How Many Madoff Red Flags Can You Count?

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.

Comments

[john s. gordon:]

inconceivable gross incompetence @ SEC.
> jack

Jan 13 08:10 AM

[Leftfield:]

Okay, with all the trillions sloshing around Wall St. and the revolving door with Washington, nobody knew how to do their job. Including other fund managers who were happy to collect commissions turning over their funds or parts thereof, to Madoff.

Nor the press. Notice the concentration of news organizations and the lack of whistleblowers of any kind preceding this, the largest financial debacle ever.

There's been plenty of regulation. Any procedure involving government involves ever-proliferating new rules, steps and regulatory hurdles to do anything in the average person's life. My mother has lived on the same house on Cape Cod since 1945, and when the septic needed repair, some of the driveway was dug up. Took 1-1/2 years and numerous motions with the town to repave the gash due to "environmental concerns." Nearby, a huge new house has recently appeared on the edge of the dunes. I'm sure the wealth and connections of the owner had nothing to do with that environmental pass.

Madoff remains in his suite planning his coverup while a kid jumping a subway turnstile would be in jail. I'm sure the solution will be, more taxes.

Jan 13 08:42 AM

[Leftfield:]

I meant, it took numerous motions for my mother to be allowed to have her driveway repaired herself.

Jan 13 08:45 AM

[amangold:]

The two most important red flags were:

1. No independent broker (or bank) custodian.
2. No reporting by the independent custodian to clients on the contents of the investment portfolio.

If the investment manager can get his hands on the money, and does not tell you what is in the fund, the risk of monkey business is much higher.

Jan 13 08:50 AM

[dashephe:]

If its too good to be true, then it probably is not true. I don't care who is selling it. caveat emptor.
Now we get to watch as increased regulation increases fees and dwindles away at more of the average investors returns. All because the 'elite' and supposedly financial savvy where taken for a ride.
Madoff investors didn't become millionaires by blindly trusting people with their money. They seem to have forgotten that trust is no substitute for due diligence and following business 101, if it's too good to be true then it probably isn't true.

Jan 13 10:07 AM

[helplessobs...:]

The strong take it from the weak, then the smart take it from the strong. Then we have the stupid idle rich, they know nothing, they know nothing. Now they will be forced to learn something, the lessons of life that most of us learned as we carefully husbanded our small earnings and savings.

Jan 13 11:22 AM

[bobbobwhite:]

Where is Madoff's auditing CPA in all this? Haven't read a word about that and what was done and how often, etc.

A property manager friend has required outside audits for HOA records every year in his contracts or he won't manage the property. Just to protect him and them from anything "funny", like the Madoff shenanigans.

Another PM I know refuses audits and convinces the HOA boards that they "can't afford them w/o raising HOA dues". So, guess which HOA dues are the highest with the most disgrunted, almost violent, homeowners? Not the first one, that's for sure.

Any of this seem a little too familiar? If they are not required, why are outside audits not required by regulators for firms like Madoff's?

Jan 13 12:11 PM

[Andy B.:]

Not that I'm on the side of Madoff, but how do we know that any of the "investors" weren't in on the scheme with Madoff laundering the money for them and funneling the cold hard cash back to them, tax free? Maybe those organizations and investors were also on shaky financial ground and this was their "way out". Maybe the ones running these banks and organizations were good buddies with Madoff. Maybe good friend Madoff took the fall to save their hides knowing his life is almost over. (he's 70) Maybe he took the fall to just stay alive or even keep his family alive. You don't rip off that much money and stay alive, you just don't. That's another clue that the others were involved.

I find it hard to believe that all these billionaire financial-type people, organization and bank investors invested billions of dollars into one company that had only one actual auditor. Something stinks to high heaven here and it isn't just Madoff. I also believe that many in the SEC were paid off to look the other. It would be very easy to corrupt them when billions of dollars were involved. The government should look into their finances too, though I doubt it because they're pretty busy being involved in their own $700 billion dollar heist from the taxpayers to pay attention.

I think many of those people running all these collapsing banks and corporations have systematically been plundering these institutions for a long time and now that they are all getting caught the government is looking the other way, especially the federal law enforcement agencies who are supposed to be protecting us. They're in on it, too. Thieves and liars, the whole bunch of them.

Out of the tens upon tens of thousands of employees employed by the FBI, the SEC, Internal Revenue Service Criminal Investigative Division, Internal Revenue Service Criminal Investigative Division, Postal Inspection Service, Secret Service, Financial Crimes Enforcement Division, the Federal Trade Commission National Association of Securities Dealers and the myriad of other untold numbers of federal law enforcement agencies, nobody saw a thing, nothing. What a joke our law enforcement agencies are. Now you know where your tax dollars are going...besides in the pockets of the corrupt politicians, no where.

Oh yeah, Madoff operated alone, just like Lee Harvey Oswald. (wink-wink) LOL

Jan 13 08:04 PM