Institutional Investor's Alpha Magazine - February 2009 - (Page 34)

Bernard Madoff Securities. It worked for decades, ending only when the markets collapsed, the economy stagnated, credit seized up and Madoff could no longer sustain the illusion, admitting in December to a Federal Bureau of Investigation agent that he had been running a scam that was bankrupt and had vaporized perhaps $50 billion of investors’ money. Quiz investors on what they were thinking — how could anybody go with a manager who was so famously guarded about what he was doing with their money? — and they will no doubt mirror how Madoff must have seen it. People with close knowledge of the ﬁasco say that those who put money with him also have a three-part answer to what motivated them: Fund-of-funds managers with a reputation for being in the know had signed off on Madoff; the proof was in the pudding (returns were steady and redemptions ready!); nobody with any regulatory authority had ever moved to shut Madoff down. It was simply accepted as fact that Madoff was the real deal. What mere mortals would dare to question the conventional wisdom? “The deep, underlying issue here is about trust and conﬁdence, and even some of the most experienced investors had both trust and conﬁdence in Bernie Madoff and the funds and subfunds invested with him,” says Gregory Curtis, chairman of Pittsburgh-based Greycourt & Co., an advisory ﬁrm that helps guide investment choices for 100 clients worth a collective $9 billion, two of whom were partially ensnared in the Madoff web through no fault of Greycourt. Beyond the traits they had in common before the blowup, Madoff investors shared a new one after the fact: an understandable reluctance to discuss what happened (even the ones who got out early enough to make money may have to give it back [see box]). “Why on Earth anyone would have 50 percent of their assets with one fund or manager is something I simply do not understand,” says Russell Kamp, CEO and head of quantitative strategies at Toronto-based Invesco, which manages some $26.5 billion in assets. “Most managers would not have more than 5 percent in any one stock; why would you do anything different with an allocation to a fund or manager?” “A good portion of the investors were individuals who did not do their due diligence, or relied on second- or thirdhand due diligence, which unfortunately is just typical of this kind of phenomenon,” says Roxanne Martino, founder GHOST OF A BLOWUP PAST MAY PAY THE WINNERS A VISIT O f the hundreds, if not thousands, of investors caught in Bernard Madoff’s web, a select few may be breathing easy because they redeemed their holdings before the collapse of Bernard L. Madoff Investment Securities. But the relief may be short-lived. Case law stemming from the 2004 blowup of $450 million hedge fund ﬁrm Bayou Group may force those who profited with Madoff to give the money back. The U.S. Bankruptcy Court for the Southern District of New York found in October that some Bayou investors were paid “ﬁctitious proﬁ ts” when Bayou was insolvent. Madoff has been charged with running a $50 billion Ponzi scheme; Bayou was much smaller, but in essence it too was a Ponzi operation. No one in the Bayou case has been forced yet to return any proﬁts, but there has been a partial settlement. The case is still in the courts, but socalled clawback laws may require investors who came out ahead to return their winnings. “Actual intent to hinder, delay or defraud creditors is a fraudulent transfer that can be rescinded,” explains Michael Missal, a partner at Washington law ﬁ rm K&L Gates and a former lawyer for the enforcement division at the Securities and Exchange Commission. At issue is the concept of fraudulent conveyance. Missal says it means investors can keep the money they have withdrawn only if it was taken out in good faith — without any idea, for instance, that there were problems. Lawyers for investors who lost money in Bayou argue that some of those who got out were tipped off to the imminent collapse. One way for Bayou investors to defeat a fraudulent-transfer claim would be by “affirmatively showing that it was redeemed in good faith and for value,” Missal says, “a tough thing to do in some circumstances.” In 2006, Bayou’s court-appointed receiver brought more than 130 fraudulent-transfer proceedings against investors who had redeemed profit and principal. The move was aimed at recovering some $122 million, and the court subsequently ruled that “ﬁctitious proﬁ ts” had to be returned and that investors who made money could even be required to pay interest. Appeals have been ﬁled, and to date about 90 investors who cashed out of Bayou have settled, agreeing to return proﬁ ts as well as a portion of their principal. Several dozen have also been ordered to return all of their principal. The court did side with a small group of investors who got out before the blowup, ruling that they had done so in good faith. A number of cases have been ordered to trial. If the Bayou ﬁght seems complicated, imagine what may ensue over Madoff, who had far more investors and much greater losses. David Herzog, a partner at Indianapolisbased law ﬁrm Baker & Daniels, which is representing DePauw University’s endowment in its efforts to recoup its investment with Bayou, says there are strong parallels with the Madoff case. But the complexity of the alleged Madoff fraud and its huge cast of characters — investors, advisers, subadvisers, brokerage and clearing operations — as well as its international scope, may keep it from ever being untangled. Another case that may prove pertinent is that of Tom Petters, whose Minnetonka, Minnesota– based Petters Group Worldwide allegedly perpetrated a $2 billion fraud, says Christopher Addy, a principal at Montreal-based due diligence ﬁ rm Castle Hall Alternatives. Prosecutors allege that Petters used the ﬁrm to defraud hedge funds and other investors from 1995 to 2008. “Petters is a very good example for two reasons: One, a lot of people accessed him through Palm Beach [Florida] circles, similar to Madoff, and through an intermediary that they thought was doing appropriate due diligence,” Addy notes. “And two, Petters’s strategy was similar to Madoff’s in the sense that you couldn’t prove any assets were there.” Madoff has probably taken note of what happened to Samuel Israel III, the founder and manager of Bayou. Israel was sentenced last April to 20 years in prison for defrauding investors. He faked his suicide and went on the lam but turned himself in less than a month later and is now serving his time. — M.C.G. 34 • INSTITUTIONAL INVESTOR’S ALPHA • FEBRUARY 2009

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - February 2009

Institutional Investor's Alpha Magazine - February 2009 Contents Letter From the Editor Longs & Shorts Digging Out A Call to Mentor Dicey Detroit The Constant Skeptic Cover Story: The Undaunted What Were They Thinking? Dark Days in Greenwich True Stories from the Commodities Files Return of the Native The Quest for Cover Moving On from Madoff

Institutional Investor's Alpha Magazine - February 2009

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