Madoff: Investment Fund, or Virtual Reality Game?

It's beginning to look like Bernie Madoff's business model had less in common with a hedge fund or investment management firm than it did with an online virtual reality game. Sort of a Sim City for investors. The money sent in was real: everything thereafter was from Oz.

Until now, we've thought of Madoff's business as another financial management operation gone crooked. Think rogue currency traders, badly hedged positions, or just pump and dump.

But the Madoff scandal may be truly unique.

Consider this, from the Boston Globe:

A federal agency that regulates brokerage firms says there is no record of Madoff's investment funds placing trades through his brokerage operation. That leaves only two options - either he was placing trades only through other firms, which would be highly unusual, or he was not placing any trades.

"There was no evidence of the Madoff broker-dealer executing trades for the [Madoff] investment adviser," said Herb Perone, spokesman for the regulatory group, the Financial Industry Regulatory Authority [FINRA]

What are the implications?

• If there were no trades, then there were no investment gains. The "profits" he made were a myth.

• Madoff has claimed he made money only on trading commissions--but if there were no trades, then there were no commissions.

• The statements he issued to investors were truly fictitious. His "statements" were to real accounts as an avatar is to a gamer.

All an investor could know for sure was that you gave Madoff money, and you got back pieces of computer paper with ink on them.

Let's say you sent in $1M through a feeder fund. You got back monthly "statements." Let's say you got a return of 15%. In five years, you "owned" $2M.

But follow the money. Your original $1M went to Madoff's bank account. Each year, Madoff took out a few percent ("transaction fees"), and your feeder fund took 20% of your "profits." (Neither "transaction" nor "profit," of course, are real; the only thing real is that Madoff and the feeders took money out).

In five years, that's about $400K. Instead of $2M, you know "own" $600K. And of course, "own" belongs in quotes too.

Even that was bupkus. Virtual reality money. Sim City money. Monopoly money. In the real world, it didn't exist except in Bernie's bank account and a computer program.

But it did exist, you say; people got their money back!

Close your eyes and envision Christopher Walken, in his best Balls of Fury voice, saying, "What paht of 'Ponzi Scheme' dint you unduhstand?"

I've seen some Madoff statements. They look like day-trader accounts. They show page after page of "transactions," without any subtotals or easy way of matching buy/sell orders.

If you checked, the market prices all looked valid. They were. They just weren't hooked up to a real account. He was in effect running an entire trading system in simulation mode--and telling everyone it was real.

If you looked at the bottom of your "statement," you'd find Madoff's broker-dealer firm's name. Except--it apparently never made those trades.

Many people believe it's impossible that one man could pull all this off. I'm not so sure.

Madoff made his reputation on building complex financial systems, covering the full range of investment management--accounts, trades, taxes, clearinghouses, balances.

All he had to do was switch the input signal from real accounts to simulated accounts. And every programmer knows what happens then: GIGO--Garbage In, Garbage Out.

Call it the Madoff Virtual Reality Trading Simulation Game.

And pay no attention to that man behind the curtain.

Comments

[Cynthia Diaz]

Now, it seems the list of investors scammed by Madoff is growing in Spain. I just read an article on NewsInferno (http://www.newsinferno.com/archives/4618#more-4618) about the lawsuit and investigation that involves at least €120 million.

[not going2take it]

I keep stating - its just part of an elaborate shell game
poised to distract us from the real underpinnings
of the imminent financial collapse ahead.

The banks and failing financial system
leading to our governments' financial collapse.
Folks we are in big(ger) trouble!!!

The power people have already looted the vaults
and are running from the mess they have
created for financial gains.

[KCFreedom]

You gotta wonder if Madoff was simply a front fund raiser for a particular entity or cause. He may know some politically damaging information, so that would explain how he can sit at home with a monitoring bracelet, when the proper thing to do for public consumption was to take him away to jail in cuffs on television. Put it on the "Cops" show.

[Novista]

Maybe the real scam is that he was doing something illicit: bag man for a drugs cartel? funding an arms dealer? I can think of other things that are really into TinFoil Heart territory.

Anyway, all it takes is one really big deal to go sour, eh?

[Mavin1620]

I really like you post and your point of view. It provides a context that many people will overlook. With current game software, this could be done with practically flawless reports as game software plugs in real stock prices. What sophisticated Ponzi schemes we could have then.

[cgreen23]

Very thoughtful, value-adding commentary Mavin1620, thanks.

[jerichoj8]

And Zero Schapiro and FINRA couldn't pick up on this? Good luck at the SEC!

[Mavin1620]

I agree with the argument and conclusions that Charles H. Green makes in this post. As the facts are revealed, Green's observation about this being a "virtual reality game" will be even more solid.

He may need to revise his post where he states: If you checked, the market prices all looked valid. They were. They just weren't hooked up to a real account." This statement is likely to be factually flawed. He cites the Boston Globe article, however the Reuters article Madoff's fund may not have made a single trade (Fri Jan 16, 2009 6:55am EST), quoted below:

"There also appear to be discrepancies between monthly statements sent to investors and the actual prices at which the stocks traded on Wall Street.

For example, his November statement showed he bought software maker Apple Inc's securities at $100.78 each on November 12, about a month before his arrest.

But Apple's stock on that day never traded above $93.24. The statement also showed he bought chip maker Intel Corp at $14.51 on November 12, but Intel's highest price on that day was $13.97.

"You could print up any statements you want on the computer and send it out to a client and the chances are the client wouldn't know, because they are getting a statement," said Neil Hackman, president and chief executive of Oak Financial Group, a Stamford, Connecticut-based investment advisory firm."

[philopatris]

Well said, but as the price of any stock on any given day is easily available, that means that none of his investors ever sat down and checked the prices on the statement against googling for actual prices on the day claimed. Or did and thought it was just a blip that they didn't match. Or that Bernie got special prices...yet the special prices given as an example are not bargains.
He lived off people that didn't and wouldn't check the truth of their statements? Amazing.