14 December 2008
Jose D. Roncal
An epic fraud has just been uncovered – this time it doesn’t involve those new exotic and complex securitized debt/credit default swap packages. No, this one is a good old-fashioned Ponzi scheme—and it’s so big it could surpass Enron!
Bernard Madoff, former Nasdaq Stock Market chairman and founder of privately held Bernard L. Madoff Investment Securities LLC, has been arrested and charged with securities fraud in what federal prosecutors called a Ponzi scheme that could involve losses of up to $50 billion.
Here’s how it worked. Madoff’s clients included several prominent hedge funds. Even though business had been insolvent for at least four years, he kept paying out returns to investors. How did he do it? By using money received from new investors, because Ponzi schemes need net inflows of money to work.
Who would have doubted the integrity of one of the most reputable firms on Wall Street run by an individual that was instrumental in framing the structure of the SEC?
Once again, where were the auditors/accountants? Did it not raise any red flags that the company had reported consistent earnings for the past 20 years? And how could this privately-held company managing that amount of money not be regulated, audited, controlled or provide any safeguards to their so called “investors?”
Apparently the SEC had even received numerous letters from investors trying to sound the alarm that something didn’t smell right. Why was no investigation conducted?
Yes, I understand the secretive nature of Hedge Funds, but will this finally be enough to wake up regulators to change these ineffective oversight rules?
I’ve always maintained that the word “investment” is a misnomer. It’s all speculation. Nothing is really safe. Now the search begins to find the gory details of the billions lost. But what has really been lost is more faith and trust in our financial system. Madoff’s firm had been highly regarded on Wall Street, but trust me, this downfall will just be the tip of the iceberg.
The economic downturn has already caused a run on Hedge Funds and the redemptions have been enormous. Investors cashed out a record $130 billion in November alone. In Madoff’s case, he’d only had requests for $7 billion of redemptions but was struggling to find the liquidity to return funds.
We’ll find out in the next few hours just how serious the collateral damages will be. Early indications are that the actual number of clients is few, but each stands to lose billions. This will not do much to bolster the confidence in the rest of the investment world.
It just drives home the point that there are so many weak links in our financial system, so little government oversight, and too many loopholes that invite under-handed deals.
It will take years to revamp the structure of the system. But I still have a hard time understanding how the watchdogs, the regulators, state auditors, private auditors, accountants, and even the investors can be so blind.
There are tough lesson to be learned, and many questions to be answered. One of the most important and relevant questions we have to ask ourselves is posed in the title of our book, “The Big Gamble: Are You Investing or Speculating?”