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Almost every other day, the newspaper alarms us with another scandal gone wrong with ethical lines. May it be Tyco, WorldCom and the big scandal of Enron, the economy and stakeholders are to suffer. Therefore, business ethics has evolved into a major subject over the past few decades. (ANY JOURNAL)This essay narrates a corporate scandal that was based around the ties of a Ponzi scheme. Bernard Madoff is known to be the executor of the most fraudulent and deceitful scheme in history, for which he was sentenced for 150 years. The introduction defines a Ponzi scheme, its attributes, origin, and introduces Bernard Madoff.
A Ponzi scheme, often related to pyramid schemes, is a fraudulent set up where current investors are paid by the money invested by the following investors. More often than not, there isn't a legitimate profit earned by the Ponzi schemer but a cycle that revolves money in the targeted market. In order to attract further investors, the scheme usually tends to return high percentages of profit and therefore grows quite rapidly. (Shruti - Mathematics of Ponzi schemes)
Permitting the operator's imagination, the nature of pursuing investors to devote money can lie from investments in stocks to investments in real estate. The types of depositors enticed into the scheme are usually targeted and can differ in nature of their religion, professions or members of a common group. (http://www.imf.org/external/pubs/ft/wp/2009/wp0995.pdf). Technically speaking, there are two types of Ponzi schemes, one which is intended as a fraud and another in which a right company turns itself into playing the dirty tricks of a Ponzi deal. (http://www.mathonconservatorship.com/\documents\Cnsrvtr_2nd_Rpt_9_30_05.pdf)
As the scheme promotes itself, it sooner or later grows widespread among communities, which could alert the authorities of such a fraud and business law comes into place. Typically, there comes such a rush period in which the number of investors are too much to handle or new investors do not enter the scheme and the scheme collapses, it is inevitable. At this final stage of the scheme, the recent investors are the one to suffer as most early investors and the operator would have made high margins of profit. (http://web.ebscohost.com/ehost/pdfviewer/pdfviewer?vid=1&hid=107&sid=81af978d-3153-489b-9b5e-026f45e0726c@sessionmgr110)
Usual maneuvers of Ponzi Schemes
Ponzi schemes go around the bush for so long and for so many by offering great returns on investment. Another psychological factor "Social Consensus Tactic" in which the operator pays off the initial investors with great profits which provides proof and belief in other doubted investors and thus expanding the business. After the initial set up, ponzi schemers do not accept everyone and anyone. Therefore, by not promoting the scheme, word of mouth comes in handy and the business appears to be exclusive to some. This illusion makes the investors align with the scheme as they would fear to lose out on a chance of gaining high profits. http://www.lfblaw.com/ANM2.pdf
How it all started?
Ponzi scheme is named after the flamboyant and notorious Charles Ponzi, who in 1920s gave true light to such a scheme. Through high returns (50% for 45 days), of purveying foreign postal stamps, Charles Ponzi attracted and was approached by many. He claimed the returns by the rate difference in supplying international postal stamps in US. (Sibeesh - ssnr02939999) He masterminded the techniques of such a skill, in which he would pay the first investors with their high profit returns through the money gathered by the incoming investors. The real success to Charles was the ever expanding list of investors and businesses and therefore went out of the targeted market and was too much to cope up with. (http://proquest.umi.com/pqdweb?index=8&did=1621875211&SrchMode=2&sid=1&Fmt=3&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1271841411&clientId=67651)
As the word spread about the legal issues regarding Ponzi's dealing, betrayed and heated investors rushed through the doors of Charles office to which he couldn't hold long and was captive. (SIBEESH - PYRIMAD 11)
Bernard Madoff, a financial genius, born on April 29, 1938, graduated from Hofstra in the field of political science. Madoff later decided to master the subject of law but dropped out to open his own investment company in 1960, Bernard L. Madoff Investment Securities, L.L.C.
Through exquisite human skills and through sources of Madoffs father in law, Madoffs business developed into a reputed investment company. The company challenged the straightforward routines of the existing brokers. Madoff's firm kept doing well due its participation in the stock market and in 1970 Madoff decided to hire his family members and close friends to join him in the peak of his business world. Having completed their graduate studies, Madoff's sons Andrew and Mark, both joined in to help flourish the family business. http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article5344752.ece .It wasn't long before the company made drastic changes, by helping NASD builds a program to develop stock quotes, NASDAQ program/system (National Association of Securities Dealers Automated Quotations), for which Madoff functioned as the president of the boards of directors. With reliable and consistent return on principle (10%), the company reached bigger and better heights to a point where in 1980s, Madoffs firm dealt with 5% of the Stock exchange market. Madoff built his contact list, through a very charismatic personality and through contributing to the Jewish charity organizations and several other foundations. http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article5344752.ece
MAIN BODY -The scandal's relation to Ethical Theories
In this section, the essay goes further reciting the biggest scandal yet witnessed and is then linked to several ethical theories to compare and contrast Reality Vs Theory situations.
" How do you excuse betraying thousands of investors who entrusted me with their life savings?" - Bernard Madoff. http://www.nydailynews.com/money/2009/06/29/2009-06-29_text_of_bernie_madoffs_statement.html
Investors were made to believe that their money was applied by Madoff in high reaping investments, when the truth was that there were no investments and definitely no profits. Madoff used the old dirty trick of a Ponzi scheme in which he used the invested money to pay off clients who backed off. Due to reputation of reliable returns the firm became the stock markets most high-flying investment companies. Therefore, this helped Madoff to rotate the money in the economy.
Theory Vs Reality
Madoff applied the Planned behavior theory which focuses more on the fact that human beings can control their behavior whereas the theory of reason does not. The theory is based on 3 main indicators; attitudes toward the behavior, social norms and perceived control, and these are all influenced by one factor; intentions. Related to the theory, Madoff's attitude was way positive for performing false activities for so long. He had gained enough power and control of the situation by perfect execution and contacts that an unethical business was made easier to get away. Madoff's intentions to play such scheme were preplanned, objective and thus, behavior was in alliance with the ends.
Bloomberg testified that Madoff's investment company was situated on the 17th, 18th and 19th floor. The 18th and 19th floors were complete different divisions which handled the market services and legitimate trading of the company. http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article5345751.ece .
Theory Vs Reality
Relating Madoff's scandal to Agency theory which states that managers or operators can sometimes act in a self-interest mode, therefore they don't always follow a culture to maximize shareholders returns. (1) Agency theory is described to contain 3 role players, one the principle (operator), agent (hired by the operator to assist in third party relationships) and a third party through which the principal might deal with to earn profits.(2) As mentioned by some visitors to the 17th floor, it was an office chock-full of computers and notes on financial transactions. It was here where Madoff's fraudulent activities took into full charge, the heart to a multimillion dollor fund, only run by 20 employees. http://www.independent.co.uk/news/business/analysis-and-features/the-madoff-files-the-man-behind-the-most-audacious-fraud-in-history-1518939.html The theory helps find a common end between managers' decisions and the interest of the shareholders by introducing performance based incentive programs. With all dynamics, agency theory can sometimes lead managers to be self-centeredness which could lead to unethical behavior and thus an unethical culture. (1). Madoff's plan was based and centered among these 20 ought employees, who were paid extremely high with extra bonuses and incentives.
There was a huge network of fundraisers who actually helped Madoff in passing him billion dollars of cash from their acquaintances. Unaware that they were stepping into a con scheme, Madoff planned to earn higher profits, through commissioning these middlemen for the subcontracted business they bought to him. He made them falsely believe that the money would reap profits through investments and the bonds would raise their value reliably soon It all started with Carl Shapiro, who received the first cheque of $100,000 from Madoff himself. Along the business lines, Shapiro and Madoff got along, in which Shapiro was incredibly impressed by Madoff's investment strategies and therefore, directed his acquaintances to Madoff. The list of accomplices goes on, including Scotsman Donald Ross, Ezra Merkin (Member of New York's Jewish community), Walter Noeal and many more that followed the same idea, thus helping Madoff succeed in his fraudulent venture. By this time, Madoff was highly reputed, and had investors ranging from celebrities to entrepreneurs. Some of the celebrities that have invested their money with Madoff are Kevin Bacon (Actor), John Denver (Musician) John Malkovich.
Theory Vs Reality
One of the legal duty of board members is of the fiduciary duties. It is when legal or ethical relationships of confidence or trust between two or more parties are created. The general nature of these duties includes personal interest, and the fact that someone should not take personal advantage of their position of trust. http://www.gillhams.com/dictionary/497.cfm. Madoff's accomplices put themselves in situations where their self-interest (commissions) was in direct conflict with the moral duties of the job. Hence, getting benefits of such an act but at the same time, risking loyalty and principles of their organization, these accomplices joined hands in Madoff's trade.
"You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time." Abraham Lincoln.
It was always going to be hard to trust Madoff's tactics of consistently returning investors high rates of profit. Harry Marcopolos, a math mastermind, while working in an investment firm based in Boston suspected Madoff's strategy. Marcopolos couldn't believe that the execution was legitimate and thus wanted to crack the code. After intense research, Marcopolos was unable to figure out how Madoff was able to guarantee a profitable return to his investors.
Jumping to conclusions, Marcopolos assumed that either Madoff was using means of an illegal accounting trick, "Front running" (A stockbroker trick in which the price of a share is increased by betting a higher price on the bond). Or that Madoffs' firm is nothing but the world's largest ponzi scheme. When Marcopolos decided to inform the authorities (US Securities and Exchange Commission SEC), they acted quite ignorant towards the issue. During the next few years, Marcopolos would would still campaign to reveal the secrets behind Madoff's strategy. He spent time gathering facts and figures and he constantly sent them to the SEC hoping to win a reward.
Theory Vs Reality
Whistle blowing concerns the reporting of unethical or even illegal activities to someone who has the position to take action, or even to prevent the wrong doing. (Ethics text book, p.128). It includes wrong doing with internal as well as external parties. (13) It can often expose and even end unethical activities which may be taking place in the business.Harry Marcopolos was known as the whistle blower who pointed out Madoff's ponzi scheme for several years to the SEC investigators. (13)
Marcopolos realized that there was something suspicious about Madoff's accounting books, it turned out that Madoff used a one-person audit firm, Friehling & Horowitz. This was a very small firm based on the outskirts of New York, creating doubts of how such a firm could audit a business worth millions of dollars. Madoff's investors too speculated that returns might have been false; however they still continued investing due to greed. At this point of time, there was a further in-depth investigation on Madoff's campaign, in which it was finally discovered that Madoff was deliberately trying to cover his company's profile from the rest of the world, giving an illusion that investors were penetrating through a rightful path. However, the authorities did not bring this matter to the awareness of the public.
Theory Vs Reality
The ethics law imposes three duties on board members. These consist of the duty of care, good faith and loyalty.
The duty of care involves the board members to guarantee that the corporate executives carry out their management responsibilities as well as complying with the law in the best possible way, in the Madoff's case SEC were too easy going and disregarding. It helped Madoff escape on first blush, which has proved costly.Â (Ethics text book, 430). The duty of loyalty expects the organization to give full commitment when making decisions which affect the organization in any possible way. Faithfulness is vital in the duty of loyalty. Hence, through further readings, it was identifiable that SEC regulators overlooked the possibility of fraud in Madoff's business early on, thus effecting the organization. (Ethics text book, 431)
Through an earning management and CSR point of view, Madoff made high earnings (profits) and therefore attracted many, but Madoff also had an insolvent balance sheet. (Liabilities > Assets). Definitely, there was use of creative accounting in which accounting firms tend to manipulate their financial information in a determined way to the public view. This method used by insiders of transforming financial equations in favor of the business is known as earnings management. Madoff's way of earning profits and escaping from authorities was based on such management skills and therefore, the company in general wasn't very socially responsible, towards the economy or stakeholders but at the same smoothing the earnings. (4)
"I'm not sure I'll be able to hold it together" - Bernard Madoff.
In 2008, crisis struck the economy due to which, new investors were reluctant to devote money into Madoff's firm.
Due to the prevailing economic condition, it led investors retrieve money from Madoff's firm. Madoff had used that money for personal expenses and to pay other investors along the way. Madoff snapped and decided to solicit money.
By this time, Madoff had to clear combined outstanding payments of $7bn to his clients. In fact, Madoff only had a very small fraction of the outstanding amount and because he was facing difficulty soliciting the money, he decided to distribute the leftover money to his employees, family and friends.
Hence, Madoff rescheduled employee bonuses earlier than the usual. Madoff's sons Andrew and Mark, were surprised at this decision and demanded a justification of this unusual decision taken during the credit crunch. Madoff confessed that the entire business was nothing but a planned ponzi scheme, a big lie to get richer in the fastest but not the most pleasant way. Andrew and Mark were both caught in the shock of such unethical happenings and decided to alert the legal authorities. http://www.independent.co.uk/news/business/analysis-and-features/the-madoff-files-the-man-behind-the-most-audacious-fraud-in-history-1518939.html
Theory Vs Reality
We would advise that Andrew and Mark followed two ethical theories consequently, Rawlsian's Justice theory and virtue ethics. It was as if, they were behind the veil of ignorance, completely disregarding that Madoff was their father, overlooking all those other barriers such as the money, family publicity and future consequences. They followed Rawlsian's theory in which he states that a fair decision is only fair if it is impartial. Both Andrew and Mark, made decisions on the basis of just and fairness, not on impartiality or feelings.( http://www.emeraldinsight.com/Insight/viewPDF.jsp?contentType=Article&Filename=html/Output/Published/EmeraldFullTextArticle/Pdf/0010460804.pdf) Virtue ethics can be related to Madoff's sons as their decisions bought about the well being of others and themselves as individuals. Of course, faced in a moral dilemma, Andrew and Mark both had character traits of those of honest, fair, selfless and honorable people. ((http___www.emeraldinsight.com_Insight_ViewContentServlet_contentType=Article&Filename=_published_emeraldfulltextarticle_pdf_0510130901)
Bernard Madoff allegedly confessed in a courtroom full of worried citizens, that his balance sheet was insolvent and it had all been a business in disguise. According to Madoff's statements, the fraud began in 1990 and it was a good deal gone bad business. Experts on the other hand hint that the fraud may have been into place way before, 1980s.
Bernard estimated that his losses in the market exceeded $50 billion, he was found guilty to operating 11 illegal courses of actions. Some of them being, Securities fraud, wire fraud, mail fraud, three illegal counts of money laundering, investment advisor fraud and incorrect documentation with the SEC. After the end of this, when Madoff was under arrest, his firm showed an outstanding total of $65 billion in the books. Madoff's fraud was declared to be the world's largest fraud and for that he was sentenced 150 years in jail on June 29, 2009.
Thousands of people were at stake and Bernard knew the consequences of his actions. Stock Market, Brokers, Investors, communities, family and friends, even the economy and government were affected due to such an occurrence. http://www.timesonline.co.uk/tol/news/wor ld/us_and_americas/article5331997.ece The Bernie Madoff fraud also disturbed the financial services of some major banks Institutional clients who despaired to invest in Madoff's firm, loaned money through these banks and Madoff's hoax meant failure for investors to return the liable money back. Banks such as HSBC being the most affected ($1bn), BNP Paribas, Banco Santandar, Royal bank of Scotland and more to mention were victims of Madoff's venture. http://economictimes.indiatimes.com/News/International_Business/HSBC_worst_hit_of_Bernard_Madoffs_USD_50_bn_fraud_Report/articleshow/3841456.cms
Theory vs. Reality
The stockholder theory refers to a group of people who invest their money into another group (Business Managers) to gain an increased profit on principal.. For the stockholder, managers themselves act as the agents, who are authorized to manage the money given by the stockholders. (8). The theory states that the managers actions with the funds invested should be in alignment with the directions notified by the stockholders.(8) In Madoff's case, he broke every tie of this theory by not investing money into ventures, as the stockholders directed but by using it for personal expenses and paying off profits of earlier investors, hence spending the money for self-interested goals without authorization of the stockholders.
The stakeholder theory is a model of corporate social responsibility. It shows that all managers have ethical responsibilities within a company to their stakeholders. (Ethics text book. Of course, business has it that there are times when stockholders are given partiality over stakeholders.Â Â (8). All the stakeholders were widely affected by Madoff's actions as many people had invested their live savings in his business, which they ended up losing. Stakeholders in Madoff's case would be banks, economy, indirect and direct communities such as the charitable Jewish communities etc who were highly effected by Madoff's actions. Thus Madoff did not regard the interest of these stakeholders while making business judgements.
The social contract theory claims that all businesses are ethically required to develop the wellbeing of its employees and the society in general, without going out of the limits of law. (8)It would be pretty self-explanatory to conclude this theory by Madoff's actions, the self-interest and egoistic notion of his venture, deliberately put lives of many in trouble. But also the fact that he did what he did, by going against the law proved him to be totally against the social contract theory.