Red Flags that Existed in the Madoff case

Red Flags that Existed in the Madoff case

Red flags are indicators warning investors of fraud. Bernard Madoff’s brokerage firm, Bernard L. Madoff Investment Securities LLC (BMIS) was involved in securities fraud. However, there were red flags the company was engaging in fraud. It failed to conduct segregation from the service providers. These functions were undertaken within the organization without being overseen by a third, party. Affiliate brokerage BMIS provided the opportunity to manipulate the rates of performance and asset misappropriation. This is a red flag for any hedge fund. Auditing was done by obscure auditors. Friehling and Horowitz, was small and did not undergo regular peer review. The choice of this small auditing firm to check on the asset base of a large company like BMIS is questionable.

BMIS had a strange fee structure; it was awarded because of its investment services but did not have an operating fund. The final investors paid the performance fee, which should not be the case. The company was suffering from reversals instead, Madoff paid out the current investors with finances received by new ones and this money was quickly used up. The Madoff family had majority influence and decisions were made in secret by senior managerial relatives (Gregoriou, et. al, 2009). Madoff was the sole decision maker with minimal external consultations. Lack of operational transparency compromised the decision making process. However, internal controls are meant to protect the assets of the investors from fraud. The company’s documentation was questionable; the paper tickets had no stamps to prove the investment results.

 

 

References

Gregoriou, G. N., & Lhabitant, F. S. (April 01, 2009). Madoff: A Flock of Red Flags. The Journal of Wealth Management, 12, 1, 89-97.

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