As we review more documents from Fairfield Greenwich Group, we are developing a better understanding of how the firm explained Madoff's returns to itself and its clients. We still have yet to see evidence that FGG knew Madoff was running a Ponzi scheme.
We still have yet to see evidence that FGG knew Madoff was running a Ponzi scheme. The documents do suggest, however, that FGG:
Closed its eyes, shoved its fingers in its ears, and hummed as Madoff made the firm $500 million of fees in the past five years (and more before that).
Took all the credit for the trading strategy and based its fees on the premise that FGG, not Madoff, was the brains behind the operation. The firm almost always spoke as though it managed its primary Madoff fund, Fairfield Sentry, itself. If Madoff ever came up in FGG's marketing materials, he was described as a "broker."
Knew that the key driver of the fund's stated returns was NOT the "split-strike conversion strategy" but market timing. The firm never explained, however, how this superb market timing was supposedly executed.
As investigators dig through the FGG wreckage, therefore, one of the key questions will be how partners like Walter Noel, Jeff Tucker, and Andres Piedrahita explained Sentry's astonishing market-timing ability to themselves and their clients.
If the best answer is "proprietary models," FGG may well be found to have been negligent in its failure to conduct adequate due diligence. Consistent market timing is extraordinarily difficult, and Madoff's claim that he could do it when others couldn't should have set the same alarm-bells clanging at FGG as it did elsewhere.
We suspect that the more likely answer is "We thought he was front-running." Lots of other folks on Wall Street thought Madoff was front-running, including some major Madoff investors, and, for most folks, this seemed to explain his preternatural timing ability. The trouble for FGG with this explanation is twofold: First, front-running is illegal. Second, the firm doesn't mention front-running it its fund documents. If FGG did rationalize Madoff's performance on the suspicion that he was front-running, the firm will likely be exposed to charges of fraud.
FGG itself is almost certainly toast regardless of what investigators find. The legal distinctions will come into play with respect to victims' ability to go after the personal assets of Noel, Tucker, Piedrahita, et al.
Fairfield Sentry Semi-Annual Review
As you can see from this excerpt of a February 2008 semi-annual review of the Fairfield Sentry fund below (full document embedded beneath), FGG clearly acknowledges the importance of market timing to the fund's success. It does not, however, offer any insight into how this timing is achieved.
To put this in the terms of another competitive endeavor: This is akin to a football coach explaining his team's success by saying that the strategy is to run for short gains up the middle...and then casually mentioning that that half the time it just throws (and completes) 100-yard bombs.
The other obvious absurdity here is the idea that you would ever need to run a "split-strike strategy" if your timing was this good. The split-strike strategy limited gains in bull markets, so if you could always see these bull markets coming, why would you ever implement it? Why wouldn't you just switch between an S&P 500 index fund and Treasuries? To again put this in football terms, why would a coach ever run for short gains up the middle when he knew that, at will, he could just complete 100-yard bombs?
As many of our investors know, Sentry applies a synthetic index replicator and options trading strategy known as the split strike conversion (“SSC”) and alternates between periods of time invested in this combined stock/options position and time invested in a cash stance consisting of short-dated U.S. Treasury Bills. As such, the Fund typically spends more than half of the trading days in each year exposed to movements in the S&P 100 Index, albeit on a hedged basis. For the rest of the year, the Fund assumes a “risk-free” Treasury position and earns short-term money market rates of return as it seeks to protect capital during unfavorable market conditions for the SSC.
The key to switching between these stances boils down to a question of timing – and timing, in its various forms, is the principal source of alpha in this strategy...
As one might expect, consistently delivering positive performance across different market environments requires some adaptation. Bull markets of the sort seen in the late 1990’s (and even as recently as 2006) are ripe with entry and exit opportunities conducive to bull-spread investing. Conversely, bear markets characterized by negative momentum, skittish investor behavior, and poor liquidity pose additional timing and trading challenges. Over the 17 years it has been in existence, Sentry has recognized and adapted to a number of these regime shifts.
For example, in the momentum and liquidity rich equity markets of 2006, Sentry accurately identified four major trend reversals during the year and implemented the SSC strategy around these periods of positive market directionality. Each of these four implementations lasted more than two months (longer than its long-run average holding of about four weeks). In contrast, weaker equity markets in 2007, characterized by relatively fewer periods of sustained positive market directionality (especially during the latter half of the year), meant that trading had to be more nimble and the SSC had to be constructed around shorter-term perceived trading opportunities. In fact, of the seven implementation cycles in 2007, all but one lasted fewer than four weeks.
Here Is Today's Madoff Roundup:
Bespoke Investment Group Seeking Alpha
Stop the Presses: SEC Halts a Ponzi Scheme!
In what could possibly be the biggest 'too little, too late' moment of the century, the SEC announced today that it halted a $23 million Ponzi scheme targeted at Haitian-Americans.
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John Carney Clusterstock
Judge Approves $28 Million For Madoff Firm
Employees of Bernard L. Madoff Securities, the business run by arch-Ponzi scheme Bernie Madoff, just got a small boost today when a judge approved $28 million to pay salaries and expenses while the firm liquidates.
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Henry Blodget Clusterstock Dan Slater WSJ.com Law Blog
Madoff Civil Case Moving Swiftly; The $50 Billion Question
Beginning tomorrow, Manhattan federal judge Louis Stanton will preside over three big issues in the civil case against Bernie Madoff, accused of running a $50 billion Ponzi scheme.
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TheNewsTribune
Madoff investors could get help
NEW YORK – A judge presiding over civil claims filed against disgraced financier Bernard Madoff says he may be willing to consider extending relief from an investors' fund to those who invested in Madoff's business through third parties.
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Eddy Elfenbein Seeking Alpha
Social Security: A Ponzi Scheme?
Jim Cramer says it is. To everybody in the press, who's calling Bernie Madoff's alleged $50 billion scam the 'largest Ponzi scheme ever,' I say give me a break, Cramer said on his Dec. 17 show.
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The Seattle Times elap
Civil case against Madoff to tackle investor issues
Beginning Wednesday, the federal court in Manhattan will be the forum for three important issues affecting investors caught in the widening scandal surrounding Bernard Madoff, accused of operating a $50 billion Ponzi scheme.
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Henry Blodget Clusterstock
Frenchman Who Killed Self Honest About Secret To Madoff's Returns
As we've discussed, many folks on Wall Street assumed Bernie Madoff was cheating--they just thought he was cheating by front-running instead of by operating a Ponzi scheme. Mark Stein Portfolio.com:
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Daily Brief
Madoff Trustee Starts the Clock
Turns out that someone may actually make some money off of Bernard Madoff's Ponzi scheme. Unfortunately for investors trying to recoup their money, it will be the trustee presiding over the liquidation of his investment firm.
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John Carney Clusterstock
Madoff's Employees To Get $28 Million
Investors may be left with nothing but the employees of Bernard Madoff's firm need another $28 million in pay.
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BMI Headlines
Dear NY Times: Speaking of Ponzi Schemes
Social Security is 'identical' to Madoff's 'scheme,' so Americans should stop being duped.
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Cityfile
A Few Highlights from the Madoff Collection
From left to right (click photo to enlarge): 1. Madoff Canvas Tote Bag; 2. Madoff Securities Cap; 3. Bernard Madoff Gray Fleece Blanket, 4. Bernard L. Madoff Backpack; 5. Bernard L. Madoff Emergency Kit; 6. Bernard L. Madoff Golf Umbrella; 7.
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Stephen J. Dubner FREAKONOMICS
I just received the following e-mail from my accountants, who have several clients invested with Bernard Madoff.
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Stefan Blog for Democracy
Is Social Security a Ponzi scheme?
BusinessWeek thinks so. Of course, Ponzi schemes only collapse when the the plan cannot get enough new people in to offset the payments to the old, but social security requires enrollment, so if it is a Ponzi scheme, it's a perfect one. Thoughts?
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CrankyProfessor The Cranky Professor
Whatever happened to 'don't put all your eggs in one basket'?
From an interesting Madoff article at Bloomberg.com: U.S. foundations that invested with Bernard Madoff donated more than $73 million to nonprofit organizations in 2007...
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Steve Young The Huffington Post
2008's Biggest Coincidence: Kevin Costner and Me
For all those who took America to the cleaners this year, you can be pretty sure if anyone of them end up in court, there will be a high paid attorney pleading...coincidence.
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Tom Kuntz Ideas
'Is Social Security a Ponzi Scheme?'
Economics In the wake of the Bernie Madoff scandal, a lot of people are saying Social Security is a Ponzi scheme too.
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Mo Rocca Political Machine
My New Years Resolutions ... for Jennifer Aniston and Bernie Madoff
Here is a piece I did for celebrity? (Why do so many stars only date each other?!)And do you think that Bernard Madoff can be redeemed? If so, what would Madoff have to do to be forgiven?
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Charles H. Green Trust Matters blog
Smoking Guns in the Rear View Mirror: Madoff and the SEC
Experienced bloggers tell me to lead with the headline, as in newspaper stories. So here it is: read this link. It's the document sent to the SEC in 2005 accusing Bernie Madoff of running a gigantic Ponzi scheme.
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Sox First
The legal fallout over Bernard Madoff has taken a new turn with a judge ruling that Madoff must provide a list of all investments, lines of credit, loans, business interests, brokerage accounts, and...
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Bill Zielinski Seeking Alpha
Where Is Madoff's $50 Billion?
Based on Bernard Madoff's own estimation, he lost approximately $50 billion of investor funds. Every since this disclosure, the biggest questions are where did the money go and how much of the $50 billion remains.
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Merv PrairiePundit
Did Madoff stash cash offshore?
NY Post: Investigators believe that Bernard Madoff has stuffed hundreds of millions of dollars in Ponzi profits into offshore tax havens from which they could prove tricky to recover.
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Reilly Mcshane Hollywood Newsroom
Is Social Security a Ponzi Scheme?
In the aftermath of the Madoff implosion, quite a few people have pointed out the parallels between a Ponzi scheme and Social Security.
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Lita Epstein BloggingStocks
Money losers of 2008: The many investors with Bernard Madoff
This post is part of our feature on Money Losers of 2008. See all 20.
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jjn1 Memex
Good picture gallery in Fortune magazine. Don't think much of the yacht, though. Not a patch on Paul Allen's.
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