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The reason it worked I reckon is because the consistent returns that were reported kept attracting more investors. And, most investors had a lot more money than they'd ever need to live off, so they probably kept it with him, only withdrawing comparatively small amounts needed to support a lifestyle. If the returns stayed good, more money would come. The crash meant that out-of-the-ordinary amounts were being requested and which obviously didn't exist.
Another takeway: to separate asset management with brokerage. Dividing businesses out of compositional units has already occurred in terms of accounting and business consulting firms (eg Arthur Andersen, Deloitte). Now perhaps it should happen with brokerage and asset management?
Financial market participants and financially literate people understand this not to be true; markets cannot function if all participants are dishonest. This would be why drug cartels always collapse under their own weight.
But, as with most things, appearances matter, and Madoff, Dreier, and, no doubt, more such scandals, feed the fires.
The case needs to be made that effective regulation is not simply more regulation but rather the right kind of regulation. Optimists see in Obama's economic team and Rahm Emannuel a group of people who can beat back the lunatic left wing of the Congressional Democrats. I hope that these optimists are correct.
I have also advocated on this blog a social network of market participants, where ratings, comments and feedback can be applied, whereby the aforementioned feeds can be embedded. Also, a rather experimental idea of allowing business and individuals to swap confidential data in a bid to build trust that would otherwise be hard to find. A centralized system like this one would best receive endorsement from the government as a goto-point - and they could tender it as such.
What do you think Roger?
This is such a marketing 101 perception problem -- the public is being inundated with all of this and all they can think is that some "hedge fund" manager ran off with 50 bln USD.
The talk I've been hearing of this makes me worry that real hedge funds are going to get thrown under further spotlight to be made an example of for more regulation. Hopefully enough smart people bring up the fact that Madoff was SEC REGISTERED.
FGG's Due Diligence Process
FGG's due diligence process is deeper and broader than a typical Fund of Funds, resembling that of an asset management company acquiring another asset manager, rather than a passive investor entering a disposable investment.
A number of areas of inquiry are examined by a team of FGG professionals who specialize in evaluating respective areas of risk. Typically, a manager has been investigated and monitored for six to 12 months before that firm can be accepted onto the FGG platform. Long negotiating periods enable FGG to be more confident of its decisions before proceeding with a manager. Areas of examination are centered around the following:
1. Portfolio Evaluation, Investment Performance, and Financial Risks:
A core area for further analysis is to attempt to dissect and further understand investment performance, how a manager generates alpha, and what risks are taken in doing so. As portfolio management and risk management incorporate elements of both art and science, FGG applies both qualitative and quantitative measures. FGG:
Examines independent prime broker trading records
Conducts detailed interviews to better understand the manager's methodology for forming a market view, and for selecting and exiting core positions
Analyses trading records
Conducts a number of qualitative and quantitative tests to determine adherence to risk limits over time
Confirms portfolio loss risk controls, diversification and other risk-related control policies, as well as any experience regarding unexpected or extreme market events
Reviews the risk and return factors inherent in the strategy
Evaluates capacity issues, which may affect alpha, as well as expected opportunities going forward within each candidate's strategy
Analyses the various drivers underlying a particular portfolio's risk
Evaluates credit risk and market risk both at the instrument and portfolio level
Assesses the extent to which leverage is used by a manager, as well as how it is used, the funding sources, and the impact on the risk profile of the fund
Investigate whether or not private or special registration securities are held, and determine how the daily trading volume and inventory held compares to the float and/or daily trading volume for a given security
FGG also conducts many quantitative reviews of investment performance in light of:
Fees and fee structure
Historical draw-downs
Return volatility
Commissions earned
Performance return in calm versus volatile markets
Current/historical correlation of the fund under consideration with standard industry benchmarks, peer groups, and other FGG or competitor funds used as benchmarks
FGG attempts to understand the return attribution for individual securities in the portfolio, and conducts a full suite of VaR analyses and stress tests to model the loss distribution function under extreme market scenarios. Leverage, concentration limits, and long/short exposures are examined over time to assess whether they have remained within operating guidelines.
Style fidelity is another key area of inquiry; the manager's trading pattern over time and through various market environments, FGG determines whether the manager is prone to trade outside of their area of expertise.
2. Personal Background Investigation:
FGG examines the abilities and personalities of the individuals involved in managing the fund through extensive interviews, as well as background investigations.
FGG verifies:
Education
Personal credit standing
Litigation and regulatory background
Track record
Other indicators
FGG explores the manager's experience and qualifications relative to the strategy being managed. Prior professional associations of a manager's key personnel can be crucial in understanding a person's experience and character and how they run their investment management business.
3. Structural and Operational Risk:
"Operational risk" refers to the risk of loss resulting from inadequate or failed internal processes, human resources, or systems, or from external events. Operational failures, including misrepresentation of valuations and outright fraud, constitute the vast majority of instances where massive investor losses occur. Other operational risks include staff processing errors, technology failure, and poor data.
Pricing models, as well as the adequacy, independence, and transparency of valuation procedures, contingency plans, and other trading and settlement procedures are all matters for close scrutiny by FGG professionals.
FGG seeks a sound understanding of whether a hedge fund possesses key controls in the areas of portfolio management, conflicts of interest, segregation of duties, and compliance. FGG carefully assesses the controls and procedures that managers have in place and seek to determine actual compliance with those procedures, often suggesting modifications, separations of responsibilities, and remedial staff additions.
4. Legal, Compliance, and Regulatory Risk:
FGG's legal, compliance, and accounting teams specialize in investment management regulation, securities compliance, corporate operations, and tax issues. Hedge fund managers function within an ever more complex legal and regulatory landscape, and the role of this part of the diligence exam is to determine the seriousness of any deficiencies in this area which may cause risk of sanction, loss, or reputational embarrassment.
Both in-house and retained legal professionals interview the management and staff of the manager, research regulatory filings, and review corporate organizational documents, as well as fund memoranda and related material contracts.
Greed is neither necessary nor sufficient, in my view.
What is necessary is that the mark never thinks: "what is in it for the other guy?".
If BM was touting an 10-12% return with no volatility, he didn't need private money. BM could have established a new savings and loan system: lend at 2% and earn 10-12%, borrowing from public banks and "earning" from his "trades".
A private lender to BM made no sense, if the private lender thought "what it is in it for BM?". The only sensible conclusion was that there was something screwy with the economics of the deal.
{Kid Yellow used to say that he was happy to take money from marks that thought they had tumbled to a fixed race: the mark was happy to think he was screwing the horse operators, public, and track. The Kid was happy to offer the other side of that bet.)
he is dead 15 years...
do you know who is behind that its important to me thax je