Sign Of The Times? Former Nasdaq Chair Charged With $50 Billion Fraud

You might have seen the news that a former chair of the Nasdaq was arrested yesterday for running what federal investigators called a “$50 billion swindle.”

Bernard Madoff was turned in by his sons, who said that their father had admitted to them that his investment advisory business was “a giant ponzi scheme,” reports the Wall Street Journal.

But a close look at what happened suggests that Madoff’s alleged crime may merely have represented an extreme version of the type of financial chicanery that helped cause the current economic crisis.

In a criminal complaint, an FBI agent wrote that Madoff, 70, had:

deceived investors by operating a securities business in which he traded and lost investor money, and then paid certain investors purported returns on investment with the principal received from other, different investors, which resulted in losses of approximately billions of dollars.

Madoff’s firm, Bernard L. Madoff Investment Securities, serves primarily as a middleman between buyers and sellers of shares. But an offshoot of the company manages investments for hedge funds and other institutions, as well as wealthy individuals. According to a civil complaint filed by the SEC, the alleged fraud was run through this investment business.

The steady returns that this business provided appear to have caused skepticism over the years. The Journal reports:

A number of traders suggested [Madoff’s] firm could be buying shares for its own account just before it filled orders for customers, an illegal act called front-running. In 2001, Mr. Madoff told Barron’s that charges of front-running were “ridiculous.”

An executive in the securities industry, Harry Markopolos, contacted the SEC’s Boston office in May 1999, urging regulators to investigate Mr. Madoff. Mr. Markopolos continued to pursue his accusations over the past nine years, he said in an interview on Thursday, and according to documents he sent to the SEC that were reviewed by The Wall Street Journal.

“Bernie Madoff’s returns aren’t real and if they are real, then they would almost certainly have been generated by front-running customer order flow from the broker-dealer arm of Madoff Investment Securities LLC,” Mr. Markopolos wrote to the SEC in November 2005.

The criminal complaint filed by the FBI quotes two employees — believed to be Madoff’s sons — as saying that Madoff was “cryptic” about the activities of the company’s investment arm, and kept the investment offices on a separate floor.

Things appear to have come to a head earlier this month, when Madoff told one of his sons that “clients had requested approximately $7 billion in redemptions, that he was struggling to obtain the liquidity necessary to meet those obligations.”

[On Wednesday] the sons met with Mr. Madoff … at his Manhattan apartment, the complaint says.

…At the apartment, Mr. Madoff confessed that his business was a fraud and that he was “finished.” He said he had “absolutely nothing,” that “it’s all just one big lie,” and that it was “basically, a giant Ponzi scheme.” He told them the firm was insolvent, according to the complaint.

In other words, Madoff got himself into a situation where he didn’t have enough money to pay back investors — jut like those Wall Street banks we just bailed out. That’s not to say that the charges against Madoff aren’t serious — it’s only to point out that they’re not unconnected to the broader economic turmoil.

Madoff, who is said to have started his business with $5000 he saved from working as a lifeguard at Rockaway Beach, didn’t enter a plea during a court hearing last night. A preliminary hearing is scheduled for Jan. 12, 2009.

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