George M. Mangion | Wednesday, 01 July 2009

Lessons to be learnt from the Madoff scandal

They say that ‘when it rains it pours’ and this is very true when mammoth scandals such as the ‘Madoff’ and ‘Ponzi’ schemes surface.
The Madoff scandal, which is thought to have costs investors as much $65bn, has led to a litany of lawsuits around the globe, as investors seek to recoup their losses that in some cases stretch into hundreds of millions of dollars. It is thought that several well-capitalised banks fear investors class action as they start to target those with most assets.
While the world faces an economic crisis and unemployment is at an all-time high, we read about the miseries inflicted by fraudsters who were previously highly regarded by society and the regulators. It is unbelievable how one gets to set himself in high circles and run off with people’s wealth.
Does this ring a bell for us in tiny Malta?
It seems to me that local commentators are so familiarised to the daily fracas reported in the financial markets, that they seem to have disregarded Madoff’s 150 year prison term. They possibly consider it as no big deal.
Yet, banks and investment funds across the world lined up to admit investing billions of dollars in companies that led to Bernard Madoff, the same man US authorities accused of masterminding massive fraud.
None of the flamboyant names in the banking hierarchy were spared. Europe’s biggest bank, HSBC, joined a list of top names in world finance admitting huge potential losses in a suspected pyramid fraud scam. Britain’s HSBC Holdings Plc is alleged to be another bank to join the growing list, saying it had exposure of around $1 billion, making it one of the biggest victims of the alleged fraud. Not surprisingly HSBC Securities Services, the bank’s asset custodian arm, is facing legal action from fund investors, that blame it for the losses suffered following the collapse of the failed investment scheme in the US. As custodian, HSBC was responsible for moving the fund’s capital in and out of the investment companies, upon instructions from its clients.

The losses
Custodians do not usually take direct investment decisions, but earn fees from facilitating transactions. The scandal triggered criticism of Luxembourg investor-protection rules and custodians’ liability for investor losses. France, where investors may have incurred losses of more than €500 million has strongly lobbied the Commission to strengthen European Union mutual-fund rules. Simultaneously, shares in Santander, the second-largest in Europe after HSBC, plunged after the lender said it had an exposure of more than €2.3 billion ( $US3 billion ) to Madoff Investment Securities in New York.
Bernie (Madoff) is alleged to have confessed to defrauding investors of €38.5 billion ($US50 billion ) in a long-running scam that collapsed after clients asked for their money back as a result of the global financial crisis. It is not known how much of the scam affected Maltese investors but one cannot but stop to ponder if top banks and highly placed investment advisors fell for Madoff ‘s charms.
It is not inconceivable to reason that Maltese investors were lured to part with their cash. The competitive coupon rate on offer was always attractive.
It will not be the first and the last financial scam that local investors were unavoidably lured into. Does it bring memories of the Argentina bonds or the fallout from the Bical debacle which is still under liquidation almost forty years after it collapsed?
Another example that comes to mind is the financial scandal associated with the UK magnate Robert Maxwell( Chairman Daily Mirror ) during the late 1960’s who managed to find ways to siphon funds from his employees’ pension funds without being detected by the trustees and the regulators.
Maxwell was a highly regarded figure in the Harold Wilson Labour party administration. He was knighted and rubbed shoulders with the ‘elite’ inside the British House of Lords before eventually committing suicide on his luxury yacht.
So back to Madoff. How did he manage to conceal his evil scheme for so long and in such massive proportions, when the watch dogs such as the SEC were on guard?

How he did it
Was it for his political connections or that he was Jewish, or perhaps because he was Nasdaq’s former president and was highly respected by the banking sector?
Bernie never made any investments. He siphoned money even from his closest friends, and the mystery is all about how his actions went undetected for so long, when he systematically pilfered the money to finance a lavish lifestyle for his family.
US authorities allege that Madoff consistently delivered high returns to clients by secretly using the principal investment from new investors to pay out to other investors in a scheme known as a “pyramid fraud “.
But eventually the penny dropped and Judge Denny Chin of the Manhattan District Court has condemned him to 150 years in prison.
When asked by the judge how he felt, it was reported by the media that Bernard Madoff slowly leaned forward on the defence table and spoke in monotone for about 10 minutes.
At various times, he referred to his fraud as a “problem,” “an error of judgment” and “a
tragic mistake.”
Unashamed he was not asking for forgiveness and not offering any excuses for his behavior. Still the burning question on everybody’s lips is how could a single person manoeuvre the biggest scam in history.
Surely he must have been in cahoots with fellow assistants (not to mention people in high places ). Thus one can imagine that the staff around him who served on those foundations’ boards, are not completely off the hook. In theory they are supposed to be stewards of the public trust, overseeing tax-exempt assets for the benefit of the broader public.
Can we learn a lesson here? Yes, observers have commented about the need for regulators to improve their due diligence when considering potential investments by high ranking public organisations and there can be no doubt that there is room for improvement in that regard.
It is true that we are closing the barn after the horse has bolted, but still no heads have rolled from the regulators and overseer boards that monitor public oversight.
Ironically this “oversight” is funded through the tax payer. However still, did the scam only impact third parties such as banks and anonymous organisations that collect trust funds for investment on behalf of institutions? No, it also involved Madoff’ s intimate friends as well.

Nobody spared
A touching example which stands out is the defrauding of a small Jewish foundation of its funds .This foundation was set up by Elie Wiesel, the Nazi concentration camp survivor who went on to win the Nobel Peace Prize .” Wiesel invested all $15.2 million that his foundation had amassed and his wife took care of 1,000 Ethiopian children in Israel. It is now penniless.

The lesson
With hindsight, it seems that over the centuries investors have not really learnt their lesson. It forms part of the fragility of human nature to gamble with money, especially in high risk securities in the hope of superior returns. Some are wise and cash in while the going is good, but most will be tempted to stick on to their investment waiting for better times in hope that the upturn will be around the corner. Regrettably, for most of the time, it always is too late.
In conclusion, one can never doubt the force of attraction investments with a high coupon rate will have, often leading to be over-subscribed, as we all know it in Malta. Investors should always seek information through independent advisers, and never rush where angels fear to thread.

George Mangion
Partner at PKF – an audit and business advisory firm



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01 July 2009

Malta Today


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