Madoff Update

Due to size and shock of this story, it has been all over the web and papers. The Wall Street Journal has an entire page devoted to it. This scandal is every bit as shocking and disruptive as Enron was. Because so much information is becoming available, I see no need to repeat everything the WSJ is reporting (visit their page, the source of the facts below). Instead, I'd like to summarize a few new facts and add a few questions of my own.

As I surmised in my last post on Madoff, his fund was not registered with the SEC until just recently- 2006. The SEC makes a point to inspect every new registered investment advisor within their first year of registration, something they apparently did not do in Madoff's case. Not that is would have done any good, for they may have missed the crime anyway. Had they caught it, this would have been big news a year earlier and probably not dimished the size of the crime very much. What is shocking, is that the SEC had been warned several times that Madoff was probably a fraud!

The most glaring revelation so far is that a rival named Harry Markopolos once tried to reverse engineer Madoff's performance and concluded it was impossible. "Madoff Securities is the world's largest Ponzi scheme" he wrote to the SEC in 1999.  Markopolos went so far as to purse this allegation over the past nine years with the NY and Boston bureaus of the SEC. Obviously, his efforts were in vain.

Another huge red flag a careful and reasonably informed reader should have picked up: In Madoff's registration statement, (Item 5,E) he indicates he is compensated by commissions only. Hedge funds are known for commanding generous fees. Typically, they charge 2% annually plus 20% of the profits, but Bernie was just taking commissions. Why would someone as savvy as Madoff not charge what he is worth, let alone able to charge? Indeed this fee structure probably left over $1 billion in fees out of Bernie's pocket (he was getting it by other means we know now). To add insult to injury, since Bernie also owned a broker-dealer he would be earning commissions on trades placed through the firm he also owned. This, my friends, would be a giant red flag. Not having an independent broker confirming trades would be a show stopper for the SEC and for any investor checking out his operation.

Which all begs the question why Tremont, Fairfield Greenwhich Advisors, Kingate Global and Fix Asset Management- funds which fed money to Madoff according to the WSJ- couldn't figure this out. To be fair, they aren't alone: Grupo Santander, BNP Paribas, Nomura Holdings, Royal Bank of Scotland, French investment bank Natixis, Swiss private bank Reichmuth & Co, European investment manager EIM Group and plenty others all fell for it. A Tremont spokeperson made this statement as quoted in the Journal:

"Tremont was victimized by not just a person but also a scheme and a complex process designed to deceive individuals and organizations, managers and analysts - including some of the largest and sophisticated financial institutions in the world". 

When I was young and wanted to do something foolish with my friends, I would make the case that "everyone was doing it, dad." My father used to say to me "if everyone jumped off a bridge, would you do it too?" (Base and bunge jumping were not yet accepted thrill-seeking activities like sky diving). Tremont's job was to do research on behalf of its clients to avoid be taken by such a scheme. Indeed, just because others bought subprime loans, doesn't mean it was ok. Just because "everyone" and "sophisticated" investors were buying dot com stocks at the height of the bubble in 1999 doesn't make it ok. Taking bribes is not ok, just because other politicians do it. As highlighted by the many independent red flags, clearly there was something fishy and ample reason to avoid it. We all make mistakes, but it is a little hard to believe that Tremont, Fairfield and others never came across the red flags all those years. IF they did see the flags, why were they ignored?

This story is big and will probably surprise and offend us for a while longer. A Steven Speilberg charity appears to be a victim too. Maybe Sir Steven will make a movie out of it?