Viewpoint: Madoff, the Midas who made an ass of investors

[Legal Beagles]

He was immensely rich; a man of prodigious enterprise; a Midas without the ears, who turned all he touched to gold. He was in everything good, from banking to building. He was in parliament, of course. He was in the City, necessarily. He was chairman of this, trustee of that, president of the other."
No, this is not Bernard Madoff, who was arrested last week for the biggest trading scam in Wall Street history, accounting for $50bn of losses. It is a description of Mr Merdle, the fictional banker in Charles Dickens' Little Dorrit, whose bank collapse ruins hundreds of investors across the City.
Madoff, like Merdle, was a pillar of the community. He was a former chairman of Nasdaq, the New York technology market, and even a one-time adviser to the US regulator, the securities and exchange commission. He was so well plugged into the US establishment, it seems, that few people raised doubts about the fact that his supposed $17bn of funds were audited by an obscure accounting firm with a staff of three - one of whom is a 70-year-old partner based in Florida and another, a secretary. Regulators actually inspected the broking firm on two occasions in the past three years, but maintain he kept the fraud off its books, making it impossible for them to spot.
It is claimed Madoff was running a classic pyramid scheme, relying on new money coming in to pay returns to existing investors. If the new money dries up or punters demand their investments back, then it quickly implodes. The alleged scam appears to have been running for years, recording consistent returns of 10-12% a year even in a falling market. The SEC's failure to spot anything amiss with Madoff's business is a further indictment of the light-touch US regulatory system that was one of the causes of the credit crisis in the first place. Some analysts raised concerns about Madoff's methods. But if he was falsifying his financial statements and markets are booming, few questions are asked.
Investors were happy to accept Madoff's exceptional record - even if it is almost unheard of for even top fund managers to rack up consistent returns that beat the market in all conditions. Most investment styles go in and out of fashion and all money managers have an off-year now and then.
Investors ignored one of the classic rules of investment: "If it seems too good to be true, it usually is." Some of the world's biggest banks such as RBS and top-name fund managers such as Nicola Horlick lost money in Madoff's madness. Did they conduct any due diligence before committing funds? As so often in finance, greed triumphed over rational thinking. Dickens could almost have written the plot.
Crisis? What crisis?
Sterling touched a new low against the euro yesterday when it was trading at a little over €1.11 against the single currency. Cue renewed speculation of a one-for-one exchange rate before the last disgruntled skiers arrive back from ruinously expensive holidays in Courchevel this winter.
There are reasons why the pound has been so weak. Britain's economy is peculiarly vulnerable to the global downturn and the government needs to sell a lot of gilts to fund a budget deficit that may hit 10% of GDP. With an open economy and an exposed banking sector, the UK may turn out to be Iceland without the fish and thermal power.
Or maybe not. The pound has already fallen by 26% on its trade-weighted index since the start of 2007, a bigger depreciation than the 19% decline after Black Wednesday and now looks cheap. One firm selling designer menswear in more than 50 countries around the world says that its best-performing store this year has been the one in Covent Garden. A sign that consumers are not really tightening their belts? No, a sign that European shoppers are flooding into London looking for bargains.
The other side of the coin is that Britain's consumer-led recession will be mirrored in 2009 by a more traditional industry-led recession in the eurozone's two biggest economies: Germany and France. Germany is already badly hit by the squeeze on capital spending since the credit crunch. Demand for exports of its hi-tech machine tools is plunging as firms in Asia, Europe and North America mothball investment plans.
Talk of sterling hitting parity against the euro is reminiscent of speculation back in the summer that oil prices, then nudging $150 a barrel, would carry on rising to $200 a barrel. Once the oil story migrated from the business pages to lifestyle columnists moaning about the cost of filling up the 4x4, it was time to get out. The same applies to sterling. The time to have sold the pound was when it was worth $2.11 against the dollar, not now.
deborah.hargreaves@guardian.co.uk

• Bernard Madoff
• Corporate fraud
• Regulators
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• Scams
• United States

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[Legal Beagles]

Inquiries begin into two suspected cases of multimillion-pound fraud


The Serious Fraud Office is looking into two multimillion-pound suspected fraud cases in Britain that have come to light in the midst of months of credit market turmoil, the Guardian has learned. Following the allegation of the biggest financial fraud in US history last week, Britain's SFO believes it is looking at "a step-change in the kind of cases we've been looking at in terms of money at risk".
The SFO's director, Richard Alderman, believes these embryonic investigations could represent a return to high-profile prosecutions after the collapse of a handful of cases.
Only a few details of the suspected frauds have been divulged, but one is understood to involve stocks and shares. "We spotted some discrepancies ourselves and we have a small team looking at it," a spokesman said. "It is potentially a big case."
Alderman is also looking at a second suspected large-scale fraud, though it is at an even earlier stage of inquiry. Neither case has yet become a formal SFO investigation.
The spotlight was thrown on UK credit crunch-related frauds as repercussions from the Madoff scandal continued to reverberate around the world. It was confirmed yesterday that Royal Bank of Scotland - majority owned by the taxpayer - and HSBC are among the most affected banks in Europe, facing potential losses of £400m and $1bn respectively. London-based hedge funds Man Group, RAB Capital and Nicola Horlick's Bramdean Alternatives have revealed exposures of $360m, $10m and $21m respectively.
Spain's Santander, which includes Bradford & Bingley, Abbey and Alliance & Leicester, said its direct exposure was $23m but clients of its hedge fund business could face potential losses of $3.1bn. Other big financial institutions admitting to significant exposures include Japanese bank Nomura, France's BNP Paribas and Natixis.
But despite a flurry of trading updates from banks and hedge funds, analysts last night estimated less than half the casualties from the Madoff scandal had yet been identified. A complex web of international investments and a culture of secrecy in the hedge fund industry has left a great deal of uncertainty over Madoff exposures.
Andrew Stimpson, a banking analyst at KBW, said: "We have added up approximately $19.5bn of exposure to Madoff worldwide ... that means there is another $30.5bn of the alleged $50bn fraudulent Ponzi scheme unaccounted for."
The Financial Services Authority was yesterday urgently contacting firms across the City to establish what exposure they have to the Madoff funds and ensure that any potential losses are disclosed to the stockmarket.
Meanwhile, industry insiders predicted a wave of class action lawsuits against those fund managers who trusted Madoff with client funds.
Hedge fund professionals are also bracing themselves for a regulatory backlash against an industry that has ballooned in the last 10 years, largely beyond regulatory supervision.
Meanwhile, the FSA refused to comment on its interest in the Madoff case.
The hedge fund manager is registered with the FSA, along with his two sons, brother and six other employees of Madoff Securities International, a proprietary trading operation based in London which insists it is "not in any way part of" the troubled New York firm.

• Bernard Madoff
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[Legal Beagles]

Light touch, laissez-faire - or simply 'anything goes'?


The failure of America's financial supervisor, the Securities and Exchange Commission, to spot the Bernie Madoff scandal is another blow to the embattled regulator after a year of criticism. Time and again US regulators have been accused of being asleep at the wheel.
Guided by a laissez-faire economic philosophy, the Bush administration has favoured a relatively light touch in its oversight of Wall Street. Critics wonder whether this has tipped towards an era of "anything goes".
Madoff's alleged $50bn (£33bn) fraud went undetected for years until investors, alarmed by the global financial meltdown, began clamouring to withdraw money. It became clear that the 70-year-old fund manager didn't have any.
Until September 2006, the investment advisory arm of Madoff's business was not even registered with the SEC on the grounds that it was outside the agency's remit. The SEC examined the books of Madoff's brokerage division in 2005, finding three minor trading violations.
Experts question whether the Washington-based regulator has sufficient teeth. James Cox, a securities law professor at Duke University in North Carolina, told Bloomberg News that the system was broken. "There are just so many people out there who are and aren't registered that it really just overwhelms the system," said Cox. "There is no easy way to expand the regulatory net unless we're willing to put the might of the federal budget behind it to carry out more inspections."
In the eyes of critics, regulators' grip on Wall Street is too loose. Financial authorities were accused of allowing banks and mortgage companies to run riot in an orgy of uncontrolled lending, leading to the sub-prime mortgage crisis. The true liabilities of institutions were consistently blurred.
An official report into the collapse of the investment bank Bear Stearns concluded in September that the SEC had missed "numerous potential red flags" over the 85-year-old firm's financial predicament.
In a smaller-scale scandal compared with Madoff's fraud, a Connecticut hedge fund, Bayou Group, was found to be in effect a $450m pyramid scheme three years ago. Its boss, Samuel Israel, had even invented an imaginary auditor without initially being detected.
The inner workings of the SEC were criticised last year by a disillusioned former investigator, Gary Aguirre, who complained that he had been prevented from probing the workings of a prominent hedge fund.
Aguirre said a culture of rotating jobs from Wall Street into regulatory authorities was damaging: "It's very friendly - it's a club. I'm here, I'm inside, now I'm outside, now I'm inside again."
In the case of Madoff, investigators believe that the fraudulent fund manager kept an entirely separate set of books to hide losses in his asset management business.
Regulators argue that it is very difficult to detect such a scam, given that Madoff maintained an ostensibly legitimate set of accounts and was meeting all withdrawal requests from his investors.
In common with many Wall Street figures, Madoff was a significant political donor. Since 2000, he has handed at least $100,000 to the Democratic senatorial campaign committee. Beneficiaries of his largesse include the New York senator Charles Schumer, a prominent defender of Wall Street on Capitol Hill.
The London-based Alternative Investment Management Association, which has been pushing for a voluntary code of conduct to fend off greater mandatory regulation, described Madoff's exposure as an "extraordinary situation".
"Clearly, lessons must be learned, restitution must be secured for investors and processes/safeguards must be improved to prevent such a situation recurring."

• Bernard Madoff
• Corporate fraud
• Regulators
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• UK banking sector
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• United States

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