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What Were They Thinking?

Take a look at yet another scandal that topped the headlines over a large part of 2009. After reading “What Were They Thinking?” answer the following questions.

Explain how ethics in business and the law are related. How are they different?

What is the impact of ethical behavior on the development of social responsibility for businesses?
What Were They Thinking?  Conventional wisdom helped drive supposedly sophisticated investors to bet on Bernie Madoff. Mere mortals had no business questioning his record and reputation Bernard Madoff could have schooled Charles Ponzi on just how big and for how long a scheme built on deceit could go. The original huckster had no shortage of chutzpah, but Madoff, by all accounts, had it coming out of his ears. To get at the answer to why investors acted like such sheep is to strike close to what must have been going on in Madoff's head too. He was a Wall Street cognoscente, a former chairman of the Nasdaq Stock Market and a widely sought-after money manager believed to have found the secret to investment success, logging 10 percent annual returns year in and year out with almost nary a down month — or so he said. In the end there was no secret and there were no returns, it seems, but there was this: Madoff, a brilliant student of investment, had found three weaknesses in the system and had exploited them all. First was the fact that many supposedly sophisticated funds of hedge funds and investment advisers whose job is to live and breathe the mantra of due diligence didn't. Second was that simple greed struck investors not just blind but also dumb and made them forget that if something seems too good to be true, maybe it is. Third was that regulators failed to see someone like Madoff for what he was. They accepted him as a powerful investment adviser and broker who kept his books to himself in his 17th-floor office in the famous Lipstick Building in midtown Manhattan. Madoff, in sum, got away with his alleged deception for so long because he seems to have known instinctively that investment advisers, investors and regulators would work together as unwitting accomplices by believing what they wanted to believe about Bernard L. Madoff Investment Securities. It worked for decades, ending only when the markets collapsed, the economy stagnated, credit seized up and Madoff could no longer sustain the illusion, admitting in December to a Federal Bureau of Investigation agent that he had been running a scam that was bankrupt and had vaporized perhaps $50 billion of investors' money. Quiz investors on what they were thinking — how could anybody go with a manager who was so famously guarded about what he was doing with their money? — and they will no doubt mirror how Madoff must have seen it. People with close knowledge of the fiasco say that those
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who put money with him also have a three-part answer to what motivated them: Fund-of-funds managers with a reputation for being in the know had signed off on Madoff; the proof was in the pudding (returns were steady and redemptions ready!); nobody with any regulatory authority had ever moved to shut Madoff down. It was simply accepted as fact that Madoff was the real deal. What mere mortals would dare to question the conventional wisdom? "The deep, underlying issue here is about trust and confidence, and even some of the most experienced investors had both trust and confidence in Bernie Madoff and the funds and subfunds invested with him," says Gregory Curtis, chairman of Pittsburgh-based Greycourt & Co., an advisory firm that helps guide investment choices for 100 clients worth a collective $9 billion, two of whom were partially ensnared in the Madoff web through no fault of Greycourt. Beyond the traits they had in common before the blowup, Madoff investors shared a new one after the fact: an understandable reluctance to discuss what happened. "Why on Earth anyone would have 50 percent of their assets with one fund or manager is something I simply do not understand," says Russell Kamp, CEO and head of quantitative strategies at Toronto-based Invesco, which manages some $26.5 billion in assets. "Most managers would not have more than 5 percent in any one stock; why would you do anything different with an allocation to a fund or manager?" "A good portion of the investors were individuals who did not do their due diligence, or relied on second- or thirdhand due diligence, which unfortunately is just typical of this kind of phenomenon," says Roxanne Martino, founder and co-portfolio manager of Chicago-based Harris Alternatives, which oversees $10 billion in funds of hedge funds. "There was also an impression given that it was difficult to get in, which put another level of pressure on people not to do due diligence — they didn't want to rock the boat. "I think there were a lot of signs," adds Martino, whose firm invests with about 50 managers. "I just don't think people were looking for them."
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This question was asked on Jan 23, 2013.

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