Coda of Bernie Madoff’s Ponzi Orchestra

White-collar crimes are nonviolent crimes that are committed by individuals or organizations for financial gain. They often involve deception, fraud, or other forms of financial misconduct. White-collar crimes can have a significant impact on society. 

They can cost businesses and individuals billions of dollars, and they can erode public trust in the financial system. A well-known case of such is the Bernie Madoff scandal or fraud. Bernie Madoff was a Wall Street financier who ran a Ponzi scheme, considered the largest in history. 

The scheme operated for over 17 years, from 1992 to 2009, and defrauded investors of over $65 billion. Madoff’s case is a classic example of a white-collar crime. A Ponzi scheme is a deceitful investment strategy where fresh capital from new investors is utilized to settle the debts of earlier investors. 

This creates the illusion of a prosperous investment scheme. If the inflow of money into the scheme surpasses the outflow, everything appears to be in order. However, once this situation is reversed, the scheme crumbles. 

This fraudulent system derives its name from Charles Ponzi (1920), an Italian swindler who offered clients a promise of doubling their investments within three months. 

He claimed to achieve this through a novel investor cash flow model and the exchange of arbitrary earnings reply to coupons between Europe and the United States. Within a year, the plan unravelled, resulting in investors losing over 20 million dollars.

Keywords: White Collar Crimes – Ponzi Scheme – Bernard Madoff – Indian Legislation

The expression “white collar crime,” coined by American criminologist Edwin Sutherland in 1939, referred to the characteristic dress of the criminals, who were typically businesspeople, high-ranking professionals, and politicians. 

Edwin Sutherland defines white collar crimes as “a crime committed by a person of respectability and high social status in the course of their occupation.” 

Corporate crime refers to white-collar crime that is committed as part of a coordinated and orchestrated effort to benefit a corporation’s monetary interests. In some circumstances, fake entities masquerading as legal businesses or partnerships commit corporate crimes. 

Corporations cannot be imprisoned, but they can be criminally penalized through fines and other consequences. In many circumstances, criminal culpability is predicated on the actions or omissions of the company’s employees and executives. 

The term ‘blue-collar crime’ first appeared in the 1920s. The word was then applied to Americans who did manual labour. They often choose darker-coloured clothing to make stains less obvious. Some people used to wear blue collared clothes. 

These were hourly workers for a modest wage. White-collar crime has existed for millennia and is common in many types of enterprises, professions, and industries. Blue-collar crimes are committed by persons who labour physically, using their hands, whereas white-collar crimes are committed by people who are knowledgeable and utilize their knowledge to perpetrate crimes. 

The Supreme Court in State of Gujarat v. Mohanlal Jitamalji Porwal and Anr. Justice Thakker[i] the difference between ‘blue collar crimes’ and ‘white collar crimes’ were laid down. 

It was elucidated that where one person can murder another in the heat of the moment, causing financial loss or conducting economic crimes requires strategy. It entails calculations and plan formulation to generate personal gains.

The word ‘Ponzi’ is affiliated with Charles Ponzi, the most ostentatious early practitioner of a scheme in which the fraudster constructs a plausible investment, attracts investors, and then uses the money from older investors to pay off newer ones, while raking in a tidy profit. 

In 1919, Charles led investors to believe that they could earn a 50 per cent return in as little as 90 days. Thus, the term for such activity is known as the ‘Ponzi scheme.’ Like Charles Ponzi, Bernie Madoff was one such character who orchestrated such a scheme for 17 years. 

Madoff’s reputation and social connections helped him gain the trust and confidence of investors, enabling him to attract significant investments. Additionally, regulatory and oversight failures allowed the scheme to go undetected, potentially due to inadequate due diligence and ineffective monitoring. 

The conviction and sentence of American investment adviser Bernard Madoff to 150 years in prison in 2009 for 11 federal charges involving a $65 billion Ponzi scheme raised public, investor, and financial industry awareness of this sort of investment and securities fraud.

Madoff Scheme

Bernard Madoff was an American financial adviser who executed the largest Ponzi scheme in history, estimated cost of the scheme (involving almost 8,000 clients) is more than $50 billion. Thousands of investors were defrauded over 17 years. 

Madoff attracted investors claiming that he would generate steady and large returns, around 10% to 20% per annum. He used a legitimate trading strategy for high returns on investments called the ‘Spilt-Strike conversion.’ 

The split-strike conversion strategy is more commonly known as a long stock collar. A split strike conversion typically involves selling an out-of-the-money (OTM) call and using the proceeds to buy an OTM for every 100 shares that you own. 

The Bernard L. Madoff Investment Securities LLC (BMIS) had notable and high-profile investors like Carl Shapiro, Jeffry Picower, Stanley Chais and Norm Levy, who made long profitable involvement in the BMIS LLC. Bernie would deposit client funds into a single account which was used to pay the existing clients who wanted to cash out.

Downfall

Madoff’s orchestra ended when the recession started in the year 2008. He was unable to keep up with the investors’ returns when the market value sharply lowered in late 2008. 

In November 2008, Bernard L. Madoff Investment Securities LLC reported year-to-date returns of 5.6% during the same period when the S&P 500 dropped 39%.[ii] This downfall led him to confess to his sons about his fraud; his sons reported him to the police the very next day. 

The SEC (Securities Exchange Commission) started investigating Madoff in 1992. Harry Markopolos filed an SEC complaint against Madoff in May 2000, but the Regulator of the SEC ignored him saying that Harry was ‘jealous’ of Madoff and had no concrete evidence to support his complaint.

Aftermath

Madoff’s final account statements, including millions of pages of fake trades and shady accounting, showed that the firm had $47 billion in “profit.” 

He pleaded guilty in 2009 to 11 federal felony counts, like money laundering, wire fraud, and securities fraud.[iii]Bernard Madoff was ordered to pay back to the investors/victims $170 billion and was sentenced to 150 years of imprisonment. 

A Madoff Victim Fund (MVF) was set up in 2013 to help compensate those Madoff defrauded, but the Department of Justice didn’t start paying out any of the roughly $4 billion in the fund until late 2017. 

[iv] Richard Breeden, a former SEC chair who is overseeing the fund, noted that thousands of the claims were from “indirect investors”—meaning people who put money into funds that Madoff had invested in during his scheme.

[v]After thorough investigation, it was brought to light that Madoff’s Scheme ran for more than 5 decades beginning in the 1960s.

Indian Laws on Ponzi Schemes

Ponzi schemes are regulated and addressed under the Prize Chits and Money Circulation Schemes (Banning) Act, of 1978. 

Section 2 (c) of the said Act defines money circulation schemes as, ‘money circulation scheme means any scheme, by whatever name called, for the making of quick or easy money, or for the receipt of any money or valuable thing as the consideration for a promise to pay money, on any event or contingency relative or applicable to the enrolment of members into the scheme, whether or not such money or thing is derived from the entrance money of the members of such scheme or periodical subscriptions.’

[vi]The SEBI law defines the collective investment scheme (CIS) in section 11AA of the SEBI Act of 1992. Whereas, in Companies Act, 2013 lays down provisions for fraud, mismanagement and investor protection which can be applied to Ponzi schemes. 

Sections 447 and 448 deal with punishment for fraud and false statements. 

Section 447 of the said Act provides for the punishment of fraud in company matters. On conviction, the offence of fraud is punishable by imprisonment, a fine, or both. With increasing fraud in recent years, Indian regulators have regarded it most appropriate and vital to regulate fraud in company matters. 

Section 448 of the Companies Act, 2013 states that any person who obtains a loan, reward, or advantage of any sort from any company, company officer, representative, or other person by making a false statement or document, or who places any person on a false appearance of title or obligation, must be punished. 

Section 206 of the Companies Act, 2013 requires the company to keep and maintain a proper book of accounts and financial statements. These provisions help in bringing such Ponzi schemes to light so that many are not victims of such schemes. 

Notable instances of such Ponzi schemes in India include the Social Trade Scam, Qnet Scam, Sraddhaa and Rose Valley frauds, among others. Currently, there exists no dedicated legislation or framework within the government to effectively prevent or manage these fraudulent schemes. 

Individuals proven to be engaged in such activities will face legal consequences for engaging in deceit and fraud under the provisions of the Indian penal code. 

Nonetheless, given the rising frequency of these Ponzi schemes, the Indian authorities have recognized the imperative to adopt appropriate measures to combat these malicious organizations.

 Conclusion

White-collar crime has gained worldwide prominence due to advancements in commerce and technology. India, like any other nation, has not escaped the clutches of such criminal activities. 

The recent progress in information technology, especially in the latter years of the 20th century, has introduced fresh facets to white-collar crime. 

A novel category of technology-driven offences, often referred to as cybercrimes, has proliferated significantly. These offences transcend geographical boundaries and can be carried out remotely, posing a significant challenge to global law enforcement agencies in the modern era. 

The distinctive nature of these acts allows for anonymous execution, enabling perpetrators to victimize others from a distance without being physically present. 

The key regulatory organization that could play a major part in avoiding the Ponzi scheme or lowering losses if adequate procedures were taken, the SEC, which ignored repeated allegations against Madoff and urged Madoff to dream large, has undoubtedly learned a valuable lesson from this fraud. 

Saradha case is a very notable Ponzi scheme in India. The present laws and existing regulations are adequate to deal with financial scams such as Ponzi schemes, pyramid schemes, and so on. Adequate application of existing legislation, as well as thorough monitoring of such innovative business strategies, should be strictly considered by regulatory organizations. 

Various organizations that gather funds from the public fall within the oversight of different governing bodies. To illustrate, entities like non-bank financial corporations (NBFCs) are subject to the regulatory and supervisory authority of the Reserve Bank of India (RBI) as outlined in the RBI Act of 1934. 

Credit funds and money traffic programs operate under the purview of state governments. Furthermore, the collective realm of investment agreements is overseen by the Securities and Exchange Board of India (SEBI) by the stipulations outlined in the SEBI Act of 1992. 

Activities conducted by non-NBFC entities are guided by the regulations of the Companies Law. In 2013, SEBI’s authority was expanded to effectively tackle illicit money pooling schemes and various fraudulent activities. 

To counter the increasing menace of deception, the government initiated inquiries by the Serious Fraud Investigation Office (SFIO) in the fiscal year 2013-14 (up to December 2013) against 76 enterprises, marking the highest count over three years. Additionally, an inter-ministerial team was established in the same year to formulate regulations to combat Ponzi schemes. 

The recently enacted corporate legislation also incorporates robust provisions aimed at preventing and addressing professional misconduct, ultimately safeguarding the interests of investors.

 References

[i]AIR 1987 SC 1321

[ii]https://www.washingtonpost.com/wp-dyn/content/article/2008/12/12/AR2008121203970_2.html?hpid=topnews

[iii]https://www.pbs.org/wgbh/frontline/article/madoffs-inner-circle-faces-sentencing-for-largest-ponzi-scheme-in-history/

[iv] https://madoffvictimfund.com/

[v] https://www.investopedia.com/terms/b/bernard-madoff.asp

[vi]Section 2 (C) – Prize Chits and Money Circulation Schemes (Banning) Act, 1978

This article has been contributed by Shaline Samuel.