The Big Bad Madoff Ponzi Scheme

[Catoneinutica]

[GuyJean]

... So, the working stiff who just got laid off from his software development schtick, as well as his real-estate agent wife, can take comfort in the fact that the plutocrats are feelin' the pain, too...

eeyyyyyyyyyyyy

GJ

[omae mona]

I think we're going to find that the SEC was pretty negligent. It was, apparently, glaringly obvious for years that this was a ponzi scheme. People wrote letters to the SEC warning them, and it appears the SEC never followed up.

The funniest part of the story, to me, is the "funds of hedge funds" that got burned. These companies charge rather high fees above and beyond the actual money managers. All they do, in return, is select hedge funds or money managers that they think are suitable investments. A big part of that job is "due diligence", making sure the investment is safe. For people that do this for a living, it sounds like Madoff practically had big signs up on the door saying "Madoff Ponzi Schemes, Inc.". What fund-of-funds are supposed to do is check that there is a proper auditor confirming the assets are what the manager says (there was not in this case), that there is a proper bank holding custody of the assets (there was not), that the pattern of returns remotely matches the strategy the manager says he's investing in (it did not). These are just the basics. Any fund of funds who put money into Madoff basically have been caught with their pants down, neglecting 100% of the duties they were supposed to be performing in exchange for those high fees. Oops.

[Catoneinutica]

http://www.boston.com/business/personalfinance/articles/2008/12/14/financiers_alleged_swindle_confounds/

"We've been contacted by people all over the country and around the world, as far away as Hong Kong," said Brad Friedman, an attorney at the New York law firm Milberg, one of a number of firms representing people allegedly defrauded by Madoff. "We have a scary number of clients who literally had all their liquid assets, everything but their home, tied up with this guy."

-----
As far away as Tokyo, perhaps?

[GuyJean]

A detailed, interactive article:
http://online.wsj.com/article/SB122914169719104017.html?#articleTabs%3Dinteractive

GJ

[pheyton]

This is just incredible that a 50billion fund could be a ponzi scheme. How in the hell could no one have known this was going on? Or were they just so greedy they didn't care cause they were making money?

I was at a bank luncheon last week and the CEO who was giving the talk had just returned from DC. He said things are going to get much worse next year. The Congressmen and other Gov. people expect unemployment to hit 10% in the US by March. It was a very sobering thing to hear from a bank CEO.

I've also heard there are 2 more time bombs in the pipe, commercial real estate loan defaults, one of which just happened here in So. Cal 1.5billion default, and the credit card bubble. The credit card companies are going to start calling in your debt to cover theirs and it ain't going to happen.

It seems that the whole system has to collapse and be rebuilt. Maybe that is what is happening?

Brave New World ya'll!

[Taro Toporific]

The list of the stupid....
[INDENT][SIZE="4"]
Bernie Madoff's Victims: The List [/SIZE]
clusterstock.alleyinsider.com/2008/12/bernie-madoff-hosed-client-list
[/INDENT]

[kamome]

I think we're going to find that the SEC was pretty negligent. It was, apparently, glaringly obvious for years that this was a ponzi scheme. People wrote letters to the SEC warning them, and it appears the SEC never followed up.

The funniest part of the story, to me, is the "funds of hedge funds" that got burned. These companies charge rather high fees above and beyond the actual money managers. All they do, in return, is select hedge funds or money managers that they think are suitable investments. A big part of that job is "due diligence", making sure the investment is safe. For people that do this for a living, it sounds like Madoff practically had big signs up on the door saying "Madoff Ponzi Schemes, Inc.". What fund-of-funds are supposed to do is check that there is a proper auditor confirming the assets are what the manager says (there was not in this case), that there is a proper bank holding custody of the assets (there was not), that the pattern of returns remotely matches the strategy the manager says he's investing in (it did not). These are just the basics. Any fund of funds who put money into Madoff basically have been caught with their pants down, neglecting 100% of the duties they were supposed to be performing in exchange for those high fees. Oops.

A little background on funds of funds. They usually charge a 1% management fee and 10% performance fee above the fees that the underlying investment managers charge. Whether that's "high" or not is a matter of opinion. Certainly, many investors choose to put their money into FOFs because they see a value in doing so-the ability to diversify, the ability to invest in one vehicle that tracks the returns of a particular sector, etc.-that justifies the fees. FOFs certainly aren't a "bad" vehicle to get into as long as they are run by scrupulous managers who do a good job of selecting the right underlying funds and minimizing risk. Unfortunately, some FOFs decided to invest ALL of their money into Madoff. It isn't clear why they did this]

[Mulboyne]

A major problem is that it would not necessarily be clear even to FOFs who did the proper due diligence that Madoff was operating a scam. The auditor was certainly a red flag, but using a small, lesser known auditor is not necessarily a negative for investors (perhaps a smaller auditor charges less fees, which means better returns for your investors). Also, no one, even those who perform thorough due diligence, can know what Madoff (or any other investment manager to a hedge fund for that matter) is investing in at a given time. That information is usually kept secret to safeguard a manager's ability to profit from knowledge imbalances in the market. So, any investor would have had to take Madoff's performance reports at face value.

That's giving the fund-of-funds too big a pass. One of the key claims of any fund-of-funds is that their due diligence allows them to exclude managers who take too much risk, have poor compliance etc. Those who invested in Madoff clearly didn't do this due diligence. The SEC has undoubtedly tripped up but why would a fund of funds rely solely on the SEC to spot wrongdoing? Saying that fund-of-funds didn't have access to the information they required is a poor defence. If they couldn't get adequate information then they should have avoided introducing their investors to such funds. It is becoming apparent that none of the strategies he claimed to be using could have generated the returns he claimed and one of the clearest duties for a fund-of-funds is to satisfy themselves that investment and performance do match.

[kamome]

Those who invested in Madoff clearly didn't do this due diligence.

I don't think it's as clear - yet - as you say it is. I'm just saying that there are limits to what information due diligence can yield. The fact that so many investors were duped by this guy means that it's possible he did a good job of covering up the red flags.

The SEC has undoubtedly tripped up but why would a fund of funds rely solely on the SEC to spot wrongdoing?

I didn't say that. Of course an FOF shouldn't be relying on the SEC to spot the wrongdoing.

[omae mona]

A maor problem is that it would not necessarily be clear even to FOFs who did the proper due diligence that Madoff was operating a scam.

Gotta disagree here, strongly. Well, ok, technically it might not be "clear he was operating a scam", but basically none of the myriad safety nets were in place to assure he was not operating a scam. Normally I think a FoF would reject such an investment.

The auditor was certainly a red flag, but using a small, lesser known auditor is not necessarily a negative for investors (perhaps a smaller auditor charges less fees, which means better returns for your investors).

The audit fee should be irrelevant to a $50 billion organization. To the contrary, this tiny little shop (apparently consisted of a 78-year old retired guy in Florida and a secretary who manned the office in New York) was manifestly unequipped to look at the books of a $50 billion fund.

Also, no one, even those who perform thorough due diligence, can know what Madoff (or any other investment manager to a hedge fund for that matter) is investing in at a given time.

There are a lot of "clues", like 13-F filings, and none of Madoff's alleged trading activity was visible in any of the public filings where they should have been. Smart investors noticed that and declared it a scam years ago.

Other things that were flaming, smoking, bright crimson flags were:
[LIST]
[*] He was his own custodian, meaning any securities he held were directly registered to his company, rather than a bank or a prime broker. No 3rd party had a record of the assets he supposedly had. Very unusual.
[*] He was his own executing broker (no 3rd party could confirm he was trading what he said)
[*] The pattern of returns was just *absurd*. The volatility was close to zero, and the returns were regularly 12% annually with virtually no variation, even in the last few months.
[*] For generating returns that probably should have gotten him recognized as "greatest money manager ever", he wasn't charging the normal 2%/20% fee structure that hedge fund managers get rich off of. He was simply (supposedly) earning money off of brokerage commissions since he used his own brokerage subsidiary for all trading. That in and of itself is a terrible incentive structure]

There are a bunch more I have read about but temporarily forgot. If I recall, even the auditor listed a bunch of red flags in the annual report, which investors ignored. Things like writing all trades on paper tickets (a practice ripe for abuse and inexcusable in 2008 when computers have been around for a few years now).

That information is usually kept secret to safeguard a manager's ability to profit from knowledge imbalances in the market. So, any investor would have had to take Madoff's performance reports at face value.

In 2008, I think any investors that are still taking any money managers' performance reports at face value are screaming "please, rip me off". There are lots of ways (fund administrators, outsourced back office, proper auditors, prime brokers, etc.) to confirm assets while maintaining secrecy for the manager, and again, half a FOF's job is to make sure this is all set up right. Decent FOFs would never, place money in a fund where they could not at least confirm assets exist. Confirming valuation is a different story, of course.

[omae mona]

Just to make this a little Japan-related, some just-off-the-wire news. Nomura Holdings reports a 27.5 billion yen exposure to Madoff (which is, presumably, all lost).

[TennoChinko]

The list of the stupid....
[INDENT][SIZE="4"]
Bernie Madoff's Victims: The List [/SIZE]
clusterstock.alleyinsider.com/2008/12/bernie-madoff-hosed-client-list
[/INDENT]

the same source also provides a little gem that helps eliminate any sympathy you might have for the "victims":

http://clusterstock.alleyinsider.com/2008/12/i-knew-bernie-madoff-was-cheating--thats-why-i-invested-with-him

[quote]
[SIZE="5"]I Knew Bernie Madoff Was Cheating--That's Why I Invested With Him[/SIZE]
Henry Blodget | Dec 12, 08 6:03 AM

Interesting tidbits coming in about Bernie Madoff (read indictment here).

Specifically, we're hearing that the smart money KNEW Bernie had to be cheating, because the returns he was generating were impossibly good. Many Wall Streeters suspected the wrong rigged game, though: They thought it was insider trading, not a Ponzi scheme. And here's the best part: That's why they invested with him.

For years and years I've heard people say that [Bernie's] investment performance was too good to be true. The returns were too steady -- like GE earnings under Welch -- and too high given the supposed strategy.

One Madoff investor, himself a legend, told me that Madoff's performance "just doesn't make sense. The numbers can't be straight." Another sophisticated Madoff investor actually went through trade confirms in order to reverse-engineer the strategy and said, "it doesn't add up."

So why did these smart and skeptical investors keep investing? They, like many Madoff investors, assumed Madoff was somehow illegally trading on information from his market-making business for their benefit. They didn't consider the possibility that he was clean on that score but running a good old-fashioned Ponzi scheme.

And another from Whitney Tilson:

One friend who saw this coming said Madoff had his own broker-dealer and a relative as his finance guy]

[Catoneinutica]

Karma doesn't get much more kosmic than this (from Taro's link):

Bernie Madoff's Victims: The List

...
Thyssen Family. Source sends the following: Thybo Investments grew out of a family office for Thyssen. They have been in fund of funds it seems since 1989. Thybo International is a "proper" fund of fund but it's newer share class G invests only in one manager - and i'm 99% sure it's Madoff as the returns are almost the same. Some more info. The fund started in Jan 2007. Ernst & Young. Luxembourg are the auditors. UBS Luxembourg is the administrator. Thybo states on their webpage: "Our track record incorporates audited financial statements at both a composite firm-wide and individual portfolios level."
...


Fritz Thyssen was one of the "top hats" who helped install Hitler ojisan, and his company has always had a bit of murk clinging to it; same goes for the Swiss.

And now a Jude runs off with your booty - shoulda stuck with sharia-compliant instruments, guys!

[gkanai]

Nomura Has 27.5 Billion Yen at Risk Linked to Madoff (Update2)

That's about $302 Million USD at today's rates...

[gkanai]

Harry Markopolos (an investor) was calling for an investigation of Madoff in 1999: Madoff fraud case raises questions about SEC

[omae mona]

There is a 7.5 year old article from hedge fund publication MARHedge showing there were plenty of people, a long time ago, saying "this all makes no sense". It looks to me like professional investors had to be heavily immersed in self-delusion or totally inadequate due diligence to be invested with this guy.

[gkanai]

It looks to me like professional investors had to be heavily immersed in self-delusion or totally inadequate due diligence to be invested with this guy.

Devastating. Makes Nomura (or any of those other financial firms who invested with Madoff) look like idiots or chumps or fools, take your pick.

[omae mona]

Here is a blog post from the Financial Times that nicely summarizes some of the red flags that were noticed by many investors over the years.

The blogger seems to think Nomura's investment was an investment of customers' money. It's going to be very interesting to see if Nomura lets their customers take the loss (very doubtful to me) or cover at least the customers' principal with Nomura's own cash (much more likely - This is Japan).

[kurohinge1]

eeyyyyyyyyyyyy

So, GJ, are you also hinting that the Ponzi scheme was really a Fonzie scheme?

Or that Madoff has "jumped the shark"?

[Ketou]

Is it just the news I watch, or is this getting very little attention in the Japanese media?

[kurohinge1]

Is it just the news I watch, or is this getting very little attention in the Japanese media?

Perhaps the terminology is too confusing for them.

I've summarised some industry terms below, which may assist.

PONZI SCHEME

Named after Charles Ponzi and most recently made famous by Bernard Madoff, a Ponzi scheme is a fraudulent investment operation based on funding abnormally high returns to investors from the money paid in by subsequent investors, instead of the profit from any real business.

FONZIE SCHEME

Named after Henry Winkler's character Arthur Herbert Fonzarelli aka "The Fonz" or "Fonzie" from the U.S. sitcom "Happy Days", a Fonzie scheme is similar to a Ponzi scheme but involves young ladies (investors) and an apparently charming man (the investment). Investors eventually realise that the investment has no substance but there is high volume and the man keeps enough outgoing investors around to lure new investors into thinking that the investment is worth pursuing. A Fonzie scheme that has difficulty attracting initial investors is called a "Potsie", named after another character in the series.

FOZZIE SCHEME

Named after Fozzie Bear - a fictional puppet character created by Jim Henson –]http://www.fuckedgaijin.com/forums/attachment.php?attachmentid=3232&stc=1&d=1229391305[/IMG]

[omae mona]

[Ketou]

[Greji]

[quote="omae mona"]Why is it that I always seem to fall victim to Fozzie Schemes? ]

I never learned any of those fancy terms, although I am quite familiar with and have been known to respond to nezuminaki!

[Mulboyne]

[omae mona]

News outlets are now reporting Aozora Bank has lost 12.4 billion yen (about $135 million) due to the Madoff fraud. Article at nikkei.net (Japanese).

[FG Lurker]

[IkemenTommy]

Think about this scheme the next time you are out in Roppongi.

Urban Word of the day:
December 16: Ponzi Crawl

A pub crawl that adds a new person to buy a round at each location. Each new person is promised that they will get free drinks at all the future bars if they buy this round. Obviously, whoever joins the ponzi crawl last gets screwed!

Let's get some suckers to buy us beer on a ponzi crawl this weekend.

[nottu]