The Madoff story had a lot of wrinkles to it. Madoff like a lot of people on Wall Street had a huge ego, and with his Ponzi scheme it did start out legitimate, but then Madoff ran into hot water and instead of admitting losses, basically started aggressively getting other people into the fund to cover the losses, and it turned from being an aggressive hedge fund into a Ponzi scheme. The reason he got away with it is a combination of things, for one thing, Madoff being a big player on the street, being one of the founders of the NASDAQ market for example (and Madoff being a big marketmaker), gave him a lot of power, and one of the reasons that Madoff could keep the Ponzi scheme from being investigated all those years was a political thing. I have dealt with the SEC, and it is in a very, very political environment, and Madoff had a lot of political clout. So if someone filed a complaint against Madoff and someone at the SEC went to investigate him, or someone got suspicious of his returns, Madoff and/or his lawyers would likely browbeat the person from the SEC investigating the complaint or whatnot, and if that failed, they would get in touch with some powerful politicians, who would basically call up the head of the SEC and ask them why they were investigating their friend Bernie (in other language).
Understand that the people working for the SEC also don’t like to make waves, because often that compliance person you see at the SEC will gain experience at the SEC, and then will be hired by one of the Wall Street firms (at probably double the pay), so they have every reason not to make waves, and that is one of the reasons it worked for as long as it did. Among other things, the phony trade tickets that supposedly covered the returns on the hedge fund were so sloppy that if it had been investigated even on a surface level, it likely would have been blow out the window.
For the person who asked about the legitimate and illegitimate operations. Madoff operated basically two different businesses, there were the market making and trade operations (a market maker in something like the NASDAQ market is a brokerage firm that trades certain stocks and posts a quote with their buy and sell prices for a particular stock on the NASDAQ quote systems that people can hit, it is how stocks trade on NASD). Those were legitimate operations, the basic nuts and bolts of a securities firm. Then there was the Madoff investment fund, and that was what was illegitimate, that was the Ponzi scheme that we all came to know and loathe. In a sense, the trading firm acted as a cover for the ponzi scheme, they would process some legitimate trades through the trading arm (though if investigated, as I noted above, would not explain the fund making money), but they also created a lot of fake trading tickets that made it look like the fund was trading to its profits.
I don’t know how much people actually got back from Madoff’s Ponzi scheme, to be honest not being a forensic accountant I couldn’t wade through the reality. Funds like Madoff’s generally target well off investors, hedge funds by the very nature are risky, and their fundamental premise is a high rate of return, which in the financial world generally comes about only by taking huge risks. Most hedge funds have gateway investments in the millions of dollars, so it isn’t like most ordinary people would be investing in them knowingly. However, with Madoff, investment managers and advisors and other financial agents invested money in the madoff funds using money from ‘little people’, so they basically were taking ma and pa’s retirement nest egg and investing it in a ponzi scheme…and were showing ma and pa 15% returns (while probably pocketing the 5% between that and what Madoff was ‘returning’ more than likely), a lot of people had money in Madoff who didn’t know it until it went bust. Personally, I think a lot of financial advisors and fund managers who were recruited by madoff (probably with some nice fees to them from Madoff) should have gone to jail as well, in some cases they were treading a very shadowy ethical and legal line by putting money in with Bernie, or any hedge fund for that matter. Their duty is supposed to be towards those they are advising/representing, and among other things, I think they, like the investors in Madoff’s funds directly, had to have suspected it was a scam, Madoff’s funds were returning 20% yields when the markets tanked or were doing well, and anyone with half a bit of investment knowledge knows that is basically a unicorn, a mythical beast, a fund that just goes up and up.
One of the problems with hedge funds is the managers of them have every reason to lie or to basically create a ponzi scheme. When the real estate backed instruments went south in 2008, a number of hedge funds were heavily into these kind of investments, they knew they were under water, and instead of telling the investors they were under water, they literally borrowed from Peter to pay Paul, they borrowed billions from commercial banks to cover withdrawals from their funds, with the collateral being the mortgage backed instruments…which in the end were pretty much worthless. Madoff from what I know hit a downturn at one point, and like the managers of the hedge funds I just mentioned, convinced himself he could work his way out of it, used new investments to cover for people pulling money out, it just took his fund took a look longer to implode then what happened with the hedge funds I was talking about.