US$65b. 136 countries. 40,000 victims. No one expected the largest financial scam in modern history to be plotted by a former chairman of Nasdaq.
Financial scams arguably began at the same time money began circulating amongst people. The first recorded instance dates back to 300 BC, when a Greek merchant attempted insurance fraud by sinking his ship to claim its cost. Unfortunately for the man, he drowned while trying to escape the ship. While he didn’t make money, he at least made history.
Of all the fraudsters that have surfaced since then, none comes close to Bernard “Bernie” Madoff. Madoff was a prolific hedge fund manager back in the early 1980s, and even became Nasdaq’s chair in the 90s. His success came from becoming a market maker – starting small, he grew his company to become a firm executing 9% of the NYSE’s daily trades. He profited from the bid-ask spread of stock prices, making approximately $100m for himself every year.
So what exactly happened here? Well, that first part of Madoff’s business was actually legitimate and honest. But then there was his “hedge fund” that promised investors 18-20% returns a year. When the Fed’s interest rate was between 3-6%, it’s no wonder that even Steven Spielberg and Larry King threw their money at Bernie.
How Madoff sold himself was through his “investing strategy” of buying blue-chip stocks in the S&P 500, and then purchasing call and put options in order to multiply profits in an uptrend and hedge against losses in a downtrend. Unfortunately for investors, sweet-talking Madoff had absolutely no idea how to do that. Instead, he actually put all the cash he received into a savings account with JP Morgan ($JPM) and used that, plus cash from new investors, to pay out any withdrawal requests. Yup – it’s a classic example of a Ponzi scheme.
It all ended for Madoff when the GFC happened in 2008. His hedge fund still promised extraordinarily high returns despite the entire stock market collapsing, raising eyebrows amongst experts. Spooked investors began withdrawing from his fund, and without any new inflow of funds, Madoff could not keep things up. In December 2008, he confessed to his sons and was turned in to authorities the next day. He was later sentenced to 150 years in prison.
Madoff’s story is coming to Netflix ($NFLX) in the new year as a four-part doco series. While scandals this epic aren’t frequent, financial scams still happen on a daily basis. If it sounds too good to be true, it probably is.