'Madoff Investment Scam' is explained in detail and with examples in the Investments edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
The Madoff investment scam began as a legitimate stock brokerage business that ballooned into one of the largest hedge fund like structures before being discovered as the largest Ponzi scheme fraud in history. Auditors only uncovered the scam in 2008 when Bernie Madoff admitted to his sons what he had done. They promptly turned him into the authorities.
At this point, the $17.1 billion that Madoff’s operation stated it had under management was mostly gone. He confessed to have committed fraud that amounted to more than $50 billion and enmeshed famous clients, banks, charities, and investment funds from around the country and world.
The list of investors who were entrapped by the Madoff investment scam was long and distinguished. It included producer/director Steven Spielberg, the New York Mets baseball team owner, clothing magnate Carl Shapiro whose losses neared $550 million, a group of Jewish charities, and thousands of wealthy retired individuals. Among the global and savvy banks and other financial firms that were taken in by Bernie Madoff included British banking giant HSBC, Spanish banking powerhouse Santander, and alternative investment group Fairfield Greenwich that sent $7.5 billion to Madoff’s investment pool.
The Madoff operation looked like a hedge fund on the surface. His clients’ money actually resided in brokerage accounts at his company. Madoff operated like a Smith Barney or Merrill Lynch would with their investors. Much of his money arrived from so called funds of funds. They liked to invest assets into hedge fund pools. Feeder funds that he had developed personal relationships with would funnel money his way. There were banks like the Dutch division of Fortis that made substantial loans to funds of funds which desired to invest money with Madoff.
It is not hard to understand what drew people into the Madoff investment scam. He proved to be one of the pioneers of market making. Bernie Madoff had been chairman of NASDAQ before and had given counsel to the U.S. government on issues relating to the markets. He had acted as a generous philanthropist as well. Madoff created excitement and snob appeal by refusing to take some would be investors and insisting that his clients not talk to those outside the firm.
His returns consistently demonstrated impressive 10% per year performances, even in bad and challenging markets. Yet Madoff himself almost never reported a negative month for his investments. They way he did this was to use new investors’ money to increase the supposed returns of his existing clients.
The Madoff investment scam fooled auditors and regulators for decades. His claim was that he used a split-strike conversion investment strategy to generate such consistent high returns. The idea was that he would purchase and sell different types of options to lessen volatility on the S&P 100 options market.
Several advisory companies warned their clients against investing in his company. Aksia determined that the options market on the S&P 100 proved to be far too tiny to be able to accommodate his massive portfolio size. Quantitative research company MPI ran an analysis in 2006 to come up with a viable strategy which offered returns comparable to his and could not.
Madoff’s strategies most closely resembled a fraudulent hedge fund Bayou that failed a year before his. He had no external custodian but chose to clear all of his own trades. His auditor who signed off on his practices had only three employees, one of whom was an 80 year old and another a secretary.
The biggest alarm should have been the absolute secrecy under which he ran his investment business. A skeleton team operated it much like a black box at a distance from the company’s vastly larger staffed broker dealer. The clients remained in the dark as to how he generated these near magical returns consistently. Most of them did not mind this. The ones who did and asked too many questions, he simply ejected from the investment fund.