Madoff: What a Week

It’s hard to believe that it was only a week ago that federal prosecutors charged Bernard Madoff with orchestrating what may be the biggest Wall Street fraud ever. The Madoff scandal has rocked the financial world and wiped out tens of billions of dollar invested by wealthy individuals, pension plans, charities, foundations and other hedge funds.

It’s a big mess and the fallout from the Madoff affair will be us for weeks and may be months to come. But a week later, much remains a mystery about what some are already calling the financial crime of the century. Then again, the century isn’t even a decade old.

Here are 5 big unanswered questions and where the facts are pointing:

1) Just how much money was lost in the Madoff scandal?

Madoff, in allegedly confessing to his sons, said investors may have lost $50 billion. But that number’s probably high. In January, Madoff reported having $17 billion in assets in his money management business. So far, the total tally of reported investor losses is a little more than $25 billion. But some of that total includes double counting because many investors who are reporting losses borrowed money from banks, which are reporting their own potential exposure. Plus, some of Madoff’s early investors may have already made back their principal based on year’s of payoffs with money the former Nasdaq chairman took in from subsequent investors. Some of the people may have to give back some of the payments they’ve received.

2) Did Madoff act alone?

Right now, no one else has been charged in this matter. But Madoff’s empire was largely a family business. Authorities are reportedly investigating what Madoff’s relatives, including his wife, knew about the alleged scam. The small audit firm that checked Madoff’s books and records is also drawing scrutiny. Given the magnitude of the fraud, it seems unlikely that one person could have pulled it off alone. But financial crimes—in particular, hedge fund frauds—often involve only a few bad actors. Why? There’s always the fear that the more people who know about a scam, the more loose lips there will be.

3) How could the alleged Madoff scam have gone on for such a long time?

No one knows for sure when the alleged scheme began. Madoff had been managing money for more than two decades. Did it start off as a Ponzi scheme? Probably not. Most likely Madoff lost a lot of money along the way. But instead of telling investors he blew it, he probably tried to cover up his losses and hoped to make it back at a later date. In all likelihood that strategy failed and the only way for Madoff to keep the game going was to continue taking in money from new investors. A Ponzi scheme can go on for a long time, as long new money keeps coming in and just a few investors seek to withdraw their initial investment. What appears to have done Madoff in was the credit crunch. In the fall, many of Madoff’s European investors—obviously worried by the state of the global markets—sought to redeem some $7 billion investments. That was money Madoff didn’t have.

4) Should the funds of hedge funds that invested the majority of the money in Madoff’s firm done more to uncover the alleged scheme?

The funds of funds involved with Madoff all say they were duped just like everybody else. That may be true. But it’s the job of funds of funds managers to investigate a hedge fund thorougly before investing in it, and following up with subsequent inquiries. That’s a big selling point of the funds of funds business and the main justification for the extra level of fees they charge investors. So far, there’s no evidence the funds of funds that invested with Madoff knew of any potential wrongdoing. But one has to wonder if the huge fees they received from marketing and selling Madoff’s firm dulled their curiosity.

5) Should the SEC have uncovered Madoff?

The SEC already has admitted that its prior investigations into Madoff were faulty and regulators could have been done a better job. A number of people on Wall Street, including some of Madoff’s competitors, sent letters to the Securities and Exchange Commission warning regulators that something was amiss at Madoff’s firm. To be fair, detecting fraud is difficult. But the SEC has enormous power to subpoena records and get access to trading records, something ordinary investors can’t do. The SEC has been understaffed for a long time. But the agency has a history of being more aggressive with smaller firms that are less able to put up a fight than it is with bigger Wall Street firms. Either way, the SEC has a lot of explaining to do.

These questions are only start. What are some of the things you want answers to? Let’s hear them.

Updated Dec. 18, 3 p.m. (ET) I’ve noticed that some people are wondering why Madoff was hit with so many redemption notices this fall, if the fund was up. I’ve got a possible answer. Investors aren’t just pulling money out of funds that are down, they are also fleeing funds that are up. Investors are trying to preserve cash and getting the cash from wherever they can. It’s worth noting, that more than 75 hedge funds have frozen redemptions, leaving fewer alternatives for investors to redeem money from. With regards to Madoff, I’m told the redemptions came from his European investors—many of whom were relative newcomers. Madoff’s long-time investors, in particular ones from Jewish foundations and Jewish community groups—didn’t put in redemptions. This may be a testament to the misplaced loyalty that members of the Jewish community had in Madoff, who appears to have targeted people who shared his religious faith.

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