So how did Madoff get away with his $50 billion fraud? Time will tell when and how it started, although I’d hazard the dot com bust. Madoff may have been unwilling to report losses, and assumed (initially) that no one would be hurt if he fibbed if he could eventually trade his way out of trouble. But given the freakish consistency of his returns, it could have been phony from the get go.
The critical bit was that Madoff’s firm executed its own trades. No nasty third-party records to diverge with what the customer statements showed.
But another shocker came to light today: the SEC, via its own protocols, should have inspected the Madoff Ponzi operation prior to the end of 2007 and failed to. Why? Evidently, due to Madoff’s good reputation in the industry.
What is particularly curious (if my assumptions are correct) is that Madoff kept his registered status, which meant he would at some point have the SEC knocking on his doors. I am assuming he registered in 2006 because that is when the SEC has an initiative underway to register hedge funds with over $25 million in assets under management. Some evaded it by getting investors to agree to 2 year+ lockups (that put them in a different category). But the registration requirement was nullified when a hedge fund manager sued successfully, claiming that the SEC was misusing its statutory authority under the Investment Advisers Act of 1940. Most hedge fund then removed themselves from registration; for some reason Madoff did not. Did he somehow think he could bluff the SEC, or did he have a death wish? (Note: I am assuming the Madoff investment operation was considered to be a hedge fund, otherwise, it should have been registered as an investment adviser long ago).
In any event, that particularly day of reckoning did not come to pass.
A former Madoff employee called me, in many ways as gobsmacked as everyone else about the massive fraud. He said that the firm was very compliance oriented in the other aspects of its business, and was if anything overly zealous. That squeaky-cleanness in the activities visible to the marketplace in retrospect served as useful cover.
But the former employee also said that even at the time, some things that did not add up, although since the rest of the firm was on a separate floor from the investment operation, they didn’t think about them too deeply.
1. The returns were too good, too consistent. “it meant Bernie was either a genius or a crook.” Since Bernie had been an innovator and was genuinely (by appearances) a really nice guy, it was hard to see him as a crook.
2. The operations types in the investment arm were way way overpaid (someone had seen the pay stubs) and seemed not very smart and not very good. Many were related (ie, family members, but not the Madoff family)
3. The investment arm was peculiarly secretive and what they said about its strategy did not mesh with the returns.
The former employee is also pretty certain that the Madoff family members were in the dark and not part of the fraud.
Bernard Madoff’s investment advisory business, alleged to be a Ponzi scheme that cost investors $50 billion, was never inspected by U.S. regulators after he subjected it to oversight two years ago, people familiar with the case said.
The Securities and Exchange Commission hasn’t examined Madoff’s books since he registered the unit with the agency in September 2006, two people said, declining to be identified because the reviews aren’t public. The SEC tries to inspect advisers at least every five years and to scrutinize newly registered firms in their first year, former agency officials and securities lawyers said….
“Given what the SEC claims is the magnitude of the fraud, this is something you would hope an inspection would have uncovered,” said Mercer Bullard, a University of Mississippi law professor and former mutual-fund attorney at the SEC. “It’s hard to imagine a fraud of this alleged size not being accompanied by significant and pervasive compliance problems.”…
More than a decade earlier, in 1992, Madoff faced regulatory scrutiny as part of a lawsuit the SEC brought against two Florida accountants, whom it accused of raising $441 million while selling unregistered securities over three decades, according to SEC statements and a press report at the time.
Madoff told the Wall Street Journal at the time that he had managed the funds unaware they had been raised illegally. The SEC determined that the investors’ money was all accounted for, and didn’t accuse him of wrongdoing, according to the report….
Such a large Ponzi scheme — in which early investors are paid with money raised from subsequent victims — should prompt lawmakers to review how the U.S. polices brokerages, wealth managers and unregistered advisers, such as hedge funds, said James Cox, a securities law professor at Duke University in Durham, North Carolina….
Barry Barbash, a former head of the SEC’s investment management division, said the agency has tried to focus its inspections on money managers who pose the biggest risks. The regulator uses criteria such as which securities a firm is buying and who its clients are, said Barbash, a partner at Willkie Farr & Gallagher LLP in Washington.
“Given the state of SEC resources and given the way that they go about determining whether an inspection is necessary, it wouldn’t surprise me that a newly registered firm wasn’t inspected,” Barbash said.
Any suspicions about Madoff may have been dampened because of his association with industry groups, watchdogs and politicians.
He 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.”