“Bernard Madoff was able to pull off what is allegedly the largest investor fraud in history because people trusted him. But why did people believe his lies when there were so many reasons not to?” – Blaine F. Aikin.
For a full month, I have avoided writing anything more about Bernard Madoff; not because there was nothing new to say, but because it seemed that there was so much readily available about the tragedy.
However, an article in the January 18, 2009 edition of Investment News is worth highlighting. What We Can Learn from Madoff by Blaine F. Aikin discusses how a proper fiduciary investigation should have and did raise many red flags.
Here is a summary:
Good fiduciaries are necessarily skeptical, so they sought verification of key information before they would invest. Their due diligence paid off; they uncovered troubling information in six areas of essential inquiry for fiduciaries.
First, Mr. Madoff didn’t use an independent custodian.
Second, his financial auditing was provided by a tiny, obscure accounting firm.
Third, Mr. Madoff produced his own performance reports and wouldn’t allow independent performance audits.
Fourth, the extraordinary investment success claimed for the fund didn’t jibe with reasonable investment benchmarks, and the results couldn’t be substantiated when subjected to fundamental testing of the trading strategy.
Fifth, the business structure of the fund made little economic sense. Moreover, it seemed designed to avoid regulatory oversight and to frustrate due-diligence efforts by prospects and clients. Rather than organize as a hedge fund and charge a lucrative performance-based fee, Bernard L. Madoff Investment Securities LLC operated as a commission-based broker-dealer with distribution provided through hedge funds of funds.
Finally, he showed little appreciation for, and no processes to apply, fiduciary standards of care. … He rejected potential investors who asked penetrating questions, reacting to such inquiries as an affront to someone so accomplished in creating wealth.
There were many hedge funds which invested their clients’ money with Bernard Madoff. The hedge fund managers collected sizable fees for being conduits or “feeders.” Amazingly enough, they claim that they did their homework and investigated Madoff thoroughly. One firm in particular was quoted in the New York Times on December 14th defending their actions.
The Fairfield Greenwich Group “performed comprehensive and conscientious due diligence and risk monitoring,” Marc Kasowitz, a lawyer for Fairfield, said in a statement. “FGG, like so many other Madoff clients, was a victim of a highly sophisticated massive fraud that escaped the detection of top institutional and private investors, industry organizations, auditors, examiners and regulatory authorities.”
Now, Fairfield is seeking to recover what it can from Mr. Madoff.
The fraud was long lasting, and the red flags should have been apparent. Some investment managers completely missed the warning signs. But not all. According to Blaine Aikin, “a number of dedicated fiduciaries, including several large financial institutions, investment advisers, retirement plan sponsors and endowment administrators, found Mr. Madoff’s magical ability to generate consistently stellar returns to be too good to be true.”