Bernie Madoff is a Bad, Bad Man
Other than Bernie Madoff, who else is responsible for this mess? An experienced banker, investment manager, and expert witness examines some of the issues in this significant investment fraud case.
The Bernie Madoff situation raises a great many questions as to who is responsible for what in this disastrous mess. Let’s look at this from an analytical standpoint.
Limited Damage Control
The Securities Investor Protection Corporation (“SIPC”) is an insurance fund much like the more familiar FDIC, and provides coverage for securities losses, right? Not quite. Here’s why:
Madoff had basically two chief business entities: (1) The NASDAQ market-making arm that is covered by SIPC insurance and (2) His investment management and advisory arm that was not covered by SIPC insurance. The missing client funds were in the investment management arm.
Unfortunately, there is also a wrinkle to the SIPC coverage since SIPC covers brokerage accounts up to $500,000 per customer. In order to do business with Madoff, he generally required that you have an account of at least $1 million. Since most people do not have $1 million to invest in one account, a great deal of the money invested with Madoff was pooled money, such as through pools created by hedge funds. For this example, let’s assume that a hedge fund or investment management firm is the “customer.” The way these investment funds work is that the fund will typically have with a firm like Madoff’s one brokerage account made up of commingled funds from multiple participants, maybe a hundred or more, invested in that one brokerage account. Of course, the actual number of participants can be anywhere from one to – pick a number. This means that SIPC’s $500,000 insurance coverage for an investment fund’s account presumably would have to be prorated by the investment fund among its participants in the account.
As a very simple hypothetical example, suppose an investor invested $100,000 with an investment fund, and the investment fund combined that $100,000 with similar investments from 99 other investors and placed all of the $10,000,000 into a brokerage account with Madoff’s company. Theoretically, in this simple example, each investor would represent a 1% interest in the fund. This means that the SIPC would pay $500,000 insurance coverage for the entire brokerage account, and presumably each investor would receive approximately 1% of the $500,000 which is equivalent to $5,000 for their $100,000 investment, resulting in a loss of $95,000. (Keep in mind that Madoff claims that he never made any legitimate investments with his clients’ funds, and there have been other rumblings that he at least invested some of the funds some of the time in government investments, but who knows if what he says is true. At this point, Bernie Madoff can’t look a cyclops in the eye.)
Therefore, it appears that only a small fraction of the Madoff-related losses will be covered by SIPC insurance.
Who’s to Blame (Other than Bernie Madoff)
What about prevention? Who was asleep at the switch in this situation?
The answer is: Lots of people.
You can point a finger at almost anyone in this case, to wit:
● Bernie Madoff. Enough said. (By the way, the name is pronounced "Made-off" as in "Made off with everyone's money.")
● Bernie Madoff’s coworkers and associates – In my professional opinion, it is inconceivable that one man could do what was done in this situation without the assistance of others who had to know what was going on. How do you work in an investment operation where there are no (or few) investments and no (or few) trades taking place? Where are the trade tickets? Who is posting these trades to the accounts? Who is moving the funds that have to be moved in order to pay for these trades? Who is recording the inflow of funds that come from the always profitable sale of these investments? Who built the phony financial and IT system that accomplished all of this? People have to ask those questions.
● The Securities and Exchange Commission – Don’t these guys oversee the integrity of investments like Madoff was supposedly placing these funds into? Isn’t there some mechanism for following funds placed into a fund like Madoff’s and insuring that they actually go into investments? Madoff’s operation was not exactly sub rosa. Recall that he was at one time the chairman of NASDAQ.
● The Money Managers – Aren’t people who accept your investment funds responsible for investing those funds only in safe places where you are actually paid a return and can get your money back? Isn’t that why they charge you a fee? Instead, these guys were standing in line begging Bernie to take their clients’ funds! Aren’t these money managers responsible for performing basic due diligence?
● Madoff’s Bank – As a banking professional, former banking regulator, and banking expert witness consultant, I have been asked several times, by media people as well as by other professionals, where was JPMorgan Chase Bank while Bernie was socking away all this money in his account at their bank? We probably never will know the real figures of how much he had in his account. However, let’s assume that the bank account contained somewhere in the range of at least the alleged lost amount of $65 billion up to the $170 billion Madoff has been ordered to repay in restitution, in my opinion, that’s a bank account that would grab the attention of any banker. In fact, that account alone would make Bernie by himself somewhere between the 16th to the 30th largest bank holding company in the country. To place this into perspective for you, the Bernie Madoff National Bank would be about the same size as the likes of Comerica, Keycorp, Fifth Third, TD Banknorth, Regions Financial, BB&T, Capital One, or SunTrust. The point is - and as a former banker myself and as a consultant to over 60 banks, it is my opinion that an account of this size is so rare and significant that high-level bank officers should be all over it and should know what is going on with the business that owns the account. And to me as a banking and business professional, it strikes me as very odd that Madoff chose to concentrate all (as far as I have heard) of his funds at one bank. Did Madoff have a reason for concentrating his incredible pile of funds in one bank? So far, scant details have been revealed about the relationship between Bernie Madoff and JPMorgan Chase Bank, and I look forward to hearing a more detailed explanation before I reach any conclusions on this subject.
● The Accountants – Three accountants for a multi-billion dollar investment fund? To place this into perspective for you, and to relate it to banking with which I am more familiar, when an outside audit team comes into a bank of the size of Madoff’s investment operation, you would expect to see a team of at least two or three dozen accountants, and very likely even more. An audit of an investment operation like Madoff’s should be somewhat similar in scope and complexity to the audit of a similarly sized bank. Is there any more of a red flag than an audit carried out by three accountants, and carried out by the same three accountants year after year after year?
● The New York Attorney General – How is it that whoever has held the job of Attorney General of the State of New York in recent times has always been involved up to their eyebrows in overseeing businesses, yet they missed this one? I do not know what their role is in overseeing businesses in New York, but it simply strikes me as odd that the New York Attorney General is always making headlines on issues overseeing businesses, but was asleep at the switch while Bernie was socking it away, and in plain sight.
● The Investors Themselves – How many times do we have to hear that old cliché: “If it’s too good to be true, it probably isn’t true.” Nevertheless, it is important to keep in mind that the investors relied upon a whole host of layers of highly paid professionals and governmental regulators upon whom we typically rely as a normal part of the establishment put in place to provide protection to consumers, as listed above, that failed them.
It will be interesting to see how the numerous lawsuits that result from this unfortunate case develop as they work their way through our legal system. As a result, I predict that our financial system will emerge from this fiasco with a clearer indication of where various responsibilities lie in these complex investment situations.
Not enough is known at this time to answer the questions posed in this article, and I certainly plan to learn more about this situation before I make any pronouncements on where blame lies in this tragedy.
ABOUT THE AUTHOR: Don Coker
Don Coker has 40 years' experience as a banker, bank regulator, investment manager, consultant, and expert witness. Called on as an expert witness consultant for over 400 cases nationwide for plaintiffs and defendants. Over 100 testimonies. In DRI and AAJ databases of recommended experts. Widely published. Highly credible.
Clients have included the IRS (7 times), FDIC, 8 of the country's top 10 banks, 12 of the world's 45 largest banks, over 60 banks worldwide, and 33 of the country's top 250 law firms.
Mr. Coker serves clients worldwide from his office in the metro Atlanta, Georgia area.
Copyright Don Coker
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.For specific technical or legal advice on the information provided and related topics, please contact the author.