December 19, 2008

Was Madoff running two frauds?

A reader suggests Bernie Madoff must have been running two scams, on and off: the famous Ponzi pyramid scheme, but also abusing his position as a "market-maker" to front-run (i.e., insert his buy and sell orders just in front of his customers' orders in the direction that they are running.)

The idea that Madoff was flexibly switching back and forth among his scams makes a lot of sense. It's hard to keep a Ponzi scheme going for years, and it's hard to avoid being caught front-running because it's such an obvious gag. So, you do a little front-running to get the Ponzi scheme going, turn it off before the SEC gets around to checking, turn it back on when you need to get through a tough stretch with your Ponzi scheme, etc. Further, having a well-known opportunity to front-run as a market maker serves as great advertising among your sophisticated investors who assume your too-good-to-be true returns coming from cheating outsiders, not from cheating the insiders.

Why confess only to the Ponzi scheme? Well, that probably helps limit the number of family members who go to prison.

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Anonymous said...

Markipoulis (spelled from memory), who wrote the letters explaining the Madoff fraud to the SEC years ago, propsed that Madoff's returns could only be explained by front running or by a Ponzi scheme. In his letter he suggested that the front running was less likely, but still a real possibility. He didn't even suggest the possibility of both going on at the same time, but it does kind of make sense. If you're a smart dishonest guy, why wouldn't you use all the tools at your disposal. The only reason not to use a tool is if it increases your risk of being caught. So using too tools sparingly is better.

Anonymous said...

Re: Madoff - “He might have violated a primitive rule against hurting your own tribe,” said Ira Moses, director of Clinical Services at the William Alanson White Institute, a psychoanalytic training center. “He may have broken a taboo amongst criminals.”

What's that say about the actions of Europeans over the past, uh, 3,000 years?

Anonymous said...

The scary thought to ponder is that actually Wall Street had become a giant Ponzi scheme before it came crashing down: money in, money out, but few real investments to show for. Hence the bubble burst.
Madoff may have been the tip of the iceberg.He's certainly taking the fall for many other operators. Being 70 yo, he'll be out of jail soon while his family and partners safely hide the money.