The Great Debate

from The Great Debate UK:

Where did all the “Madoff” money go?

- Erin Arvedlund is a journalist who has worked for Dow Jones, The Moscow Times, TheStreet.com, Barron's and the New York Times.  She is author of "Too Good to be True: The Rise and Fall of Bernie Madoff". The opinions expressed are her own. -

Where did all the money go?

After I wrote "Madoff: The Man Who Stole $65 Billion" this was probably the first question I received from almost everyone. And I am forced to tell the bizarre truth: there's probably no money left.

This is the nature of what are known as "Ponzi" schemes, or a classic pyramid scheme--Bernard Madoff constantly had to raise money from new investors to cash out the old investors, or "redeem" them, as a traditional hedge fund or mutual fund would.

But Madoff was not running a traditional hedge fund--not at all. He was running a cash-in/cash-out fraud, using the London branch of his brokerage firm as the piggy bank where he would wire money to and fro to make it look like he was trading for the hedge fund.

But there was no hedge fund, and there was no $65 billion at the end. Madoff lied about the amount of assets he was overseeing.

So where did the money go?

The tough questions after Madoff

Matthew Goldstein

Jun 30, 2009 08:32 EDT

– Matthew Goldstein is a Reuters columnist. The views expressed are his own –

Even as Ponzi king Bernard Madoff goes away to prison for the rest of his life and then some, there are still so many unanswered questions — both big and fundamental.

Were Madoff’s sons involved? What did his wife Ruth know? Were the operators of the giant feeder funds that sucked in tens of billions of dollars in investor money in on the charade?

Those questions, though important, ultimately pale when compared with the bigger ones that remain about the root causes of the worst financial crisis since the Great Depression.

Indeed, for all the misery Madoff and his Ponzi brethren have caused, none of those scam artists were the cause of the crisis that brought the financial system to the brink. If anything, it was the financial crisis that helped flush out Madoff and his scurrilous ilk, as many investors rushed for the exits at the same time.

So that’s why Congress needs to act quickly to get up and running a bipartisan commission to study the underlying causes of the financial crisis. House Speaker Nancy Pelosi likens this new 10-member panel to the Pecora Commission, the famous Depression-era investigative committee that led to passage of Glass-Steagall — the 1933 law that drove a wall between commercial and investment banking.

The 1999 repeal of Glass-Steagall contributed mightily to the current crisis by opening the door to an anything-goes mentality on Wall Street and allowing far too many banks to become too big to fail.

from Commentaries:

Allen Stanford’s many lives

Matthew Goldstein

Jun 4, 2009 10:30 EDT

The clock is still ticking on what would appear to be an inevitable indictment for disgraced Texas financier R. Allen Stanford, the man who allegedly ran an $8 billion Ponzi scheme out of his Antigua-based bank. It appears the federal prosecutors manning the investigation are trying to make sure they have an airtight case before filing criminal charges--something Stanford and his lawyer expect will happen any day.

At first blush, it's hard to fathom why it should take this long for prosecutors to file charges, given that Stanford and two of his top associates were the subject of a civil action by the Securities and Exchange Commission nearly three months ago. One of those associates, Laura Pendergest-Holt, has even been indicted on federal obstruction of justice charges. But still nothing on Stanford.

Bryan Burroughs, in the most recent issue of Vanity Fair, does a good job detailing how just about every US investigative agency was on Stanford's tail for more than 15 years. But whether it was allegations of money laundering, or fleecing investors with the sale of dubious CDs, no one was ever able to get the goods on Stanford.

In fact, I'm told Houston and New Orleans agents from DEA and IRS even considered running an ABSCAM-style sting on Stanford in 1998. The plan called for the agencies to work together and rent a yacht and throw a party with undercover agents posing as big-time drug dealers. The agencies planned to invite Stanford and some of his cronies to the party to see if he'd be willing to do business with the drug dealers. In other words, help them hide the proceeds from their illegal trade. The sting never happened.  It's not entirely clear why.

Ironically, a year later, DEA agents in Miami would praise Stanford as being one of the good guys in agreeing to turn over money that a group of alleged drug dealers had stashed away in an account at his Antigua-based bank. Again, it's not clear if the Miami agents knew about the aborted sting the Houston agents had discussed.

Sure, a lot of the difficulty in going after Stanford stemmed from the simple fact that he kept the core of his operation in a tiny country, whose political leaders were all too cozy with the native Texan and dependent on his largess to fuel the nation's economy. But there probably also was a simple lack of will on the part of the SEC, FBI, DEA and IRS to follow things through, in part because so many of Stanford's banking customers were Latin Americans.

Or, as Burroughs describes, may be it was the aggressive lobbying by the investigative firm Kroll that tamed the authorities looking into Stanford. And, of course, don't rule out the impact of inter-agency turf battles making it difficult for anyone investigative agency to take the lead and bring Stanford to justice.

Why did the SEC fail to spot the Madoff case?

– Mark T. Williams, a finance professor at the Boston University School of Management, is a risk-management expert and former Federal Reserve Bank examiner. The views expressed are his own. –

With Congress now probing the Bernard Madoff case, some claim the SEC missed the risk because of under staffing. Even if that’s an issue, one SEC enforcement officer using basic risk-management skills, asking probing questions, searching for clear answers, and exercising timely follow up could have helped in detecting this fraud before it grew to such a staggering size.

The central flaw at the SEC is that its current oversight approach is not sufficiently risk focused. Moreover, any changes in approach have tended to be in response to a specific event instead of incorporating an overall risk-based approach across all areas under their regulatory purview.

The SEC is responsible for overseeing registered broker-dealers, transfer agents, clearing agencies, investment companies and investment advisers, yet there is not a consistent risk approach used in all of these examinations. For example, in 2003, after widespread unlawful trading practices surfaced in the mutual fund industry, the SEC took steps to take a more risk-based approach.

Yet these higher examination standards were not viewed important enough to be applied to investment advisers such as Bernard Madoff. The weakness in the SEC’s existing examination approach can be best highlighted by the fact that, in the last 16 years, while Madoff’s firm was investigated 8 times, no fraudulent activities were ever uncovered.

As part of their broad regulatory mandate, the SEC is responsible for overseeing over 10,000 investment advisers. This agency needs to adopt a “where there is smoke there is fire” approach. The SEC must become risk focused in the scope and frequency of its monitoring and surveillance operations. Given the significant number of investment advisers, even if we assume that 99 percent are low risk, that still leaves 100 that need to be closely monitored and scrutinized.

The SEC should keep a detailed list of the top risky investment advisers and use it to prioritize and set review frequency. Currently, there is no clear indication that the SEC links review frequency or scope of exam with level of perceived riskiness. Former SEC Chairman Arthur Levitt recently indicated that only 10 percent of investment advisers are examined every three years. A wealth of new fraud can be dreamed up, hatched, and perpetrated at such firms in the interim.

We are all Madoff investors

J Saft

Jan 2, 2009 09:48 EST

– James Saft is a Reuters columnist. The opinions expressed are his own –

It was perhaps inevitable that we ended 2008, the year we learned we were up the creek, with a great financial scandal: the Madoff Ponzi case.

What is even more remarkable is the way in which the alleged fleecing of many billions of dollars from wealthy people and charities — investors who should have known better or employed people who did — serves as a mirror for the broader culture, showing how we went wrong and where we are left now that we realize our errors.

The main difference really is that Madoff’s purported victims, or enablers or co-fantasists, say they found out their wealth was illusory all of a sudden whereas for most people in the English-speaking world, this is happening little by little.

Bernard Madoff, for those of you just waking after a long winter’s nap, is accused of defrauding as much as $50 billion from investors in funds he promised would deliver a steady — suspiciously steady — 12 percent or so a year in good times or bad. But rather than a miraculous hedging strategy, authorities say Madoff has confessed to running a pretty simple Ponzi operation: paying out “earnings” to those who demanded them from new commitments of cash from those who wanted in. And of course, given that the man could “make” heady sums with no risk in all markets, the cash flowed in and the redemption calls were, for a long time, manageable.

Madoff has not appeared in court to formally answer the charges. But that there was one man, or a man with confederates perhaps, who was willing to engage in a harebrained fraud that was mathematically doomed to failure would not be that surprising, sadly. That an army of either rich sophisticated investors or their highly paid advisors played along and, seemingly, genuinely believed that they were growing rich is far more interesting.

One point, highlighted by Tim Lee of consultancy piEconomics in Stamford, Connecticut, is that the $50 billion headline figure is about as inflated as California real estate prices were a year ago. That $50 billion is likely to turn out to be not the amount lost but the amount people wrongly thought they had. It’s likely that the actual strategy followed by Madoff could return little more than Treasury notes minus fees; in other words he could make for you what you could get for yourself with no help but then pay himself handsomely for the gymnastics.

Minimizing exposure to investment management fraud

– Mark T. Williams, a finance professor at the Boston University School of Management, is a risk-management expert and former Federal Reserve Bank examiner.  The opinions expressed are his own. —

It looks like the oldest trick in the book was used to allegedly bilk wealthy investors, banks, charities, endowments, and hedge funds out of their money.  How could sophisticated investors have been duped by what could potentially be the largest Ponzi scheme in U.S. history?  The answer may center on their due diligence prior to signing up with the investment firm run by Bernard Madoff, accused of masterminding the massive fraud.

Due diligence is the rigorous process undertaken to evaluate the controls, credibility, and capabilities of an investment firm prior to putting money at risk.  This process doesn’t stop once a money manager is chosen, but continues over the life of the relationship.  The $50 billion in reported losses and the fact that this scheme went undetected for so long are stark reminders that there is no substitute for solid investor due diligence and ongoing monitoring.  Unfortunately, it has taken a down market to expose such fraud.

The following are 10 steps to help to reduce the chance of fraud.  (Note: Until a human fraud meter is perfected, such risk can never be completely eliminated.)

1.      Find a great money manager not a great friend.

Make sure the candidate pool is based on professional reputation, capabilities, investment track record, size of audit firm, and level of overall risk controls.  Deciding on the right money manager should be a pure business decision.  Confusing this business relationship with friendship or a person’s golfing handicap can cloud sound judgment.

2.      Conduct your own independent due diligence.