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Anatomy of a Financial Fraud: Madoff, Stanford, and the $100 Billion Shell Game

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Anatomy of a Financial Fraud: Madoff, Stanford, and the $100 Billion Shell Game The University of Texas School of Law 2009 Page Keeton Civil Litigation Conference October 29-30, 2009 Austin, Texas Anatomy of a Financial Fraud: Madoff, Stanford, and the $100 Billion Shell Game Stephen F. Malouf Stephen F. Malouf The Law Offices of Stephen F. Malouf, P.C. 3811 Turtle Creek Blvd., Suite 1600 Dallas, Texas 75219 (214) 969-7373 [email protected] Continuing Legal Education • 512-475-6700 • www.utcle.org Anatomy of a Financial Fraud: Madoff, Stanford, and the $100 Billion Shell Game I. INTRODUCTION On December 11, 2008, FBI Special Agent Theodore Cacioppi met with Bernard Madoff at Madoff’s apartment in New York. after the FBI was informed by certain Madoff employees that Madoff had confessed to them that “in substance, ...his investment advisory business was a fraud.”1 According to Cacioppi: After identifying myself, MADOFF invited me, and the FBI agent who accompanied me, into his apartment. He acknowledged knowing why we were there. After I stated, “we're here to find out if there's an innocent explanation." MADOFF stated, “There is no innocent explanation." MADOFF stated, in substance, that he had personally traded and lost money for institutional clients, and that it was all his fault. MADOFF further 'stated, in substance, that he ~paid investors with money that wasn't there." MADOFF also said that he was “broke" and "insolvent" and that he had decided that “it could not go on," and that he expected to go to jail. MADOFF also stated that he had recently admitted what he had done to Senior Employee Nos. 1, 2, and 3. Thus ended the largest financial fraud in U.S. history. Madoff subsequently plead guilty to Securities Fraud; Investment Adviser Fraud; Mail Fraud; International Money Laundering; Money Laundering; Making False Statements; Perjury; False Filing with the S.E.C.; and Theft From an Employee Benefit Plan on June 29, 2009. The massive Ponzi Scheme Mr. Madoff orchestrated is estimated to have caused losses in excess of $50 billion, and didn’t end because the SEC or the securities’ industry exposed it, but because Madoff confessed. On June 18, 20009, Robert Allen Stanford (“Stanford”) and several affiliated entities and persons were indicted for Conspiracy to Commit Mail Fraud, Wire and Securities Fraud; Wire Fraud; and Mail Fraud.2 The Ponzi Scheme they are accused of having orchestrated is estimated to have caused losses of over $7 billion. Prior to that, on February 17, 2009, all of Stanford’s related entities were placed into receivership. The anatomy of the fraud perpetrated by Mr. Madoff and alleged to have been perpetrated by Mr. Stanford is simple - they took money from investors, promised to invest it in securities, but instead spent most of it. In some instances they used money invested by new investors to make payments to past investors. That’s it - classic Ponzi Schemes. This article will examine why people 1 Complaint in United States of America v. Bernard Madoff at ¶ 5, 08 MAG 2735 (S.D.N.Y.)(December 11, 2008). 2 There has be no judicial determination of the guilt or innocense of Allen Stanford or his affiliated entities. Accordingly, unless otherwise noted, all statements related to the conduct of Mr. Stanford or his related entities are allegations only. 1 invested with Messrs. Madoff and Stanford, the red flags raised by third-parties over the course of a decade, and the fallout from their actions. II. HOW DID IT HAPPEN? The U.S. Securities and Exchange Commission (“SEC”) describes a Ponzi Scheme as follows: Ponzi schemes are a type of illegal pyramid scheme named for Charles Ponzi, who duped thousands of New England residents into investing in a postage stamp speculation scheme back in the 1920s. Ponzi thought he could take advantage of differences between U.S. and foreign currencies used to buy and sell international mail coupons. Ponzi told investors that he could provide a 40% return in just 90 days compared with 5% for bank savings accounts. Ponzi was deluged with funds from investors, taking in $1 million during one three-hour period—and this was 1921! Though a few early investors were paid off to make the scheme look legitimate, an investigation found that Ponzi had only purchased about $30 worth of the international mail coupons.3 In a 477 page report titled Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme - Public Version (the “OIG Report”) the SEC Office of Investigations concluded that: [T]he SEC received more than ample information in the form of detailed and substantive complaints over the years to warrant a thorough and comprehensive examination and/or investigation of Bernard Madoff and BMIS for operating a Ponzi scheme, and that despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. The OIG found that between June 1992 and December 2008 when Madoff confessed, the SEC received six10 substantive complaints that raised significant red flags concerning Madoff’s hedge fund operations and should have led to questions about whether Madoff was actually engaged in trading. Finally, the SEC was also aware of two articles regarding Madoff’s investment operations that appeared in reputable publications in 2001 and questioned Madoff’s unusually consistent returns.4 The investigation into the SEC’s failures to sooner uncover the Madoff and Stanford schemes reveal 3 http://www.sec.gov/answers/ponzi.htm. 4 U.S. Securities and Exchange Commission Office of Investigations, Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme - Public Version, August 31, 2009 at 20-21, http://www.sec.gov/news/studies/2009/oig-509.pdf. 2.
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