LEO ARTEMIO A.

PUERTOS
LS 316 – Banking Laws
ATTY. CLAIRE MARIE B. MAURO
April 15, 2021
INTRODUCTION

This term paper is about Bernard Lawrence Madoff. The person who orchestrated the
world’s largest Ponzi scheme that ran for several decades. It is amazing how Madoff
perpetrated the Ponzi scheme for several years in secret, the only reason why it was
uncovered was that he admitted the same to the Securities and Exchange Commission.
This work will show that it doesn’t matter how intelligent you are in financial matters, if
you are blinded with greed for money, still, you can be deceived by market frauds.

WHO IS BERNARD MADOFF?

Bernie Madoff, in full Bernard Lawrence Madoff was born on April 29, 1938 in Queens,
New York, to Jewish parents Ralph Madoff and Sylvia Muntner. He is an American
hedge-fund investment manager and former chairman of the NASDAQ (National
Association of Securities Dealers Automated Quotations) stock market. He is best
known for operating history’s largest Ponzi scheme, a financial swindle in which early
investors are repaid with money acquired from later investors rather than actual
investment income. After spending his freshman year at the University of Alabama, he
earned a degree in political science from Hofstra University, Hempstead, New York in
1960. He studied law briefly at Brooklyn Law School also in 1960 before founding
Bernard L. Madoff Investment Securities with his wife, Ruth, who worked on Wall
Street after earning a degree in psychology from Queens College, City University of
New York. Madoff’s specialty was so-called penny stocks—very low-priced shares that
traded on the over-the-counter (OTC) market, the predecessor to the NASDAQ
exchange.1 Bernie Madoff began his Wall Street career in the early 1960s as a trader
in penny stock. Eventually, he formed the business, Bernard L. Madoff Investment
Securities LLC, that would go on to become one of the largest penny stock brokerage
and wealth management firms. Madoff was a true entrepreneur – the computer trading
software program developed by the investment advisor and his brother, Peter – was
eventually adopted by the NASDAQ trading exchange and laid the foundation for much

1
https://www.britannica.com/biography/Bernie-Madoff
of the electronic trading systems that are commonplace now. In fact, Madoff served as
chairman of the NASDAQ exchange in 1990. 2 On December 2008, Bernard Madoff was
arrested for defrauding thousands of individuals and organizations of billions of dollars
for over two decades. In March 2009, Madoff pleaded guilty of soliciting funds to buy
securities and failing to invest the money, using it instead, as did Charles Ponzi, to pay
returns to early investors and for his own benefit. According to the office of the United
States Attorney, at the end of November of 2008, Madoff’s investment advisory
company had approximately 4,900 client accounts, and reported that they held a
balance of $64.8 billion. In fact, after his arrest, these investments were found by the
3
government to be worth “only a small fraction” of that amount.

HOW BERNARD MADOFF PERPETRATED HIS SCAM?

So how did Madoff achieve his remarkable returns? He claimed to use “a split-strike
conversion strategy” to achieve his reported returns. Split Strike Strategy, also known
as "collar" or "bull-spread", is a strategy of buying a basket of 30-35 blue-chip stocks of
S&P100 and then protecting the stocks with put options. According to Harry
Markopolos, a mathematician and financier, who figured out the fraud in just a few
hours, said, “Madoff had a consistent 1% return a month and 12% return a year no
matter how the market moved”. This alone should have been a red flag to his investors.
When Harry Markopolos was investigating the case, he spoke with different derivatives
traders, heads of research, portfolio managers and investors about Bernie Madoff’s firm.
Surprisingly, Markopolos realized that these people were, in fact, suspicious of Madoff’s
fraud. So how come so many intelligent people were left unaware? The bottom line is
that these people were willing to accept his nonsensical explanations as long as the
returns kept coming in. The interesting examination again is that no matter if the index
went up or down, Bernie Madoff returned the same 1% per month. Madoff's strategy
description claimed that his returns were market-driven, yet his correlation coefficient
was only 6 percent to the market. By looking at these numbers, we can tell that his
performance line was certainly not coming from the stock market. Moreover, it is a well-

2
https://corporatefinanceinstitute.com/resources/knowledge/other/bernie-madoff/
3
https://link.springer.com/article/10.1007/s12115-010-9345-z
known fact that volatility is an important part of the market. The most interesting part is
that none of these investors were able to catch his fraud, even though Harry
Markopolos was able to prove it in just 4 hours using the data analysis. In 2008, many
investors started withdrawing their money from Madoff’s company at a hastened pace
due to the financial crisis. Some investors were even concerned by how Bernie Madoff
was able to get such high returns for his clients even when the stock market was about
to collapse. At this point, it was extremely difficult for Madoff to keep everything secret.
As a result, he turned himself into the FBI and SEC. According to interviews, no one
from his family or work knew that the whole firm was a big fraud; he was running the
scheme by himself. 4

HOW BERNARD MADOFF GOT AWAY WITH IT FOR SO LONG?

Madoff's apparently ultra-high returns persuaded clients to look the other way. In fact,
he simply deposited their funds in an account at Chase Manhattan Bank—which
merged to become JPMorgan Chase & Co. in 2000—and let them sit. When clients
wished to redeem their investments, Madoff funded the payouts with new capital, which
he attracted through a reputation for unbelievable returns and grooming his victims by
earning their trust. Madoff also cultivated an image of exclusivity, often initially turning
clients away. This model allowed roughly half of Madoff's investors to cash out at a
profit. These investors have been required to pay into a victims' fund to compensate
defrauded investors who lost money. 5

CONTRIBUTORY ROLES OF BANKS IN THE NON-DETECTION OF THE SCAM

JP MORGAN CHASE

JPMorgan Chase was Madoff's "primary banker for over 20 years, and was responsible
for knowing the business of its customers. JPMorgan Chase is on the verge of agreeing
to a historic settlement with federal authorities over its relationship with Bernie Madoff.
The bank may pay fines of up to $2 billion, while also agreeing to a deferred prosecution

4
https://digitalcommons.pace.edu/cgi/viewcontent.cgi?article=1288&context=honorscollege_theses
5
https://www.investopedia.com/terms/b/bernard-madoff.asp
for violating the Bank Secrecy Act. An earlier lawsuit against JPMorgan filed by Irving
Picard, the court-appointed trustee tasked with recovering Madoff's clients' funds,
provides a good indication of the charges facing the company. Additionally, the lawsuit
alleges that JPMorgan "had everything it needed to unmask and stop the fraud it had
unique information from which it could have reached only one plausible conclusion:
Madoff was a fraud."

1.  JPMorgan Chase ignored years of red flags in Madoff's Chase bank account
that he used for money laundering and Ponzi scheme payouts. Banks are required
to know the purpose of customer accounts and monitor them for suspicious activities,
but JPMorgan Chase never halted or reported the suspicious activity in Madoff’s
account. Over a roughly seven-year stretch from 1998 to 2005, the account made $76
billion in payouts to a single customer. Madoff made odd repetitive transactions,
oftentimes in a single day, frequently using handwritten checks. In 2002, the account
made 318 payments of exactly $986,301 to a single customer.

2.  JPMorgan Chase seems to have violated basic account monitoring and "know
your customer" principles. The activity in Madoff's account didn't appear to reflect any
"legitimate business purpose."

3. JPMorgan Chase knew at least as far back as 2006 that Bernie Madoff funds
were suspicious. Around 2006, JPMorgan Chase began considering selling its own
financial products based on Madoff feeder funds. Before selling these products to
investors, JPMorgan Chase had to check out Madoff and the funds that the bank
wanted to base its own products on.

4. Despite its suspicions, JPMorgan Chase went ahead and sold to its customers
financial products based on Bernie Madoff feeder funds. Most of the funds
JPMorgan Chase created and sold to investors used borrowed money to magnify the
returns from Madoff funds. By March 2007, JPMorgan Chase had $100 million worth of
Madoff products it was structuring in the pipeline and was thinking of creating an
additional $100 million to $200 million.
5. JPMorgan Chase sold more Madoff-based products to customers after ignoring
internal warnings that Madoff was running a Ponzi scheme.

6. JPMorgan neglected to report Madoff to American law enforcement even after it

told a British financial authority that the bank was retrieving its own Madoff
6
investments because he was a fraud.

WESTPORT NATIONAL BANK

Further, another bank interconnected in the vast Ponzi scheme perpetuated by Madoff, is
now in spotlight. The Westport National Bank and its parent company, Connecticut
Community Bank according to a lawsuit filed by investors who lost a combined $60
million in the Madoff Ponzi scheme should have stood sentry over their funds. Richard
Abramowitz, an investor who lost money at the hands of Madoff, testified that it had been
his impression that Westport National would take possession of his assets and verify
their existence. The bank, however, said it had no obligation to catch the Madoff fraud
7
and that its custodian contract is limited its obligations to “ministerial duties”.

CONCLUSION

Indeed, Bernard Madoff’s investors have enough knowledge to figure out the fraud
before they lost all of their money but because of the huge interest rates, they were
blinded by greed and gluttony for money, as a result they suffered massive financial
losses. The Madoff scam also exposed the failure of the United States Securities and
Exchange Commission to uncover the scam that already operated for several years.
Their failure to do their jobs cost the hard-earned money of people from all walks of life
from the different parts of the world to get wiped out in an instant. Therefore, the moral
lesson here from Buddha that we can absorb and contemplate is “To stop suffering, stop
greediness. Greediness is a source of suffering”. To dream for a better life is not immoral
but when you achieve that dream through greed, then, it becomes dangerous.

References:
6
https://www.fool.com/investing/general/2013/12/14/why-the-bernie-madoff-case-is-so-dangerous-for-jpm.aspx
7
https://dealbook.nytimes.com/2013/07/08/madoff-case-puts-focus-on-duties-of-custodial-banks/
https://www.britannica.com/biography/Bernie-Madoff (The Editors of Encyclopedia Britannica)

2
https://corporatefinanceinstitute.com/resources/knowledge/other/bernie-madoff/

3
https://link.springer.com/article/10.1007/s12115-010-9345-z (Lionel S. Lewis,Published: 24 July 2010)

4
https://digitalcommons.pace.edu/cgi/viewcontent.cgi?article=1288&context=honorscollege_theses (Nurilya
Sattybayeva,2019)

5
https://www.investopedia.com/terms/b/bernard-madoff.asp (Adam Hayes and Khadija Khartit,2020)

6
https://www.fool.com/investing/general/2013/12/14/why-the-bernie-madoff-case-is-so-dangerous-for-jpm.aspx
(John Reeves and Ilan Moscovitz, December 14,2013)

7
https://dealbook.nytimes.com/2013/07/08/madoff-case-puts-focus-on-duties-of-custodial-banks/ (Susan Antilla,
July 8,2013)