As if there wasn't already enough bad news coming out of the world of finance, the Financial Times reports that an alleged multi-billion-dollar financial scam in the United States could result in heavy losses for investors across the globe.
According to the FT, "Investors around the world were rushing to assess potential losses from what could be Wall Street’s biggest fraud – a multi-billion-dollar scheme allegedly perpetrated by investment manager Bernard Madoff."
The FT explains that "the case threatens to stoke fears among investors and encourage withdrawals from hedge funds struggling to raise cash to meet redemptions. At least one civil lawsuit had been filed....on behalf of Madoff investors seeking to recover money."
It appears that Mr Madoff had, for many years, run a Ponzi scheme, which, according to Wikipedia, "is a fraudulent investment operation that involves paying abnormally high returns ("profits") to investors out of the money paid in by subsequent investors, rather than from net revenues generated by any real business...It usually offers abnormally high short-term returns in order to entice new investors. The perpetuation of the high returns that a Ponzi scheme advertises (and pays) requires an ever-increasing flow of money from investors in order to keep the scheme going.
Wikipedia points out that the "system is destined to collapse because there are little or no underlying earnings from the money received by the promoter. However, the scheme is often interrupted by legal authorities before it collapses, because a Ponzi scheme is suspected and/or because the promoter is selling unregistered securities. As more investors become involved, the likelihood of the scheme coming to the attention of authorities increases. The scheme is named after Charles Ponzi, who became notorious for using the technique in 1903. Today's schemes are often considerably more sophisticated than Ponzi's, although the underlying formula is quite similar and the principle behind every Ponzi scheme is to exploit investor naïveté."
The FT explains that "Bernard Madoff presided over the biggest alleged fraud in the hedge fund industry, thanks to an investment strategy that appeared to provide steady returns with almost no risk of loss....Slick marketing and a wide network of contacts brought Bernard L Madoff Securities dozens of the biggest investors in the industry, attracting well over $10bn – and possibly $17bn – from clients who are supposed to be some of the smartest in the world.
The FT reports that "Bernard Madoff began 2008 with a reputation for savvy investing and $17bn under management from 23 clients. He ends the year with his reputation in ruins amid allegations that he defrauded investors out of as much as $50bn over two decades....The story of how this secretive investment manager, a former chairman of Nasdaq, crashed and burned over several days in December has managed to shock an investment community already reeling from the implosion of the credit markets this year.
Bernard Madoff’s investment funds shared several points in common with high-profile fraud cases of recent years. The consistently high returns had previously aroused suspicions; there was a lack of third-party oversight; there was a very small accounting firm for the size of the operation; he had his own broker/dealer operation; there was a lack of clarity as to exactly what he was invested in."
