Blogs and Stories
The Madoff Victims Who Came Out Ahead
)
Stuart Ramson / AP Photo
Some feeder funds, which directed money Bernie Madoff's way, ended up hundreds of millions of dollars in the black. So why are they claiming ignorance of his crimes—or worse, describing themselves as “the greatest Madoff victim”?
Like the mythic vampire, a Ponzi scheme needs to find new blood to sustain itself. So while Bernard L. Madoff had no problem creating the illusion of constantly expanding profits through the simple device of wholly inventing the transactions in accounts he managed, the only way he could meet requests for redemptions was to find new money. The amounts he needed became staggering in the 1990s, as a handful of his longtime associates cashed in billions of dollars of imaginary profits in their accounts.
His feeder funds fared well, earning hundreds of millions of dollars in fees from their 20 percent cut of Madoff’s imaginary profits and their equally imaginary “performance.”
To replace these billions, Madoff needed a new source. The mother lode he turned to was the ganglia of so-called feeder funds.
A feeder fund, unlike a hedge or private-equity fund, does not manage investments. It is simply a marketing operation. Its principals raise money from investors—often through their social, country club, and professional connections—that they then consolidate into a single account, which they funnel to a money manager with whom they have an arrangement.
Typically, in return for finding investors for the money manager, the feeder gets a relatively small placement fee of about 1 percent. The money manager then charges for his investing skills, typically deducts a performance fee of 20 percent from the profits as well as an annual “net asset” fee of 2 percent on the investor’s nest egg.
But Madoff offered feeder funds a much more alluring deal for finding him money. Instead of merely giving them the standard placement fee, he allowed them to take the entire cut of profits usually reserved for the money manager by waiving all his fees. This generous accommodation became extremely lucrative for them because Madoff reported profit annually of about 15 percent. So the principal of the feeder could deduct 20 percent of that putative profit from all their clients’ accounts, transfer it to their own “carry” account, and redeem it, with the result that they got cash while their clients’ fictitious profits grew each year.
But why would a highly successful money manager like Madoff make such an accommodation and essentially work for free for feeders? The explanation Madoff gave was that he was not greedy and content making a mere .04 cents a share from trading stocks in the accounts (which he could have made anyhow if he charged them a fee). As incredible as this rationale might sound, feeders had little incentive to look a gift horse in the mouth. This amazing inducement, together with the track record Madoff had totally invented, brought in enough from feeder funds to more than cover the $8 billion in withdrawals made by his longtime associates.
For their part, his feeder funds fared well, earning hundreds of millions of dollars in fees from their 20 percent cut of Madoff’s imaginary profits and their equally imaginary “performance.”
America's Hot Jobs (and Not Jobs)
The Daily Beast is dedicated to news and commentary, culture, and entertainment. We carefully curate the web’s most essential stories and bring you original must-reads from our talented contributors.
Bringing Down Bachmann
Benjamin Sarlin is a reporter for The Daily Beast. He previously covered New York City politics for The New York Sun and has worked for talkingpointsmemo.com.
The Plot to Purge GOP Moderates
Benjamin Sarlin is a reporter for The Daily Beast. He previously covered New York City politics for The New York Sun and has worked for talkingpointsmemo.com.
Questions for Obama's Car Czar
Edward Jay Epstein studied government at Cornell and Harvard, and received a PhD from Harvard in 1973. The Big Picture: The New Logic of Money and Power in Hollywood is his 13th book. The sequel, The Hollywood Economist will be published in January 2010.
Was the AIG Bailout a Conspiracy?
Edward Jay Epstein studied government at Cornell and Harvard, and received a PhD from Harvard in 1973. The Big Picture: The New Logic of Money and Power in Hollywood is his 13th book. The sequel, The Hollywood Economist will be published in January 2010.
The Man Who Gutted the Ivy League
Edward Jay Epstein studied government at Cornell and Harvard, and received a PhD from Harvard in 1973. The Big Picture: The New Logic of Money and Power in Hollywood is his 13th book. The sequel, The Hollywood Economist will be published in January 2010.
This is an interesting article but old news.
The feeder funds were depending on Madoff's accountant for certifying authenticity, existence etc, and then those documents were used by the feeder funds, so the clients assumed the bigger and better known accountants were doing the auditing.
SEC should have known something was up. Considering the well known 8 flags were all waving frantically for recognition.
[RED FLAG #1
Madoff Investment Securities was both the broker dealer and investment advisor:
madoff broker dealer SEC investment adviser public disclosure red flag madoff broker dealer 2 SEC investment adviser public disclosure red flag
RED FLAG #2
Madoff traded in the same securities that he recommended to advisory clients:
madoff conflict of interest SEC investment adviser public disclosure red flag
RED FLAG #3
Madoff not only was the broker dealer, creating a conflict of interest where his firm was trading in the same securities as he was trading for clients, but he actually had custody of the assets!
madoff custody of client assets SEC investment adviser public disclosure red flag
RED FLAG #4
They got into some hot water over some small compliance issues. Madoff's firm was censured and fined a small amount $7,000. This meant they did have a blot on their records:
madoff violation 2 SEC investment adviser public disclosure red flag madoff violation SEC investment adviser public disclosure red flag
RED FLAG #5
Jim Vos, head of Aksia - a hedge fund advisory firm, noticed that although Madoff's firm was supposedly highly advanced and automated, they sent paper copies of their trading records to clients instead of providing electronic access to the firm's trading platform.
RED FLAG #6
Madoff Investment Securities' auditors were Friehling & Horowitz, a 3 person team which consisted of one lone CPA with a small 13%u2032 by 18%u2032 office in New York. Hardly adequate to monitor a firm that traded a good chunk of NYSE and NASDAQ volume.
RED FLAG #7
Shockingly enough, Madoff didn't take the usual 2/20 fees most hedge funds do. Instead he only profited from the trades that his firm was doing for the "investment fund", claiming that this was enough. Given this form of compensation, it is very possible most "sophisticated investors" assumed that Madoff was involved in some sort of shenanigans but turned a blind eye for those stable returns.
Here's an excerpt from a 2001 Barron's article on Madoff Investment Securities secrecy:
Curiously, he charges no fees for his money-management
services. Nor does he take a cut of the 1.5% fees marketers like
Fairfield Greenwich charge investors each year. Why not? "We're
perfectly happy to just earn commissions on the trades," he says.
Perhaps so. But consider the sheer scope of the money Madoff would
appear to be leaving on the table. A typical hedge fund charges 1% of
assets annually, plus 20% of profits. On a $6 billion fund generating
15% annual returns, that adds up to $240 million a year.
The lessons of Long-Term Capital Management's collapse are that
investors need, or should want, transparency in their money manager's
investment strategy. But Madoff's investors rave about his performance
- even though they don't understand how he does it.
RED FLAG #8
Madoff Investment Securities was a family business, with Madoff's brother, sons and daughter as well as his niece (married to a previous SEC compliance officer) all worked at the firm.
mark madoff and bernard madoff investment securities] excerpted from http://www.tradersnarrative.com/the-madoff-red-flags-lets-count-them-2154.h tml.
amazing story,madoff is pure evil!
Madoff's scandal had a huge impact on the real estate market all over the world. Here is another blog with some more information on the effect Madoff had on the Palm Beach Real Estate. David Fite, the owner of a Palm Beach real estate agency, talks about Madoff's scandal here: http://www.fiteshavell.com/blog
Thank you.
As a first time user, your comment has been submitted for review. It can take anywhere from a few hours to a day or two for your comment to be reviewed, depending on the time of week and the volume of comments we receive.
Please log in to leave comments.