Fund managers are paid to manage client funds in a manner which reflects a thorough level of diligence and care.
The same applies to senior executives of financial institutions with respect to the way in which they invest shareholder funds.
Neither are paid to simply hand client or shareholder money over to scam artists, and their behavior with regards to the Madoff fraud, in which many did just that, represented a serious breach of their duty of care.
What the scandal involved
The scandal, committed by Bernard Madoff, a former chairman of NASDAQ, appears to have worked as follows:
Mr. Madoff ran a financial services firm, which he started in 1960. As part of its offering, the firm ran an investment management and advisory division, which essentially managed client funds in brokerage accounts within his firm.
The division (whose clientele consisted predominately of banks, investment funds and wealthy individuals) appeared to deliver exceptionally consistent results, recording returns on investment in the vicinity of ten per cent every year, year in, year out, even throughout periods of unfavorable market conditions.
One problem – in reality, such results were not in fact being achieved, a fact which Mr. Madoff was hiding by running an illegal pyramid, or Ponzi type of scheme, whereby the payment of returns to existing shareholders was being funded out of contributions from new investors rather than out of profit.
The scheme unraveled during the financial crises, with fresh contributions from new investors drying up combined with an abnormally high demand for withdrawals.
They should have been suspicious
A number of warning signs pointed to the fact that something wasn’t right, and bankers and fund managers who invested shareholder/client money with Mr. Madoff have no excuse for their lack of diligence.
Briefly speaking, the warning signs included:
• An unrealistic degree of consistency in investor returns;
• Claiming to use hedging strategies in the S&P 100 options market, which one independent research firm concluded was too small to handle a portfolio of his size;
• Lack of transparency, including refusal to allow clients online access to their accounts, and ejecting from meetings investors who asked difficult questions;
• Lack of accountability – including the practice of clearing his own trades, (highly unusual within the industry) and using a firm with just one qualified accountant as an auditor.
(See Wikipedia article and The Economist report for details)
The consistency of returns was a giveaway, and Madoff’s claims (which included the achievement of consistent returns of around ten per cent per year, year in/year out, and at one point, recording seventy two months of gains in a row) should have been seen for the lie that they were.
Simple common sense dictates that regardless of the effectiveness with which hedging techniques are used, returns of that level of consistency are not achievable in fluctuating financial markets.
Any banker or fund manager who conducted any diligence at all would not have worked out that something was amiss, and the haphazard way in which some invested with Mr. Madoff was simply astounding.
“It’s all the SEC’s fault”
Equally astounding is the readiness of some clients to blame the SEC, as opposed to taking responsibility for their own lack of diligence.
This lame excuse is blamed being touted by Union Bancaire Priv’ee, a Swiss private asset management company, who claims that the exposure of its clients (estimated at $USD 1.1 billion) is the result of failure on the part of the SEC to effectively monitor Mr. Madoff’s firm. (refer article)
That’s ridiculous. UBP manages approximately $USD124.5 billion in funds, and a firm of this size surely has an obligation to its clients to conduct proper due diligence with respect to any hedge funds or money managers with whom it invests substantial amounts of client funds.
Any mistakes made by the SEC do not in any way absolve UBP or any other fund manager or bank of responsibility for their own failure to fulfill their duty of care.
Just admit to your mistakes
Clients and shareholders have every right to be livid about the way in which fund managers and banks simply handed their money over to a scam artist.
Those banks and fund managers who invested with Madoff should just own up and acknowledge that they breached their duty of care.
They are not paid to be sheep. They are paid to be diligent with client/shareholder funds.
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