With losses estimated at $50 billion, “l’affaire Madoff” is deemed the largest financial fraud in world history. Not since Charles Ponzi scammed millions from investors in the 1920s have world financial markets seen such a systemic breakdown of what should have and could have been done to prevent fraud. Institutions and individuals alike bear the pain, forcing some organizations to shut their doors, declare bankruptcy, withdraw charitable donations, offer fewer scholarships or go back to work, long after retiring.
Litigators and regulators are busy filing lawsuits and enforcement actions that could take years to settle. Questions abound. Who was responsible for due diligence? What could have been done before the fact to preempt financial ruin? What can be done now to avoid subsequent losses?
Based on research of publicly available information, I count well over a dozen red flags, including but not limited to the following:
- Regularity of returns despite market volatility
- Complex strategy
- Poor transparency about performance reporting standards
- Unknown audit firm
- Seemingly limited due diligence by some parties
- Unclear assignment of investigation-related duties (knowing who does what)
- Questionable diversification
- Few questions asked about risks
- Limited internal controls, if any
- Lure of "movie star" reputation
- Limited attention paid to hedging efficacy
- Limited knowledge of rebalancing techniques
- Limited knowledge of trading limits and stop loss points
- Limited knowledge of collateral risk
- Unclear understanding as to who played the role of fiduciary
- Limited knowledge about asset valuations and related valuation process.
It goes without saying that much remains to be learned about the Madoff situation. The good news is that more attention, at least for some organizations, will now be paid to due diligence and prudent process.