Madoff and the Failure of the SEC

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Few Wall Street
gurus or members of the financial press, if asked on December 11,
would have said that the news of Senate Republicans spurning Bush
and killing the automotive bailout would not be the next day’s top
headline. They would have been sadly mistaken.

News
broke on December 12 that Bernard Madoff, former chairman of the
NASDAQ stock market, was arrested for committing fraud. This was
not in the form of some minor chicanery, but a fifty-billion-dollar
scam. Lest the reader think that the word scam is too harsh, I will
put it in Madoff’s own words; he referred to his operation as "all
just one big lie" and "basically, a giant Ponzi scheme."

For those unfamiliar
with the nature of a Ponzi scheme, it relies on funds from new investors
to pay falsified, and abnormally high, returns to existing investors.
As Madoff demonstrated, as long as there is sufficient money coming
in, it can reach massive proportions and continue for years.

Madoff managed
to lure billions of dollars away from huge charities, as well as
wealthy individuals in both the United States and Europe by getting
them to invest in his hedge fund. He did so by claiming extraordinary
returns (generally in the low double digits). His scheme eventually
reached a staggering $50 billion under "management." This
all came crashing down around him after market conditions led to
a considerable amount of redemptions (investors asked for their
money back).

Hedge funds
are different from mutual funds in many respects. Most notably,
hedge funds are not burdened by the same government regulatory requirements
that mutual funds are. They also generally have much different compensation
structures and considerably higher barriers to entry for potential
investors. Due to hedge funds’ relative freedom from excessive government
intervention and regulatory burden, they are often able to generate
higher returns than the average mutual fund; indeed, most mutual
funds underperform compared to the S&P 500 benchmark.

Read
the rest of the article

December
20, 2008

Briggs
Armstrong [send him mail]
is a student at Auburn University majoring in accounting and minoring
in finance.

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