The Madoff plot thickens
The so-called “independent auditor” of Madoff’s Ponzi scheme seems to have been something of a storefront operation. Unbelievable that this didn’t raise red flags.
Oh, wait. Apparently, it did, according to the article. But the red flags didn’t raise any red flags. Maybe the regulators were color blind.
The lack of investigation is partly explained by the overburdening of the SEC inspection system itself:
“There are just so many people out there who are and aren’t registered that it really just overwhelms the system,” [Duke securities law professor] Cox said. “There is no easy way to expand the regulatory net unless we’re willing to put the might of the federal budget behind it to carry out more inspections.”
But, as previously noted, there were bona fide complaints and suspicions registered about Madoff’s scheme (see also this). It makes more sense to me that the failure to regulate may have had more to do with collegiality and reputation:
[Madoff] sat on a committee of academics, regulators and executives formed in 2000 by former SEC Chairman Arthur Levitt to advise the agency on new stock-market rules in response to the growth of electronic trading. Madoff has led the trading committee at the Securities Industry Association, Wall Street’s biggest trade group, and served as chairman of the Nasdaq Stock Market.
Since 2000, he has given at least $100,000 to the Democratic Senatorial Campaign Committee and more than $23,000 to the party’s candidates, including Senator Charles Schumer of New York and Senator Frank Lautenberg of New Jersey, who leads a charitable foundation that invested with Madoff.
“You can see where people would pull the shades down over their eyes in terms of recognizing what could be one of the great frauds of our time,” Levitt said in a Bloomberg Television interview. “I’ve known him for nearly 35 years, and I’m absolutely astonished.”
Well, there’s a sucker born every minute, and apparently one of them might be Arthur Levitt. But Madoff was apparently one smooth operator, almost on the order of a world-class spy in his ability to lead a double life and dissemble—and to screw his friends, associates, and clients, which included many large charities.
And fasten your seat belts. Madoff may not be alone. It’s not a coincidence that the Ponzi nature of his hedge fund is emerging now, during the financial crisis. Ponzi schemes rely on relatively good economic times; they collapse if too many people want to pull out their money at once.
That’s exactly what happened to Madoff, and it is likely that it will happen to others who are similarly overextended. In a “bad news, bad news” way, the financial crisis acts as a sort of plaque discloser for such operations.
“a committee of academics, regulators and executives formed in 2000 by former SEC Chairman Arthur Levitt to advise the agency on new stock-market rules in response to the growth of electronic trading”
I was wondering how they ever caught on to Martha Stewart.
Nice line about red flags!
Holman Jenkins makes a great point in yesterday’s WSJ.
Ponzi schemes are prone to collapse and Madoff stayed afloat for decades. It’s therefore highly unlikely that he had been simply running a scam. Rather, he ran a conventional options trading fund and ran it well enough to make most of the money he hauled in through actual gains on the market.
But from time to time, when returns were down, he’d dip into inflow for payouts. Over the decades, his options bets always recovered in time to cover the paid out inflow.
But with the most recent crisis, that didn’t happen. Confident that it would eventually reverse, Madoff “doubled down” his bets and lost catastrophically — the Black Swan came gliding in to bring down his decades of money making.
It’s less surprising that Madoff fooled so many people when you consider that not all his business was bogus. Much of what he was doing was legit. Rather than simply ignoring the rules, it was more like he was cutting corners. Ironically it was his the scale of his success and thus his desire to maintain it, that drove him to increase the level of cheating to catastrophic proportions.
Many lessons for all.
“But Madoff was apparently one smooth operator, almost on the order of a world-class spy in his ability to lead a double life and dissemble…”
Hmmm. Perhaps he should be sentenced to working as an under cover operative for the CIA in Iran. It’s a perfect setup — if he succeeds, we’ve put his skills to work in order to gather valuable intelligence. If he fails (i.e., gets found out), he gets killed.
There’s a piece in WSJ today regarding another financial adivsor/manager that have tried in vain for 10 years to SEC regarding Madoff’s operation.
Call it the new age of Caveat Emptor
Boggy, I believe you know something about finance.
I call this the end of the Age of Blind Credit.
A very old and useful idea, Steven.
Actually, Neo, I think it is more likely that he was in it as (more or less) legitimately as other traders until it went bad and he figured that his pool was so large that it would hold him until things flipped. He should have been more up front but that hesitance makes him more of a human than a robber captain.
As for they collapse if too many people want to pull out their money at once that’s true of any institution that accepts items of value and reinvests them.
But, hey – I voted for you twice.
I love it! I just followed the links and it wasn’t even much of a storefront. It was one guy. The is great! They quote people who say that “normally” (love that) an operation that size would use one of four or five big firms.
Like Arthur Anderson? Enron used them.
But, really. This always happens. Things go along and stocks go up and real estate goes up and any kind of cyclical element goes right out the window because each and every trader, politician, pundit, et al knows he is so damn smart and THAT is why everything is going well.
Then when something happens, and it always does, because it has to, and a lot of people are way out on a limb they all point to the mote in the other fellow’s eye.
I have to say, Bogey Man’s description of Madoff’s business is the most likely and accurate I’ve read — in DAYS of reading article after article on Madoff.
I find it vaguely amusing, and more than a little irritating as scores of financial writers having anointed them selves brilliant seers — seers into the past, that is, looking BACK through all those rear view windows of time! If I see one more “red flag” phrase!!! Those “red flags that are so prevalent in Madoff’s records, are obvious only now, after so many self-annointed geniuses, knowing what they do now, pore over anything and everything until they find some “AHA!” item(s) that they might now proclaim to the world should have been a dead giveaway to corruption.
IN FACT, as has been repeated over and over in news articles, on financial stations and the MSM ad infinitum, Madoff fooled some of the most sophisticated investors in the world. Not just SOME, but LOTS and LOTS of them. That is because, as Bogey Man said above,
“It’s therefore highly unlikely that he had been simply running a scam. Rather, he ran a conventional options trading fund and ran it well enough to make most of the money he hauled in through actual gains on the market.
“But from time to time, when returns were down, he’d dip into inflow for payouts. Over the decades, his options bets always recovered in time to cover the paid out inflow.”
That is a much more logical set of circumstances. It’s one thing for people to say (of course, not maliciously) “Better he (she, they) than me.” A sort of “by the grace of G-d.” But it’s another thing to see repeatedly, articles dripping w/ implications of stupidity and ignorance on the part of investors.
For those who don’t read here regularly, I’m actually one of the “hes” — actually a “she,” — whose savings as well as that of my family’s, particularly my 86-yr. old father’s was invested with Madoff, as of 4 years ago. Now, not only gone is our income, but quite likely most of, if not all, of our principle. So I’m paying particular attention to much of the news.
Also, it should be known, I’ve read inaccurate articles calling Madoff’s business a hedge fund. The entire business was not. For those who don’t know what hedge funds are, they are funds devised as an investment vehicle for the very, very wealthy — those that can afford losses. The investment funds invest in very high risk trades with the objective of reaping the highest possible rewards. In recent years, hedge funds have proliferated as greed does, and many people who do not have that kind of money, still invest with the hope of getting lucky. Somewhat like winning the lottery.
Madoff had different divisions of his business: market making for certain stocks (he is credited with changing the nature of modern stock trading by being one of the first to “create a market” for particular stocks. In other words, they were a clearing house for purchases and sales of specific stocks. This is common now. He also had funds in which other independent outside funds, and funds of funds invested, and moneys that banks invest. He also had a proprietary trading business — headed by one of the sons, and which, at this time, is said to be completely independent of the money management. He also invested the funds of other hedge funds for them, as well as certain funds (pools) of funds. And that brings us to the division which yielded Mr. Madoff the most opportunity: money management — for individuals, for foundations, for trusts — private and charitable.
Enough has been written in the last week, and is available over Internet and in MSM that I don’t want to waste time repeating.
However, what I did want to point out, is how ridiculous some of these articles are – in part, or in whole, (I’ve seen similar comments on these pages as well) to question the wisdom of all investors in the face of those supposedly obvious and pesky red flags. When most people consider where to invest their funds, they don’t throw darts at the “Money Manager” section in the Yellow Pages. They usually ask for recommendations — from friends, from bank officers, read about different stock brokerages and such. Then their “due diligence,” is often asking for references, following those up, and looking for the appropriate certifications and licenses of the companies and individuals, as well as funded insurance on accounts and so forth.
Very few people ask to look at other person’s statements, excerpt trades at random, extrapolate what this means in fund activity by using that person’s investment in relations to the firm’s entire business, and then go to historical references to check the volume of transaction activity of that particular security at that point in time, and compare findings to see if that seems reasonable. Yet that is what many articles actually opine when they say investors should have seen those fed flags, and had they done that which I just described, they would have. Oh. Woulda’ coulda’ shoulda’.
Any investment is a risk. It’s also a risk to hide your cash in an old shoe, too, but more than likely, you wouldn’t. Most people who are at all financially astute, before handing over their money — regardless of how how much that may be — ask plenty of questions before handing a check over. Those regard the stability of the financial co., their history, any legal troubles and solvency. Beyond that, personal references and the like, as mentioned before. That’s reasonable. That’s even more than cautious for the average person. Now a company operating as a fund and taking other’s money, charging a fee, and then turning it over to another company (without the initial investor’s knowledge)* (and sometimes funds are placed still again creating layers of fees not to mention anonymity of those who are actually managing the money) probably has a bit more fiduciary responsibility. For one, I would like to see a requirement for disclosure to client investor re: where the funds are actually parked, who’s really investing them, and all the fees along the chain to create a more competitive and honest market. That is, I think the initial investor is entitled to know who ultimately is handling his money, and how much of the fees he is paying to his money manager is direct, or going to 2nd or 3rd parties who will ultimately determine the gains (or losses). That is one area in which transparency is missing and I think of significant importance to an investor.
Finding the just the right amount of regulation is like walking a tightrope: enough is needed for balance and to keep individuals and businesses who would handle the money of others’, honest. However, govt. must be careful so as not to constrain the financial system and put a ceiling on innovation and growth. This actually can be seen in the effect of the govt-imposed Sarbannes-Oxley Act. In the wake of such debacles such as Enron, Tyco, Adelphi…Congress rushed to put stringent reporting requirements in place for companies, in order to forestall repeats of the huge disasters. In hindsight, however, it has turned out that the enormous costs of fulfilling the law’s requirements, has cost most businesses enormously. Similarly, it goes in the securities businesses. There are so many people involved, so many cos., so many kinds of financial instruments and types of transactions which can have numerous layers of interaction. When is enough just enough to temper the risk acceptably?
Oy vay! Carried away with writing and end up with a treatise. So sorry. Feel free to scroll quickly if I got too long-winded and boring!
But neo = I voted for ya, too! Here’s hoping…!
“But Madoff was apparently one smooth operator, almost on the order of a world-class spy in his ability to lead a double life and dissemble–and to screw his friends, associates, and clients, which included many large charities.”
Part of his ability to pull it off could have to do with the possibility it didn’t start as a scam. For awhile he probably was being honest and straight with investors. Then he just lost big.. Tried to recoup by making more [bad] investments and lost big again… and didn’t know how to get out afterwards. Started honest and ended up desperate…
Steven Says:
“Hmmm. Perhaps he should be sentenced to working as an under cover operative for the CIA in Iran. It’s a perfect setup – if he succeeds, we’ve put his skills to work in order to gather valuable intelligence. If he fails (i.e., gets found out), he gets killed.”
I thought a better punch line would be that he should help the Iranian government with their investments. 🙂
Neo,
Who was brilliant? Obama or his 27 year old speechwriter????
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/17/AR2008121703903.html?g=1
excerpt:
where the only furniture in place is a blow-up mattress on the hardwood floor. He sometimes writes until 2 or 3 a.m., fueled by double espresso shots and Red Bull. When deadline nears, a speech consumes him until he works 16-hour days and forgets to call home, do his laundry or pay his bills. He calls it “crashing.”
Where was this reporting BEFORE the election???
3 pages on this guy by the Washington Post NOW????
The largest Ponzi scheme is still active (and just as broke as Madoff’s).
You can’t pull your money out, and our forced participation is through confiscatory action.
Baklava: There was a fair amount of reporting on Favreau before the election. In fact, I wrote this post based on it.
Baklava–
Depends if “BRILLIANT” refers to the actual policy, the way it is presented to the citizens of this country, or the delivery of words, no?
Talked to a judge some years ago, before the income tax code was simplified. The subject was a guy selling tax benefits. Yup. Buy a case of Bibles or something and then donate it….
Anyway, as the judge said, it seemed to work. Do it and the feds sent you money.
It wasn’t illegal until they caught you–and him.
So, however questionable the thing seems, if money comes back, the questions are mostly answered.
The bull market is defined as a temporary and random movement of stocks which convinces the ordinary investor that he’s a financial genius.
“It’s therefore highly unlikely that he had been simply running a scam. Rather, he ran a conventional options trading fund and ran it well enough to make most of the money he hauled in through actual gains on the market. ”
I think that’s far from clear. According to various press reports, there just doesn’t seem to have been anywhere near the volume in options trading that you would have had to have seen if he was really managing all that money in the strategy he claimed he was using.
Steven’s right about the options volume issue. I trade options for fun and profit myself, and the first thing I thought when I heard the strategy Madoff was supposedly using was that there’s no way you could run it on top of $50 billion. The size of the required trades are way too big for the market. The strategy also won’t prevent losses. It will limit them in down markets, but the loss potential is as large as the gain potential percentagewise.
The Wall Street Journal Online has a copy of the allegations (may not be on the free part of the WSJ site) about Madoff that Harry Markopolos sent the SEC in which this is pretty well laid out. These allegations date back to 1999.
Obama has a speechwriter? OMG! How could I have voted for him! No presidential candidate has ever had a speechwriter before!
Oh, wait.
No presidential candidate has ever had a speechwriter before!
No candidate has ever had such a vapid, adolescent speechwriter before, anyhow….
No president has ever had a 27 year-old chief speechwriter before.
It goes a long way in explaining how historically illiterate Obama’s campaign speeches were.
Thanks Neo…
Obama’s words were so dazzling though 🙂 Had people fainting…