Unintended Consequences: Bernard L. Madoff

Bernard Madoff has been charged with what will likely be cited as the largest investment fraud in history.  Most of us remember that the real damage in the markets in the last recession came in the wake of the news of corporate frauds, well after 9/11.  Corporate scandals of yesteryear have done amazing damage to the markets, even after what people thought was the worst was over.  This news about Madoff has the potential to unwind what few threads of confidence that have been holding the current market together.

While most retail investors probably have never heard of Bernie Madoff, some of the wealthiest Americans and some of the most respected institutional investors certainly do.  My question is whether Madoff is obscure enough to escape creating a mass panic predicated on a systemwide loss of fiduciary trust.  

Of course the fact that he was printing his own statements for his clients will be the center of some of debate, it should isolate some fallout since most fiduciaries clear through a firm that is not their own.  Although, I strongly doubt that hedge funds will remain fully unregistered, unregulated entities after this.  In fact I cannot see how unregistered entities will ever be allowed to exist again.  How could this have gone on so long?  His brother was the head of compliance!

Nonetheless I am worried for the market’s reaction tomorrow, and in the weeks ahead if this event spurs a massive wave of redemptions from hedge funds, and the many other unintended consequences.  What I can’t believe is that they let him go for $10 million in bail.  Did the judge not do the math.  He’s probably got 10 times that stashed away in hiding places around the world.

For some perspective on how the firm billed itself, here is the copy from the Bernard L. Madoff Investment Securities website describing the firm. Oddly it is an archaic website, built in mid 1990’s static HTML, not all that advanced for a company promoting itself on the cutting edge of technology in the financial industry.  How could they have fooled so many with a website like this?

A Global Leader in Trading US Equities

Bernard L. Madoff Investment Securities LLC is a leading international market maker. The firm has been providing quality executions for broker-dealers, banks, and financial institutions since its inception in 1960. During this time, Madoff has compiled an uninterrupted record of growth, which has enabled us to continually build our financial resources. With more than $700 million in firm capital, Madoff currently ranks among the top 1% of US Securities firms. Our sophisticated proprietary automation and unparalleled client service delivers an enhanced execution that is virtually unmatched in our industry.

Madoff Securities’ clients include scores of leading securities firms, banks and financial institutions from across the United States and around the world. The firm is a leading market-maker in all of the S&P 500 stocks as well as over 350 NASDAQ issues. The firm is known for its fine pricing as well as its ability to execute most orders in seconds.

Madoff Securities’ superior service is made possible by a sophisticated dealing staff backed by the securities industry’s most advanced technology. It is underpinned by the personal commitment of founder Bernard L. Madoff and his brother Peter B. Madoff, who is the senior managing director. Their dedication to providing quality executions has enabled the firm to become a leader in the US “third market,” which trades US listed equities away from the exchange floor. Madoff Securities is a registered US broker/dealer regulated by the Securities and Exchange Commission and the Financial Industry Regulatory Authority, Inc. [More]

Here is the  SEC press release announcing the charges:

SEC Charges Bernard L. Madoff for Multi-Billion Dollar Ponzi Scheme

Washington, D.C., Dec. 11, 2008 — The Securities and Exchange Commission today charged Bernard L. Madoff and his investment firm, Bernard L. Madoff Investment Securities LLC, with securities fraud for a multi-billion dollar Ponzi scheme that he perpetrated on advisory clients of his firm. The SEC is seeking emergency relief for investors, including an asset freeze and the appointment of a receiver for the firm.

The SEC’s complaint, filed in federal court in Manhattan, alleges that Madoff yesterday informed two senior employees that his investment advisory business was a fraud. Madoff told these employees that he was “finished,” that he had “absolutely nothing,” that “it’s all just one big lie,” and that it was “basically, a giant Ponzi scheme.” The senior employees understood him to be saying that he had for years been paying returns to certain investors out of the principal received from other, different investors. Madoff admitted in this conversation that the firm was insolvent and had been for years, and that he estimated the losses from this fraud were at least $50 billion.

“We are alleging a massive fraud — both in terms of scope and duration,” said Linda Chatman Thomsen, Director of the SEC’s Division of Enforcement. “We are moving quickly and decisively to stop the fraud and protect remaining assets for investors, and we are working closely with the criminal authorities to hold Mr. Madoff accountable.” [More]

If nothing else, you can bet there is going to be a lot of luxury assets up for sale in the New York area from this.  Art, jewelry and high end real estate are going to be auctioned once some of Madoff’s investors realize how much they have lost, and may never recover if all of this turns out to be true.

For more information see the links below:

SEC Charges Bernard L. Madoff for Multi-Billion Dollar Ponzi Scheme
SEC, Dec. 11, 2008

Ex-Nasdaq chair arrested on fraud charge in NYC
Larry Neumeister, Associated Press, December 11, 2008

Kass: The Madoff Story Is Huge
Doug Kass, TheStreet.com, December 11, 2008

U.S. trader arrested over massive fraud
Edith Honan, Reuters, December 12, 2008

Madoff Charged in $50 Billion Fraud at Advisory Firm
David Glovin and David Scheer, Bloomberg, December 11, 2008

Top Broker Accused of $50 Billion Fraud
Amir Efrati, Tom Lauricella, Dionne Searcey, WSJ Online, December 12, 2008

Prominent Trader Accused of Defrauding Clients
Diana B. Henriques, Zachery Kouwe, The New York Times, December 11, 2008

Bernard Madoff held for $US50bn pyramid fraud
Chad Bray, The Australian Business, December 12, 2008

Madoff Securities: Quality Executions and Service Through Innovative Technology
Bernard L. Madoff Investment Securities Website, Accessed December 11, 2008 11:45PM


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