Posts filed under “Regulation”

Vast Under-Investment in Due Diligence

With everyone tsk-tsking the Madoff scandal — the amount lost, the after-the-fact obviousness, the SEC incompetence — I thought now was as  good a time as any to look at the actual research, due diligence and manpower thrown at investigating managers and funds.

Not surprisingly, it is tiny — at least, when compared with the heavy lifting of equity research. The asset management and brokerage industry is vastly under-invested in due diligence; the resources applied to hedge funds and managers is a comparative pittance.

Note that every major brokerage firm — from Merrill Lynch to UBS to Morgan Stanley to Credit Suisse and beyond — offer a platform to these managers. Their managed assets group, private wealth management, (even retail brokerage) have access to these funds and managers.

And the due diligence that’s performed? It would be generous to call it weak. I was vetted a few years ago, and the items I was prepared to answer questions about — an IRS stock option issue (now resolved), a bankruptcy (someone with a similar name, not me), a few dumb items on my credit score — never came up. I was stunned how superficial the process was.

There have been more mutual funds than equities for a long time. A variety of firms, most notably, Morningstar, devote lots of resources and manpower to analyzing these funds. There are now more hedge fund managers than there are US stocks. Throw in the biggest of the individual managed account firms (like Madoff’s) and its significantly bigger.

Yet the research, resources and manpower dedicated to investigating the managers and hedge funds is a pittance of what’s applied towards researching just the S&P500 equities.

Consider these data points: The typical big firm covers at least half of the S&P500 equities. Usually, there are 3 separate divisions that do so: Asset Management, Investment Banking, and Institutional Trading. Due to compliance rules (Chinese Walls, Spitzer rules, etc.) each does a very different form of research. The research can be long-term investing/asset management focused, or it could be geared towards iBanking, or it might simply be institutional trading. This often means some bigger firms have more than one analyst covering the same individual stock.

One firm I am familiar with — let’s use a range to avoid identifying them specifically — has this headcount:

  1. Wealth Management Research: 50-75
  2. Investment Banking Research: 300-400
  3. Institutional Trading: 150-200

Let’s assume half of these people are analysts, and the rest are admin/marketing/sales.

How many people do you think they have vetting the 250-500 hedge fund and individual managers on their platform?

Under 10.

I surmise this ratio — somewhere near 25 to 1 — is typical throughout the industry.

If you want to know why a sociopath like Madoff slipped through the cracks — as an industry, we do not dedicate enough resources to vetting managers.

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UPDATE JANUARY 8 2009 1:21PM

Credit Suisse Urged Clients to Dump Madoff Funds IN 2000
Credit Suisse Group AG, whose clients lost almost $1 billion in Bernard Madoff’s alleged swindle, urged customers more than eight years ago to withdraw cash from his firm because the bank couldn’t determine how he made money, said three people familiar with the matter.

Oswald Gruebel, who headed the private-banking unit of Switzerland’s No. 2 lender at the time, made the recommendation after meeting Madoff in New York in June 2000, the people said, speaking anonymously because the details were private. Credit Suisse customers proceeded to redeem about $250 million from Madoff-run funds, half the total held by the bank’s clients, the people said.

Category: Bailouts, Hedge Funds, Investing, Legal, Regulation

SEC Under Fire; $50 Billion Fraud

Atkins was republican SEC commissioner from 2002 to 2008; Cox says SEC failed to act on allegations against Madoff; Investors lost up to $50 billion in Madoff’s alleged scheme; Analysis by Paul Atkins, Former SEC Commissioner

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The Madoff Scandal – Interview with Former SEC Chairman Arthur Levitt

Category: Legal, Regulation, Video

S.E.C. Chairmen, 2001-08

Here’s an excerpt from Bailout Nation, about a subject under much discussion today: The incompetence of the S.E.C.

Part IV: Market Failure
Chapter 14. Casting Blame

Over the course of two terms, Bush appointed three SEC Chairmen, each ill-suited for the position. It was a veritable parade of poor choices for the role of regulating stock markets. His first appointment, Harvey Pitt, was a securities industry defense attorney and was wholly unsuited to the position. Instead of representing the interests of investors, Pitt was an industry lapdog. Pitt pledged a “kinder and gentler” SEC just when the opposite was needed in the midst of a huge run of corporate misfeasance.

In an era of corporate accounting scandals, Pitt had close ties to the accounting industry. And for inexplicable reasons, Pitt met with the heads of companies under active SEC investigation. As a Wall Street lawyer, Pitt had “recommended that clients destroy sensitive documents before they could be used against them – advice that seemed to find echoes in the SEC’s investigations into Enron and its shredder-happy auditor, Arthur Andersen.” Pitt had to recuse himself from many of the SEC’s votes — they were frequently about the clients he had represented as a defense attorney. By July of 2002, Senator (and future GOP presidential candidate) John McCain was calling for Pitt’s resignation.

Pitt, not surprisingly, demoralized the agency. To investor advocacy groups, having Pitt as SEC chief was like putting Osama bin Laden in charge of Homeland Security.

The next SEC Chairman Bush appointed was William Donaldson. He is the one who allowed the net-cap rule to be exempted for the five biggest banks in 2004. Instead of 12 to 1 leverage, banks levered up 30 and even 40 to 1 after the waiver. It isn’t glib to say the financial meltdown was three times as bad as it might have been for Donaldson’s SEC agreeing to this waiver. It would be charitable to call his chairmanship undistinguished.

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Category: Legal, Regulation

Bernie Madoff on the Modern Stock Market

Implicated in a $50 billion Ponzi scheme, at a 2007 roundtable discussion with Justin Fox, Ailsa Roell, Robert A. Schwartz, Muriel Seibert, and Josh Stampfli.

These are some excerpts featuring Madoff, recently implicated in a $50 billion Ponzi scheme.

The full video is here

Category: Legal, Regulation, Video

Madoff Story Smells Funny

I have no special insight into the Madoff story.

However, my spidey sense is tingling.

Consider this: Running a billion dollar Ponzi scheme has to be very time consuming. Running a $50 billion Ponzi scheme by yourself, at age 70?

I don’t think it can be done.

Just generating the phony transaction receipts is a full time job.  How did this son-of-a-bitch do it all by himself? Madoff HAD TO HAVE HELP.

I simply cannot believe he did it himself, all alone. His entire scheme was predicated upon finding another 1% of assets every month to payout to the prior investors. Between raising moeny and running operations, it was more than a 1 man job.

And when the market hit the skids and topped out so fast — it fell much quicker in 2008 than in 2000 — he ran out of manuevering room. Madoff had to know he was going down, and everyone who was working with him — everyone who knew of the scheme — they were going down, too.

So he confessed — TO HIS SONS. AND THEY TURNED HIM IN.

And Bloomberg reports they are already represented by Martin Flumenbaum, a lawyer.

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Maybe I’ve read one too many detective novels, but consider this strictly hypothetical, based on-no-facts whatsoever, wildly imaginative hypothesis: If I were running a $50 billion Ponzi scheme, I would have to bring in someone close to help me with it.

Who is closer than my family?

When it became clear there was no where else to turn, instead of bringing down the entire dynasty, I would have them turn me in, to protect the family and what left of the legacy.

I would take the fall so they wouldn’t have to.

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As I noted, I have no special facts, no insight into this what-so-ever.  Other than the story we have been fed so far doesn’t make any sense.

Who was Madoff’s accomplices? I have no idea, but there has to be some! If I were the SEC, I would be looking over close friends and family closely. Very, very closely.

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Category: Credit, Legal, Markets, Regulation

NYT: Don’t Forget Shumer’s Role in the Mess

“Since the financial meltdown, people have been asking, ‘Where was Congress? Why didn’t they see this coming? Why didn’t they provide better oversight?’ And the answer for some, including Senator Schumer, is that they were actually too busy pursuing a deregulatory agenda. Their focus was on how we have to lighten up regulation on Wall…Read More

Category: Bailouts, Corporate Management, Legal, Markets, Regulation

History Lesson: Madoff tops charts; skeptics ask how

> Go to NakedShorts and read the entire 2001 article of the various ways some people challenged the Madoff story: > If it sounds too good to be true… > UPDATE: Paul points to this Barrons story from 2001 Don’t Ask, Don’t Tell Barron’s MAY 7, 2001 http://online.barrons.com/article/SB989019667829349012.html >

Category: Legal, Regulation

More CRA Idiocy

Howard Husock has an exercise in cognitive dissonance in today’s NYT Op-Ed pages titled Housing Goals We Can’t Afford, and it begins: “The national wave of home foreclosures, many concentrated in lower-income and minority neighborhoods, has created a strong temptation to find the villains responsible.” What can you say about an Op-Ed whose very first…Read More

Category: Bailouts, Data Analysis, Legal, Politics, Psychology, Regulation

SEC’s Chair’s Bailout Bull$%&t

In what I can only type with a combination of disgust and astonishment, SEC Chairman Christopher Cox blames the current crisis on the “boom-and-bust cycles” of markets. “Financial markets, of course, are not perfect. In particular, they are susceptible to boom-and-bust cycles. Cycles of this sort have been a hardy perennial over the past 400…Read More

Category: Bailouts, Legal, Markets, Regulation

Capitalist Fools

Terrific piece in Vanity Fair by Nobel prize winner Joseph Stiglitz. I especially love the accompanying art work nearby. Stiglitz is da man: “The administration talked about confidence building, but what it delivered was actually a confidence trick. If the administration had really wanted to restore confidence in the financial system, it would have begun…Read More

Category: Bailouts, Corporate Management, Markets, Regulation