Maybe if we turned out engineers instead of MBA’s we could invest in companies that actually manufacture and sell products profitably instead of giving our money to three card Monte men who hang on the Street.

(chorus)
Palm Beach got run over by Bernie Madoff’s Ponzi reindeer
Just two weeks before Christmas Eve
You can say there’s no such thing as a Wall Street scamster
But as for we in America, we believe

He’d been chalking up bogus Alpha
So the SEC said he had to go
And as he waltzed out of his lair on Third Avenue
Defiant as he was, he said, “Positive returns, hell no!”

When they woke up yesterday morning
It was clear the Palm Beach clique had been attacked
May as well stick a note to their own foreheads
Saying, “Oh Lord, please give us our money back!!”

(repeat chorus)

Now we’re all so proud of our regulators
They’ve been taking this so well
See them crammed in Madoff’s office
Knowing that SEC Chairman Cox will soon be sent to pink slip h-e-l-l

It won’t be a Merry Christmas thanks to Madoff
Nor a Happy Hannukah as well
And we just can’t help but wonder
Dosn’t all of Wall Street have that pungent Ponzi smell?

(repeat chorus)

Now that Madoff’s books are on the table
See all the other asset managers dance a jig (Ah!)
And the bogus billion dollar earnings
That not surprisingly had been rigged!

Be forewarned all you rich country club investors
Better watch out for yourselves!
You should not make be dreaming of serial Alpha
With hedge fund goofs who play golf better than yourselves!

(repeat chorus)

George

A long time ago, I was a member of a board of directors for an investment advisory firm. At that time, to start an investment advisory firm, in contrast to a broker/dealer firm, one only had to register with the SEC. I don’t believe it required an application (which could be refused), but merely a registration, making one a ‘registered’ investment advisor (as a matter of right). After that, the only thing the firm did of an informative nature was to file an annual registration statement with the SEC. That was it. Once in while, more than a year but less than two years later, a gentleman from the SEC would show up, and satisfy himself the sums stated in the filed statements were correct.

He did not ‘audit’ the company’s books. That would require access in greater detail, and require much more time. And should not be the job of government in any case. It is the job of a solvent private auditor against whom one might collect a private judgment for negligence etc. One can’t sue the sovereign, the US, without its consent, and it does not generally consent to being sued. And wouldn’t that be lovely, with juries returning tremendous judgments against the US as the auditor of last resort to be paid by taxpayers?

As for private auditors, they confer no real assurances that financial statements are true and correct. They only confirm, after taking a statistical significant sampling, that that the company statements appear to be true and correct. To guarantee that they are correct, the auditor would have to have all funds going in and out of the company, and all bills sent to the company for payment be directed first to the auditors. In other words, the auditor would have to a ‘lock box’ where only the auditor first got to see everything concerning the company of a financial significance, before sending things along to the company to take care of and enter in its books. Then, the auditor would have to have significant insurance coverage against one of its employees turning against the auditor and knowingly approve false and misleading company financial statements.

Regardless of how much responsibility should be and is off loaded by government to the private sector auditors, the fact also remains the SEC has only a very few people to check on investment advisors. I don’t know the number, but I bet it is impossibly high, maybe 5,000 advisors to 1 SEC statement checker, due entirely to Congressional failure to fund a sufficient number of checkers.

Separately, I have not seen it adequately developed that smarty pants investors, such as Nicola Horlick, have no right to complain in any event. After the Depression, no one was exempted from the protection given investors by the ‘33 and ‘34 Acts. If a public offering was involved, one had to satisfy all protective requirements. A ‘public offering’ was defined and the definition disputed, but some believed that if you were going to or might offer a ‘deal’ to 100 or more, regardless of their acceptance of your offer, you were making a public offering, and had to go through the chairs to get a governmental permit to offer your deal to anyone.

Then, in the late ’60s, state and federal governments decided to withdraw protection for so-called ’sophisticated investors.’ The term was variously defined, but it usually required a statement from the investor that the investor had some sort of experience making investment decisions for one’s own account, and had some minimum amount of income and net worth. It was justified on the basis that the government didn’t need to spend money protecting those capable of protecting themselves and this same class of people didn’t want to waste money (getting new public issues approved was and is extremely costly) on things they didn’t need. The rich, knowledgeable sophisticated investor was better able than government to assure themselves the deal being offered was legitimate, and only they, the buyers, knew what is was really worth (what they were willing to pay).

Just as anyone can gain admission to any internet website offering views of naked persons in provocative poses by clicking on the button claiming one is ‘18 years or older,’ one could qualify as a ’sophisticated investor’ by claiming they were possessed of the minimum experience, income, and net worth. No one checked their claims. At this point, riskier deals got peddled, and the buyers/investors who wanted ‘in’ merely lied as did the subprime borrowers who also wanted ‘in.’ (Those who are not but want to be rich are just as capable of lying as are the poor.) They wanted ‘in’ for reasons of fear (to be just as socially superior and accepted as their relatives, friends, neighbors etc. who also were ‘in’), and for greed (just like the janitor who buys lottery tickets).

Through this door, the avarice of salesmen went directly to the those who had more dollars than sense, and the rise of speculation in real estate (almost all of the syndicated deals of the ’70s + were offered to sophisticated investors), venture capital, and hedged stock funds. The compensation was unregulated, and the lawyers, accountants and salesmen probably made far more money offering these non-public deals. Fast forwarding to today, I know things have changed since I was a director almost 20 years ago, but I don’t think human nature has changed. These stories feigning sympathy for the fools whose arrogance and conceit prevented them from checking things out thoroughly before investing, and passing on questionable deals are repugnant. They are getting what they wanted and deserved.

In closing, I can also assure you from personal experience that most of the ‘investors’ in Madoff’s scheme do not want to be exposed as investors in his scheme. If their names remain silent and are not exposed, they can ignore their loss, but once their names are public they look absolutely stupid, ignorant, negligent and so on. A bunch of people I know personally once invested in an absolutely fraudulent multi-million dollar oil and gas syndicated deal, and when the fraud was discovered, and everyone was offered their money back, almost half wanted nothing to do with the recovery. Almost all who refused, were stock brokers and salesmen, who did not want it known they were ever in. They did not want it known by their clients that their brokers and salesmen were capable of making such stupid mistakes. They got their way, as the deal never made headlines, even when the principals were sentenced to jail about a year later. Look at Nicola. Who would want to put money in the hands of someone so fat, dumb, and lazy. Who would invest almost 10% of her firm’s money with someone she herself did not check out thoroughly, like, for example, visiting Madoff’s one room office? They don’t need her to throw their money away on silly deals. If I had money in her firm, I would ask for it back immediately, because all of her investments are now questionable.

Regardless, I hope you find time to report on the fact that the ‘rich’ asked not to be protected, and weren’t and should receive no sympathy for getting what they wanted.

I bet his policy of “gradual sells”, and “structured illiquidity” were sorely put to the test by his closest clients in November.

House Oversight Committee Hearing on AIG – 7th Oct 2008.
Excerpt between Rep. Peter Welsh (Democrat, Vermont) and Mr Lynn Turner (Chief Accountant, SEC. 1998–2001.)

Rep. Peter Welsh: Mr Turner… I think you said that the SEC Office of Risk Management was reduced to a staff, did you say of… ‘one’?

Lynn Turner: Yeah when that gentleman would go home at night he could turn the lights out. In February of this year we had gotten down to just one person at the SEC responsible for identifying the risk at all the institutions

Rep. Peter Welsh: So that included the 62 trillion dollar credit default swap…?

Lynn Turner: That’s correct.

Rep. Peter Welsh: And how did he do..?

Lynn Turner: Well I suppose he got the lights turned out, but he didn’t get the problems taken care of… [ ] …Yeah in all fairness to the SEC… the staff over there that I’ve dealt with over the years have been excellent. But when you only have one person, there’s no way on gods green earth that anyone, Chairman Cox, or anyone else, could even imagine that this person could do the job. When you cut it down to ‘one’, you know what your doing, you know that your basically saying were not gonna do the job.

Rep. Peter Welsh: Yes… was there a systematic depopulating of the regulatory force so that it was impossible actually for regulation to occur if you have one person in that office? …and then I understand that 146 people were cut from the enforcement division of the SEC, is that what you also testified to?

Lynn Turner: Yes… Yeah, I think there has been a systematic gutting, or whatever you want to call it, of the agency and it’s capability through cutting back of staff.