• Madoff and Blagojevich: Stealing – Easier When No One Is Watching

    By • Dec 15th, 2008 • Category: Madoff, PCAOB, SEC

    Both are accused of being corrupt.

    One gentleman has been under a cloud of suspicion for a while.  He’s denied it and dared prosecutors to wiretap his conversations, to come and get him.  He hid his activities in plain site.  As visible as a major state Governor has to be, he also kept a low profile, not talking to his Lt. Governor for over a year.   He didn’t even speak at the convention that nominated a fellow Illinoisan to be President.
    The other gentleman was a pillar of the financial services business community.  He welcomed attention in those areas that burnished his golden reputation for business acumen and philanthropy.  He walked the halls of prestigious institutions and government agencies, sitting on Boards and advising others on how to run fair and efficient markets.
    “He sat on a committee of academics, regulators and executives formed in 2000 by former SEC Chairman Arthur Levitt to advise the agency on new stock-market rules in response to the growth of electronic trading. Madoff has led the trading committee at the Securities Industry Association, Wall Street’s biggest trade group, and served as chairman of the Nasdaq Stock Market.”

    But he also had secrets and held the details of activities that led to his shocking admissions very close to his vest.   His painfully obvious suspicious and questionable activities were never fully scrutinized because of his golden history and impeccable reputation,
    In both cases, acute circumstances led to the unraveling of their schemes.  
    For Illinois Governor Blagojevich, it was the spectacular rise of Illinois Senator Barack Obama to the US Presidency. This left a hole that presented the Governor with a “golden opportunity ” to use the power of his office to mitigate the financial pressure his family was under.  There had been many years of expensive legal advice.  But he was greedy and displayed that avarice in what’s being called a crude and very vulgar attempt to extort. He’s now forced famous US Attorney Patrick Fitzgerald’s hand.  
    For Bernard Madoff, it was the current “financial crisis” which precipitated sudden large requests for redemptions from his private hedge fund.  It turns out, according to Mr. Madoff himself, he was running a “Ponzi scheme.”  Everything works fine as long as new money is coming in and no significant funds have to go out. At the end, there’s reportedly only a few hundred million dollars available in cash out of more than 50 billion dollars that had been invested with him in previous years.
    You expect that such a large “Ponzi scheme” — in which early investors are paid with money raised from subsequent victims — will prompt lawmakers to review how the U.S. polices brokerages, wealth managers and unregistered advisers, such as hedge funds.  
    …The SEC, via its own protocols, should have inspected the Madoff Ponzi operation prior to the end of 2007 and failed to. Why? Evidently, due to Madoff’s good reputation in the industry.

    What is particularly curious (if my assumptions are correct) is that Madoff kept his registered status, which meant he would at some point have the SEC knocking on his doors. I am assuming he registered in 2006 because that is when the SEC has an initiative underway to register hedge funds with over $25 million in assets under management. Some evaded it by getting investors to agree to 2 year+ lockups (that put them in a different category). 


    But the registration requirement was nullified when a hedge fund manager sued successfully, claiming that the SEC was misusing its statutory authority under the Investment Advisers Act of 1940. Most hedge fund then removed themselves from registration; for some reason Madoff did not. Did he somehow think he could bluff the SEC, or did he have a death wish? (Note: I am assuming the Madoff investment operation was considered to be a hedge fund, otherwise, it should have been registered as an investment adviser long ago…)”

    There were many other opportunities for suspicions to be raised, followed up on or,  at least, for some investors to dig deeper.  
    I twittered the news as soon as I heard it, on CNBC, December 11, at 3:26 CST.

    At that time, the size of the problem was not yet apparent.  The next day, Naked Capitalism linked to my post on the PCAOB report with an additional comment: 

    “With the Madoff scandal, I suspect there will be a renewed focus on the quality of audits (and I have yet to see who was doing his books).”

    Friehling and Horwitz does not have a web page. According to Bloomberg News

    “The New City, New York, auditing firm Friehling & Horowitz signed off on the annual financial statement of Madoff’s Manhattan-based investment advisory business through Oct. 31, 2006, according to a copy obtained by Bloomberg News. Friehling & Horowitz included one partner in his late 70s who lives in Florida, a secretary, and one active accountant…

    The copy of the four-page annual financial statement, dated Dec. 18, 2006, attested that the financial statements of Madoff’s securities firm were “in conformity with accounting principles generally accepted in the United States.”  The financial analysis said Madoff Securities had $1.3 billion in assets, including $711 million in marketable securities and $67 million in U.S. debt. Members’ equity, the firm’s net worth, was $604 million, according to the document.

    The firm operates from a storefront office in the Georgetown Office Plaza in New City, New York, sandwiched between a pediatrician’s office and another medical office.”


    So why did so many “sophisticated” investors put their money and their faith in an operation that,  if you didn’t know Mr. Madoff, threw up all the red flags typical of a scam? In fact, some have claimed that the problem is too much regulation…  But then ideologues will grasp at straws to explain the fundamental fact so evident in this an many of the “financial crisis” stories:
    Ethical relativism is alive and well. The extreme sense of entitlement and unadulterated self-interest inherent in some of the worst offenders is an example of pure evil.
    I see bad people.

    “The smart money KNEW Bernie had to be cheating, because the returns he was generating were impossibly good. Many Wall Streeters suspected the wrong rigged game, though: They thought it was insider trading, not a Ponzi scheme. 

    And here’s the best part: That’s why they invested with him.”

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    14 Responses »

    1. weird story. Love to hear more about it

    2. Criminals build walls of false integrity around them to gain the trust of their victims.

    3. Very interesting closing cite, from Henry Blodget no less, that investors suspected Madoff was not on the up and up but stuck with him since they thought his outsize returns were due to insider trading, not a Ponzi scheme. This investor behavior may make for an interesting research report (calling all academics) if not an investigation in and of itself.

    4. Isn’t it always the way that greed, selective thinking or myopia get in the way of sound judgment when things seem to be going really well. CA, Enron…the list goes on.

      @edith: whever I read Blodget I’m always tempted to think pot, kettle, black. But that’s another story I guess.

    5. @Dennis:

      Who better to learn from then a Blodget or Mr. Antar above…usually a dog can smell a dog…from a long ways away.

      This fraud will reverberate through the industry and beyond for some time…not just in the lawsuits against Madoff but people suing fund of funds and the like.

      Good interview with Mort Zuckerman on CNBC today – he keeps asking – why didn’t those investing (he had a fund manager invest for his charitable trust) do their DUE DILIGENCE?

      Naked Capitalism also discussed how other traders knew what the strategy was and that even replicating it would not produce the returns stated – again DUE DILIGENCE would’ve keyed in on this.

      Hell of a news day in the fraud world – Seimens pays 800m after very long investigation, Madoff has eviscerated people’s wealth (suppose they may have only lost 80% had they invested it in the broader market in the past year!), Marc Dreier scammed $380m from various funds…

      I think the question is in the Madoff situation – where the hell was the SEC? Forget sleeping at the wheel – they were passed out drunk in the bed of a pick-up truck – the hangover is going to be a bitch.

      When will Obama announce a new SEC Chairman? Perhaps the SEC will be abolished or merged into another agency as the OTS is going to be with the OCC…

      The regulatory framework is going to shift yet again – maybe the teeth will be sharper this time than post ENE, Worldcom.

    6. This is a great blog!!! glad I found it..….very educational…thank you…I will put it on my favorites list.. I also learned a lot about trading strategies from 3 other great books. Hedge Fund Trading Secrets Revealed..by Robert Dorfman..and Confessions of a Street Addict of course by Jim Cramer..written before he got really famous.and Richard ARMS..STOP AND MAKE MONEY….all 3 are riveting and very informative. You should check them out if you like reading behind the scenes stuff about hedge fund and what methods they use to make money.

    7. http://www.cfo.com/article.cfm/12796960/c_12797084?f=home_todayinfinance

      Interesting little article on CFO.com today. It looks like that little shop is now under investigagtion. The question is, how could a small shop be capable of doing such a big audit?

    8. @Chicago Accountant

      News flash: That little shop most likely did nothing but provide a signature to a report in exchange for a healthy sum. Sort of funny considering how little their signature would have been worth if anyone had really looked at it closely.

    9. It was more of a rhetorical question. I can only assume little to no work was done. Simply put, one accountant, who may or may not be a CPA could not do the work on his or her own. I wouldn’t be surprised if the firm had a handful of “clients” and did the same type of “work” for each.

    10. http://online.barrons.com/article/SB122931054024706045.html?mod=9_0002_b_online_exclusives_weekday_r1

      “As reported, Madoff used a tiny, unknown accountant for audits while his own market-making firm handled trading and operations, including custody.”

      ” ‘I couldn’t get dollar one if we didn’t have, if not a Big Four, then top five, six or seven, accounting firm. And I would have to clear through a prime broker,’ this pro explains.”

    11. This whole saga may demonstrate that having a Big 4 auditor is actually worth something and they not necessarily the bungling clowns that Francine and others here portray them to be.

    12. http://money.cnn.com/2008/12/17/news/companies/madoff.auditor.fortune/index.htm?postversion=2008121808

      Funny how things you suspect turn out to be true.

    13. The next step is to follow the money. Determine who profited off the scheme and investigate them. I’m sure Madoff wasn’t the only person to enrich himself.

    14. In response to:
      "The Devil's Advocate said…
      This whole saga may demonstrate that having a Big 4 auditor is actually worth something and they not necessarily the bungling clowns that Francine and others here portray them to be."

      Nobody's saying the Big 4's clowns; the Big4 pimps themselves out for money from their clients with the same way
      Friehling & Horowitz did for Madoff. They're pimps, not clowns.

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