How did it happen? How were some very intelligent people, including the local philanthropic community, duped by Bernard Madoff?
A quick and easy answer is that the client/victims seemed to have placed perception ahead of due diligence. A deeper examination reveals a higher lever of complexity.
Bernard L. Madoff Investment Securities, LLC is registered with the Securities and Exchange Commission. This implies investor protections in the form of regulation and oversight. If an adviser retains custody of client assets, he must have independent audits performed in addition to the unannounced audits conducted by the commission. If the firm does not retain custody (we are in this group), the client has the statements of the third-party custodian to match against the adviser statement. This check-and-balance system is virtually fraud-proof.
However, a review of documents available to the public show that between 52 percent and 75''percent of Madoff's clients were other pooled investment vehicles (e.g. hedge funds). Hedge fund clients need only qualify as sophisticated investors, a status granted to them on the basis of net worth. There will be assertations that the SEC should have uncovered the fraud, but the client/victims may have been relying on the Madoff name without consideration of what type of investment entity held their funds. If Madoff's hedge fund occupies the floor below his advisory firm, should we assume that SEC personnel ever made the trip downstairs? We know from the West Palm Beach KL Group fraud, though on a smaller scale, that hedge fund regulation is weak to nonexistent.
Despite the wide difference in scope, look at the commonality of the two cases:
1. The principals led a first-class lifestyle, had a history of success and were perceived as experts.
2. The annual returns were above normal, almost "too good to be true."
3. Their offices were expensive and well-appointed.
4. Their strategies were secretive and too complicated to explain.
5. They were selective as to client acceptance.
6. Their clients relied solely on company prepared reports.
Dorothy eventually did return from Oz, but not before finding out that the wizard was just a befuddled old man behind a curtain. For those of us who manage client funds in an honorable manner and welcome the due diligence of prospective clients, we are saddened to know that the Madoff investors never had the opportunity to pull the curtain aside.
THOMAS M. NOLAN
West Palm Beach
Editor's note: Thomas M. Nolan is the chairman of Atlantic Capital Management in West Palm Beach.
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