The Fund of Madoff Issues - Essay Example

? Madoff Introduction The world of the 21st century is moving at a pretty fast pace. It is important to that the high amount of technologicaladvancement that has happened since the beginning of the previous decade has played a major role in influencing the level of competition that exists in the market place. The competition in the market is so fierce that it becomes too tempting for the company’s existing in various markets around the world to implement strategies that large benefit the needs and desires of a particular organization or individual. In some cases the companies around the world, collaborate and act in regards to each other so as to form a collusive or cartel kind of a behaviour and activity. This creates the scenario where the companies purposely cheat the common people or players in the market in regards to their money or other basic rights. In this case, the focus is on the securities fraud created by Bernard Madoff. Discussing about the origin of the fraud, it needs to be stated that the securities firm was started by Bernard Madoff in the year 1960 under the name of Bernard L Madoff Investment Securities LLC. The company was based in New York and was under the sole ownership of Bernard Madoff. Bernard Madoff also headed an investment advisory business which focused on taking billions of dollars from multiple wealthy individuals, institutional investors and middle class people. The middle class people were made to invest through feeder funds which belonged to that of Tremont Capital Management and Fairfield Greenwich Advisors. The performance record of Madoff was pretty impressive as well. Over a long period of around 15 years, he incurred a loss of around 13 months only. To keep a growth record which is clear of any suspicions from the investors, the owner of the investing firm Bernard Madoff kept showing annual gains of around 10 percent on an annual basis. The sterling performance of Madoff over the long term of around three decades helped him in garnering attention and positive reputation from various financial communities of America. It is important to note that under the facade of sterling performance of the companies owned by Madoff, the greatest Ponzi scheme that might have existed in the financial sector of the world till date was pulled off. The reality behind the sterling performance of the companies owned by Madoff is that a Ponzi scheme was being executed where Madoff focused on using the money provided by new investors to repay the obligations of the previous ones. All the highly profitable facts, figures and reports that were displayed by the companies held by Madoff were completely fake in nature. Reports from various reliable sources highlight that on the December of 2008, Bernard Madoff had a meeting with his sons, where he disclosed that the entire business is complete fake and the fact that he owes around 7 billion USD to multiple clients. In that meeting he also wanted to distribute the Christmas bonus of the employees earlier than usual. After the meeting, the Madoff Juniors consulted with their individual and private attorney who placed the call to officials of the federal government on the evening of December 10. On 11 December, 2008 Bernard Madoff was finally arrested for the execution of a 65 billion USD Ponzi scheme. As of March 2009, Bernard Madoff was pleaded guilty in connection to around 11 acts of felony, which included the fraud of securities. After the weeks, following the arrest of Madoff, investors who lost out on large sums of money filed a number of class action lawsuits under the Southern District of New York (Benson, 3). 2. Explanation of the Madoff Fraud While explaining the Madoff Fraud for this particular assignment, it needs to be stated the entire explanation can be done in regards to the five tragic truisms that are very essential to be discussed and properly related in the assignment. First Tragic Truism The first tragic truism belongs to the category of people. The truism that has been discussed here states that a majority of the people are highly obedient in a work setting. They are more likely to follow the command that has been passed to them through a legitimate source. As a result, this gives a power to the managers to do unethical things as well. This might lead to the evolution of a scenario where the employees may not be aware about the illegal nature of work that has been asked to perform by them by their managers. Because of fear as well as financial needs, the employees prefer to follow the manager’s orders even if they feel that the actions are wrong. This also creates scenarios where in order to avoid unpleasant circumstances, employees look for alternative jobs or in rare cases even become whistleblowers. In relating to this case, the issue of McMahon needs to be discussed. The job of McMahon who was an employee of one of the many companies owned by Bernard Madoff comprised of organizing and documenting project that was supposed to create custom technology for the firm’s trading operations. One year after Madoff’s arrests in the year 2009, it was revealed that the legitimacy of House 5 was actually a cover up for House 17. It was later revealed that the legitimate front of Bernard L Madoff Investment Services (BLMIS) was using IBM Application System/ 400 computer located on the 19th floor which was popularly known as House 5. On the 17th floor, a second IBM AS/ 400 existed which took care of the trading account of the entire company. This resulted in phony trade confirmations and official looking yet fake statements for around 4903 clients. Further to hide the entire setup from the employees, the company focused on providing the traders with a mix of green screen as well as M2 based computers which executed the in-house develop trading software popularly known as MISS. (Dodge, 17). Also, the key punch operators were deliberately fed wrong basket, which were manually inserted in House 17 (Dodge, 20). Hence, in relating to the truism, it can be stated that the employees were deliberately provided wrong information by the company. A majority of them had no idea about the company’s illegal set of operations. Second Tragic Truism The second tragic truism was in regards to managers and their way of managing. In elaborating it, it has to be mentioned that since the business decisions and the business relationships are complex in nature, the legitimate priorities conflict with each other thereby leading manager to take decision with impact and inadequate information. In relating to this case, it can be said that Madoff never disclosed his investment strategy (Insurance Advocate, 18). Also, he strongly prohibited the fund managers from naming him as the actual manager in their performance and marketing exposures. In various cases after the arrest of Madoff in December 2008, it was found that the investors had no clue that the fund was actually diverted by their fund managers to Madoff. Case in point is the diversion of investment funds of Ascot Partners without prior knowledge to the investors (Benson, 22). The barriers that were created by Madoff for the managers responsible for managing the fund clearly highlighted that the managers were provided limited information in regards to the ways of managing the company processes and this acted as the stepping stone to incorrect ways of management. Third Tragic Truism The third tragic truism is in connection to the organizations. Talking about this particular truism, it has to be stated that the stakeholders who are separated either by psychological or physical distance often undermine the factor of ethical behaviour. In this case, the auditor of Bernard Madoff Investment Securities was Friehling and Horowitz. The company was located in a small 13 by 18 inches office in the area of Rockland County in New York and had only three employees. One of the employees was a secretary while the other employee lived in Florida (Benson, 22). The factor of audit though is now openly questioned played a major role in increasing the layer of fake authenticity for the Ponzi scheme pulled off by Madoff. While state laws of the United States require that the accounting firms undergo peer review, the law of New York had a loop hole which helped the accounting firm of Madoff to escape that particular and otherwise mandatory review (Insurance Advocate, 18). Hence, in relating to the above truism, it can be stated that the physical distance of the BMIS and its accounting firm led to the undermining of the factor of underlying ethical behaviour. Fourth Tragic Truism The fourth tragic truism is in regards to oversight and accountability. As per this truism, the stakeholders which include the board of directors, consumers, investors, whistleblowers, auditors, lawyers and regulatory agencies are expected to hold managers and the businesses accountable for their actions. In the real world, the weakness of legal, auditing as well as legal nature contributes to the generation of scandals related to ethicality. In this particular case, the fake auditing reports of BMIS by the merely existent audit firm Friehling and Horowitz greatly contributed to the ability of Bernard Madoff to pull off the Ponzi scheme based monetary and investment structure for around three decades. Apart from this, the legal loop hole that existed for the state of New York in connection to the need for peer review of the auditing firms also helped the auditing firm Friehling and Horowitz to remain unregistered and continue to provide services to BMIS. In relating to the truism discussed in this case, it can be pointed out that the weakness of the auditing and legal frameworks helped in Bernard Madoff to execute the mother of all Ponzi schemes. Fifth Tragic Truism The fifth tragic truism is again in regards to the people. The underlying truism is that the US people want to do the right thing and they want others as well to do the right thing. Reputation and trust is very important to the organizations and individuals. In extreme cases, personal attributes even trigger breach of ethicality. Discussing on this note, it can be said that the Ponzi scheme that was executed by Bernard Madoff for around three decades was largely an outcome of his own greed for money and the various luxuries money can buy (Insurance Advocate, 15). During the period of execution of the Ponzi scheme, Madoff enjoyed the luxuries related to a lavish lifestyle along with acquisition of properties and social recognition and prestige. His own and unique strategy of providing normal returns rather than unique returns helped in getting away from suspicion. Hence, it can be related and said that the personal attribute of Madoff in regards to greed greatly helped in the process of creating ethicality based breach by Madoff. 3. Consequences to Important Stakeholders The stakeholders refer to a group of individuals who are directly or indirectly affected by the decisions taken by the company. The stakeholders are interested in the profitability of the company and since this group of individuals invest their money with the principal objective to earn more profit from their investment. They authorize managers to manage their funds and managers act as agent of principal (stakeholders). There are many stakeholders that are affected by actions of Madoff since many people had invested their life savings in the company which ultimately led to losses. The important group of stakeholders those are likely to be affected by Madoff’s actions Banks, Charitable Community, Bernard Madoff and BMIS, Employees, and External Shareholders. 3. a. Bernard Madoff and BMIS Bernard Madoff was no doubt a financial genius that graduated in the field of political science from Hofstra. The company or fraudulent entity was created through exquisite family sources and human skills that transformed Madoff’s business into reputed business entity. During the period when the company actively participated in stock market (during 70s), it performed well. Then Madoff decided to hire close friends and family members to join him. Thus, from the case it was revealed that not only Madoff, but his friends and family members were important stakeholders of the business entity that were affected. The total estimated market losses exceeded $50 billion and Madoff was found guilty for running 11 illegal operations. The company reportedly showed outstanding total liability of $65 billion. 3. b. Banks The Bernard Madoff fraud distributed the financial services of some the renowned financial institutions and banks who despaired to invest in Madoff’s company. It was difficult to loan money through this group of banks which considered Madoff’s fraudulent schemes meant failure investors to return the money they are liable to return. The stakeholders belonging to this group includes BNP Paribas, Royal Bank of Scotland, HSBC, Banco Santandar, etc. Among the consortium of banks the most affected stakeholder was HSBC with net exposure over $1 billion. 3. c. External Shareholders (Inc. Government) Thousands of people were at stake from the activities of Madoff and the company knew the consequences of the actions. The stock market brokers, investors, kin and kith of investors, government and economy were all affected from the fraudulent activities. There is no debate regarding the fact that moral sentiment of these stakeholders would be adversely affected after the incident and they will refrain from investing in the company in future. 3. d. Charitable Community Ethically, the company was conducting illegal activity of hiding their true financial position from public. The charitable community that is generally motivated for investing in such ponzi schemes especially when the company that launches the scheme represents the same as social cause. Needless to say that these communities were under false expectations and their contribution was misused by the company. 3. e. Employees Madoff primarily operated as broker who also ran asset management company. It was found that organizational structure of Bernard L. Madoff Securities LLC was suspicious. This was revealed from the fact that company charged very less fund management fee compared to other hedge funds. The net fund under management was about $750 million but Madoff stated and made employees and other stakeholders believe that it manages over $15 billion. The company was run by mere 20 employees. 4. Lessons Learned a. Prevention 1: CSR Point of View Madoff was able to attract many investors to invest in their ponzi schemes since the company made high earnings and was able to increase profitability. Therefore, higher profits encouraged more individuals to invest in company’s schemes. The lesson learned from this study from the point of view of Corporate Social Responsibility (CSR) is that the company inflated their earnings and profits and used creative accounting to manipulate true financial position of the company. This was apparent from the fact that even though the company’s balance sheet revealed that their total liabilities were higher than total assets (High financial risk), their stated higher earnings and profits. This means that the company was on the verge of insolvency and in order to protect themselves from the suspicion of investors the company adopted creative accounting. Such an act is considered as misrepresentation of true facts and is against the best interest of various stakeholders. Hence, in short the company was not considering its corporate social responsibility and accountability when involving in fraudulent activities. b. Prevention 2: Earnings Management The internal and external stakeholders of the company were widely affected from the activities of Madoff. The management is entrusted with the responsibility of efficient handling of stakeholders’ funds. In this case it was found that the management manipulated the financial and accounting information of the company and kept the public at large unaware of true financial position of the company (which was on the brink of insolvency). The method used by company’s finance and accounts for intentionally transform financial details of company in favor of business is also known as earnings management. It was learned that Madoff’s method of earning profits from providing false information to public and escaping the suspicion of authorities was the result of management skills of its employees. c. Prevention 3: Stakeholders’ Theory From the perspective of stakeholders’ the managers are similar to agents who are authorized to manage the money invested by stakeholders and they are compensated for providing services in favor of this objective. It was learned from the case of Madoff that there was conflict of interest between the objective of managers and stakeholders. While the former wanted to earn superior profits and commissions by falsifying financial data, the later obviously seeks safety of principal and earnings from investment. Thus, the case reflects genuine illustration of spending money for self-interested goals without proper authorization of respective stakeholders. Works Cited Benson, Sandra S. The CPA Journal. USA: New York State Society. 2009. Print. Dodge, John. Securities Industry News. USA. 2009. Print. Insurance Advocate. Madoff’s Jenga – Like Con-struct Falls Hard on Insurers.USA: Chase Communications Group. 2009. Print. Descartes, R. Case Study: Bernie Madoff’s Ponzi scheme: Reliable Returns from trustworthy Financial Advisor. 2011. Web. October 21, 2013. < http://dcollins.faculty.edgewood.edu/pdfdocuments/Madoff%20Case.pdf>. Wilkins, A. M., Acuff, W. W., and Hermanson, D. R. Understanding a Ponzi scheme: Victim’s Perspectives. 2012. Web. October 21, 2013. < http://www.bus.lsu.edu/accounting/faculty/lcrumbley/jfia/Articles/FullText/2012_v4n1a1.pdf>. Drew, J. Ponzimonium: Madoff and the Red Flags of Fraud. 2010. Web. October 21, 2013. < http://equella.rcs.griffith.edu.au/research/file/75a550bb-fd4f-36f3-9fca-9f6011283876/1/2010-07-ponzimonium-madoff-and-the-red-flags-of-fraud.pdf>. The New York Times. Bernard L. Madoff. 2013. Web. October 21, 2013. < http://topics.nytimes.com/top/reference/timestopics/people/m/bernard_l_madoff/>. Bibliography Goldwasser, Dan L. and Eickemeyer, John H. Accountants Liability in the Madoff Scheme: A CPA Journal Symposium. USA: New York State Society. 2009. Print. Wells, Joseph T. Ponzis and pyramids. USA: New York State Society. 2009. Print. Kramer, Roderick M. Rethinking Trust. USA: Harvard Business Review. 2009. Print. Kravitz, Richard H. Socially Responsible Accounting. USA: New York State Society. 2009. Print. Wong, Jeff. The IT Secrets Behind Bernie Madoff’s Ponzi Scheme. USA: Bank Technology News. 2009. Print. Galagan, Pat. Trust Falls. USA: American Society For Training and Development. 2009. Print. Martin, George A. Who Invested with Madoff? A Flash Analysis of Funds of Funds. USA: Euromoney Institutional Investor Plc. 2009. Print. Dodge, John. The Technology Behind the Scam. USA: Investment Dealers Digest. 2009. Print. Read More