The legally speaking blog posted below is published weekly by Aaron Sachs and Associates of Springfield, Missouri, specializing in Missouri personal injury and accident practice.

Is the Madoff investment scam another blow to our staggering economy?

Aaron Sachs, A Missouri attorney will answer questions about Bernard Madoff this week.
Wall Street broker Bernard Madoff convinced the rich and famous to invest billions of dollars in his hedge fund. With Madoff’s arrest and revelations that the whole fund was a fraud, many of those people may never see their money again. But Madoff’s thievery could have far reaching effects that go far beyond the Palm Beach country clubs where he recruited investors.

Q: Aaron, this week’s topic is the Madoff scam. Who is Bernard Madoff?

A: Madoff founded his own investment firm in 1960. His firm was heavily involved in the founding of the NASDAQ stock exchange. In recent years, Madoff Investment Securities got involved in asset management. People would give him money, trusting that his investment strategies would pay off for them.

Q: So he wasn’t an unknown quantity?

A: No, and that’s part of the problem. He had such a pedigree on Wall Street, and had such success for many years, that people were inclined to trust him. They trusted him even though there were danger signs as far back as 2005 that something was fishy with his investment strategies.

Q: What were the early warnings?

A: Madoff’s investment strategy, something known as a “collar trade,” is well known. His fund reported almost constant growth – five to 15 percent every month – for years. That reported growth continued even recently, when the markets themselves were down as much as 40 percent. It’s impossible for anyone to be that consistently successful. Also, regulators and other fund managers tested his strategy. Even using historic market data, they could not duplicate his success.

Q: Were there official investigations?

A: There were two official SEC inquiries into Madoff, but only minor violations were ever found.

Q: What was actually going on at Madoff Investment Securities?

A: It was a giant Ponzi scheme. We talked about those a few weeks ago – the scam artist brings in money by promising high returns on an investment, then pays off those early investors by getting more money from newer investors. It inevitably collapses, since there’s no real source of income and you can never find enough new investors to keep the scam going. This was probably the largest Ponzi scheme pulled off by a single individual in history.

Q: Madoff’s fund wasn’t really making double digit gains?

A: Investigators think Madoff may have made some initial gains by “front running,” an illegal practice in which a firm buys or sells stocks on its own behalf before it executes orders made by its clients. Other than that, his entire asset management firm was hollow.

Q: How was he caught?

A: In recent months, Madoff’s investors started pulling money out of his fund, to the tune of $7 billion. He couldn’t cover it, and the whole scheme was collapsing. He tried to pay millions of dollars in bonuses to employees and family members, but his sons, who work in the firm but reportedly had no idea it was a fraud, confronted him. He admitted it was a scam, and his sons turned him over to federal authorities.

Q: What is Madoff’s current status?

A: He is free on $10 million bail and subject to a 7 p.m. curfew. He also surrendered his passport. He is charged with one count of securities fraud. A conviction could result in a 20 year prison sentence and a fine of $5 million. Many of his former investors are also suing him.

Q: Will anyone get their money back?

A: It’s unlikely. Some investors who pulled their money out of the fund may have to give it up to repay other victims of the scam.

Q: How far will this reach?

A: The total amount Madoff defrauded is $50 billion, which is a damaging amount by itself. But many of his investors were other investment funds, schools, charities and a number of foreign investment houses. The effects will ripple throughout the economy.

Q: Aaron, what’s the bottom line on the Madoff scam?

A: Many of the victims were blinded by greed. They were so eager to make more money that they didn’t stop to question if Madoff’s strategy made any sense. Unfortunately, a lot of innocent people will be dragged down by the fallout from this.