Relevance of the Sarbanes-Oxley Act of 2002 to the Madoff Scandal

The investment scandal perpetrated by Bernard Madoff is the largest financial fraud in the history of capitalism. It is believed that Madoff’s secretive investment advice firm caused a loss of nearly $65 billions for the 4,000 odd investors who trusted his firm with their wealth. The investors consisted of several celebrities as well as people from middle and lower classes, thereby making the loss more acute for the latter group. This essay will explore the relevance of the Sarbanes-Oxley Act of 2002 to the Madoff Scandal.

The Securities and Exchange Commission (SEC), which is an agency of the Federal government that is entrusted with the task of regulating the financial markets is one of the chief culprits behind this failure. The SEC had brushed aside several warning signals in the years leading up to 2008, either due to the incompetency of their auditing staff or due to collusion with the fraudsters. Ever since Madoff started his ponzi investment scheme two decades ago, there have been independent reports that questioned the sustained high earnings of Madoff’s investments, in spite of the market downturn. It was only in 2008 that the truth about the firm’s fabricated accounting practices came to light, following which Bernard Madoff was duly tried and convicted for 150 years in prison. (Long, 2009)

Unfortunately, for many investors, the conviction is not an adequate compensation for the amount of wealth they lost. Seen in this context, the enactment of the Sarbanes-Oxley Act in the year 2002 was long overdue. The act attempts to tighten accounting and audit procedures by making business corporations in America comply with higher standards of accountability. Studied in retrospect, the Madoff scandal could have been thwarted at an initial stage if the firm had complied with the regulations mandated by the Sarbanes-Oxley Act. For example,

“Section 404 of the Sarbanes-Oxley Act requires each issuer’s annual report to include an internal control report which shall … contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. In addition, section 404 requires each issuer’s auditor to attest to and report on management’s internal control assessment”. (Coustan, 2004)

When the Sarbanes-Oxley bill was initially proposed, it set out to address the loopholes then present in the corporate governance laws. While the whole of Sarbanes-Oxley Act includes many clauses and subclauses, its essence is to make accounting practices in the USA more ethical. The only drawback of such an elaborate reworking of corporate governance laws is the additional cost involved. It is a matter of speculation if the Madoff scandal could have been prevented had Sarbanes-Oxley been implemented earlier than 2002. But there is no doubting the fact that the accounting misrepresentations carried out by Bernard Madoff and his cohorts were in breach of Sarbanes-Oxley regulations, both in letter and in spirit. (Kohn, 2004)

For example, Madoff’s ponzi investment scheme showed investors double digit annual returns on their investments, when in truth the money went straight to Madoff’s business bank account with Chase Manhattan Bank. Whenever an investor would request a redemption, Madoff’s firm would pay using funds from new investors, the excess being sent straight to the Chase Manhattan account. The trouble started when this vicious spiral of new infusions and redemptions went out of control. The savings and retirement pensions of many investors were lost in this artificial investment scam, reiterating the fact that regulatory overhauls such as Sarbanes-Oxley are highly relevant to the prevention of such scandals in the future. (Parles et. al., 2007)

1 2