Myths About Madoff's 'Ponzi Scheme'

Bernie's Game Wasn't What They Told You

by Leveymg, Daily Kos (March 18 2009)


Bernie Madoff's colossal investment fraud is almost everywhere described as a "Ponzi scheme". That echoes the very words Madoff, himself, used to describe it to the FBI agents who arrested him on December 11.

I've been running "basically, a giant Ponzi scheme", he told investigators. But, that was quite misleading.

Madoff gives the impression that his scam was a classic, self-contained Ponzi, wherein the first investors see the payouts and later investors are the ones whose capital provides the payouts. In that scheme, Ponzi pockets the proceeds.

But, it didn't really work that way. Madoff Securities was not designed to rip-off its own customers. Instead, it sustained itself over four decades by an infusion of money from "feeder fund" franchizes, the proceeds of which were methodically diverted into hidden accounts. It was part multi-level marketing, part money-laundering scheme, and part bleed-out fraud designed to provide a cover for conversion of funds that would be used by banks a continent or two away from Madoff's Manhattan headquarters.

And, it really wasn't an ethnocentric raid designed to impoverish any particular national or religious group - that would be killing the Golden Goose, but it may have had that effect. Madoff's biggest clients were powerful banks and politically well-connected, philanthropic men who owned them. Their customers will get some of their money back through deposit guarantee insurance, law suits and other institutional safeguards. Madoff's own customers get first crack at funds eventually recovered - there is no way that Madoff spent $65 billion on caviar and vintage wine.

An accounting of Madoff's real estate and personal property, including that placed in the name of his wife, Ruth, amounted to no more than $67 million - not a lot by Wall Street standards. Bernie was smart, emotionally controlled, and personally frugal. His refusal to take the deal reportedly offered by the feds - trade what he knows for allowing Ruth to keep most of their joint assets - is telling. No, Bernie didn't squander it all away. Most of the money his fund piled up over the years is still out there.

This was a giant money-laundering scheme. Madoff was convicted of two counts of money-laundering, along with other charges. He refused to admit to the involvement of others, which is what the prosecution wanted him to do, so the offered plea deal was withdrawn. A Ponzi involves a single hub that draws in cash to the center - Madoff's network was a money pyramid that involved multiple players moving money upward, each taking a share. That is a distinction with a real difference - this is not a completed prosecution. That still leaves the question of who the US Attorney thought Madoff was working with. Here's an obvious place to start:

The answer to where that money is goes back to where it came from.



The Feeder Funds - Swiss Bankers, Aristocrats and Vultures Wrapped up in TARP

As for the feeder funds, seventeen of the twenty largest investors in Madoff Securities were banks or insurance companies. The others were huge "funds of funds", unregulated hedge funds and private equity funds. It was the comparative small-fry who got scalded. The bankruptcy courts will have to come to the rescue of many of the 4500 individual investors and those who were attracted through smaller feeder funds.

Most of the biggest losses were sustained by large Swiss, Euro and Asian banks - but, they will survive, and their customers will eventually receive some sort of substantial recovery or part of a government bail-out. Like so many scandals of the era, this too will pass, and public attention will wane.

But, take a good look, anyway.

Tremont Group Holdings, Inc - Robert Schulman

The third largest institutional investor in Madoff's scheme is Tremont Group Holdings Inc, a fund of funds owned by Massachusetts Mutual Life Insurance Co. Tremont is attached to an institution so big that its customers are also likely to regain the $3.3 billion in reported losses as the result of investor law suits. A 2007 Hoover's profile characterized the firm as follows: "Tremont Group Holdings wants to make you a tremendous amount of money - and to make a tremendous amount for itself, as well ..." {1}

Prior to his well-timed resignation as Chairman in July 2008 after the Mass Mutual takeover, Tremont had been run by its founder Robert Schulman. Tremont was one of Madoff's "early customers". Schulman now runs a charity with his wife, and invests in real estate. He is named as a co-defendant in an investors' suit along with Tremont, Mass Mutual and the company's auditing firm, KPMG (Bearing Point), which recently announced its own bankruptcy. Deja vu? {1}, {2}

The Independent Funds

There were only three independent funds among the top feeders: Fairfield Greenwich Group, Walter Noel's hedge-fund, ($7.5 billion in losses); Ascot Partners, headed by former GMAC Chairman Ezra Merkin ($1.8 billion); and Access International Advisors ($1.2 billion), a European investment fund.

AIA - Rene-Thierry Magon de la Villehuchet

In 2007, AIA took over management of the Rothschilds family bank portfolio previously managed by UBS. AIA founder, Rene-Thierry Magon de la Villehuchet, committed suicide in his Manhattan office days after the Madoff scandal became public.

Villehuchet had carved a lucrative franchize for himself peddling access to the exclusive Madoff connection among Europe's richest glitterati, including Bettencourt family heirs to the L'Oreal cosmetics family.

* * *

Most of these private hedge funds were not only rich, they had close ties to government officials and political figures, access to public money, and knew how to benefit from bailouts. Ezra Merkin was chair of two large American industrial corporations, GM and Chrysler, which have already received more than ten billion dollars in TARP bail-outs, and are currently seeking more.

Ascot Partners - J Ezra Merkin

J Ezra Merkin is also owner of a large stake in Bank Leumi, the privatized national bank of Israel, which he acquired with partner Stephen Feinberg, founder of Cerberus Capital Management, which grew (along with others) during the Sharon - Olmert era from a bank holding company into a large global hedge fund.

Accusations abound that Noel and Merkin failed to perform due diligence, and in some cases, allegedly deceived their own customers that they were placing client funds with Madoff. For well over a decade, Madoff had a reputation on The Street not only for phenomenally steady returns but also the whiff of illegitimate methods. The only thing that nobody could quite figure out was how he did it. Suspicions were quietly voiced that he was using insider knowledge gained from his proprietary trading platform that was adopted by the NASDAQ exchange Madoff headed.

But, if the preliminary findings are indeed correct, Madoff hasn't been trading listed stocks in customer accounts for at least thirteen years. But, Bernie nonetheless managed to consistently pay out tens of billions in dividends during that period. At the eight to seventeen percent annual returns his investors were reportedly receiving, that would have depleted the fund's capital in half that time. It is arithmetically not possible that Madoff was simply paying his older investors out of the funds gained from newer, and only from those funds. As one long-term investor who got out a couple years ago remarked, Bernie "never missed a quarter". If he wasn't trading, Bernie had to have another source of funds, someone who was. A feeder relationship can operate in both directions, if regulators aren't looking very closely at both ends. And, in fact, as we are learning, regulatory authorities in several countries in the last decade have been legally blind.

Among the Madoff feeder-funds, closest attention has focused on Ascot Partners. But, J Ezra Merkin also operates a hedge firm, Gabriel Capital, which partnered with Cerberus in the takeover of the distressed US auto industry and made a big move into the defense sector during the Bush years. The partnership left companies in both sectors worse off for their attentions, but made these hedge funds owners hundreds of millions richer. Money lost in operating failing companies have been made up by lucrative government contracts and bailouts, a not entirely unexpected bonus.

The new TARP loans now being sought are in addition to the $13.4 billion the US Treasury lent earlier to Merkin's GM, and Fineberg's Chrysler. In 2006, GM sold 51 percent of Merkin's GMAC to Feinberg's private equity firm Cerberus Capital Management LP (which also owns Chrysler). In May 2004, Feinberg's private equity group, Cerberus Capital Management, LP (Cerebrus is the three-headed dog that guards Hades), became majority owner of IAP Worldwide Services, Inc, one of the US Army's largest contractors in Iraq. IAP was at the center of the Walter Reed Army medical center privatization scandal. (For the sordid details of this fetid corner of pirate capitalism, see note {4} below.)

Other key parts of the business model pursued by Madoff's private feeder funds has been political influence-peddling and its financial partner, money-laundering, facilitated by bank secrecy. Merkin and Feinberg are major campaign contributors to GOP candidates and backers of the Likud Party and other right-leaning parties in Israel. Merkin is involved in the same fundraising network for Israeli charities as Morris Talansky, a secretive financier and philanthropist. Talansky's illegal campaign contributions to Israeli PM Ehud Olmert led to the Israeli Prime Minister's resignation. Haaretz reports, "Olmert's close associates called Talansky 'the banker' or 'the launderer'". {5}

Cerberus-Gabriel has earned a global reputation as a politically-connected "vulture capital" firm. As a hedge fund, it plays the downside, and swoops in on distressed firms considered essential to the national interest. Characteristically, it breaks companies up and sells off their assets when it cannot successfully green-mail governments, extracting huge concessions and cash incentives in several countries. "Crash and burn", in the parlance.

Fairfield Greenwich Group - Walter Noel

Walter Noel, like Merkin, is well connected, both financially and politically. According to the WSJ, his fund was part of the fund of funds of the Swiss private bank Union Bancaire Privee (UBP), "one of the world's largest managers of funds of funds. As of June, it managed some $124.5 billion." {6}

UBP pioneered the use of hedge funds in private equity, and is currently the world's second largest hedge fund manager. Because of Swiss resistance to international efforts to stem money-laundering, the Madoff scandal has offered the first opportunity to peek inside some of the inner workings of this most secretive of major global financial operators. Noel was also an active contributor to conservative political parties in the United States and Israel. Noel and his wife have contributed to the presidential campaign funds of John McCain, George W Bush, Dan Quayle and George H W Bush.

* * *

Look Closely, and You'll See a Snake Swallowing Its Own Tail

Recall that Madoff's Securities was actually a network of banks connected to hedge funds connected by "funds of funds", drawing from a half-dozen major large feeder funds and about thirty smaller brokers. Many of them escaped official scrutiny, and were virtually self-regulating. Their auditing was either non-existent, or unreliable. The scam went on for at least fourteen years, yet no one in a position to notice blew the whistle, and the feeders kept depositing funds in Bernie's accounts. See Table below.

These funds accounts were deposited at a number of US and foreign banks. At that point, a curtain has been drawn down on what happened to the $64.8 billion principal and reported earnings in the fund. The strange secrecy about Madoff's foreign bank accounts has been imposed by the court - in itself, this is a red-flag that this was no conventional Ponzi scheme.

Table 1: "Madoff's Victims: A List of Reported Victims and Their Exposure", in Wall Street Journal (December 17 2008), page A14. (Victims For Whom No Exposure Amount Is Available Are Not Shown.)

Fairfield Greenwich Advisors (investment management firm): $7500 million.
Tremont Capital Management (fund of funds run by Tremont Group Holdings): $3300 million.
Banco Santander SA (Spanish bank): $2870 million.
Ascot Partners (hedge fund founded by GMAC chief J Ezra Merkin): $1800 million.
Access International Advisors (New York investment firm): $1400 million.
Fortis Bank Nederland NV (Dutch bank): $1350 million.
Union Bancaire Privee (Swiss bank): $1000 million.
HSBC Holdings PLC (British-Chinese bank): $1000 million.
Natixis SA (French investment bank): $560 million.
* Carl Shapiro (former chairman Kay Windsor Inc): $550 million.
Royal Bank of Scotland (British Bank): $492.76 million.
BNP Paribas (French Bank): $431.17 million.
BBVA (Spanish bank): $369.57 million.
Man Group PLC (British hedge fund): $360 million.
Reichmuth & Co (Swiss private bank): $327 million.
Nomura Holdings Ltd (Japanese brokerage house): $303 million.
Maxam Capital Management Inc (fund of funds based in Dairen, Connecticut): $280 million.
EIM SA (European investment manager with $11 billion in assets): $230 million.
Aozora Bank Ltd (Japan bank in which Cerebus Capital owns majority stake): $137 million.
AXA (French insurer): $123 million.
UniCredit SA (Italian bank): $92.39 million.
Nordea Bank AB (Swedish bank): $59.13 million.
Hyposwiss (Swiss private bank owned by St Galler Kantonalbank): $50 million.
Banque Bendict Hoetsch & Cie SA (Swiss private bank): $48.8 million.
City of Fairfield-Connecticut (town pension fund): $42 million.
Bramdean Alternatives (asset manager): $31.2 million.
Haredi Insurance Investments & Financial Services Ltd. (Israeli insurer): $14.2 million.
Societe Generale (French bank): $12.32 million.
Groupama SA (French insurer): $12.32 million.
Credit Agricola SA (French bank): $12.32 million.
Richard Spring (individual investor): $11 million.
RAB Capital (hedge fund): $10 million.
Banco Populare (Italian bank): $9.86 million.
Korea Teachers Pension (Korean pension fund): $9.1 million.
Jewish Community Foundation of Los Angeles: $6.4 million.
Neue Privat Bank (Swiss bank): $5 million.
Clal Insurance Enterprise Holdings Ltd (Israeli financial services): $3.1 million.
Mediobanca SpA (via its unit Compagnie Monegasque de Banque): $671000.

Now, squint, and it becomes a snake swallowing its own tail.

UPDATE:

I've stated my theory of the case, and it just so happens to parallel the one the prosecution based their case on: Madoff couldn't pull this off alone. He was working with other parties. There is a whole pile of money out there - it isn't all gone.

We can debate the size of the actual residuals all day. I can accept the proposition being put forward by NPR and others that the true value of the fund was closer to $20 billion than $65 billion. I assume that "churn" (trading assets back and forth to increase their notional value) is part of how Bernie operated with others in his circle. But, that doesn't change the essential part that there's still a big pile of loot out there, and someone's holding it and obtaining use value from it. Is it in a foreign bank or banks? The court imposed secrecy on that part, so we should probably assume that some of it is being held by foreign banks. Was some of it rebated to one or more feeder funds? Why haven't these questions been answered? Obviously, there are some problems with this prosecution - but, that's just my opinion.

Bernie refused to reveal what he knows about the disposition of the missing funds, so the US Attorney withdrew the proffered plea agreement. Bernie goes to jail for life - his wife won't keep the $72 million in goodies. The case might end there, but I'm trying to answer the questions Madoff (and the prosecution) won't.

My biggest issue with the term "Ponzi Scheme" is that it implies what forensic investigators call a "hub and spoke" scam with money feeding from victims to a single spider at the center. The fact is, however, that Bernie's fund actually was structured as a multi-level Pyramid Scheme, with money moving up levels, each layer taking a cut. That's a distinction with a major difference - others were involved in the conspiracy - and, that implies the prosecution is not yet complete.

I am not the one who made the original assumption of a conspiracy - the FBI and US Attorney did. I am not the one who assumed that the Madoff fund was a "fund of funds". That's how its described in the court record, a characterization that even finds its way into paragraph 24 of the reputable reporting.

So, when I say, it is really not a Ponzi scheme and the first place to look for the remaining loot is the major feeders and the banks, that is hardly a leap. It is, at least to me, the most obvious.

What I find to be absurd is the assumption that someone is willing to go to jail for life leaving his wife destitute for no good reason. Why wouldn't Bernie give the feds the details of where those funds went?

Madoff doesn't claim they never existed or they were all spent. The government found in its Forfeiture Demand that $177 billion went through Madoff's fund over the course of thirteen years. According to SEC filings and multiple sources in sworn statements to federal investigators, Madoff's fund declined perhaps $10 billion during 2008 before it went belly up last December. That leaves a lot of money made in previous years that simply disappeared.

The money is real. Someone has it. Anyone who states otherwise is making an extraordinary assertion that requires extraordinary proof.

Why is this so hard for some to grasp? Goes to show the power of a media-created meme of a one-man "Ponzi scheme" that's really an international money laundering ring. More on this in a following installment.

NOTES:

{1} Tremont Group Holdings, Inc. (Rye, New York) in Hoover's Inc.
http://www.hoovers.com/tremont/--ID__101157--/free-co-factsheet.xhtml

{2} Tremont Group Funds Invested $3.3 Billion With Madoff by Katherine Burton, Bloomberg (December 15 2008)
http://www.bloomberg.com/apps/news?pid=20601087&sid=aCT_aoIRYqRg&refer=home

{3} Pomerantz Law Firm Sues KPMG and Tremont Group in Madoff Related Derivative Action On Behalf of Rye Select Broad Market XL Fund (Globe Newswire, New York (February 04 2009)
http://newsblaze.com/story/2009020415373300001.pz/topstory.html

{4} Larger CIA and DoD Privatization Scandal Emerging from Walter Reed Story, US Attorneys Firing [Rumsfeld, Top GOP Figures Profited from Privatization of VA Hospital, CIA Contractors] by Leveymg, Daily Kos (March 10 2007) http://www.dailykos.com/story/2007/3/10/21556/5045

{5} Olmert financier prefers to avoid the limelight by Uri Blau, S Shamir and G Leshem, Ha'aretz (October 6 2008) http://www.haaretz.com/hasen/spages/981755.html

{6} UBP Scrambles to Explain Madoff Ties by Cassell Bryan-Low et al, Wall Street Journal (December 30 2008) http://online.wsj.com/article/SB123058674048040525.html


http://www.dailykos.com/storyonly/2009/3/18/709990/-MYTHS-ABOUT-MADOFFS-PONZI-SCHEMEBernies-Game-Wasnt-What-They-Told-You


Bill Totten http://www.ashisuto.co.jp/english/index.html