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Business Ethic Essay

  1. Describe three types of illegal business behavior alleged against Mr. Madoff and for each type of behavior, explain how the behavior is illegal or unethical in the conduct of business.

Affinity fraud.

As opposed to giving all investors high returns, Madoff usually gave average but fixed returns to an exclusive group of clients. He marketed his investment ways as being too complex for outsiders to comprehend. The business of his firm was extremely secretive, and his financial reports were not easily disclosed. He targeted wealth Jews called the ‘Jewish target’ and they usually help their meetings in exclusive country clubs. Madoff targeted a class of prominent and wealthy Jewish organization and executives, and they trusted him because he was Jew. This form of marketing which targets members of a given ethnic or religious community is referred to as an affinity Ponzi or affinity fraud. (Randall, 2008)

This behavior is unethical because, Madoff exploited the friendship and trust that is there in groups of community members as they share many common things. Due to the closely knit structure of many communities, it is hard for law enforcement agencies or regulators to notice an affinity fraud. In such a situation, the aggrieved victims fail to inform authorities or seek legal remedies, and instead opt to try to work things out within the community. This is evident whereby the fraudsters gain the respect of religious and community leaders who induce other people to invest.

Use of influence.

Madoff and his family gained atypical access to regulators and lawmakers in Washington through the top grade of the industry. His family had high-level and long-standing links with the securities industry and financial market association, which is the main securities industry organization. Madoff and his brother Peter were members of the board of directors of this association.

In 2008, Peter resigned from this board as a result of the increasing criticisms of the links between Washington and Madoff firms. Between 2000 and 2008, it is said the Madoff and Peter donated over $ 56,000 to this association and also sponsored industry meetings for SIFMA. Moreover, Shana Madoff was a member of compliance and legal division of SIFMA.

This behavior is unethical because Madoff could have used members of his family to influence or sway the decisions of SIFMA. There is a conflict of interest because SIFMA has the responsibility of regulating the activities of companies in the securities industry, yet Madoff owns firms that should be regulated by this association.

Purported strategy and front running.

Madoff used an investment strategy whereby he bought blue-chip stocks and later took options contracts against these stocks; this strategy is referred to as a collar or split-strike conversion. Under this strategy, Madoff owned between 30 and 35 of the S&P 100 stocks and used calls and put options depending on the fluctuation of the market.

The ‘calls’ are sold to raise the return on investment, and at the same time allowing the stock portfolio to move upwards. However, the front running is what was viewed as illegal. In front running, Madoff would execute customer orders on their behalf of clients and would take advantage of the prior knowledge of customers’ pending order. (Randall, 2008)

The practice of front running is illegal because pending orders that have been submitted by clients will have an impact on the price of a security. When the broker buys these securities for their own accounts, it will give him an advantage that is unfair, because he can be able to make a profit once the prices of the securities rise.

  1. Name three types of parties who were impacted by the actions of Mr. Madoff and describe how they were impacted.

The main clients of Mr. Madoff included wealthy individuals, universities, charities, hedge funds, and banks. Of these clients, the three most affected parties were:


Some of the banks that were affected include a Spanish bank, Banco Santander. This bank was forced to pay approximately 1.38 billion euros to its private banking clients as a result of the losses that were related to Mr. Madoff.

Bank Medici, an Australian had invested about $2.1 billion with Madoff. The bank owned a quarter of Unicredit SpA and the hedge funds in this bank were all invested in Mr. Madoff. The other bank affected is Union Bancaire Privee a Swiss bank that lost approximately $ 700million. Over 50% of the 22 funds of this bank had been invested in investment vehicles that were owned by Mr. Madoff. Other banks that were affected directly and indirectly include Fortis bank, BNP Paribas, and the Royal Bank of Scotland.

Hedge funds.

Some of the hedge funds affected include Ascot partners. This is a hedge fund that was founded by Ezra Merkin, the fund had about $1.8 billion in assets invested with Mr. Madoff. The other hedge fund that was affected is Man Group PLC, a UK hedge fund. This company invested in funds that were indirectly and directly by Madoff securities, the company lost over $360 million. The other hedge fund that was affected by the scandal is Kingate management. This company lost nearly $2.8 billion that it had invested heavily with Madoff.

Individual investors.

The individual clients and investors included economist Henry Kaufman, Jeffrey Katzenberg, Steven Spielberg, actors Zsa Zsa Gabor, John Malkovich, Krya Sedgwick, and Kevin Bacon. Others included Larry Silverstein, a developer of World Trade Center, and the Elie Wiesel foundation owned by Wiesel and Marion, the foundation lost over $15.2 million in savings.

  1. Describe three business safeguards (risk management) that may have prevented the harm caused by Mr. Madoff.

One safeguard that should have been implemented is to ensure that the company that a business is dealing with is registered with the proper government regulatory body. It is good practice, that in the asset management industry, that the company that one is dealing with is registered with government regulators. Nevertheless, registration is not mandatory for a company to be viewed as an appropriate investment. The information regarding the lack of registration should be analyzed together with a company’s own independent diligence analysis. When a company is registers its finds with regulatory authorities voluntarily, it indicates that a company is holding itself to oversight by external parties and superior fiduciary standards.

The second safeguard that a company can implement is to analyze the transparency of a fund. A business should be able to access the executive officers of a fund for it to be viewed as institutionally transparent. Mr. Madoff was famous for being unwilling and paranoid to answer any questions about his business practices and trade strategy. It is alleged that Madoff indirectly and directly threatened to expel investors who asked many questions. Senior management did not even release any performance information and discouraged any questions from fund investors.

The third safeguard that a business can take is to make sure that an investment company has a fee structure, which aligns its own financial interests with those of the investors. The remuneration of a manager of a hedge fund should be pegged on their performance. If this is not the case, then the interests of the mangers and investors will not be in line. In the absence of a monetary partnership whereby the transacting parties share the rewards and risks of investments, there will be an increased likelihood of managers misappropriating the clients’ funds.

  1. Describe three ways private investors might have better protected themselves from risk.

There is a number of ways that private investors can protect themselves from being conned. Firstly, an investor should ensure that his accounts are held by an independent custodian. Such custodians include Pershing, Schwab, mutual funds, or other custodians. The custodian has the responsibility of keeping the funds of a client safe, confirming the safety and location of assets, and ensuring that a client gets statements on a regular basis. The advisor’s authority should only be limited to making trades in a client’s account, receiving copies of trade confirmations, tax documents, and monthly statements, and to subtract management fees from accounts.

Secondly, private investors should have a certified financial planner. The planner should to train clients and should comply with code of ethics under as stated by the financial planning association. In addition, clients should only invest in bonds and stocks that they understand. For example, if one invests in bonds and stocks, one should be able to understand the performance indices. Clients should ensure that their advisors can explain any performance that they consider being contradictory with benchmarks.

Thirdly, private investors should avoid the exclusive, elite club mentality. Many people wanted to be associated with Madoff so that they could become part of the elite and privileged community. Madoff used his charisma and mentality of exclusivity to attract wealthy clients who wanted to become part of the elite club.

  1. Describe three legal actions that possibly may be brought against Mr. Madoff under criminal or civil law.

The first legal action that can be taken against Mr. Madoff is money laundering. Under money laundering, Madoff will be accused of taking part in transactions to hide the destination, source, or identity of money that has been gained illegally. It is illegal to deal with money or property which is either in part or wholly acquired through proceeds of a crime. Madoff is said to have allegedly laundered over $250 million of investor funds by moving money from his advisory firm located in New York to London, and afterwards he returned the money back to US. This gave a false view that he was actually trading in Europe, while this was false.

The second legal action that can be taken against Mr. Madoff is securities fraud or investment fraud. Under securities fraud, it is illegal to induce clients to make a sale or purchase decision on the foundation of untrue information; this is against securities law as it results in losses for the clients. This form of fraud covers deceptive practices in the commodity and stock markets, and happens when clients are tricked to invest based on false statements.

The third legal proceeding that Mr. Madoff can face is the issuance of false statement. The law prohibits the presentation of false information, or cover up by any scheme, trick, or concealing a material fact. The law also criminalizes the issuance of materially fraudulent, fictitious, or false representation or statement. Furthermore, it is illegal to use or make any false document or writing that is materially fraudulent, fictitious, or false entry or statement. In the case of Madoff, he never released credible financial information, he also refused to answer investor’s question regarding his companies’ financial information.


Randall, D. (2008). Rich investors ‘wiped out’ by Wall Street fraud.

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The Independent. Retrieved July 10, 2010 from http://www.independent.co.uk/news/world/americas/rich-investors-wiped-out-by-wall-street-fraud-1066090.html

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