Madoff Investment Securities Revealed As “Stunning Fraud”

Our complaint alleges a stunning fraud that appears to be of epic proportions.

– Andrew Calamari (subscription required), Associate Director of Enforcement, SEC New York Office

It’s all just one big lie…. basically, a giant Ponzi scheme.

– Bernard Madoff allegedly said this to his two sons, and business partners, at his Manhattan apartment

It’s a proprietary strategy.  I can’t go into it in great detail.

– Bernard Madoff told Barron’s In May 2001 (“Don’t Ask, Don’t Tell” (subscription required), Barron’s, May 7, 2001)

I’m not interested in educating the world on our strategy, and I won’t get into the nuances of how we manage risk.

The strategy is the strategy and the returns are the returns.

– Bernard Madoff to trade publication MAR/Hedge in May 2001 (“Madoff tops charts; skeptics ask how”, MAR/Hedge, May 2001)

Even knowledgeable people can’t really tell you what he’s doing.  People who have all the trade confirmations and statements still can’t define it very well.  The only thing I know is that he’s often in cash [when volatility levels get extreme].

– A very satisfied investor (subscription required) told Barron’s in May 2001

They always sold the fund as being regular variable income.  But no one really knew what the strategy was.

– Palm Beach Country Club member (subscription required), where Bernard Madoff marketed his funds

Anybody who’s a seasoned hedge fund investors know the split-strike conversion is not the whole story.  To take it at face value is a bit naive.

– A former Madoff investor (subscription required)

The numbers were too good to be true, for too long.

– Girish Reddy, Managing Director, Prisma Partners

What Madoff told us was, ‘If you invest with me, you must never tell anyone that you’re invested with me.  It’s no one’s business what goes on here.’  When he couldn’t explain how they were up or down in a particular month, I pulled the money out.

– An investment manager (subscription required) who took over a pool of assets that included an investment in a Madoff fund

A couple of interesting notes about Madoff’s investment advisory business:

• Using a strategy called “split strike conversion” which involved selling calls and buying puts on a basket of owned stocks, Madoff reported only three down months between January 1996 and December 2004 – a 9 year, 108 month period.  Sophisticated investors familiar with the strategy were mystified about how consistent and low volatility his returns were.
• Madoff took no management fees for his investment advisory services.  They just earned commissions on the trades which they processed through the market-making side of the business.  This amounted to leaving on the table a quarter billion dollars a year Barron’s estimated back in 2001.  Why would he do that?
• Madoff was secretive to the extent of not even wanting his investors to tell anybody they were invested with him.  That’s a bizarre marketing strategy!

Some lessons:

• Clients should demand some level of transparency in the management of their money.
• This kind of secrecy and bizarre compensation arrangement should have raised some serious red flags.
• Finally and always: If it seems too good to be true, it probably is.