Madoff S Ponzi Scheme and How it Could Have Been Prevented

Business Ethics - Contemporary Case 2: Madoff's Investment Firm

The investment Ponzi scheme of Bernie Madoff and his hedge fund for wealthy clients was a major violation of ethics by Madoff, as he showed a severe lack of transparency (hiding his actions and never divulging how his trades were profitable) and a consistent habit of lying to clients by using one's fund to pay off another. Madoff's investment firm was essentially based on deception: he promised extraordinarily high returns on investments made the world's wealthy elite -- and so long as they did not all attempt to withdraw their investment at the same time, and so long as new investors continued to come to the firm, Madoff had enough capital on hand to pay out the promised returns. The fact that he did not actually make profitable investments with his clients' money, however, while claiming that he did so, is what caused the major problem for Madoff and his clients. Once authorities began to investigate Madoff's firm, clients began to withdraw funds and the house of cards collapsed: Madoff's Ponzi scheme came to a crashing halt and billions of dollars belonging to clients was lost (Schultz, Greenberg, 2009).

The ethical issue at the heart of the Madoff scandal was deception and was manifested in his lack of transparency and in his lies about what he could actually deliver to clients. Using Kidder's Ethical Checkpoints, the issue could have been resolved earlier on in the firm's history by observing the checkpoints and addressing each one accordingly.

The first of Kidder's Ethical Checkpoints is: "Recognize that there is a moral issue." For Madoff, the moral issue should have been the red flag of outright deception. Not only was he deceiving his clients, he was also deceiving himself with the thought that he could keep the charade going. Madoff was simply robbing Peter to pay Paul, as the maxim goes. His clients entrusted their savings with him with the expectation that they would receive a significant percentage of their investment in return each year. Yet Madoff had no real, legal or verifiable method of doing as he promised. His career was based on a deception. This was the moral issue that he needed to recognize and address in order to save both himself and his clients from loss.

The second checkpoint is: "Determine the Actor." In the case of Madoff's investment firm, he was the principal actor; although members of his family also worked in and for the firm, he was viewed by legal authorities as the primary party responsible for defrauding his clients. He testified that he never let on to what his firm was actually engaged in, and while speculation swirled as to how he could keep the deception from persons involved with the business, he himself was the main actor and the one arrested and charged by federal authorities. Thus, the key to this step would have been to address Madoff directly, had anyone else in the firm developed a suspicion of what was afoot. By going straight to the source, this checkpoint would have been addressed.

The third checkpoint is: "Gather the relevant facts." These were clear: Madoff never published his actual trades, and the accounts he gave did not match actual trade volume for the days and times specified by him. The inconsistency of his narrative with the actual market events was enough evidence that something was off at Madoff's firm.

The fourth checkpoint is: "Test for Right-versus-Wrong issues." In this case, the legal test is sufficient: Madoff broke the law regarding investment regulations; but the stench test can also be applied: Madoff's lack of transparency and fuzzy narratives were simply not compelling and indicated untrustworthiness to anyone willing to look.

The fifth checkpoint is: "Test for Right-versus-Right Paradigms." Madoff most likely suffered from the "truth versus loyalty" paradigm, aiming to keep the firm and his family afloat and thereby suppressing the truth of his actions.

The sixth checkpoint is: "Apply Resolution Principles." In Madoff's case, the ethical thing to do would have been to close the firm and return everyone's investment, even if that meant selling off his own property and assets.

The seventh checkpoint is: "Look for a third way." For Madoff, compromise was not really an option: since what he was doing was criminal, the alternative to closing the firm and returning his clients' money was to keep the ill-gotten gains in offshore accounts and go to jail himself. His investors still lost -- so it was not a very positive "third way."

The eighth checkpoint is: "Make the decision." This was Madoff's big problem: he could not make a decision to stop, even though he knew what he was doing was wrong. In the end, the decision was made for him -- by the police.