that was very successful at manipulating market inefficiencies, Bernie controlled a separate fund that showed year over year success-promising 15-20% annually.  His separate investment company was viewed as an exclusive investment club that only certain people were allowed to invest in.  When agreeing to invest, investors would agree to follow Bernie’s “split-strike conversion” strategy and essentially not ask questions for fear of being kicked out.  His private investing club attracted many high-profile investors like Steven Spielberg and Kevin Bacon among others.  This investment group started in the beginning of his company and grew over the years to “manage” billions of dollars.  Though it seemed like he was an investment genius, the problem, that wasn’t discovered until 2008, was that the money wasn’t invested in anything except his own personal bank account.