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1. What was Madoff’s “First Brush with the SEC”? What rules were Bienes and Madoff accused of violating? How could proper action at that point have prevented the later overwhelming Ponzi scheme?

Madoff’s first brush with the SEC occurred in 1992 regarding the claims that an unregistered investment advising company was offering – 100 percent safe investments at extremely high and consistent rates of return over significant time periods to distinct customers. Following this allegations, the SEC suspected the involvement of Avellino and Bienes, which was one of Madoff’s feeder funds, in a Ponzi scheme.

Bienes and Madoff were indicted for violating a number of rules including selling unregistered securities and failing to register as an investment advisor; this violations were directed at Avellino and Bienes. Madoff L. Securities was also accused of a number of violations including failing to register as an investment advisor; the brokers’ need to find the best feasible price for customers, is related to the fact that Madoff’s purported returns and strategy were impossible together with the strategy that Madoff used for customer accounts.

Perhaps, the most appropriate course of action by the SEC that could have prevented the later overwhelming Ponzi scheme could be through extensive investigations. SEC handled the manner lightly from the first allegations of malpractice, and this is what led to its development towards a huge scam. The SEC was misguided in its investigations in the sense that it failed to investigate the possibility of a Ponzi scheme but instead focused on determining whether Madoff was a registered investment advisor.

2. As Madoff was attracting feeder funds (as described in Chapter 3), what incentive did he offer (i.e. what did he not charge) in order to attract new “investors” /feeders?

The success of a Ponzi scheme depends on its ability to attract new investors/feeder funds and ensure that there are no sudden outflows, which is achieved through stability. In the case of Madoff’s scandal, feeders/investors were not only attracted by the consistent and high returns, but also Madoff did not charge any fees from client’s money. According to Madoff, he was making money from the market, making and trading operations and commissions, and there was no need to charge fees on the client’s money; this acted as an incentive that attracted several feeders/investors to his Ponzi scheme. For a feeder fund such as the Fairfield Greenwhich group, the client fees added up to million annually, which was taken from a fraction of the assets and returns. In order to maintain investors and feeder funds, Madoff also embarked on instilling confidence among investors. For instance, withdrawals were timely, coupled with consistent returns; as a result, investors were wary of clearing their money from Madoff’s scheme. Madoff also relied on kickbacks to banks in order to attract investors, particularly in Geneva, whereby, by 2003, one-third of fund managers had invested in Madoff to the tune of $ 14 billion dollars.

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3. How was Madoff able to use falsified statements to account for “gains” and “losses” and his Ponzi scheme? (Chapter 4 of the video).

The United States Securities and Exchange Commission reported that Madoff had back office that was mainly involved with producing falsified trading statements based on the reports that Madoff had ordered for each customer. The back office employees utilized a computer program that is specifically designed to facilitate the backdating of trades and falsify the account statements in order to account for any losses or profits. In addition, there were cases whereby returns were calculated even before the opening of a customer’s account. Most clients focused mainly on the bottom line, the returns, and failed to scrutinize the falsified statements for any potential discrepancies.

In addition, Madoff did not invest any of the clients’ funds; rather, he paid false returns out of their assets. This was facilitated by the creation of falsified financial statements that pointed out consistent and high financial returns while at the same time defending this returns by arguing that he had devised an exceptional trading strategy. In order to hide the fact that Madoff was not actually involved in trading, he maintained that he was involved in making overseas purchases and came up with clients’ account statements that contained forged positions and transactions. It can be argued that these falsified customer account statements concealed Madoff actual trading strategy, which helped in furthering the Ponzi scheme.

4. Before being caught in the Ponzi scheme, how did Madoff respond to clients asking any questions regarding the specifics of his operation and his investment approach?

It is evident that Madoff was extremely secretive regarding his trading strategy and the operations of his firm. Madoff did not allow his clients to ask any questions regarding the details of his operation and his investment strategy. In fact, if an investor asked any questions how Madoff did his business, he would threaten them and Madoff was willing to return the money of complaining clients. Madoff tricked his clients with the notion of combining derivatives with securities of blue chip companies to evade potential risks. Madoff claimed that his investment strategies are extremely complex and difficult for investors to comprehend. Since Madoff evaded due diligence with regard to his investment strategies, he often brushed off clients who were questioning his methods and even threatened them that he would reimburse their money if they doubted his methods.

5. The video (Chapter 4), talks about how several people in the field suspected Madoff of “front running.” What type of securities fraud is “front running”? How does it allow a large broker an advantage?

Front running refers to a fraud whereby a broker buys securities based on the information obtained from the analyst department prior to the information being disseminated to his/her clients. Fundamentally, brokers engaging in the unethical practice of front running take advantage of the prior knowledge relating to pending orders from its clients. If the price of the security is likely to be affected by orders that have been submitted earlier by customers, the broker can take advantage by buying the securities for his own account first; the broker can anticipate to close out its profit depending on the new price level. As a result, front running brokers tend to either purchase securities for their own accounts prior to customers submitting their orders to increase the price, or sell for their own account prior to filling customers selling orders that tend to lower the price.

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6. Chapter 5 of the video describes a number of “red flags” that came up regarding the Madoff Fund between 2000 and 2008. What were some of these “red flags”? How were they suggestive of the Ponzi scheme?

There were several red flags that suggested that Madoff was involved in a Ponzi scheme. First, Harry Markopolos, a whistleblower and financial analyst, raised concerns that Madoff should be investigated since it was not feasible to make the returns reported by Madoff using the investment methods acclaimed by Madoff. According to Markopolos, Madoff’s figures did not add up, thus suggesting a potential fraud, which involved either a Ponzi scheme or front running. Markopolos also raised another red flag by sending a detailed memo to the SEC and approached the Wall Street Journal regarding an ongoing Ponzi scheme; however, the editors were not willing to pursue the story. Markopolos memo highlighted 30 red flags spread over 14 years since Madoff began trading. The most outstanding red flag was that Madoff had only lost for seven months in a period of 14 years; these losses were insignificant. Another red flag was raised by Erin Arvedlund, a financial journalist, who raised concerns regarding Madoff’s secrecy and how he managed to achieve consistent returns. Michael Orchant, a journalist with MarHedge and the Barron, suggested that Madoff was front running. In addition, Madoff declined the review of his records for due diligence, which was a clear indicator of fraud.

7. In the end of Chapter 5 of the video, members of the House of Representatives grills executive staff from the Securities Exchange Commission in hearings regarding Madoff. Based on what you know from this case in the information provided from Markopolos, do you feel that the SEC was negligent in their responsibilities in this case? What outcome do you feel is appropriate for the supervising members of the SEC that were aware of these allegations/”red flags” against Madoff and failed to discover the Ponzi scheme? (i.e. should they be dismissed/fired)? Why or why not?

It is evident that the SEC was negligent regarding their responsibilities in the case. This is evident by their failures to unravel the Ponzi scheme regardless of several red flags raised and tips right from its inception. This is pure negligence owing to the fact that SEC officials focused on investigating whether Madoff was a registered financial advisor. SEC officials disregarded clear indicators and red flags that were potential indicators of an ongoing fraud being perpetuated by Madoff. The shortcomings observed in the manner through which SEC handled the matter is a clear indicator of negligence since SEC officials failed to conduct extensive investigations on serious allegations raised against Madoff. SEC officials were aware of these allegations against the Ponzi scheme but failed to unravel that Madoff should be dismissed; the red flags were a clear indicator of an ongoing fraud. Fundamentally, they failed in their obligations to protect the public from such fraudulent acts because of gross negligence.

8. Chapter 6 of the video describes the end of the Madoff scheme. What caused the Ponzi scheme to become unraveled? What prompted Madoff to come forward to the FBI and “turn himself in”?

The acceleration of the market downturn in December 2008 was integral in the uncovering the Ponzi scheme. Nevertheless, Markopolos were the first to notice forthcoming signs of collapse in early 2008 at the time when Madoff began accepting leveraged money. At this time, Madoff’s cash was running out yet the scheme needed an increase in the promised returns in order to keep going. With the sharp market downturn, investors were increasingly making withdrawals from the company. In order to fund these withdrawals, Madoff was in need of money from other investors. Regardless of many new investors believing that Madoff would manage to stay liquid, deposits from new investors were not sufficient to balance the increasing withdrawals. The economic downturn is perhaps the only reason why Madoff’s Ponzi scheme was uncovered. Madoff turned himself in because his fundraising attempts to cater for withdrawals failed, which implied that the Ponzi scheme was in the verge of being unraveled.

9. Looking back over the Ponzi scheme, what do you think could have prevented this Ponzi scheme from growing to the level that it did and having the systematic, rippling effect that it did on the financial sector?

Madoff’s Ponzi scheme could have been prevented from its inception of the SEC. The progression of Madoff’s scheme can solely be attributed to gross negligence from the SEC, who ignored the several red flags and tips that were clear indicators of an ongoing fraudulent activity. Perhaps, the SEC enforcement staff was inexperienced and was misguided in their investigations in the sense that they focused on investigating whether Madoff was supposed to register an investment advisor and whether the disclosures by Madoff hedge funds investors were sufficient. They ignore the possibility of an ongoing Ponzi scheme regardless of several tips and red flags that pointed out the probability of a fraudulent activity going on. Perhaps, the SEC could have prevented this by enacting stricter rules on disclosure regarding asset and investment management. For instance, SEC was not strict enough in enforcing the observed violations at the start of the Ponzi scheme. The need to register investment advisors and ensure that they disclose their trading practices could have helped in preventing the Ponzi scheme from culminating any further.

10. If you were in charge of the SEC and/or setting up regulations in the financial sector, what are the “lessons learned” from the Madoff scandal? What regulatory, enforcement, or investigative policies do you think should be implemented in wake of the Madoff scandal to prevent future widespread of Ponzi schemes?

There are several lessons learned from Madoff’s fraud case regarding regulations in the financial sector. It is apparent that individual perpetuating fraud in the financial sector is smarter than SEC officials, which creates a gap for people like Madoff to exploit when perpetuating their fraudulent acts. The lessons learned from the case include regulatory gaps regarding the disclosure of the trading practices used by investment and asset management companies. Another lesson from the case relates to the efficiencies of SEC enforcement officials regarding the detection and investigation of potential frauds in the financial sector. Perhaps, there is need to ensure that SEC enforcement officials have the experience and knowledge regarding the activities of the financial sector. The SEC enforcement officials were not knowledgeable regarding the industry dynamics of the financial sector. Regulatory recommendations include the need for investment management companies to disclose their trading tactics; enforcement policies include ensuring that SEC officials have credible experience and knowledge of regulatory provisions regarding the financial sector.