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7 Goods Reasons Why the World’s Largest Fraud Occurred
Much has already been reported about 70 year old - Bernard L. (Bernie) Madoff, particularly how he managed to misappropriate US$50 Billion dollars, yes “US$50 Billion”. Madoff gave himself up to US Prosecutors who on 12 December 2008 charged him with a single count of securities fraud. His disclosure occurring only after he knew his business could not possibly cover the $7Billion in redemptions, funds that had already been lost in the “Affinity-Ponzi” scheme he’d been operating for decades. He had just before this, announced to his staff “its all just one big lie”. Later, the Securities and Exchange Commission (SEC) initiated civil proceedings. Madoff now assumes the infamous title, ahead of the famed but fictitious Gordon Gekko, but well ahead of the real Michael Milken, Ivan Boesky, Marty Siegel and Dennis Levine as the biggest Wall Street crook of all time. The extent of Madoff’s fraud dwarfs Enron and WorldCom in both size and audacity.
Prominent Funds Manager
Madoff had been a prominent member of the New York investment community since he started his business in the 1960s. He had even held roles as Chairman of the Nasdaq Stock Exchange and if reality could not slip further into farce, he had been an advisor to the US Government on market regulation.
(Photo – Justin Lane/EPA)
All That’s Old Is New Again – the Ponzi scheme
The fraud only came to light when Madoff confessed that his investment scheme was a total sham. Now identified as modelled on the 1920’s ‘Ponzi’ or ‘financial`pyramid’ scheme. The scheme operated by using funds obtained from the most recent investors to return some limited funds to earlier punters in order that they in turn kept bringing inducting other unsuspecting investors. Carl Shapiro, the individual who has so far been identified as loosing the most to Madoff, his close personal friend of over 50 years, has been reported as loosing US$545 Million of which $145M came from his charitable foundation. The largest identified corporate looser is Walter Noel’s - Fairfield Sentry fund which has lost an estimated US$7.5Billion of its investors money.
See article: Prominent Trader Accused of Defrauding Clients
http://www.nytimes.com/2008/12/12/business/12scheme.html?scp=10&sq=madoff&st=cse
Unbelievable Returns
Madoff’s investment firm focused on attracting wealthy and prominent investors by claiming annual returns of around 10-12% year on year. Madoff was a consummate socialiser and managed to move effortlessly among wealthy investors in the US, charming them to invest in his scheme. With the allure of easy riches and giving the appearance of exclusivity if you were permitted to invest Madoff perpetuated his reputation by being seen to invite only the select few, even going so far as to refuse certain investors. With so much local success in obtaining investors, Madoff went on to attract others from around the globe including banks and investment houses in Europe and Asia.
Warning Signs
Although the fraud itself was only discovered recently, over the past decade there were a number of red flags raised concerning Madoff’s continued success, if only someone had seen the signs. From time to time the press had questioned his claims, however, this had no obvious impact on investor confidence. In 2001, Madoff even invited a number of investors to inspect the books and in 2005 & 2007 the SEC conducted investigations into parts of the business but found no major issues.
Though the investigation into the fraud is just beginning, there is every indication that the estimated US$50 Billion in losses may be correct. So far, Madoff has accepted responsibility and continues to assert that he acted alone; although many are sceptical that just one person could orchestrate such a huge fraud.
Seven (7) Red Flags That Should Have Raised Suspicions
There were a number of warning signs, that can be used in fraud detection, that the Madoff was engaged in fraud:
1. A sole player – Madoff was the only person within the organisation who knew the ‘secret’ as to how the funds were invested and the returns derived. Madoff kept the accounts and trading records under lock and key and refused to share these with anyone.
2. Auditors – Madoff engaged a relatively small audit firm to approve the accounts. The audit firm reportedly consisted of one elderly owner, an employed accountant and secretary. Madoff avoided engaging one of the larger audit firms or those well known as financial securities specialists.
3. Relatives – Madoff engaged his close relatives to hold senior positions within the organisation making it difficult for any one of them to query his decisions or business methods.
4. Claimed performance – Madoff claimed to be producing impressive returns year in year out; 8 to 12% on average for all of his investors. These returns were reported despite the bearish conditions over the past 12 months. While market commentators queried these returns no one acted on their suspicions. Enough investors and commentators were evidently taken in by his “split strike conversion strategy” – a “collar” that combined a protective put and a covered call to limit risks, which he claimed balanced and stabilized the investment portfolio.
5. Who recommended Madoff – Many hedge funds and fund of fund managers actively recommended him. These “feeder funds” in reality were receiving significant commissions for directing investors or their funds to Madoff. It now appears there was little if any incentive or interest on their part to scrutinize Madoff’s claims of success or to demand independent and fully qualified accounts.
6. No independent custodian
Madoff’s firm held investors’ assets directly. Madoff Securities - the brokerage arm undertook the trades for Madoff’s investment business and acted as the custodian and administrator of assets. This enabled Madoff to obscure the volume and size of trades; had these been done through reputable third party brokers [as many other investment funds do] then they would have been noticed.
7. Leading investors – He managed to attract a number of prominent and sophisticated investors that were paraded around in order to bring in other wealthy clients.
Here are just a few of those that have lost some or all of their investment with Madoff:-
Access International Advisors, undetermined loss
Ascot Partners, run by Jacob Ezra Merkin, GMAC’s chairman, most of its $1.8 billion in assets
Banco Santander, $3.1 billion of client exposure
Banque Benedict Hentsch, $48 million
Benbassat & Cie, $935 million
BNP Paribas, undetermined loss
Bramdean Alternatives, 9.5 percent of its assets
The Boston philanthropist Carl Shapiro’s charitable foundation, $145 million
EIM Group, $230 million
Fairfield Greenwich Group, $7.3 billion
Fix Asset Management, $400 million
Harel Insurance, $10.9 million
HSBC, $1 billion
Julian J. Levitt Foundation, $6 million
Kingate Management, $2.8 billion
Madoff Family Foundation, $19 million
Maxam Capital Management, $280 million
Mirabaud & Cie, A few million Swiss francs
Neue Privat Bank, $5 million
Notz, Stucki & Cie, undetermined loss
Nomura Holdings, $300 million
Norman Braman, former owners of the Philadelphia Eagles, undetermined loss
North Shore-Long Island Jewish Health System, $5 million
Optimal Investment Services, undetermined loss
Pioneer Alternative Investments, almost all of its $280 million in assets
Robert I. Lappin Charitable Foundation, $8 million
Reichmuth Matterhorn fund, $330 million
Senator Frank Lautenberg’s charitable foundation, undetermined loss
Sterling Equities, run by Fred Wilpon, owner of the New York Mets, undetermined loss
Tremont Capital Management, undetermined loss
Union Bancaire Privee, $850 million
Yeshiva University, undetermined loss
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