Bernie Madoff is in prison and he handsomely deserves to be. Over years, he ran a private investment fund that took deposits from rich investors and delivered consistently great returns of 10% real terms each year or more.
The only problem is that the whole thing was a vast fraud. He was stealing funds and using new depositors’ funds to hide the hole his pilfering was creating. It’s called a ponzi scheme and is strictly illegal. Total investor losses are estimated to be in the region of £18 billion.
Can you even imagine such a figure?
The question is – how did he get away with it? There’s no single answer, but these features are significant:
• There was a very excessive degree of authority and power vested in one man (Bernard Madoff himself).
• There was a lack of scrutiny by directors and senior management and investors themselves.
• A whistleblower had contacted the regulator ten years before the scandal broke saying that the returns made were mathematically impossible. The regulator did nothing.
• The auditor was too close to the client and generally showed a deep lack of professional scepticism.
So, Madoff was a colossal failure of corporate governance. Almost every significant principle of the Combined Code was broken. Yet this happened in the USA – home to the stringent Sarbanes-Oxley Act. How could this happen? Well, SOx only applies to listed companies and Madoff was a private equity investment, so outside its scope. There appeared to be no appetite for voluntary compliance with best practice.
Perhaps the biggest lesson is that when investors are being given apparently huge returns, they become unwilling to ask questions. Indeed, investors who asked too many questions were dropped by Madoff as being a nuisance. Maybe the victims of the Madoff scandal became victims of their own credulousness and greed?