Madoff's Ponzi Scandal

Investors sent stocks lower as anxiety over the growing list of firms affected by investment manager Bernard Madoff magnified Wall Street’s concerns about the health of the financial sector. Madoff stands accused of operating an elaborate Ponzi scheme, using cash from new investors to pay off older ones, to the tune of $50 billion. US authorities allege that Madoff delivered consistently strong returns to clients by secretly using the principal investment from new investors for payments to other investors in what is known as a "pyramid fraud." The alleged offenses only came to light because he could no longer raise the money to keep his scheme going, according to the US Securities & Exchange Commission.

The 70-year-old Madoff, well respected in the investment community after serving as chairman of the Nasdaq Stock Market, was arrested as he was suspected of leading a $50 billion Ponzi scheme.Global finance giants have admitted huge potential losses in the suspected pyramid fraud scam run by the Wall Street veteran. HSBC has potential exposure of about $1.5 billion, the Financial Times reported.The Spain's largest bank said its investment fund Optimal has a 2.33 billion euro exposure to Madoff Securities. France's largest listed bank ,BNP Paribas said it has a potential 350 million exposure. Santander, the eurozone's largest bank by market value, said its clients had an exposure of 2.33 billion euros to Madoff's investment funds. Nomura Holdings, Japan’s biggest brokerage, said it had a $303 million exposure related to Wall Street trader Bernard Madoff,

Madoff’s alleged fraud has apparently shook the world. More so because it is stated to the world’s biggest financial fraud till date. Shock waves from Bernard Madoff's alleged fraud spread globally, as charities, wealthy individuals and banks disclosed losses from the prominent Wall Street trader's investment management business.Madoff claimed that he had only 200 to 300 million dollars left, while prosecutors were uncertain how much money Madoff's clients, among them banks, prominent investors and celebrities, have lost.

Bernard L Madoff Investment Securities LLC, operated as an international market broker with a separate investment advisory business for private clients. The advisory business was kept secretive by Madoff and served between 11 and 25 clients with 17.1 billion dollars under his management. New York hedge fund manager and Wall Street legend Bernard Madoff has been charged with what could be the largest Ponzi scheme in history.

Pyramid scheme

A pyramid scheme is a fraudulent investing plan that has unfortunately cost many people worldwide their hard-earned savings.A pyramid scheme is a non-sustainable business model that involves the exchange of money primarily for enrolling other people into the scheme, without any product or service being delivered. It has been known to come under many guises.

The Scheme

As its name indicates, the pyramid scheme is structured like a pyramid. It starts with one person - the initial recruiter - who is on top, at the apex of the pyramid. This person recruits a second person, who is required to "invest" $100 which is paid to the initial recruiter. In order to make his or her money back, the new recruit must recruit more people under him or her, each of whom will also have to invest $100. If the recruit gets 10 more people to invest, this person will make $900 with just a $100 investment. 

The 10 new people become recruiters and each one is in turn required to enlist an additional 10 people, resulting in a total of 100 more people. Each of those 100 new recruits is also obligated to pay $100 to the person who recruited him or her; recruiters get a profit of all of the money received minus the initial $100 paid to the person who recruited them. The process continues until the base of the pyramid is no longer strong enough to support the upper structure (meaning there are no more recruits). 

The Fraud

The problem is that the scheme cannot go on forever because there is a finite number of people who can join the scheme (even if all the people in the world join). People are deceived into believing that by giving money they will make more money ("with an investment of just $100, you will receive $900 in return"). But no wealth has been created; no product has been sold; no investment has been made; and no service has been provided. 

The fraud lies in the fact that it is impossible for the cycle to sustain itself, so people will lose their money somewhere down the line. Those who are most vulnerable are those towards the bottom of the pyramid, where it becomes impossible to recruit the number of people required to pay off the previous layer of recruiters. This kind of fraud is illegal in the Unites States and most countries throughout the world. It is estimated that 90% of people who get involved in a pyramid scheme will lose their money. 

Ponzi Schemes

The Ponzi scheme is a fraudulent investment plan. It is not necessarily a pyramid, which is hierarchical. In a Ponzi scheme, there is one person who takes people's money as an "investment" and does not necessarily tell them how their returns will be generated. As such, the people's return on investment could be generated by anything; it could come from money taken from new investors - which means new investors essentially pay off the old investors - or even from money made by gambling in Las Vegas.