“The World’s Largest Hedge Fund Is A Fraud.”

Harry Markopolos testifying before Congress, February 4, 2009.

Harry Markopolos testifying before Congress, February 4, 2009.

I recently attended a screening of the new documentary Chasing Madoff about a financial analyst, Harry Markopolos, who uncovered Bernie Madoff’s Ponzi scheme and spent almost a decade trying to get the SEC to investigate. One of his filing with the SEC was entitled The World’s Largest Hedge Fund Is A Fraud, but that wasn’t enough to get the commission’s attention. They ignored him, allowing the scheme to mushroom from a few billion dollars to $50 billion while they did nothing.[1]

The Madoff fraud is commonly perceived as demonstrating, once again, incompetence at the SEC. It is not so widely recognized as the most colossal hedge fund fraud ever. All along, it has been referred to as a “Ponzi scheme” and not a “hedge fund fraud”. Actually, it was both. Most hedge fund frauds involve a single firm. The Madoff fraud was unique for involving close to 200 hedge funds and funds of hedge funds.

Chasing Madoff makes the excellent point that Madoff was never caught; he turned himself in. He had ample time to destroy files and concoct a narrative implicating only himself. The bankruptcy trustee for the fund, Irving Picard, has indicated that “Mr. Madoff has not provided meaningful cooperation or assistance.”[2] How many people is Madoff protecting? three? fifteen? a hundred? Various investigations and lawsuits make it painfully obvious that what we know is the tip of an iceberg.

It has been widely reported how Madoff built up his hedge fund by luring prominent Jews and the philanthropies they ran. But that was in its early years. To sustain itself, a Ponzi scheme needs to bring in ever more money. By the time of its collapse, the scheme had spread tentacles around the world. That is where the almost 200 hedge funds and funds of hedge funds came in,  funneling money from North America, South America and Europe. Madoff was just starting to cultivate similar “feeder funds” in Asia.[3] The feeder hedge funds and funds of funds took hefty fees for merely passing clients’ money to Madoff. Ascot Partners, for example, had virtually all its $1.8 billion under management with Madoff. Many feeder funds were established by banks to funnel money from their private banking clients.

On February 10, 2009, decorated British soldier William Foxton shot himself in a Southampton park, becoming the second of three individuals to commit suicide as a result of Madoff’s fraud.[4] He had lost his family savings investing in two hedge funds: Herald USA and Herald Luxembourg. Both were Madoff feeder funds. Both were launched by Bank Medici in Austria.[5]

Bank Santander reported exposure of $2.8 billion for client assets they funneled to Madoff.[6] Swiss bank Union Bancaire Privee ran some 22 funds of hedge funds. Half of these invested some assets with Madoff.[7]

Bankers and hedge fund managers like to portray themselves as financial geniuses or “masters of the universe”, to borrow Thomas Wolf’s phrase. It is all marketing. Only when scandal hits do they transform into fumblers and bumblers, victims of forces greater than themselves. This is how the hundreds of hedge fund managers who funneled other people’s monty to Madoff are now portraying themselves. How could they not notice that Madoff’s performance was too good to be true? He claimed consistent positive returns with never a loss—the returns off an equity fund but with the risk of a money market fund. As Markopolos describes it,[8] Madoff was like a baseball player who not only batted a .964, but always hit doubles—no singles or triples or home runs—always doubles.

Madoff’s hedge fund raked in assets for two reasons:

  1. his purported performance, and
  2. the money he lavished on those who ran feeder funds for him.

Most of the fees Madoff charged went right back to the hedge fund managers running the feeder funds. Those masters of the universe, now turned dupes, could have saved their clients’ money if they had insisted on performing basic due diligence. A simple call to DTC, where Madoff claimed to clear trades, could have revealed that he wasn’t trading at all.[9] Madoff was secretive about his fund and resisted such basic due diligence. But it goes without saying that, if you are prevented from performing basic due diligence, you don’t invest. Why did hundred of bankers and hedge fund managers funnel billions of dollars of other people’s money to Madoff without basic due dilligence? How many noticed warning signs but chose not to ask questions precisely because the money they were making was too good?

Following the movie screening that I atended, Markopolos came on stage and answered audience questions. He has left investment management and now works as a private fraud investigator. It appears to be working out for him. He is like a walking encyclopedia of the Madoff case, not surprisingly. The fraud changed the direction of his life, and he follows it closely. I learned much from him.

The movie itself hits some high notes but was overall unsatisfying. It is a character study, not of Madoff, but of Markopolos. His is an interesting story, but it doesn’t easily fill ninety minutes. Beyond describing how Markopolos and other members of his firm spotted the fraud and worked to get the SEC’s attention, the movie takes us back to Markopolos’s childhood. We visit his high school and hear from his parents. We learn about his wedding and about his children. Over time, Markopolos grew paranoid that Madoff would learn of his efforts and have him murdered. Through reenactments, the film shows him trying on a bullet proof vest, practicing with firearms and imagining his own murder. This film noir extends to multiple scenes of Markopolos sitting alone in an office. It is pitch dark except for a single overhead light. A ceiling fan below the light casts a revolving shadown across Makopolos, passive and slumped. We are supposed to feel his fear and frustration. All I felt was my own frustration. I was learning little about how Madoff perpetrated his fraud, and the movie’s reenactments were contrived. No one places a light above a ceiling fan.

Footnotes    (↵ returns to text)
  1. The widely cited figure of $50 billion was Madoff’s own estimate. Estimates based on victims’ actual investments—not counting the bogus returns Madoff reported to them—tend to be closer to $30 billion.
  2. Henriques, Dana. Prosecutors propose 150-year sentence for Madoff. New York Times, June 26, 2009. Retrieved August 29, 2011.
  3. Markopolos gave a detailed breakdown of feeder funds by region during a Q&A following the movie screening I atended.
  4. The first was René-Thierry Magon de la Villehuchet, who worked for one of the most prominent feeder funds. The third was Madoff’s son Mark Madoff.
  5. Source: Madoff investment scandal, Wikipedia, accessed August 29, 2011.
  6. Madoff’s VictimsThe Wall Street Journal. December 16, 2008. Retrieved August 29, 2011.
  7. ibid.
  8. At the Q&A I attended.
  9. Morrissey, Janet. SEC Internal Review Cites Multiple Failures on MadoffTime, September 2, 2009. Retrieved August 29, 2011.

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