THE BLOG

Madoff Victims to Hedge Funds: Show Us the Money!

05/18/2010 10:11 pm ET | Updated May 25, 2011

In a recent blog, I gave this definition of hedge funds:

"A way for fund managers to make unbelievable profits by convincing wealthy investors, pensions and trusts they have discovered a way to achieve high returns without commensurate risk. Qualifies as one of the greatest wealth transfer vehicles in modern times."

I was being too kind.

Pre-Madoff, hedge funds were all the rage. These were the captains of Wall Street. They had figured out a way to make money in any market. Trillions of dollars flowed into their coffers. The hedge fund managers became the rock stars of the financial world.

What a difference a big fraud makes. Now many of these funds claim they were also victims of Madoff. They want you to believe they were clueless about his machinations. That's the justification for keeping their obscene fees for advising their clients to invest with him. The investors are wiped out. The hedge funds and banks are swimming in cash. Any wonder why investors have lost confidence in the financial system?

Take Ivy Asset Management for example. This is no rinky dink operation. It is wholly owned by the Bank of New York Mellon.

According to a Complaint filed by New York Attorney General Andrew M. Cuomo, (the allegations of the complaint have yet to be proven), filed in the New York State Supreme Court, Ivy scored $40 million in fees (!) by placing over $227 million of its clients' funds with Madoff.

How difficult would it have been for the Wharton and Harvard trained M.B.A's at Ivy and other hedge funds and banks to figure out Madoff was a fraud? They were handsomely paid to perform due diligence.

Cuomo alleges Ivy knew, or should have known, there weren't enough options traded to support Madoff's much touted "split strike conversion" strategy. A press release issued by the Attorney General references a memorandum, written in 2002, by Ivy's Chief Investment Officer, Howard Wohl. Mr. Wohl wrote this to a subordinate who could not figure out Madoff's sterling performance record: "Ah, Madoff, You omitted one possibility - he's a fraud!"

It's ironic that Ivy and the other hedge funds and banks who promoted Madoff can defend these lawsuits with the interest on their fees. They have lawyered up with the finest legal minds in the country, with one goal in mind: Hanging on to their ill-gotten fees and not making restitution to the clients who were harmed by their negligence.

Predictably, the lawyers (with help from Congress and the courts) are doing a fine job.

One court dismissed claims against Union Bancaire Privee Asset Management and its Swiss parent Union Bancaire Privee. These firms created 11 "fund of funds" that lost over $700 million by investing with Madoff.

This distinguished Swiss Bank has over $60 billion under management. According to a report on its web site "it is one of the biggest wealth-management banks in private hands." Its real expertise is doing due diligence on hedge funds. Here's what it states:

"Research and hedge-fund selection are all driven by a due diligence process which is divided into three main strata of risk analysis: qualitative, quantitative and structural risk. This process has been developed with one of the best experts in the auditing world and allows us to make an extremely strict selection of asset managers. The process of due diligence enables us to establish a list of recommended funds that we consider to be the elite of the industry. This list is updated every month and forms the basis of our portfolio recommendations."

Wow. That's so impressive!

You have to wonder how all these experts couldn't figure out that Bernie was running a primitive Ponzi scheme.

Did the distinguished Board of Directors of Union Bancaire decide to do the right thing and make investors whole? After all, their sterling "due diligence" utterly failed.

No way. They hired world class lawyers and got the investors' claims tossed out. In a decision by U.S. District Court Judge Thomas P. Greisa in the United States District Court for the Southern District of New York (Barron v. Igolnikov, 09-Civ. 4471), the Court found the lawsuit was preempted by the Securities Litigation Uniform Standards Act ("SLUSA"), a statute that places severe limitations on certain class actions. Judge Greisa found SLUSA applicable even though it applies only to purchases of "covered securities", which are defined generally as being securities sold on national exchanges. Hedge funds invest in "covered securities", but are not "covered securities" themselves.

At least one other Court disagrees. In a case in the same Court (Pension Comm. of the Univ. of Montreal Pension Plan v. Banc of Am. Sec., LLC, 05 Civ. 9016), Judge Shira A. Scheindlin held that SLUSA did not apply to investments in hedge funds because "...to hold otherwise would extend the reach of SLUSA to any investment vehicle with covered securities in its portfolio."

But I digress.

Simply stated, and regardless of legal technicalities, all hedge funds and banks who recommended investments in Madoff should be required to make good on the losses. Since private parties are having difficulty achieving this result, the public sector should take action. The Attorneys General in each state should follow Cuomo's lead. State Securities Commissioners should emulate the aggressiveness of Massachusetts Secretary of the Commonwealth, William Galvin, who entered into a Consent Order with another Madoff "feeder fund", Fairfield Greenwich Advisors, and obtained restitution for residents of Massachusetts.

The SEC, FINRA and banking regulators have all been reluctant to force disgorgement of fees and reimbursement of losses for entities under their jurisdiction.

It's time to say "enough." Madoff investors relied on these purported financial gurus. The burden of the losses should fall on those who held themselves out as financial experts with extensive due diligence expertise. Not on individual investors who suffered the losses.

Show Madoff investors the money!


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