Part of the story about the Madoff Ponzi scheme was that Madoff created this elusive, difficult-to-become-a-member club. The exclusivity and rejections made membership all the more desirable to greedy investors.

That actually is turning out to be somewhat of a myth.

There is much more to his canny trick of rejecting investors than initially meets the eye. In reality, he did not really turn away money from investors. What actually occurred was that he refused to take cash from people whose participation would have easily revealed the fraud.

Allow me to explain:

As we noted earlier this week (Why Might a Madoff Plea Deal Take Place?) there are lots of other parties who might get pulled into this story. But the one that intrigued me most came from Credit Suisse, when that firm and its analysts looked into Madoff’s investments, and came away skeptical or convinced there was a fraud occurring.

In particular, there was something the execs who had met with Madoff said to Bloomberg that got me thinking: They noted his little- known auditor who had just one client, his refusal to reveal AUM, his refusal to charge asset management fees. But what was especially noteworthy was the issue of why Madoff served as the custodian of his clients’ assets.

That turned out to be, IMO, the key to his “turning away investors.” This was the scam within the overall fraud, one that made his Ponzi scheme irresistible to gullible investors.

Why? Consider how Custodial accounts work: Your institutional firm, endowment or trust fund is held at a major bank (as the Prudent Man rule requires). That means outside managers use DVP trades (delivery versus payment), with the clients’ monies staying in their custodial account, and the outside firm trading it.

Here’s how that looks int he real world. Let’s say the XYZ Foundation –10 billion in assets, held (custodial agent) at Goldman Sachs. XYZ wants to give the Ima Scammer Fund 10 million in assets to trade. Ima Scammer trades the $10 million of the account, but the cash and shares all stay at GS on behalf of XYZ.

That’s how a custodial account works. The outside fund manager has control over the money only so far as handling that portion of it. But the assets stay with the custodian.

And all of those clients turned away by Madoff? How much do you want to bet me that the vast majority were custodial accounts? Given the alleged scam, Madoff couldn’t do that, because the ruse would have been revealed almost immediately. The custodial accounts could not have generated his alleged returns.

These monies weren’t turned away by Madoff; they were run away from — by him.

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UPDATE: January 15, 2009, 11:47 am

Even more amazing, the Boston Globe is reporting Madoff might not have made any trades

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Previously:
Why Might a Madoff Plea Deal Take Place? (January 2009)

http://www.ritholtz.com/blog/2009/01/why-might-a-madoff-plea-deal-take-place/

Sources:
Credit Suisse Urged Clients to Dump Madoff Funds
Cynthia Cotts, Katherine Burton and Elena Logutenkova
Bloomberg, Jan. 7 2009

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a7Ei7.DM8DHc

Category: Hedge Funds, Investing, Legal, Really, really bad calls, Regulation

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

21 Responses to “No, Madoff Never Turned Down Money”

  1. mitchn says:

    Fascinating.

  2. John Borchers says:

    It makes sense. I’m still sick of Madoff though. It’s unimportant to me.

    What is important is the next gov’t move going to be a big blunder or a game changer?

    Executive order to temporarily remove mark-to-market for banking system?

    It’s got to be something big.

    S&P500 820 target in 6 week reached.

  3. Mannwich says:

    I think the gov’t (save nationalizing the banks) is running out of “game changers”. It’s going to be “game over” soon.

  4. John Borchers says:

    Then I’m afraid it’s game over for the entire market.

  5. John Borchers says:

    My feeling is funds should support 820. If not we likely break a new low.

  6. Mannwich says:

    karen: Where are you? I hope you’re out wine shopping.

  7. Transor Z says:

    Barry,

    From today’s Boston Globe, raising the possibility that Madoff engaged in no actual trading whatsoever. That would be consistent with your theory.

    http://www.boston.com/business/articles/2009/01/15/madoff_might_not_have_made_any_trades/

  8. karen says:

    Jeff, i’m around as a reader only, since i keep getting deleted for going off-topic… i’m in speak when spoken to mode, sorry. what has to get tagged for you to win? 8000 and/or 800? Like Barry, i’m just laughing at this market. If my losses extend one more digit, the IRS won’t be getting any taxes out of me : )

  9. karen says:

    what’s driving me crazy with madoff being out on bail is that he’s living off of ill-gotten gains… stolen money. the entire family should be under suspicion. he was literally caught red handed… i’m speechless…

  10. Mannwich says:

    @karen: 7,000 Dow, 700 S&P. Still a ways to go but we’re getting there. Just messing with you a bit.

  11. Mannwich says:

    Re: Madoff: If there aren’t several people (including some of his family members) that go to prison over this, then we know for sure everything is completely f’d up beyond hope. There needs to be multiple, and I mean, MULTIPLE perp walks taking place this year and maybe next year to clean things up and restore some semblance of confidence. If this doesn’t happen, then trust won’t come back any time soon, the retail investor won’t come back, and we’re nowhere as a result.

  12. Mannwich says:

    CNBC reporting that Cuomo investigating Ezra Merkin. About time.

  13. mitchn says:

    The judges in the Madoff case know that flight isn’t the biggest risk; it’s remanding him to state custody, where some wise guy bumps him off. End of the people’s case. How come the prosecution doesn’t see that as a possibility? Would they like to see him bumped off? The safest place to stash Bernie right now is in his own condo under the watchful eye of the media and U.S. marshals.

  14. harold hecuba says:

    mitch, agree….that putz can’t even go near his own windows and see the sunrise or sunset

  15. Paul S says:

    If, (and for any number of good reasons he should), Dick Cheney is not one of the perps to do a walk this coming year- then you won’t see confidence coming back any time soon.

  16. Lugnut says:

    I had heard prior somewhere that he might not have ever traded, just paid back a portion out of received principal. Makes sense, when you consier the types of clients he had, these weren’t folks who were liable to move large portions of their net out of the account, they wanted it safeguarded. Low turnover accounts are the perfect profile for a true Ponzi.

    Ex-Nasdaq head? He needs to eat a bullet.

  17. phb says:

    Come’on Paul S – what you blame Cheney for Bernie? Puhlease!!!!

    Karen, You are spot on…why the hell is this guy out on bail living off of stolen money? Makes my head spin.

    I don’t know about you all, but I am already sick-to-death of this 24/7 coverage. Could this be considered CNBC’s OJ?

  18. KevinTren says:

    Clearly TRUST is the catalyst for current market conditions and Madoff is emblematic of the system. What follows trust in human behavior is SAFETY: as trust declines, preservation (safety) of one’s assets becomes the operation du jour. Madoff cannot be trusted and his safety is paramount to the investigation of how the fraud proliferated and to prevent such in the future.

    I’m left wondering how many suicides are forthcoming as a result of “Madoff Scams” performed by others who can’t [or won’t – see http://www.nytimes.com/2009/01/15/us/15plane.html?ref=us face the judicial system and what’s to stop Bernie from committing suicide when he’s at home unmonitored? Ironically, he’s worth more alive than dead if he provides the platform for restoring trust by providing the loopholes he exploited. The fact that sophisticated money managers put money in his care and failed to perform the due diligence to the point of uncovering the fraud speaks to the “hey, as long as I get my return, I don’t care,” mantra in America’s Executive Management pool and it’s gotten us to where we are today.

  19. Greg0658 says:

    I bounced over and read the boston article and the blogger comments .. I’ll summerize fyi

    >a poster calls him a Robinhood for America – he got rich folks to pay taxes on accruals that never happened
    >another comments that this reveals the IRS may be getting a bunch of 1040 re-statements and a need for refunds .. ouch fellow Americans – good the interest on borrowing is low
    >many bloggers making point the $50 Bil is probably the run up on the accounts and not the orginal investment which is the theft – so the tax loss is debateable
    >another asks on the idea he may not have made any trades – what did the SEC look into then?

  20. batmando says:

    Really now, could the DoJ, even if augmented by massive Obama Admin hires, actually handle the case-load of pursuing all the Ponzi schemes, Cheney shenanigans, “waterboarding is torture” (sez AG-to-be Holder) by military/CIA/CIA contractors, and on and on, much less deal with (dare-we-hope-for) Special Prosecutors investigating the DoJ’s own messes, e.g., politicization of appointments, the force-out of the US ass’t AGs around the country?
    Hardly. Much or most will be side-tracked with on-going investigations. Don’t hold your breath for indictments.

  21. investorman says:

    Sorry Barry, you are way off base.
    Madoff turned down lots of investors AND had several hundred if not thousands of custodial IRA accounts.