Ponzi Scheme:
Ponzi scheme is a fraudulent investment strategy where an existing investor is paid high short term return with the principals flowing from other new investors. So simple in explanation and so vast in its consequences. In order for this scheme to work, there has to have steady flow of investment to the fund, thus more new investors. Such strategy, which has its existance from 1920s, can easily be leveraged by a private fund house, hedge funds which are immuned to regulations.
Who is Mr. Madoff????
"Ex-chairman of NASDAQ, esteemed member of SEC, founder of Bernard L. Madoff Investment Securities, a firm which is outperforming market in terms of steady juicy return to investor in this drowning economy". Not any more.
Madoff's broker-dealer firm has its investment advisory arm which runs a massive fund house (with AUM $17 billion as quoted in public sphere) with a well-known option trading strategy called, "Collar" - that means short Call, buy Put, considered to be safest in capital market fraternity. Such strategy is deemed to suceed provided the strategist has the knack of time - when to get into market & when to come out. Since his fund was performing relatively better in this choppy market, investors(mostly big banks, fund of funds, ultra-rich individuals, charity organizations) were lured to join this exclusive black box of Madoff. With dollar dividends coming at ease, none of the investors ever scrutinized or questioned this man having distinctive background. And now, they all marred in the quagmire of Ponzi. Madoff never disclosed his investment strategy in public media nor explained that in investor reporting. He was equally illusive to regulators with very minimal disclosure, being a private broker-dealer / hedge fund manager. His stature remained tact since his stream of investors are not mass- market individuals, rather exclusive club of luminaries built on his rapport and personal relations (smells hedge fund, is n't it).
Strategy• Build an exclusive club of investors through his circle of friends
• Build the fund house framed on Ponzi structure
• Limited regulatory liability being a private firm (again, hedge fund disclosure doctrines are non-existent). SEC even could not find any clue to possible fraud charge in 2006.
• Exclusivity of investor club and steady return kept fradulent scheme suspicion at bay.
• Maintained utmost secrecy on his investment to his closest executives & employees
All split open when he faced with massive redemption pressure (around $7 billion) from investors and then he starting disclosing the real scheme to his sons- close executives in the firm. Though it is premature to conclude on the whole fiasco, but it does raise eyebrows on certain market players who are really free, arogant- hedge funds, PEs and the regulations they are tied to till now.
• SEC regulations on hedge fund industry is abysmally low - Madoff has thrived because of that. With no information on his investment details, regulators are equally blinded on the whole story.
• Limited disclosure to investors - Hedge funds being considered to possess exclusive investment strategy which are not to be shared openly, investors in those entities blindly believe and rarely questions the nitty-gritty of investment strategy and underlying risk. That's where again Madoff has maneuvered his investor group / family.
• Investor callousness- When dividend outsmarts market in this southward economy, investors were happy to count dollars than questioning the authenticity. Madoff's fund has neither details available at SEC nor Financial Industry Regulatory Authority (FINR).
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