Business Ethics


The cases are short but must be answered thoroughly and professionally. Cases should be prepared in Microsoft Word and uploaded to Dropbox on or before their due date. Each case is worth 100 points. 


Grading Criteria for Cases


90 – 100 points: Each case question is answered accurately, thoroughly, and professionally. Professionalism in writing includes proper spelling, grammar and presentation. Outside research will be presented. Reference to textbook concepts will be presented. You will provide proper citations for all research.  3 to 4 sources listed mla style.


 

Thinking Critically

Ponzi Schemes:

 

The practice of providing old (or early) investors above-average returns on their investment with funds raised from new (or late) investors in the absence of any real business operation to generate profits is illegal, unethical, and, regrettably, not a new idea. It used to be referred to as “robbing Peter to pay Paul.” In 1899, a New York scam artist named William Miller promised investors returns as high as 520 percent in one year based on his supposed insider information on profitable businesses. He scammed people out of almost $25 million in today’s money before being exposed and jailed for 10 years.

   In 1920 the practice was given a new name—Ponzi scheme—in “honor” of Charles Ponzi, an Italian immigrant who, after numerous failed business ventures began to promote the spectacular returns to be made by buying international reply coupons (IRC)—coupons that could be used to purchase stamps in order to reply to a letter, like an international self-addressed envelope—in local currencies, and cashing them in at U.S. currency rates. For example, “a person could buy 66 international Reply Coupons in Rome for the equivalent of $1. Those same 66 coupons would cost $3.30 in Boston, “where Ponzi was based. It is debatable whether or not Ponzi genuinely believed that he had stumbled across a real business opportunity—a simplified version of currency trading in a way—but his response was immediate, promising investor’s returns of 50 percent on their original investment in just 90 days. However, the opportunity attracted so much money so quickly—as much as $1 million poured into his office in one day—that Ponzi was either unable or unwilling to actually buy IRC’s. Had he tried to do so, he would have realized that there were not enough IRC’s in existence to deliver the kinds of returns he was promising his investors. Instead, Ponzi chose to use the funds coming in from new investors to pay out the promised returns to older investors—robbing Peter to pay Paul.

   It was only a matter of time before the funds coming in would be insufficient to meet the demands of older investors with their original capital and their 50 percent return. Ponzi was able to keep the scheme going by encouraging those older investors to keep “rolling over” their investment, but once rumors began to surface about questionable nature of the Ponzi enterprise, fewer and fewer people opted to roll over, choosing instead to take their money out. At that point the whole system collapsed, and Ponzi’s business enterprise was exposed as fraudulent. For his brief encounter with fame and fortune, Charles Ponzi eventually served 12 years in prison, and was deported back to Italy. He later immigrated to Brazil, still presumably in search of fame and fortune. He died in 1949 in the charity ward of Rio de Jeneiro hospital with only enough money to his name to cover his burial expenses. His name, however, lives on—the practice of robbing Peter to pay Paul was forever replaced with the name Ponzi scheme.

   In subsequent decades, Ponzi has inspired many Imitators.

·        In the 1990’s, a Florida church—Greater Ministries International—scammed nearly 20,000 people out of $500 million on the basis of a promise that God would double the money of truly pious investors.

·        Lou Pearlman, the theatrical impresario and businessman, who launched the screams of thousands of teenage girls with the boy band ‘N Sync, stole over $300 million from investors over two decades.

·        In January 2008, the Securities and Exchange Commission charged an 82-year-old man, Richard Piccoli, with operating a Ponzi scheme that scammed investors out of $17 million over five years by promising “safe” returns of only 7 percent based on real estate investments that were never made.

·        In July 2010, Fort Lauderdale lawyer Scott Rothstein sold stakes in large fictitious legal settlements scamming investors out of $1.2 billion, and causing considerable embarrassment to Florida Republican politicians who were recipients of large donations from Rothstein’s new found wealth.

·        In April 2010, former Minnesota business tycoon Tom Peters was sentenced to 50 years in prison for orchestrating a $3.7 billion scheme to convince investors that they were buying large shipments of electronics that would then be sold to big-box retailers such as Costco and Sam’s Club. Victims included retirees, church groups, and Wall Street hedge funds.

    In December 2008, a formerly highly respected Wall Street money manager, Bernard Madoff, was accused of masterminding a Ponzi scheme on such a grand scale that the practice may well be replaced with the name “Madoff scheme” from this point onward. The amount of money involved in Madoff’s alleged scam is staggering—an estimated total of &65 billion stolen over decades.

    As a traditionally low-profile investment professional, former chairman of the NASDAQ stock exchange, and an occasional consultant to the Securities and Exchange Commission on matters of investment regulation, Madoff became a multimillionaire in the early days of computer-based stock trading before he became attracted to the more lucrative business of managing other people’s money. He built a reputation of sure and steady returns for his clients, earning the affectionate nickname “T-Bill Bernie” to reflect the same security as investing in government-backed Treasury bills. Madoff’s success wasn’t based on spectacular returns from year to year (he averaged between 10 and 18 percent per year), but rather on consistent solid performance year after year. He didn’t market his services aggressively, preferring instead to allow satisfied clients to bring in family members and friends. He generated an aura of exclusively, often declining to accept investments which only served to make those potential investors want to invest with him even more.

    This perceived exclusivity and strategic marketing plan that targeted wealthy investors in places like Palm Beach, Florida, allowed Madoff to build a solid reputation over decades, attracting high-profile investors and large investments from global banks in the hundreds of millions of dollars along the way. However, the financial meltdown at the end of 2008 promoted investors to start withdrawing their funds to meet other obligations, and when Madoff was faced with withdrawal requests totaling almost $7 billion, the carefully constructed scam fell apart in a matter of hours.

    In the early emotional days of this exposed and still alleged scandal, one of the primary concerns is the appointment of blame. Who knew what, when, and could this have been prevented? The SEC has come under considerable scrutiny for its role in this. Madoff’s operation was examined on four separate occasions since 1999, with two detailed investigations launched in 1992 and 2006. No evidence of fraud was uncovered, and Madoff received only a mild reprimand for irregularities in paperwork. Now that $65 billion appears to have disappeared, with no trading records available to track the money, there are many questions to be answered. What is known for sure is that Madoff was sentenced to 150 years in jail (the maximum sentenced allowed) in June 2009. Given Madoff’s age of 71, the district judge for the case, Denny Chin, acknowledged that the sentence was designed to be symbolic and to reflect the severity of the crime and damage done to so many individual investors.

    Boston-based money manager Harry Markopoulos had written an 18-page  letter to the SEC in 2005 identifying 29 different red flags about Madoff’s operation, basically questioning the mathematical improbability of such solid returns year after year and suggesting that the only way to achieve those returns was to either trade on insider information or create a totally fictitious trading record.

    Supposedly “sophisticated” investors, who gave Madoff large sums to invest from pension funds, family trusts, and endowments, have been wiped out. Even worse, many individual investors, who entrusted their savings to other money managers who then invested that money with Madoff, have also lost substantial amounts in an investment they never ever knew they had.

    Much will be written about Madoff’s psychological state of mind in allegedly masterminding such a complex scam over decades and, more importantly, fooling so many of the elite of Wall Street and the regulatory mechanisms that are supposed to be in place to prevent such scam from ever happening. It remains to be seen whether this information will produce any dramatic changes in the regulatory framework of the financial markets to ensure that a Ponzi scheme on such a staggering scale never occurs again.

 

Questions:

1.)  Charles Ponzi was a working-class Italian immigrant who was eager to find success in America. Bernard Madoff was already a multimillionaire before he started his scheme. Does that make one more unethical than the other? Why or why not?

 

Explain how Ponzi scheme works.

2.)  Explain how Ponzi scheme works.

 

3.)  Does the SEC bear any responsibility in the extent of the Madoff scheme? In what way?

 

4.)  Does the fact that Madoff offered less outrageous returns (10-18 percent per year) on investments compared to Ponzi’s promise of a 50 percent return in only 90 days make Madoff any less unethical? Why or why not?

 

5.)  Can the investors who put their money in Madoff’s funds without any due diligence, often on the basis of a tip from a friend or a “friend of a friend” really be considered victims in this case? Why or why not?

 

6.)  What should investors with Bernard Madoff have done differently here?