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The bankruptcy court released a 162-page list naming thousands of Madoff victims, including:
◊ ◊ Aozora Bank (Japan)
◊ ◊ Nordea Bank (Sweden)
◊ ◊ Bank Medici (Austria)
◊ New York University ◊ ◊ HSBC ◊ John Malkovich ◊ ◊ Steven Spielberg ◊ Fairfield Greenwich◊ Kevin Bacon ◊
World’s Largest Ponzi Scheme
Begs the questions
1) How could this scheme go on for so long?
2) How could so many sophisticated individuals be taken in by a fund that provided no info on how it was able to achieve consistent returns of 8-13% for many years, during both good and bad times?
20+ Years of trickery
SEC did a bad job regulating. They too were caught up with the hype surrounding investors.
Split-Strike Strategy – complex with many moving parts.
Begs the questions
1) How could this scheme go on for so long?
2) How could so many sophisticated individuals be taken in by a fund that provided no info on how it was able to achieve consistent returns of 8-13% for many years, during both good and bad times?
Information Cascades
Each successive investor assumed that the previous investor did their due diligence
“Information cascades” – kind of like playing telephone.
Perhaps “sophisticated” financial institutions are NOT immune from hypes
Bernard L. Madoff
Professional Accomplishments: Founder of Bernard L .Madoff
Investment Securities (BMIS) Chairman of the Board of NASDAQ Founding Member of the International
Securities Clearing Corporation in London
Board of Governors of National Association of Securities Dealers
Exclusive Circle: Club Madoff
Bernie Madoff
Ruth Madoff’s Friends
Exclusive Circle
International Banks;College
Endowments
Feeder Funds
Mutual Funds
Yes Bailout . . . .
Millions were affected Not only wealthy white-collar
individuals, but also blue-collar individuals with retirement funds managed by one of the feeder funds.
Hedge Fund Bailout It’s been done before with
success, i.e. LTCM.
LTCM v. Madoff
Long Term Capital Management
Bernard Madoff Investment Securities
“Tail” risk(s) that triggered the downfall:
Asian Financial Crisis of 1997 & Russian Default of 1998
Current Financial Crisis
Counterparties: Wall Street Banks Feeder Funds
Prominent Management attracted investments:
John Meriwether Myron ScholesRobert Merton
Bernard Madoff
Millions of Innocent parties affected:
Approximately $4.6 Billion loss
Approximately $50 Billion loss
LTCM v. Madoff
Long Term Capital Management
Bernard Madoff Investment Securities
Hedge Fund Secret: “Secret sauce” (= profitable arbitrage and pairs trade)
Split-Strike Strategy (but in fact Ponzi Scheme)
Investment Strategy was Legitimate?
Yes No
Investor Money was …
Spread out to purchase US, Japanese, and European government bonds
Concentrated in Madoff’s pocket
Economic or legal remedy available?
No Yes
No Bailout
Legal Remedy Available People are already bringing lawsuits
against Madoff and feeder funds. Bailout will encourage Ponzi Schemes
If government bails out Ponzi scheme participants, then taxpayers stand to lose more money than Ponzi players. This incentivizes a rational person to partake in the next Ponzi game rather than avoid it.
What is a Hedge Fund?
Unregistered, privately-managed pools of capital Equity investments Leverage and short selling Absolute return
Why regulate? Long-term incentive alignment Retailization Systemic risk
Securities Act of 1933
Section 4. Exempted Transactions Regulation D, Rule 501
“Accredited Investor” Calculating purchasers
Regulation D, Rule 506 No more than 35 purchasers Sophisticated purchasers
Securities Exchange Act of 1934 “Dealer” vs. “Trader”
In the business of buying and selling securities
Registration under 15(b) Section 12. Registration Requirements
for Securities More than 500 holders of record, and Assets in excess of $10M
Investment Companies Act of 1940 Section 3(c). Further exemptions
3(c)(1) –type hedge fund Up to 100 investors No public offerings
3(c)(7) – type hedge fund Up to 500 qualified purchasers No public offerings
“Qualified Purchaser”
Investment Advisors Act of 1940Section 203(b). Registration of Investment
Advisors Fewer than 15 clients in past 12 months,
and Doesn’t hold self out as an investment
advisor
Madoff: Repeated Investigations 1999: SEC send examiners to review trading
practices 2000: SEC sends examiners to review trading
practices 2004: SEC investigates front running allegations 2005: NASD reviews Madoff 2005: SEC investigates front running allegations 2006: SEC investigates Ponzi Scheme
allegations
SEC: Organizational ProblemsUnderstaffedLawyers not financial expertsPolitical influencesLittle deterrent effect
GAO study – 92% of hedge funds in study were not in compliance.
Any Lessons Learned from LTCM? “Unique characteristics and unlikely
events” Amount of leverage is rarely seen
today Private parties were willing to buy
LTCM Counterparties could have absorbed
losses from a default
In the end…
No Bailout for Madoff victims
Regulation laws seem fine. The problem is the people running the organization.
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