No One Would Listen: A True Financial Thriller by Harry Markopolos (i wanna iguana read aloud .txt) 📕

One thing that galls me about the hedge fund of fund business is how many of these charlatans claimed to be using large, prestigious banks as their custodians to keep control of the securities in investors’ accounts. Yet, somehow, Madoff and these HFOFs were able to subvert even this commonsense safeguard. Investors may have wired their money to prestigious Custody Bank A but unbeknownst to them, this bank then wired the money straight to Bernie Madoff who, acting as sub-custodian, “self-custodied” the assets himself and then stole every dime. Obviously these large custody banks “rented” their “good names” to these HFOF charlatans but unfortunately investors didn’t realize they were being hoodwinked.

Third party plan administrators who are charged with record keeping and performance accounting were also fooled by Bernie Madoff—or were they? HFOFs like to brag about their use of these so-called third party plan administrators as an additional investor safeguard, but do they really offer investors an impervious shield against fraud? Definitely not! If a third party plan administrator does come across fraud, he’ll likely just resign the account and remain silent.

The other thing you should know about these third party plan administrators is that they are supposed to be providing independent valuations of the securities held in your account, but all too often they don’t have a clue how to value complex securities. Instead, the hedge fund manager ends up telling the plan administrator how to value the securities. In other words, these plan administrators aren’t nearly as independent as they would have you believe.

Personally, I wouldn’t want any third party plan administrator hired on my behalf unless they had a policy of mandatory fraud reporting to the authorities as soon as they spotted something amiss. Otherwise, I don’t see how a Big Four accounting firm, custody bank, or third party plan administrator offers me any value whatsoever. My view is that if you hold yourself up as a professional you have to uphold a sense of ethical duty to your clients.

Another glaring shortfall is in the sad state of HFOF due diligence. For the most part, these fund of funds are nothing more than marketing machines that pretend to conduct exhaustive due diligence. If you don’t believe me, ask what their budget for due diligence is this year in both dollar terms and as a percent of revenue. If they can’t give you an immediate answer, then they aren’t even taking the time to measure what is supposed to be their most important function—preserving your capital! My observation is that most fund of funds spend a lot more effort on their marketing than on their due diligence which, of course, doesn’t help their investors very much.

A well run HFOF can provide a diversified portfolio and generate attractive returns for their investors. While too many HFOFs got caught up in the Madoff Ponzi scheme, I applaud those organizations that did their homework and helped their investors avoid this disaster. In the United States, almost 11 percent of the HFOFs had Madoff—so 89 percent avoided him. But in Europe, particularly Switzerland, the HFOFs got hit hard. Switzerland had Madoff exposure in almost 29 percent of its HFOFs. On the plus side, most of those HFOFs are no longer operating. The key for investors is to conduct their own due diligence of their HFOF to determine that the people behind it really do know what they’re doing and actually do what they say they’re doing.

But as usual where Madoff was concerned, the numbers didn’t work. If he returned 1 percent net a month to his investors and in addition effectively paid the funds 4 percent, he had to gross 16 percent annually. He claimed that six to eight times a year, when his magical black box told him that the moon was in the seventh sun or the bones had fallen in a promising way, or whatever way he supposedly was getting the word, he would sell his T-bills and buy 35 stocks from the S&P 100 and protect them with options. Weeks later when the genie awakened again to tell him the market was going to tank, he would get out with large profits. So he wasn’t continually in the market. And when he wasn’t in the market, his money was in T-bills. That was where his math made no sense: How is he earning those returns when he isn’t in the market? He needed to be buying 16 percent T-bills in a world in which Treasury bills haven’t yielded 16 percent since the early 1980s.

Sometimes it seemed like there were more red flags in Madoff’s claims than in the former Soviet Union.

But Neil had opened a potentially very valuable link. Neil had given no reasons for this adviser to suspect his interest in Madoff was anything but responsible due diligence. This adviser still believed Neil was seriously interested in investing millions of dollars in Fairfield Greenwich Group (FGG), so he was willing to do whatever was necessary to nail it down. He even offered to set up a conversation for Neil with Amit Vijayvergiya, FGG’s chief risk officer. Neil couldn’t believe it. He immediately sent me an e-mail, wondering what questions he should ask. Even though I was busy with a dozen active cases, I dropped everything and started writing just a few thoughts. And then a few more. Eventually I had three pages of questions, more than 80 of them, although, as I wrote, “Gee, I could write questions all night. Somehow I think they’re not going to answer many of these questions in great detail in order to protect their proprietary trading methodology.”

The questions covered all of the red flags we’d been waving for so long: If two stocks with a total portfolio weight of 4 percent drop 50 percent due to company-specific risk (say subprime exposure), how are you protected against a 2 percent portfolio loss? What are your total assets under management? I’m hearing numbers in the $30 billion to $50 billion range.

Who are your