Ethical Principles and Decision-Making

1 The Changing Environment and Stakeholder Management 33

Cases

Case 1

Bernard L. Madoff Investment Securities LLC:
Wall Street Trading Firm

Bernard L. Madoff Investment Securities LLC was founded in the 1960s as a
small investment fi rm on Wall Street. With $5,000 in savings from summer jobs
and at the age of 22, Madoff launched the fi rm that in the 1980s would later rank
with some of the most prestigious and powerful fi rms on Wall Street. Madoff
began as a single stock trader before starting a family- operated business that
included his brother, nephew, niece, and his two sons. Each held a position that
was quite valuable within the company.

Madoff had also created “an investment- advisory business that managed
money for high- net- worth individuals, hedge funds and other institutions.” He
made profi table and consistent returns by repaying early investors from the money
received from new investors. Instead of running an actual hedge fund, Madoff held
this investment operation inside his fi rm on the seventeenth fl oor of the building
where only two dozen staff members were permitted to enter the secured area.
No employee dared question the security and confi dentiality of the “hedge fund”
fl oor due to the prestige and power that Madoff held. The $65 billion investment
fund was later discovered to be fraudulent, involving one of the largest Ponzi
schemes in history and shattering the lives of thousands of individuals, institu-
tions, organizations, and stakeholders worldwide.

The Man with All the Power
Bernard Madoff’s charisma and amiable personality were important traits that
helped him gain power in the fi nancial community and become one of the largest
key players on Wall Street. He became a notable authoritative fi gure by securing
important roles on boards and commissions, helping him bypass securities reg-
ulations. One of the roles included serving as the chairman of the board and
directors of the NASDAQ stock exchange during the early 1990s. Madoff was
knowledgeable and smart enough to understand that the more involved he
became with regulators, the more “you could shape regulations.” He used his
reputation as a respected trader and perceived “honest” businessman to take
advantage of investors and manipulate them fraudulently. Investors were hood-
winked into believing that it was a privilege to take part in Madoff’s elite invest-
ments, since Madoff never accepted many clients and used exclusively selective
recruiting in order to keep this part of his business a secret.

Madoff was even able to keep his employees quiet, telling them not to speak
to the media regarding any of the business activities. While several understood
something was not right, they ignored suspicions due to Madoff’s perceived
clean record and aura: “He appeared to believe in family, loyalty, and honesty. . . .
Never in your wildest imagination would you think he was a fraudster.”

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34 Ethics

Dr. Meloy, author of the textbook The Psychopathic Mind, states that “typi-
cally people with psychopathic personalities don’t fear getting caught. . . . They
tend to be very narcissistic with a strong sense of entitlement.” This led many
analysts of criminal behavior to observe similar traits between Madoff and serial
killers like Ted Bundy. Analysts discovered several factors motivating Madoff to-
ward a Ponzi scheme: “A desire to accumulate vast wealth, a need to dominate
others, and a need to prove that he was smarter than everyone else.” What ever
the motivating factors were, Madoff’s behavior was still criminal and affected a
large pool of stakeholders.

Early Suspicions Arise
Despite the unrealistic returns and questionable nature of Madoff’s business
operations, investors continued to invest money. In 2000, a whistle-blower from a
competing fi rm— Harry Markopolos, CFE, CFA— discovered Madoff’s Ponzi scheme.
Markopolos and his small team developed and presented an eight- page docu-
ment that provided evidence and red fl ags of the fraud to the Securities and
Exchange Commission (SEC)’s Boston Regional Offi ce in May 2000. Despite
the SEC’s lack of response, Markopolos resubmitted the documents again in
2001, 2005, 2007 and 2008. His fi ndings were not taken seriously: “My team and
I tried our best to get the Securities and Exchange Commission (SEC) to inves-
tigate and shut down the Madoff Ponzi scheme with repeated and credible warn-
ings.” Because Madoff was well respected and powerful on Wall Street, few
suspected his fraudulent actions. The status and wealth that Madoff had created
gave him the means to manipulate the SEC and regulators alike.

Negligence on All Sides
The negligence and gaps in governmental regulation make it very diffi cult to
point to only one guilty party in the Madoff scandal. The SEC played a crucial
role by allowing Madoff’s operations to carry out for as long as they did. For
over 10 years, the SEC received numerous warnings that Madoff’s steady re-
turns were anything but ordinary and nearly impossible. The SEC and the Finan-
cial Industry Regulatory Authority, “a non- government agency that oversees all
securities fi rms,” were known to have investigated Madoff’s fi rm over eight times
but brought no charges of criminal activity. Despite the red fl ags and mathemat-
ical proof that Markopolos presented, SEC staff allowed Madoff’s operations to
continue unchallenged. Spencer Bachus, a politician and a Republican mem-
ber of the U.S. House of Representatives, stated that “What we may have in the
Madoff case is not necessarily a lack of enforcement and oversight tools, but a
failure to use them.” Unfortunately, there could be another side to the story. David
Kotz, currently the SEC’s inspector general, planned an ongoing internal investi-
gation to understand the reasoning behind the negligence and to determine if any
confl ict of interest between SEC staff and the Madoff family could have been part
of the problem. Arthur Levitt Jr., who was part of the SEC and a chairman from
1993 to 2001, had close connections with Madoff himself. He would rely on

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1 The Changing Environment and Stakeholder Management 35

Madoff’s advice about the functioning of the market, although Levitt denies all ac-
cusations. In September 2009, it was offi cially stated that no evidence was found
relating to any confl ict of interest: “The OIG [Offi ce of Inspector General] investi-
gation did not fi nd evidence that any SEC personnel who worked on an SEC ex-
amination or investigation of Bernard L. Madoff Investment Securities LLC had
any fi nancial or other inappropriate connection with Bernard Madoff or the Madoff
family that infl uenced the conduct of their examination or investigatory work.”

Unfortunately, the SEC is not the only party to blame. JPMorgan Chase has
also been criticized for its actions regarding the Madoff scandal. Instead of in-
vesting client’s money in securities, as Madoff had promised to do, he deposited
the funds in a Chase bank account. In 2008, federal court documents show that
“the account had mushroomed to $5.5 billion. . . . This translates to $483 million
in after- tax profi ts for the bank holding the Madoff funds.” As one of Chase’s larg-
est customers, Madoff’s account should have been monitored closely. Internal
bank compliance systems should have detected such red fl ags. Unfortunately,
Madoff was savvy enough to move millions of dollars between his U.S. and Lon-
don operations, making it seem like he was actively investing clients’ money. The
massive account balances of investors should not have been diffi cult to overlook.
Don Jackson, director of the SecureWorks Counter Threat Unit Intelligence Ser-
vices, noted that “The only way to stop this kind of fraud is for the bank to know
its clients better and to report things that might be suspicious. It really comes
down to human control.” This was an area of weakness for JPMorgan Chase at
the time.

Where Were the Auditors?
For Madoff to successfully perpetrate such a large scam spanning more than
a de cade, he needed the help of auditors to certify the fi nancial statements of
Bernard L. Madoff Investment Securities. The company’s auditing ser vices were
provided by a three- person accounting fi rm, Friehling & Horowitz, formerly run
by David Friehling. For over 15 years, Friehling confi rmed to the American Insti-
tute of Certifi ed Public Accountants (AICPA) that his fi rm did not conduct any
type of audit work. Because of this confi rmation, Friehling did not have to “enroll
in the AICPA’s peer review program, in which experienced auditors assess each
fi rm’s audit quality every year . . . to maintain their licenses to practice.” Friehling
& Horowitz had in fact been auditing the books of Madoff for over 17 years, pro-
viding a clean bill of health each year from 1991 through 2008. Authorities state
that if Friehling provided integrity in his fi ndings, the scandal would not have
continued for as long as it did: “Mr. Friehling’s deception helped foster the illu-
sion that Mr. Madoff legitimately invested his client’s money,” stated U.S. Attorney
Lev Dassin. In addition to receiving total fees of $186,000 annually from the au-
diting ser vices provided to Madoff, Friehling also had accounts in Madoff’s fi rm
totaling more than $14 million and had withdrawn over $5.5 million since the year
2000. Friehling deceived investors and regulators by providing unauthorized
audit work and verifying fraudulent fi nancial statements. Given the size of the

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36 Ethics

accounting fi rm, a red fl ag should have been raised. Madoff’s operations were
too large in size and complexity for the resources of a three- person account-
ing fi rm.

Revealing the Fraud
As the U.S. economy entered the 2008 recession period, investors began to panic
and withdraw their money from Madoff’s accounts, totaling more than $7 billion.
Madoff was unable to cover the redemptions and struggled “to obtain the liquidity
necessary to meet those obligations.” He confessed to his sons that the busi-
ness he was running was a scam. On December 11, 2008, Bernard Madoff was
arrested by federal agents— one day after his sons reported his confession to the
authorities.

Global Crisis
The Ponzi scheme that Madoff ran for more than a de cade affected the lives of
thousands of individuals, institutions, organizations, and stakeholders world-
wide. A 162- page list was submitted to the U.S. Bankruptcy Court in Manhattan
detailing the affected parties. The lengthy list consisted of some of the wealthi-
est investors and well- known names around the region: “They reportedly include
Philadelphia Ea gles own er Norman Braman, New York Mets own er Fred Wilpon
and J. Ezra Merkin, the chairman of GMAC Financial Ser vices.” Talk show host
Larry King and actor John Malkovich were on the list, among others. Many
investment- management fi rms, such as Tremont Capital Management and Fair-
fi eld Greenwich Advisors, had invested large amounts in Madoff’s funds and
were hit the hardest fi nancially. Major global banks, “including Royal Bank of
Scotland, France’s largest bank, BNP Paribas, Britain’s HSBC Holdings PLC and
Spain’s Santander” were also known to have lost millions. Charitable foundations,
such as the Lautenberg foundation; and fi nancial institutions, including Bank of
America Corp., Citigroup, and JPMorgan Chase were all stakeholders in the
Madoff scandal. Ordinary individuals also invested much of their life savings into
what they believed was a “once in a lifetime opportunity.” William Woessner, a
retiree from the State Department’s Foreign Ser vice, agreed that the investors
“were made to feel that it was a big favor to be let in if you didn’t have a lot of
money. It was an exclusive club to belong to.” It has been reported that individual
losses were between $40,000 to over $1 million in total. There were 3,500 inves-
tors from New York and more than 1,700 from Florida.

The repercussions of Madoff’s Ponzi scheme have been emotional as well
as fi nancial. A French aristocrat and professional investor living within the sub-
urbs of New York, Rene- Thierry Magon de la Villehuchet, had invested almost
$1.4 billion in Madoff’s accounts. He had invested both his and his client’s money,
only to lose everything. Villehuchet felt personally responsible for the loss of his
clients’ money: “He had a true concept of capitalism. . . . He felt responsible and
he felt guilty,” said his brother Bertrand de la Villehuchet. Villehuchet’s depres-
sion grew to such a point that he committed suicide on December 22, 2008.

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1 The Changing Environment and Stakeholder Management 37

Consequences and Aftermath
On June 29, 2009, Judge Denny Chin found Madoff guilty on eleven criminal
counts and sentenced him to 150 years in prison, the maximum possible sen-
tence allowed at the time. Chin’s severe sentence was infl uenced by the state-
ments given by Madoff’s victims and the 113 letters received and fi led with the
federal court: “A substantial sentence may in some small mea sure help the vic-
tims in their healing pro cess,” stated Judge Chin. Madoff was also forced to pay
a $170- billion legal judgment passed by the government, stating that this amount
of money “was handled by his fi rm since its founding in the 1960s.” David Frieh-
ling, the auditor for Madoff’s books, was also arrested on fraud charges. He was
initially “released on a $2.5- million bond and had to surrender his passport.”
Friehling lost his CPA license in 2010, and his sentencing has since been post-
poned four times. He faces a sentence of more than 100 years in prison.

yer Irving H. Picard is a bankruptcy trustee in the Madoff scandal. As a
court- appointed trustee, Picard has fi led numerous lawsuits and has collected
$1.2 billion in recovered funds from “banks, personal property, and funds around
the world.” It is estimated that from this $1.2 billion, Picard has earned approxi-
mately $15 million. More than $116 million has been given to 237 Madoff victims,
each receiving up to $500,000. In order to help the victims of the Madoff scan-
dal, Picard started a program called “Hardship Case.” He has also fi led a $199
million lawsuit against the Madoff family, including Madoff’s brother, his two
sons, and niece, all of whom worked alongside Madoff. An additional lawsuit was
fi led against Madoff’s wife for $44.8 million, stating that she had transferred large
amounts of money from the fi rm “over a six- year period.” As of now, none of the
family members— Madoff’s two sons, brother, niece, and wife— have been found
guilty on any of the charges. Madoff’s oldest son, Mark, 46, committed suicide in
December 2010. Madoff’s victims took swift action against the negligence of SEC
and JPMorgan Chase. U.S. District Court Judge Colleen McMahon threw out
most of the $19.9 million charges against JPMorgan in November 2011, however.
The New York Mets own ers paid a settlement of $162 million in March of 2012 to
avoid going to trial to answer the allegations made by Irving Picard.

Hidden Secrets?
Despite the accusations of negligence that JPMorgan Chase received from the
public, it was one of the biggest- profi ting fi nancial fi rms in the Madoff scandal.
As stated earlier in the case, JPMorgan made a profi t of $483 million. During
2006, “the bank had started offering investors a way to leverage their bets on
the future per for mance of two hedge funds that invested with Mr. Madoff” and
decided to place $250 million of their own money inside these funds. A few
months before Madoff’s arrest in 2008, JPMorgan withdrew its $250 million,
stating that it had become “concerned about the lack of transparency and its
due diligence raised doubts about Madoff’s operations.” It is surprising that the
bank was suspicious and apprehensive toward investments with Madoff, but
at the same time raised no concerns about the large amount of money being

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38 Ethics

deposited in Madoff’s accounts within the bank. JPMorgan also failed to alert
investors to move their money, stating that “The issues did not meet the thresh-
old necessary to permit the bank to restructure the notes. . . . We did not have
the right to disclose our concerns.” Regardless of the public statements made
by JPMorgan in support of its actions, many lawyers and investors believe that
the bank had knowledge of Madoff’s scam but wanted to secure high returns for
as long as possible.

Ethical Flaws
In a 2011 New York Magazine interview, Madoff stated that he never thought the
collapse of his Ponzi scheme would cause the sort of destruction that has befallen
his family. He asserted that unidentifi ed banks and hedge funds were somehow
“complicit” in his elaborate fraud, an about- face from earlier claims that he was the
only person involved. “They had to know,” Mr. Madoff said. “But the attitude was
sort of, ‘If you’re doing something wrong, we don’t want to know.’ ” To date, none
of the major banks or hedge funds that did business with Mr. Madoff have been
accused by federal prosecutors of knowingly investing in his Ponzi scheme.
However, in civil lawsuits Picard has asserted that executives at some banks
expressed suspicions for years, yet continued to do business with Madoff and
steer their clients’ money into his hands.

In some ways, Madoff has not tried to evade blame. He has made a full con-
fession, saying that nothing justifi es what he did. And yet, for Madoff, that doesn’t
settle the matter. He feels misunderstood. He can’t bear the thought that people
think he’s evil. “I’m not the kind of person I’m being portrayed as,” he told New
York Magazine.

A main issue in this controversy is the continuous fraudulent operations that
Madoff was able to maintain for a de cade that created a $65 billion Ponzi scheme
and shattered the lives of thousands around the world. For most of the world,
Bernie Madoff is a monster: he betrayed thousands of investors, and bankrupted
charities and hedge funds. On paper, his Ponzi scheme lost nearly $65 billion;
the effects spread across fi ve continents. And he brought down his own family
with him, a more intimate kind of betrayal.

Bernard Madoff was the central stakeholder who manipulated and involved
his brother, two sons, and niece, all of whom worked inside the Bernard L. Madoff
Investment Securities LLC. Other key stakeholders included Madoff’s employ-
ees, who had invested their money into an operation they believed was legal and
ethical. The fi nancial community were also major players, including fi nancial in-
stitutions, investment management fi rms, charitable organizations, and global
banks. The government, specifi cally the SEC, and the justice department, were
also heavily involved. The lawyer Irving Picard was a key player, as was the whistle-
blower Harry Markopolos and his team who revealed the nature of the scam
early on, even though the SEC and other government regulators did not move on
the evidence.

As of October 2013, Federal authorities are working toward mounting a
criminal investigation into JPMorgan Chase, believing that the bank may have

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1 The Changing Environment and Stakeholder Management 39

intentionally neglected Madoff’s Ponzi scheme. Having recently agreed to a $13
billion settlement with the U.S. government to settle charges that the bank over-
stated the quality of mortgages it was selling to investors in the run- up to the
fi nancial crisis, the threat of criminal charges over the Madoff case represents
another major threat to the reputation of the nation’s largest bank. The resolution
of this scheme is not over.

Questions for Discussion
1. What did Madoff do that was illegal and unethical?
2. Identify some of the main reasons that Madoff was able to start and sustain

such an enormous Ponzi scheme for as long as he did?
3. Who were/are the major stakeholders involved and affected by Madoff’s

scheme and scandal?
4. Did Madoff have accomplices in starting and sustaining his scheme or was

he able to do it alone? Explain.
5. How was he caught?
6. What lessons can be learned from Madoff’s scandal?

Sources
This case was developed from material contained in the following sources:

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40 Ethics

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1 The Changing Environment and Stakeholder Management 41

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