The Bernard Madoff Quiz - What would you have done?
Although I retired from my accounting practice, I still author courses on ethics and fraud and occasionally present live programs on those topics. In my latest course on accounting fraud, I included a discussion of the Bernard Madoff scandal as personally experienced by me. Several of my clients had investments with Madoff and lost a substantial amount of money. The brief discussion is followed by a quiz asking what you would have done at the time and now with hindsight how would you have reacted.
Case Study – Bernie Madoff (Part I)
As part of your accounting services you provide limited financial planning services to your clients. One of your new clients (a middle aged married couple) asks you to review their portfolio and make recommendations for investing an additional $100,000 they currently have in cash. In reviewing their portfolio you note that the client is adequately diversified for their age between fixed income and equities.
The equity portion of their portfolio is heavily weighted (approximately 35%) in an investment with a private money manager named Bernard Madoff. Those securities have outperformed all the other investments by 3-4% per year. When you ask the client about the investment, they tell you that they feel lucky that they have been able to get Mr. Madoff to accept their account. His minimums are usually over $1 million, but because several of their friends also invested with him at the same time, he waived the minimum and took their investment of $250,000. They further told you that Mr. Madoff was formally president of the NASDQ and has a track record of over 25 years of beating the S&P 500. You do your due diligence and confirm your client’s statements about Mr. Madoff. He does indeed have a long term track record and was one of the founders of the NASDQ. On Wall Street, he is considered something of a guru, not unlike Warren Buffet, but with a different emphasis.
Questions (assuming no prior knowledge of the Madoff scandal):
What recommendations would you make to your client about the existing 35% investment with Bernie Madoff?
What recommendation would you make regarding the $100,000 they currently have in cash? How would your recommendation be affected if your client tells you that they would like to give the additional $100,000 to Madoff to invest?
With the information you have at this point in the case, is there anything else that you should do?
Case Study – Bernie Madoff (Part II)
It is now tax season and your new client has asked you to prepare their tax returns. You provide them with a tax organizer, which they fill-in reasonably well. You also ask them to include their W-2s, 1099s.
While reviewing their information you note that their investment in Madoff Investments does not have a 1099B for sales or a 1099 DIV or 1099 INT. Instead you receive a multi-page printout listing hundreds of transactions that were made during the year. You ask your client when they will be receiving the 1099s from Madoff and they show you the cover letter that says to call a specified number if you or your tax professional has any difficulty in using the information provided to prepare the client’s tax return.
So you call the number provided and speak with a representative from Madoff (later you learn it is his accounting firm). The Madoff representative explains how to use the summary sheet to record the total sales for the year, where to pick up the dividends and interest, and how to back into cost basis using the totals on the summary for gains and losses. In addition there is another printout that must be used for options trading, which is how you were told, Madoff makes the extra percentage gains on his investments. You also learn that the gains and losses for the options must be recorded on the tax return according to “the 60/40 rule” where 60% are recorded as long term and 40% as short term no matter how long they are actually held. In addition, all open options from regulated contracts are marked-to-market at year end.
In recording the information on the tax return, you notice that the total sales for the year are over $5 million.
Questions (assuming no prior knowledge of the Madoff scandal):
Should you mention to your client that the $5 million in sales may draw the attention of the IRS, because of the relative size of that number compared to the rest of the return?
Should you discuss with your client the possibility that their account is being “churned”[1]?
Based on the information you have thus far in the case, what further information do you believe you need in order to prepare the tax return with regard to the Madoff investment?
Case Study – Bernie Madoff (with hindsight)
We now know the Madoff investments for some period of time have been fraudulent.
Were there indicators that might have caused you to react differently with regard to your client’s investment?
With the advantage of hindsight, what additional due diligence could you have performed?
With regard to the financial planning
With regard to the tax preparation
Do you currently have any clients that you might need to consider whether or not there may be some inappropriate actions taking place?
If you run across a similar situation in the future, do you feel any more comfortable about how to handle it? Would you report such a situation to the SEC, IRS, or other regulatory body?
[1] Churning – the excessive purchase and sale of investments to generate higher commissions.
Case Study – Bernie Madoff (Part I)
As part of your accounting services you provide limited financial planning services to your clients. One of your new clients (a middle aged married couple) asks you to review their portfolio and make recommendations for investing an additional $100,000 they currently have in cash. In reviewing their portfolio you note that the client is adequately diversified for their age between fixed income and equities.
The equity portion of their portfolio is heavily weighted (approximately 35%) in an investment with a private money manager named Bernard Madoff. Those securities have outperformed all the other investments by 3-4% per year. When you ask the client about the investment, they tell you that they feel lucky that they have been able to get Mr. Madoff to accept their account. His minimums are usually over $1 million, but because several of their friends also invested with him at the same time, he waived the minimum and took their investment of $250,000. They further told you that Mr. Madoff was formally president of the NASDQ and has a track record of over 25 years of beating the S&P 500. You do your due diligence and confirm your client’s statements about Mr. Madoff. He does indeed have a long term track record and was one of the founders of the NASDQ. On Wall Street, he is considered something of a guru, not unlike Warren Buffet, but with a different emphasis.
Questions (assuming no prior knowledge of the Madoff scandal):
What recommendations would you make to your client about the existing 35% investment with Bernie Madoff?
What recommendation would you make regarding the $100,000 they currently have in cash? How would your recommendation be affected if your client tells you that they would like to give the additional $100,000 to Madoff to invest?
With the information you have at this point in the case, is there anything else that you should do?
It is now tax season and your new client has asked you to prepare their tax returns. You provide them with a tax organizer, which they fill-in reasonably well. You also ask them to include their W-2s, 1099s.
While reviewing their information you note that their investment in Madoff Investments does not have a 1099B for sales or a 1099 DIV or 1099 INT. Instead you receive a multi-page printout listing hundreds of transactions that were made during the year. You ask your client when they will be receiving the 1099s from Madoff and they show you the cover letter that says to call a specified number if you or your tax professional has any difficulty in using the information provided to prepare the client’s tax return.
So you call the number provided and speak with a representative from Madoff (later you learn it is his accounting firm). The Madoff representative explains how to use the summary sheet to record the total sales for the year, where to pick up the dividends and interest, and how to back into cost basis using the totals on the summary for gains and losses. In addition there is another printout that must be used for options trading, which is how you were told, Madoff makes the extra percentage gains on his investments. You also learn that the gains and losses for the options must be recorded on the tax return according to “the 60/40 rule” where 60% are recorded as long term and 40% as short term no matter how long they are actually held. In addition, all open options from regulated contracts are marked-to-market at year end.
In recording the information on the tax return, you notice that the total sales for the year are over $5 million.
Questions (assuming no prior knowledge of the Madoff scandal):
Should you mention to your client that the $5 million in sales may draw the attention of the IRS, because of the relative size of that number compared to the rest of the return?
Should you discuss with your client the possibility that their account is being “churned”[1]?
Based on the information you have thus far in the case, what further information do you believe you need in order to prepare the tax return with regard to the Madoff investment?
Case Study – Bernie Madoff (with hindsight)
We now know the Madoff investments for some period of time have been fraudulent.
Were there indicators that might have caused you to react differently with regard to your client’s investment?
With the advantage of hindsight, what additional due diligence could you have performed?
With regard to the financial planning
With regard to the tax preparation
Do you currently have any clients that you might need to consider whether or not there may be some inappropriate actions taking place?
If you run across a similar situation in the future, do you feel any more comfortable about how to handle it? Would you report such a situation to the SEC, IRS, or other regulatory body?
[1] Churning – the excessive purchase and sale of investments to generate higher commissions.
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