Introduction
The year 2009 was marked by the resonant case of the investment advisor Bernie Madoff who admitted to committing eleven federal crimes and received a 150-year prison sentence. The convict ran the biggest fraudulent scheme in the history of the United States known under the name of the Ponzi scheme. However, what makes it compelling to study in more detail is the trust that employees, co-founders, and clients put in Madoff’s venture despite it being an exemplary financial bubble. The Ponzi scheme scandal raises the question of unethical leadership that relies on charisma and social skills but not honesty or competence. This paper analyzes the case of Bernie Madoff through the lens of the issue-contingent model, the theory of stakeholder identification, and the fraud triangle.
Literature Review
In essence, Bernie Madoff ran an illegal business model in which an individual or a company used new financiers’ investments to pay returns to old financiers. In other words, the Ponzi scheme does not generate any actual profit: instead, the system is sustained by luring newcomers and convincing them to invest (Carey & Webb, 2017). The person behind the scheme uses the surplus to meet personal ends or to expand business operations. The Ponzi scheme is inherently unsustainable and may fall apart if too many investors decide to reclaim their “profits” simultaneously. For this reason, Madoff used his nigh-on flawless social reputation and leadership skills to convince investors to stay and postpone pulling their returns (Carey & Webb, 2017). The investing schemes were never fully explained under the guise of business secrecy and confidentiality. Ten years before Madoff’s arrest, Henry Markopolos, an economist who specialized in financial derivatives, mathematically proved the impossibility of Madoff’s financial returns. Yet, the fraudulent investor still flew under the radar and continued to be a respected member of the financial industry.
Madoff was not the first person to pull off the Ponzi scheme as the origins of this structure date back to the 1920s. However, it was Madoff who took the Ponzi scheme to the next level, resulting in one of the worst white-collar crimes of all time. Azim and Azam (2016) approach the case using the fraud triangle, a popular concept that explains how fraudulent crimes are committed. The three corners of the fraud triangle are motivation, opportunity, and rationalization (Azim & Azam, 2016). Motivation is an incentive to commit fraud; the component refers to the perpetrator’s mindset, personal interest, or external pressure. Opportunity stands for an environmental or personal disposition: essentially, these are circumstances that allow fraud to occur. Lastly. Rationalization means a “logical,” often superficial explanation as to why a certain deed can be justified. All of the components need to be present to enable crime.
The judge famously called Madoff’s crime “extraordinarily evil” and emphasized the staggering toll that the convict’s fraud took not only on his clients but also on American society. From this perspective, it is compelling to utilize the theory of stakeholder identification and salience when analyzing the case. Mitchell et al. (1997) contrasts the stakeholder approach with the stakeholder theory toward which they are working in their paper. The former has been the heuristic device that increased and expanded the management’s awareness of its roles and responsibilities. In essence, the stakeholder approach illuminated firms’ interests beyond profit maximization to include the needs of non-stockholding groups. Within the stakeholder theory, Mitchell et al. (1997) seek to answer the fundamental question of which groups are stakeholders and which are not. Based on power, urgency, and legitimacy, Mitchell et al. (1997) define several types of stakeholders such as dominant, dormant, dangerous, definitive, and others. The scholars conclude that power and urgency need to be attended if managers intend to serve the interests of their legitimate stakeholders.
Since morality was an indispensable question in Madoff’s case, the issue-contingent model can be used to further advance the analysis. Jones (1991) argues that while a lot has been investigated about business ethics, the aspect that is often ignored is the characteristics of an ethical issue itself. Therefore, the proposed model gauges the “moral intensity” of an issue, which comprises further elements such as the magnitude of consequences, social consensus, temporal immediacy, and others. The characteristics can help with making a moral judgment, establishing moral intent, and engaging in moral behavior in the business environment.
Analysis Page
The Fraud Triangle
Madoff’s case is an example of how motivation, opportunity, and rationalization simultaneously come into play to enable fraud. Regarding the motivation element of the fraud triangle, as a successful entrepreneur, Madoff felt the need to support his luxurious lifestyle (Azim & Azam, 2016). He had plenty of opportunities and environmental dispositions to do so. First and foremost, the investor had an immaculate resume: he was a chairman of the NASDAQ and several industry association boards involved in charity and many other humanitarian endeavors (Azim & Azam, 2016). His reputation allowed him to proceed with fraudulent activities without raising suspicions. On paper, Madoff’s company was regularly undergoing external audits in compliance with the Sarbanes-Oxley Act of 2002. However, the auditor was not neutral as it was repeatedly taking the client’s side and submitting false reports. Lastly, Madoff rationalized his deeds by convincing himself that investors brought it upon themselves by not making any additional inquiries. Apart from that, Madoff was sure that it was mostly the rich investors that were involved in his scheme, and he did not feel remorse for deceiving them.
The Theory of Stakeholder Identification and Salience
Madoff’s business had multiple types of stakeholders to which he needed to attend. However, this analysis singles out two categories, as per Mitchell et al.’s (1991) classification – dormant and dependent. The sustainability of Madoff’s Ponzi Scheme relied on investors’ willingness to “stay in the game” and abstain from requesting returns too soon. What Madoff did not take into account as a leader is a power held by the so-called dormant stakeholders who eventually destabilized the scheme. At some point, a long-term investor claimed his $7 billion returns when Madoff only had around $200-300 million at his disposal. However, it was the dependent stakeholders relying on him to carry out their will that suffered the most. While Bernie was convinced that he was only stealing from rich investors, thousands of middle-class clients lost their employee benefits when the bubble exploded. In both cases, Madoff did not assign much salience to both groups of people.
The Issue-Contingent Model
Madoff’s actions had a large magnitude of consequences: the fraud not just directly hurt investors but also undercut the trust that people and legal entities put in the financial market. The regions that were affected by Madoff’s scheme the most saw a 30% closure rate of registered investment advisor firms. Banks in the same regions observed an abnormal surge in cash deposits as their clients were losing faith in investment banking (Gurun et al., 2018). There was a social consensus that what Madoff did was evil: his charges ranged from fraud and money laundering to perjury and theft. In addition, there was a high probability of effect, as per Jones’ model, as the Ponzi scheme had been practiced for decades and resulted in financial losses each time. As for the temporal immediacy of the issue, the US business environment is still recovering from the consequences of Madoff’s fraud.
Discussion/Conclusion
The case of Bernard Madoff is symbolic of the culture of greed, dishonesty, and deception. It also demonstrates how unethical leadership and fraud are construed and enabled. As the analysis has shown, Madoff’s scheme was not original nor outstanding in its initial form. What made it so grandiose and insidious is the combination of factors: Madoff’s interest, justification of evil, his reputation in the business world, and fake auditing to deter suspicions. The fraud triangle was the theory that explained the very possibilities of financial bubbles. The issue contingency model helps to understand the failings of Madoff’s leadership. His disregard for dormant stakeholders eventually destabilized the scheme, while indifference to dependent stakeholders’ needs brought a great deal of suffering and mistrust. In essence, Madoff failed to attend to power and urgency to take care of his legitimate stakeholders. Lastly, the fraud’s effects go beyond direct financial losses, as evidenced by the issue-contingent model analysis. Madoff’s case had a profound impact on the US financial market with lingering consequences such as a lack of confidence in the system lingering to this day.
References
Azim, M., & Azam, S. Bernard Madoff’s ‘Ponzi scheme’: Fraudulent behaviour and the role of auditors. Accountancy Business and the Public Interest, 15, 2016, 122-137.
Carey, C. & Webb, J.K. (2017). Ponzi schemes and the roles of trust creation and maintenance. Journal of Financial Crime, 24(4), 589-600. Web.
Gurun, U.G., Stoffman, N., & Yonker, S.E. (2018). Trust busting: The effect of fraud on investor behavior. The Review of Financial Studies, 31(14), 1341-1376.
Jones, T. M. (1991). Ethical decision making by individuals in organizations: An issue-contingent model. Academy of Management Review, 16(2), 366-395.
Mitchell, R. K., Agle, B. R., & Wood, D. J. (1997). Toward a theory of stakeholder identification and salience: Defining the principle of who and what really counts. Academy of Management Review, 22(4), 853-886.