Reeling Off The Fairway

By Guest Contributor

By Carter Tredaniel

The year 2008 started as the previous one had, with a quarterly report to the Securities and Exchange Commission (SEC).  Bernard L. Madoff told the U.S. regulator that his investment management arm held 443 different investments totaling $17bn.  Many Madoff boosters believed the filing understated his total holdings because he supposedly moved into cash before reporting periods to avoid giving clues to his vaunted “split-strike conversion strategy”.


Its reported funds under management put Madoff’s firm among the top five per cent of the 11,000 or so investment managers then registered with the SEC.  But filing triggered no regulatory alarm bells even though Harry Markopoulos, a former industry rival, had repeatedly tried to warn regulators of his suspicions that Mr. Madoff was conducting a Ponzi scheme.


Allegedly, Madoff confessed that his investment business, which drew money from all over the world, was “all one big lie” that may have cost investors $50bn (£36bn, €39bn).


He had been endeavoring to keep up appearances, making the usual rounds of charity dinners, sporting events and industry gatherings and taking his regular summer vacation in the south of France.  His family raised $151,000 for a leukemia charity in October and he attended his company Christmas party hours before his arrest.


But beneath the surface, he and the dozens of hedge funds that sent him cash were growing increasingly strapped.  For years, they had recruited new money with ease, thanks to an aura of exclusivity and Mr. Madoff’s extraordinarily steady reported returns.  In past years, would-be investors were often told the shop was closed to new money and they would have to wait before they could buy in.  That changed.  The credit crunch not only dried up new investment but also prompted many long-time clients to ask for some or all of their money back.


While most financial frauds are confined to individual social groups or neighborhoods, Mr. Madoff stands accused of running the world’s first truly global Ponzi scheme — a pyramid set-up that survives by using money from new investors to pay off earlier backers.


Mr. Madoff’s returns appeared to many to be too good to be true.  But advocates claimed they were the result of a “split-strike conversion strategy” that used derivatives to minimize risk, while intelligence from his market-making business allowed him to time investments almost perfectly.


Several investors believed he might be front-running – illegally trading ahead of customers of the market-making division – but many stayed with him anyway.   “He had a clean record from the SEC and it wasn’t our job to spot this,” says one.  Some funds offered a more complex explanation.  Split-strike conversion enabled him to profit from periods of rising share prices by setting up what was called a “bull spread”.  This involved buying shares in 40-50 companies to mimic the blue chip Standard and Poor’s 100 Index, while using put options to protect against falls.  Selling call options, limiting the potential upside, covered the cost of these options.     REMOVE


At the Interbourse golf tournament held last May at Cabo San Lucas on the tip of Mexico’s Baja California peninsula, some participants suspected something amiss with Bernard Madoff.  Seven months later, U.S. prosecutors accused him of running the world’s biggest Ponzi scheme.


After the May tournament, Mr. Madoff and his wife went to Port Gallice in the south of France, where he owned a yacht called Bull and regularly holidayed.  Mr. Madoff also made the rounds at the U.S. Open tennis tournament, held every August in Queens, and was introduced to one former tennis star with the words: “This guy is a miracle worker.”


Behind the scenes, Mr. Madoff was trying to drum up money.  In late summer of last year, word circulated that he was ready to take in more cash, prompting one long-standing investor to set up a new feeder fund, Kallisto.


“He had an outflow of money and he needed more cash,” says the investor, who first invested his own money with him 18 years ago.  “I went to see him on October 2 and I asked, ‘If I wanted $25-$50m could I get it?’ and he said ‘sure’.”


“There is no innocent explanation,” he allegedly told the agents.  He had “paid investors with money that wasn’t there”.


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