Massachusetts Charges Feeder Fund in Madoff Fraud

Massachusetts regulators on Apr. 1 charged a fund that funneled $7 billion to Bernard Madoff with fraud, saying that Madoff, who has pleaded guilty to running a massive Ponzi scheme, coached top officers at the feeder firm on how to head off scrutiny from the Securities & Exchange Commission in 2005.

William Galvin, Secretary of the Massachusetts Commonwealth, brought the administrative action—which is not a criminal charge—against Fairfield Greenwich Group, a New York hedge fund that had about half of its $14 billion in assets invested with Madoff. The 110-page complaint seeks restitution for losses suffered by Massachusetts investors as well as recovery of performance fees.

Galvin's action against Fairfield Greenwich comes two days after a Connecticut state judge ordered the firm's assets frozen in a lawsuit brought by the Town of Fairfield's pension fund. In its claim, the town—which had $42 million in pension money invested in Madoff-related funds—named Madoff himself, family members, and other funds as well as Fairfield Greenwich. The firm was Madoff's largest feeder fund and faces other lawsuits from investors.

Fairfield Greenwich contested the Massachusetts complaint. The firm contends it "conducted vigorous and robust monitoring" of its Madoff investments and says Galvin's office "lept to erroneous conclusions without completing its investigation and without even granting a meeting with FGG in an attempt to arrive at an accurate understanding of the facts," according to an e-mailed statement. (Without commenting specifically on the statement, a spokesman for Galvin's office said investigators met with and took testimony from Fairfield employees during the investigation.)

complaint: diligence was overdue

Madoff pleaded guilty in March to running a Ponzi scheme that stretched back at least to the early 1990s and cost investors up to $65 billion. He is due to be sentenced on June 16. His accountant, David Friehling, was arrested in March on charges of accounting fraud. But no other criminal charges have been brought in the case, although there remains a tangle of civil suits against Madoff and funds that sent him money.

About half of Fairfield Greenwich's assets under management were with Madoff, including 95% of its Sentry Fund. The Massachusetts complaint alleges that the firm failed to perform the due diligence it claimed to have been doing for investors. For funneling clients' money to Madoff, Fairfield Greenwich took fees of 1% of assets under management plus 20% of investment returns, earning the fund at least $100 million a year in each of the past three years, according to the complaint. It further said that founding partners Jeffrey Tucker and Walter Noel took home more than $30 million in 2007 and that partner Andres Piedrahita, Noel's son-in-law, made $45 million.

"Fairfield and its key personnel claim to have had no idea whatsoever that Madoff was anything other than the legitimate broker and brilliant market-timer they promoted him as," the complaint says. "They were blinded by the fees they were earning, did not engage in meaningful due diligence, and turned a blind eye to any fact that would have burst their lucrative bubble."

a telltale recording of a timely call

Galvin's action says Fairfield Greenwich helped derail an SEC probe into Madoff's business in 2005. Top Fairfield officers, including Chief Operating Officer and General Counsel Mark McKeefrey and Chief Risk Officer Amit Vijayvergiya conversed by telephone with Madoff in December 2005, before Fairfield spoke to investigators from the SEC and the Financial Industry Regulatory Authority (FINRA), an independent industry regulator. (A transcript of the call, which Galvin's office said was recorded as a matter of course by Fairfield, is available here.)

"From this conversation, Fairfield clearly knew that Madoff knew what to tell SEC and FINRA examiners to avoid deeper scrutiny of his operations. By giving the SEC the answers that Madoff told them to give, Fairfield likely helped him evade SEC detection," the complaint says.

Fairfield Greenwich says that the complaint "includes sensational allegations" that employees based their answers to the SEC on a conversation with Madoff. "This is simply false. The employee referenced in the complaint provided entirely accurate information to the SEC. And the complaint conveniently leaves out the fact that the employee specifically reported his telephone conversation with Madoff to the SEC at that time," the firm said in its statement. The statement also noted that other investors and regulators did not detect Madoff's fraud.

Galvin's action will be decided by the securities division within the Secretary of the Commonwealth's office. If he prevails, the adjudicator would then determine how much Massachusetts investors could be awarded from Fairfield, says Brian McNiff, a spokesman for Galvin.

Before it's here, it's on the Bloomberg Terminal.