. Describing the types of illegal business behavior that alleged against Madoff and an explanation of the ethical or criminal behavior in the conduct of business.
To begin with, Bernard Madoff established a Ponzi scheme under the guise of an investment advisory firm that falsely represented funds from private investors. He did not invest the funds in shares and securities as he reported to his investors. Madoff also made false claims to his clients on the investment strategies he used to generate profits for clients, suggesting that the high returns for their investments were due to a split strike conversion strategy. Madoff instead used the funds to purchase and sell securities in overseas markets without the client’s knowledge. He wired the funds to the United Kingdom to offer the impression that they were security transactions (Jackall, 2010).
Again, Madoff mixed the broker-dealer aspects of his business causing conflict of interest in operations. He used funds from his investment clients for illegal trading and profited from the gains without informing them of his actions. Furthermore, regulatory bodies such as the Financial Industry Regulatory (FINRA) had limited authority over investigations at the company and did not act on the fraud claims made by competitors (Jackall, 2010). This enabled Madoff to continue with the illegal activities.
Thirdly, Madoff concealed fraud by filing falsely certified audit. The records showed consistent high returns, though there were suspicions about the firm’s bookkeeping. However, financial regulatory bodies, such as the Securities and Exchange Commission (SEC) did not find it prudent to investigate the firm. They questioned Madoff over the issue and accepted his version, without verifying the information with third-party auditors. Moreover, Madoff committed perjury when questioned by the SEC about his activities.
2. Three types of parties affected by Mr. Madoff’s actions and a description of the impact.
Mr. Madoff’s actions affected at least 339 global funds and clients more than sixty-five billion dollars in total (Jackall, 2010, p.9). This is exclusive of the emotional and opportunity costs to his clients. These clients included; private individuals, charitable organizations and companies such as unit trusts, hedge funds and investment firms.
Private individuals contributed a significant amount to the Ponzi scheme. These individuals included businesspersons, celebrities, retirees and royal families in Europe. The scheme affected members of the public in forty countries worldwide (Jackall, 2010). Most private individuals lost their funds as the state regarded them as sophisticated investors. The state assumes that sophisticated investors are aware of the risks involved due to the sums invested (Smith, 2011). The state perceived private individuals as having expertise in financial matters, hence the reluctance by regulatory bodies to impose strict requirements on Madoff’s firm.
Charitable organizations and foundations are also affected parties to Madoff’s scheme. These organizations include the JEHT foundation by Norman Levy whose assets, estimated to be more than $ 10 billion (Jackall, 2010, p.12), and claimed to have been conned by Mr. Madoff leading to its closure in 2009.
Another party affected by Mr. Madoff includes companies and institutions that placed their funds with his firm. These companies include Avellino & Beines (hedge fund company) and Fairfield Greenwich Group (a feeder fund company) (Smith, 2011). While most investment companies were mistrustful of Mr. Madoff’s operations, they routinely placed their funds in his firm for quick profits before removing them. The companies gained from short-term investments and continued to place higher funds in the scheme. Eventually, they lost all investments since they could not obtain their funds when the scheme finally collapsed. These companies lost funds entrusted to them by their clients and some eventually filed for bankruptcy.
3. Describing three business safeguards that may prevent the harm caused by Madoff’s actions.
It is critical that businesses establish safeguards against fraudulent activities such as those carried out by Mr. Madoff. These safeguards include carrying out regular internal and external audits by third-party firms and financial regulators, a risk management policy and policies on business ownership.
Firstly, regular internal auditing is critical for financial recording and ensures that business operations are above board. Though Mr. Madoff provided audit reports to the SEC during investigations, these reports misrepresented company operations and funds invested by the firm as they were conducted by his brother’s accounting firm. Therefore, the company’s financial details were confidential and inaccessible to family members only. Externally, government institutions (such as SEC) for fraudulent activities should have scrutinized the firm’s audit reports since it recorded high returns and profits when competitors experienced problems due to the economic downturn. This should have been a red flag for SEC and the fact that the firm had borrowed money from European banks to fund activities. However, SEC lacked expertise in financial regulation and Madoff’s company continued with its illegal businesses without SEC’s knowledge (Jackall, 2010).
Secondly, an organizational risk management policy will help safeguard against internal and external fraud. Mr. Madoff’s firm did not have a risk management policy to guide managers when the demand for redemptions increased from investors. As a result, the company was unable to pay its investors and feeder funds due to increased redemptions at the time when global recession had reached its peak (Suranovic, 2010).
Another safeguard is to separate businesses operations and external responsibilities (Surface, 2009). Managers should not serve in committees that may be in direct conflict with their work or organizations. This will ensure that their companies do not gain an unfair advantage over competitors. For instance, Mr. Madoff directly oversaw company operations and chaired the NASDAQ stock market and National Association of Security Dealers (NASD) while his brothers held similar high profile positions in regulatory institutions (Jackall, 2010). The power that the Madoff family derived from these positions caused competitors to remain quiet about their suspicions on their activities (Manning, 2011).
4. Describing the three ways in which private investors could have better protected themselves from risk.
Private investors need to protect themselves against fraud and financial risks by periodically seeking investment training, researching on the investment firms in the market and diversifying investments using surpluses. Private investors need training on the various investment vehicles available in the market; the risks involved and expected returns. Investors need training and legal education on rights as investors in the event that investment firms use their funds fraudulently.
In addition to training on investment methods, private investors should research on investment firms, their leadership and reputation. This research could help them identify reputable establishments that can use the funds for legal purchases of securities and company shares. They should not be attracted to quick investment schemes claiming immediate returns, while reputable investment firms do not claim to use such schemes. In the Madoff’s case, private investors should have researched on the split investment scheme and research articles by industry experts such as Henry Markopolos and investigative journalists on the scheme (Manning, 2011).
Investors need to diversify their funds in various investment methods such as shares on the stock exchange and securities. They should use at least two investment firms to manage different aspects of their funds to ensure that if one firm is affected by claims of fraud, then only the funds invested in the firm are affected. Again, their investment portfolio should show diversity in investments so that when one asset performs poorly, other assets are unaffected. Diversity will also help the client maintain liquidity to cushion against economic downturns.
5. Three possible legal actions against Bernard Madoff under criminal or civil law.
Three legal actions to conquer Mr. Madoff include securities and investment fraud, money laundering and perjury (Smith, 2011). Mr. Madoff fraudulently used client’s funds for securities and investments devoid of their knowledge and the clients may sue him for civil fraud. The fraud suit may also include charges for providing misleading information about investment options and earnings, breach of contract and inability to obtain their redemptions. Clients may also sue him for causing emotional distress due to the amount of funds lost in the US capital market (Smith, 2011). Similarly, the SEC may sue Mr. Madoff for civil fraud for providing falsified financial statements and audit records.
Another civil and criminal lawsuit against Mr. Madoff would be money laundry. Mr. Madoff regularly transferring investor funds from the US to the UK in the guise of securities investments while still charging the clients for the funds transfer. Madoff did not invest the funds in legitimate companies or securities; therefore, money laundering and wire fraud charges are possible (Smith, 2011). Finally, Mr. Madoff may also face perjury claims by SEC for providing false testimony under oath. The SEC officials relied on his testimony and did not verify the information with third-party sources such as the Depository Trust Company (DTC) (Jackall, 2010). This oversight and lack of due diligence by SEC staff allowed Madoff to continue with investment fraud (Erber, 2010).
References
Erber, G. (2010). The problem of money illusion in economics. Retrieved from SSRN http://ssrn.com/abstract=1652749
Jackall, R. (2010). The Madoff affair and the casino economy. Institute for Advanced Studies in Culture, 1-12. Retrieved from http://www.iasc-culture.org/HHR_Archives/Summer2010/Jackall_lo.pdf
Manning, P. (2011). Reframing corporate social responsibility: lessons from the global financial crisis. Critical Studies on Social Responsibility, Governance and Sustainability, 1, 207-228. doi: 10.1108/S2043-9059(2010)0000001015
Smith, F. (2011). Madoff Ponzi scheme exposes ‘The myth of the sophisticated investor’. Baltimore Law Review, 40, 215-279. Retrieved from http://law.ubalt.edu/downloads/law_downloads/6_Law_Review_Issue_2_Smith.pdf
Suranovic, S. (2010). Greed, capitalism and the financial crisis. Institute for International Economic Policy Working Paper Series (IIEE-WP-2010-22), 1-17. Retrieved from http://www.gwu.edu/`iiep/
Surface, J. (2009). Crossing into unchartered territory; developing thoughtful, ethical school administrators. Journal of Inquiry & Action in Education, 2(2), 188-196.
