Why the SEC Failed to Uncover the Madoff Fraud

Topics: Ponzi scheme, Bernard Madoff, Pyramid and Ponzi schemes Pages: 9 (3474 words) Published: January 17, 2013
Why the SEC failed to uncover the Madoff fraud
16 December 2011

The topic for my research paper is Why the SEC failed to uncover the Madoff fraud. I believe this topic is important to the accounting world due to the fact that this has been going on for 80 or 90 years. Even though there have been well known ponzi schemes, this type of fraud still persist. It is important for the accounting industry to be aware of this type of fraud in order to prevent it in the future. The Madoff fraud is the biggest so far even though people had been warning the SEC for years. I believe I will find in researching this subject the historical basis for the Ponzi scheme. How it has developed over time and the methods used to detect it today. I will also look at how the various government agencies are investigating and dealing with this type of fraud. I will start with a history of the Ponzi scheme leading up to Bernie Madoff. The $50 billion Ponzi scheme allegedly masterminded by former Nasdaq chairman Bernard Madoff punctuated a miserable year for Wall Street in the worst possible way: by underlining, yet again, that savvy market-makers can harness arcane financial instruments as weapons of mass destruction. Left in Madoff's wake are bankrupt investors, mortified regulators and a raft of unnoticed red flags. Madoff's methods previously had been investigated by the SEC, and in 2001, a prescient article raised questions about his inscrutable strategies. But for investors pocketing windfalls, the lure of easy money outstripped suspicions raised by Madoff's shroud of secrecy. When that shroud was lifted, however, Madoff's investment fund stood revealed as a classic Ponzi scheme: a con game in which the illusion of solvency was created by paying off early investors with capital raised from later entrants. As long as new investment continued to come in the door, the earlier adopters reaped fat rewards; once markets tumbled and investors withdrew, however, the whole thing collapsed like a house of cards. Though a Boston businessman named Charles Ponzi was the scam's namesake, he wasn't its original practitioner. The reigning king of the "rob Peter to pay Paul" scam was a New York grifter named William Miller, who bilked investors out of $1 million — nearly $25 million in today's dollars — in 1899. After drumming up interest by claiming to have an inside window into the way profitable companies operated, Miller — who earned the nickname "520 percent" due to the astonishing rate of return he promised investors over the course of a year — salted his scam by paying out the first few investors. After his racket was exposed by a newspaper investigation, he was sentenced to 10 years in prison. His creditors got just 28 cents back for every dollar they'd invested.

Ponzi was a charismatic Italian immigrant who, in 1919 and 1920, coaxed thousands of people into shelling out millions of dollars — including a staggering $1 million in a single three-hour period — to buy postage stamps using international reply coupons. This strategy, Ponzi promised, enabled one to purchase postage at European currencies' lower fixed rates before redeeming them in U.S dollars at higher values. A person could buy 66 International Reply Coupons in Rome for the equivalent of $1. Those same 66 coupons would cost $3.30 in Boston, where Ponzi was based. But there weren't enough coupons in circulation to make the plan workable. The ploy bore the hallmarks of both Miller's scheme and others to follow it: it trumpeted the possibility of massive gains (Ponzi promised a 50% return in just 90 days), parried questions about its legitimacy by paying out the first few investors, and collapsed when Ponzi couldn't rustle up enough fresh marks to keep up with the money going out the door.

Ponzi, who was released from prison and deported back to Italy in 1934, set the standard in the genre. But the golden age of Ponzi and pyramid schemes didn't arrive for decades. (The two...
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