Sunday, December 14, 2008
Since courts and commentators frequently like to bemoan the naivete and greed of retail investors, I get a deep sense of satisfaction when the "smart money" turns out to be equally stupid. We have seen many examples of this in the past few months with the fall of the mighty banks that, as it turned out, failed to grasp the riskiness of the exotic investments in their portfolios. A few weeks ago, the New York Times ran an excellent article detailing Citigroup's failure to heed red flags as it engaged in ever-riskier bets, NYTimes, Citigroup Saw No Red Flags Even as It Made Bolder Bets (Nov. 23, 2008). Now this week two massive frauds perpetrated on wealthy investors have been exposed, both catching the regulators apparently by surprise.
Bernard Madoff is frequently described in the press as a "Wall St. fixture." Madoff founded the firm bearing his name in 1960 and has been a prominent member of the securities industry throughout his career. Madoff served as vice chairman of the NASD, a member of its board of governors, and chairman of its New York region. He was also a member of NASDAQ Stock Market's board of governors and its executive committee and served as chairman of its trading committee. This week he allegedly informed two senior employees that his investment advisory business was a fraud. Madoff told these employees that he was "finished," that he had "absolutely nothing," that "it's all just one big lie," and that it was "basically, a giant Ponzi scheme." The senior employees understood him to be saying that he had for years been paying returns to certain investors out of the principal received from other, different investors. Madoff admitted in this conversation that the firm was insolvent and had been for years, and that he estimated the losses from this fraud were at least $50 billion. According to regulatory filings, the Madoff firm had more than $17 billion in assets under management as of the beginning of 2008. It appears that virtually all assets of the advisory business are missing.
The press reports that many investors were suspicious of Madoff's activities -- the fact that he consistently achieved 10% returns, the secrecy surrounding his investment policies, the fact that his statements were audited by a small, obscure accounting firm -- and the SEC had previously investigated him and apparently found nothing to warrant bringing charges. NYTimes, Look at Wall St. Wizard Finds Magic Had Skeptics (Dec. 13, 2008).
The alleged scam perpetrated by high-profile attorney Marc S. Dreier sounds equally crude and audacious. According to today's New York Times, Dreier talked his way into a conference room at Solow Realty and proceeded to use the setting to sell phony promissory notes "issued" by Solow Realty. He was arrested in Toronto when he apparently tried the same scam but could not get past the receptionist at the offices of the Ontario Teachers' Pension Plan. He may have bilked investors out of as much as $380 million with his various scams. And what did Dreier do with the money? Apparently it not only supported his lavish life style, but that of the 200-some lawyers at his law firm. According to Dreier's lawyer, he attracted the "best and the brightest" legal talent by paying them top dollar. Well, maybe not so bright -- not only are those lawyers now looking for jobs but the Times also reports that Dreier allowed malpractice coverage to lapse. NYTimes, Lawyer Seen as Bold Enough to Cheat the Best Investors (Dec. 14, 2008).
Let's stay tuned for further developments.