Posts filed under “Hedge Funds”
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.
UPDATE: January 15, 2009, 11:47 am
Even more amazing, the Boston Globe is reporting Madoff might not have made any trades
Why Might a Madoff Plea Deal Take Place? (January 2009)
Credit Suisse Urged Clients to Dump Madoff Funds
Cynthia Cotts, Katherine Burton and Elena Logutenkova
Bloomberg, Jan. 7 2009
The Quote of the Day comes from David Swensen, Yale University’s endowment’s chief investment officer, in Tuesday’s WSJ: Fund of funds are a cancer on the institutional-investor world. They facilitate the flow of ignorant capital. If an investor can’t make an intelligent decision about picking managers, how can he make an intelligent decision about picking…Read More
Paul Brodsky & Lee Quaintance run QB Partners, a private macro-oriented investment fund based in New York.
Outlook: As we look at the macroeconomic landscape at the onset of 2009 we see obvious negatives and not-so obvious positives for nominal asset prices. The negatives include:
• Almost unanimous deflationary expectations
• Tattered household balance sheets
• Almost no corporate growth visibility
• A higher cost of debt funding for most businesses
• An obliterated mortgage banking industry
• General pessimism among consumers and homeowners
• Heightened global military tensions, as energy exporting nations with nascent democracies struggle to maintain control while their economies contract
The lesser-recognized positives for nominal asset prices include:
• Trillions of new US dollars sitting latent in foreign reserve accounts that could be used to purchase assets at distressed prices
• Extraordinary amounts of inflation being generated by the Fed (and much more to come) – trillions of new dollars sitting latent on bank balance sheets waiting for the multiplier effect to turn them into up to 10 times that amount, leading to higher nominal prices for commodities, goods, services and financial assets
• US and European governments and central banks willing to act as “bad banks” so that their private sectors can maintain and/or enhance the nominal paper value of their assets
• The recent crash of commodity input costs and downward wage pressures, which should temporarily help businesses produce positive earnings at lower revenue levels
• US fiscal policymakers actively subsidizing home affordability and consumer recuperation
• A likely return to US–led global realpolitik, in which developed countries attempt to engage current and potential flashpoints in the developing world with diplomatic solutions.
If past is prologue, there are strong reasons to fade the notion that G7 economies are headed for a 1930s-type deflationary depression. Chief among them is that all economies of the world (via their respective central banks) issue fiat currencies, which means they can simply print money (inflate) to counteract organic deflationary pressures. This was not the case in the 1930s and it is precisely what global policymakers have begun to do.
As we look across the global investment landscape we see:
• Almost 0% “risk-free” global nominal rates of return (and therefore, substantially negative real rates), implying a dearth of risk capital at work in the markets
• Historically wide yield spreads across most tertiary bond markets (widest since the 1930s in many cases), implying; 1) a dearth of risk capital, 2) internal rates of return closer to risk-adjusted, inflation-adjusted equilibria, or 3) both
• Recently crashed global commodity prices, implying; 1) a dearth of risk capital relative to global demand, 2) global equilibrium pricing that better reflects sustainable global demand
• Generally weak US equity prices, implying; 1) a dearth of US dollar-denominated risk capital, 2) more sustainable corporate enterprise values and capital structures
• Weak US and European real estate prices, implying that previous high watermark values
We see both a reasonably-argued case for general pessimism – the continuance of declining fundamentals, and a reasonably-argued case for optimism – quickly improving commodity and equity markets (in nominal terms) that anticipate the end of poor fundamentals. The pessimistic case is obvious to all and markets either greatly or fully reflect that case. The optimistic case (in nominal terms) is less obvious, proven by generally declining prices of risk assets.
David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs, including Morning Call, Power Lunch, Kudlow & Company, Squawk on the Street, Squawk Box Asia, and Worldwide Exchange. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).
“This is a major disaster for a lot of people. You work all your life, you finally manage to save up something, and somebody who’s entrusted with it, it turns out suddenly he’s a crook. Lots of people are getting fully or partially wiped out.”
-Lawrence Velvel, 69, Dean of the Massachusetts School of Law who said he and friends had lost millions among them.
“Those with the biggest financial gains generally had their money managed by Madoff. It was an honor having him handle your fortune. He didn’t take just anybody. He turned down all kinds of people, and that made you want to give the man even more of your money. When he took your fortune, he told you that he would tell you nothing about how he achieved his returns.”
-Laurence Leamer, a Palm Beach based journalist, writing in the New York Post, December 13.
First to the structural business issues.
Cumberland Advisors did not and does not have a single penny in any fund directly or indirectly positioned with, having custody with, or in any way associated with Madoff. The Madoff structure violates all of our internal disciplines. Madoff required that investment management, brokerage, and custody all be with him under the same roof. At Cumberland we require that each of these three functions be separated by task, separately evaluated, and separately reported.
Cumberland will not invest in any conduits or vehicles where the sponsor refuses to disclose the contents of the investment. Furthermore, we recommend that our clients avoid any investments they do not understand. We also avoid any investment about which we cannot obtain a full and completely clear description, so that the investment’s merit may be independently evaluated.
Moreover, at Cumberland, all discretionary managed accounts separate asset custody from brokerage and from Cumberland as manager. Our performance reports and asset lists are separate and independently compiled from those of the custodian broker or bank. Managed accounts that are in custody at a broker have explicit permission for us to trade “street wide” when it benefits the client. We will not accept a managed account where the brokerage transactions are captive to the broker custodian unless there is a specific pricing of transaction costs and the client knows what their broker will charge them. Cumberland never acts as broker and never mixes commissions with fees. We are a fee-for-service only manager.
We recommend this structure for all of our institutional consulting clients where we are not the discretionary manager but only consultants on the strategy. We also recommend this for those whom we are advising on boards and as trustees. In fact, we advise that those who place funds as a fiduciary in any other format should consult their legal counsel before doing so, in order to ascertain if they are in compliance with fiduciary standards.
The Madoff affair’s implications for lawyers, accountants, trustees, boards, etc…
Won’t be the last one, either: Thierry Magon de La Villehuchet, who ran a fund that invested with Bernard Madoff, was found dead at his Madison Avenue office today, a New York City police officer at the scene said. The death appeared to be a suicide, he said. De la Villehuchet, 65, was a founding…Read More
There are some people worthy of blind trust with your money. They are the ones who: 1) seem to make money over time; 2) have well-audited books, which prove indeed they have; and 3) seem to have a cogent plan to continue making money in the future. All three must be satisfied and everything else…Read More
What follows is the Harry Markopolos complaint to the SEC, circa November 2005, identifying 29 red flags that Madoff was a fraud. This highly detailed complaint was filed regarding the apparent Fraud at Madoff Securities. It was ignored by the Christopher Cox SEC, which was too busy concocting schemes to dismantle the SEC rather than…Read More