Fiduciary Responsibility and Due Diligence

The big story is not how Bernie Madoff with the money; Ponzi schemes are not that uncommon although the scale of this one is awesome. The BIG story in the Madoff affair is the role of fiduciaries.

 

At first B.M. fit model of the standard Ponzi flim-flam man who preys on friends, family and fellow members of his ethnic or religious background. What is unique in this case is the involvement of a number of unrelated “fiduciaries” who were supposed to perform due diligence for their clients. Somehow these sages didn’t notice or weren’t concerned about:

 

·         Madoff companies managing the money; executing the trades, acting as custodian, and clearing trades (anyone remember Nick Leeson?);

·         A no-name, one-man, accounting firm conducting the audits;

[You would have lost me here already. I was in Singapore during the Leeson affair and couldn’t understand how a major bank could permit one person to perform all roles]

·         Amazingly (absurdly) consistent results;

·         Madoff family members in all the key trading and compliance functions;

·         Extreme secrecy;

·         A 2001 Barrons article suggesting fraud; and

·         A simple and easy-to-test options strategy that could not be replicated.

 

Yes, hindsight is 20/20, but re-read the points above…how could a sober, competent and sane compliance team OK Madoff??

 

That to me is the big story of the case: inept, or possibly corrupt fiduciaries performing the due diligence.

 

 Possible explanations?

 

1. Perhaps the teams conducting due diligence were incompetent, stupid and/or under the influence of mind-altering substances.  [Based on what I saw during my career in finance, I would not prematurely rule out this possibility.]

 

2. Perhaps the teams were greedy and unethical. There were rumors that B.M. was front-running trades from his market-making activity; the “fiduciaries” might have thought that this assured good future results. And the fact that B.M. did not ask for management fees meant they could rake in more fees…

 

 

 3. “Pay for play.” This is an Illinois tradition — think Mayors Daley, Governors Blogojevich/Ryan/et.al., recent stories about Congressmen R. Emanuel and triple-J, or most any official elected to statewide office in Illinois..

 

4. Actually those are the only three I can come up with — does anyone else have some ideas what the banks and funds-of-funds might have been thinking? (or smoking?)

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