Introduction
Following an escalation in the number of business scandals being reported by companies in the twenty first century, many firms are looking for solutions to overcome this challenge (Ferrell & Ferrell, 2012).
The fact that ethical and legal lapses have occurred at several renowned firms such as Fannie Mac, AIG, Countrywide Financial, and the Bernie Madoff’s security fraud, underscores the need for firms to incorporate ethics and responsibility while implementing all their business decisions.
Extremely evident business ethics issues affect the attitudes of people towards the business and as such, this is likely to destroy their trust (Oppenheimer, 2010). Individuals working at organizations are aware that ethical decisions form a part of their daily life.
Abusive behavior, misuse of a firm’s resources, accounting fraud, defective products, harassment, bribery, employee theft and conflicts of interest are all signs that indeed the ethical standards of a firm are on the decline. The current paper is an attempt to analyze the Bernie Madoff’s security fraud. Specifically, the paper shall endeavor to examine the ethical and legal issues surrounding the case.
In addition, the paper will also attempt to investigate how Madoff managed to convince even the most sophisticated investors to invest in his dubious scheme, how he was able to sustain it for so long without being detected, and the corrective actions that the U.S Security Exchange Commission (SEC) and the investors should take in order to avoid a repeat of a similar scheme in future.
Bernie Madoff’s Ponzi scheme
Before Bernard Madoff’s Ponzi scheme was uncovered in December 2008, he claimed in his confession that it had been running since the early 1990s. However, authorities involved in the investigation state that it had been going on for a lot longer, possibly since the late 1970s (Kirtman, 2010). Madoff would normally take money from new investors and then use it to pay the earnings of existing investors.
How investors were convinced to invest in Bernie Madoff Securities
The fact that Bernard Madoff managed to reap off even the most sophisticated investors is something worth of exploration. The scandal is therefore a sign of powerful influence principles at play.
The first main principle that could have made the unsuspecting investors to fall prey to Bernard Madoff’s scheme is the principle of scarcity (Ferrell & Ferrell, 2012). In addition, the deal was exclusive, while some of the clients were even fired for appearing to ask many questions. Another principle worth of consideration is authority.
Madoff was no stranger to authority, and it is this ‘air’ of authority that endeared investors to him. This observation has been supported by the Miligram experiment along with other related studies that examines how people with authority tend to influence others hugely.
Another principle to consider is social proof. Everybody seemed to have been investing in the scheme, ranging from Singapore’s Line Capital to Abu Dhabi Investment Authority to Stephen Spielberg. As such, it appeared very reasonable to invest in Bernie Madoff Securities as everybody else was doing it.
Fourthly, there is the issue of the liking principle (Ferrell & Ferrell, 2012). Bernie Madoff organized charity events, social networks and country club meetings, effectively bringing people into the scheme. The combination of the aforementioned factors made Bernie Madoff’s Securities so appealing that even the most sophisticated investors could not detect that it was a reap off.
Then there is the issue of motivated reasoning. Investors tend to believe that they are capable of earning say, 11 % interest just like that. Suddenly, these people are only too willing to somewhat postpone their disbelief. In a way, we were unable to appreciate that the combination of all these factors can be very powerful.
How did Bernard Madoff manage to sustain his Ponzi scheme for so long?
The fact that Bernard Madoff managed to sustain his Ponzi scheme for so long without being detected is a clear sign of failure in regulation. In a way, his being authoritative must have played a crucial role in this. For example, he was at one time the chairman of NASDAQ and as such, he was involved in the regulation as well.
In addition, he had crafted his scheme so well that he did not leave any apparent visible signs of fraud. As such, it would have been very hard to investigate the firm (Kotz, 2010). Furthermore, Madoff was still running Appelbaum, a legitimate business, even as he ran his Ponzi scheme. His investors had trust in him because he always granted them their withdrawal requests promptly.
Compared with other Ponzi schemers, Madoff did not lure his potential investors with unrealistic returns. His returns were moderate but at the same time, suspiciously consistent. The fact that the Securities and Exchange Commission failed to locate a smoking gun that would expose Bernard Madoff shows that he was very meticulous about his activities (U.S. Securities and Exchange Commission, 2009).
Also, the fact that the scheme started small and gained credibility as it became bigger could have been a contributing factor. Besides, Madoff never revealed his secret formula to anybody. Therefore, by convincing both the regulatory authorities and the investors, Madoff was able to carry out his dirty work for a long time without being detected.
Legal Issues
Bernard L. Madoff was charged by the Securities and Exchange Commission (SEC) on December 11, 2008, with securities fraud, through his Ponzi scheme. The SEC charged Madoff for having contravened the anti-fraud provisions that the SEC upholds. They include the 1933 Securities Act, the 1934 securities acts, as well as the 1940 Investment Advisers Act (Straney, 2010).
Moreover, Madoff was also indicted by the New York’s Attorney’s Office for having conducted criminal offences. He pleaded guilty to all the charges leveled against him on March 12, 2009. He was sentenced to 150 years in prison by federal District Judge Denny Chin on June 29, 2009.
Firms that offer securities to the public for investment purposes are required by the SEC to be truthful with the public about the nature of their businesses, the kind of securities they are selling, as well as the associated risks.
Accordingly, individuals involved in trading and selling of securities (for example, dealers, exchanges and brokers) need to treat their investors with honesty and fairness, and should always endeavor to give the interests of the investors the first priority (Straney, 2010).
The 1933 Securities Act demands that firms involved in securities exchange give their investors financial as well as other types of information regarding securities for sale. It also forbids misrepresentations, fraud, and deceit while selling securities.
On the other hand, the 1934 Securities Exchange Act demands that firms trading in public securities report information of their trade to the public periodically. The 1940 Investment Company Act demands that firms reveal their investment policies and financial information to prospective investors during the initial sale of stocks and subsequently, on a regular basis (Oppenheimer, 2010).
The fact that Bernie Madoff did not reveal to the investors the nature of the business, or indeed the formula for the supposed interest in money invested, shows that he had violated the three aforementioned Acts. As such, the SEC was within its right to charge him in a court of law.
Bernard L. Madoff was arrested after it emerged that he had been deceiving thousands of investors to invest in his $ 50 billion Ponzi scheme under his company, Bernard L. Madoff Securities LLC.
This fraud is arguably one of the greatest financial scandals in the history of America. This is a clear indication of the level to which business owners are capable of compromising their business ethics in a bid to reap maximum profits, with little regard for the investors who took trust in their business ideas.
Ethical issues
The Madoff crisis is a perfect example of the secretive and opaque nature of hedge funds. Initially, Bernard Madoff used to undertake honest business but in the early 1990s, he became greedy and started to fabricate returns in an effort to lure more investors. In addition, he also began to issue false statements.
This is indicative of failing business ethics. Madoff tried to convince his clients that there was need to combine derivatives with blue chip securities in a bid to hedge the associated risk (Kotz, 2010). Even when the market was down, his investors would still get steady and solid returns for their investments. Madoff was actually using the money invested by new investors to pay off his old investors.
In the process, he had a lot of money for himself. Such a practice is unacceptable because it is against the business ethics. A firm should not knowingly deceive the investor and it should ensure that the interests of investors are given the first priority. In this case, Bernie Madoff was only concerned with enriching himself at the expense of the gullible investors.
Madoff argued that his investment strategies were very technical and as such, investors would not understand them. The alleged high returns confused potential investors into investing in the scheme blindly (Kirtman, 2010). The exclusivity with which Madoff handles investors ensured that they did not pull funds, lest they found it hard to go back.
However, none of them ever suspected that this was just but a Ponzi scheme that Madoff was running. Once he took funds from investors, he would proceed to pay off redemption requests and dividends to older investors, and then make money for himself. Eventually, such a scheme is bound to fail as the number of investors who need to receive payouts increases.
Corrective action
In order to avoid similar disasters like the Bernie Madoff’s Ponzi scheme, investors can take some corrective actions so that they do not fall victim to these fraudsters. One of the basic principles that investors need to consider before investing in any business is the idea of diversification.
By diversifying one’ portfolio, you also spread the risk involved in losing your investments (Donaldson, 2008, p. 406). In addition, investors should also be keen enough to check for red flags regarding a given investment vehicle.
For example, when a securities exchange firm claims to post consistent and impressive returns even when the market is down, then something is clearly wrong and as an investor, you should be wary of such behavior.
The issue of transparency is also very important. In this case, a prospective employer should insist about knowing the nature of the business that he is putting his money into, and the risks involved. Ideally, a securities exchange firm should be able to reveal this kind of information because it is one of the requirements of the SEC anyway.
All Ponzi schemes are greed-driven and as such, we should desist from engaging in any get-rich-quick schemes (Straney, 2010). Real markets do not offer returns on investment all at once, as Madoff did. This would be yet another red flag for a would-be investor.
Upon conducting its investigations into the securities fraud case of Bernie Madoff, the SEC revealed that indeed, a few of their staff members had received specific and credible allegations about the financial wrongdoings of Bernie Madoff, although no recommendation was veer made to the Commission to take corrective action (U.S. Securities and Exchange Commission, 2009).
The SEC has been on the receiving end regarding how it conducts its risk assessment for potential fraud cases. For this reason, there is need for the SEC to enhance its examination initiatives, enhance the expertise of risk examiners, as well as a reassessment of the process of identifying risks.
The SEC should also create the office of the Whistleblower whose duty is to handle whistle-blowing tips by insiders. This may actually increase the chances of detecting fraud at public companies.
In addition, the SEC should also endeavor to make use of the 1934 Securities Exchange Act (Section 21A (e) which gives the SEC power to give rewards to informants. When such payments are made mandatory, more informants are likely to come forth.
Conclusion
Bernard Madoff orchestrated what is arguably America’s largest securities fraud. For his, he was jailed for a maximum period of 150 years. However, the fact that it took so long to detect his Ponzi scheme points at the high level of inefficiency within the SEC. Nonetheless, Madoff was also very carefully not to leave nay signs that would raise the red flag.
He started trading legitimately, was an active board members of the securities regulatory board, and a former chairman of NASDAQ. By virtue of his authority, people came to trust in him. He used the investments of new clients to pay off old investors. In addition, he also started to fabricate returns in an effort to increase his investment portfolio. In the process, he ended up violating several SEC Acts.
There has been an increase in the number of fraud cases in the business world in recent years, and this is a clear sign of waning business ethics. In order to avoid a repeat of the Madoff Ponzi scheme in future, the SEC should endeavor to re-assess its mode of examining risks. In addition, it should improve the expertise of its risk examiners. There should also be a program that rewards and protects whistleblowers.
On the other hand, investors should be on the look-out for any red flag from potential investment vehicles. They should also avoid engaging in get-rich-quick schemes.
Reference List
Donaldson, T. (2008). Hedge Fund Ethics. Business Ethics Quarterly, 18(3), 405-416.
Ferrell, O. C., & Ferrell, J. F. (2012). Business Ethics: Ethical Decision Making & Cases. Stamford, Mass: Cengage Learning.
Kirtman, A. (2010). Betrayal: the life and lies of Bernie Madoff. New York: HarperCollins.
Kotz, D. H. (2010). Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme: Public Version. Darby, PA, USA: Diane Publishing Co.
Oppenheimer, J. (2010). Madoff with the money. New York: John Wiley & Sons.
Straney, L. L. (2010). Securities Fraud: Detection, Prevention and Control. London: John Wiley & Sons.
U.S. Securities and Exchange Commission. (2009). Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme – Public Version -. Retrieved from https://www.sec.gov/news/studies/2009/oig-509.pdf