Eye on Transparency: $17.1BN+...Missing?

As we noted in The Early Look, it was disappointing to wake up to the Bernie Madoff fraud this morning. At a time when this country desperately needs leadership from the financial services industry, the news seems to get worse every day.

Madoff started his firm in 1960 and according to various biographical sources, “the firm was one of the five broker/dealers most closely involved in developing the Nasdaq market.” In addition, he has at various times served as the Vice Chairman of the NASD, a member of its Board of Governors, President of the Security Traders Association of New York, and Board member of the Depository Trust and Clearing Group.

While Bernie Madoff likely wasn’t a household name outside of Manhattan’s moneyed circles, he was clearly a substantial player in the finance industry and a major player in the asset management world. In total his firm is reputed to have managed north of $50BN dollars, with the hedge fund business managing north of $17BN.

It is unclear exactly how much money is missing, yet the SEC press release states:
“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.”

In addition, in the same press release, the SEC referenced a conversation that Madoff had with an employee and in this conversation “he admitted that the firm was insolvent and had been for years, and that he estimated the losses from this fraud were at least $50 billion.”

While it will take months to determine the extent of the losses, the number appears to be between $17BN and $50BN in client assets. If these losses are anywhere near accurate, this is one of the biggest frauds in business history and certainly the largest in money management history.

The implications for this are twofold. First, increased regulatory and transparency rules will have to come into play, a trend that will already be in place under the Obama administration and a Democratic Congress. Second, withdrawals from money managers of all strategies will likely accelerate in the short term. Investors should, and will, have serious doubts in regards to whether their money managers are doing what they say they are doing from both an accounting and strategy perspective.

We are wary that the Madoff fraud is a canary in the coal mine. While we know many, many money managers who have high ethical standards and take their fiduciary responsibilities very seriously, these types of events are rarely isolated. The potential for more Madoffs, and the broader implication of increased asset redemptions, is a tail risk that should be proactively prepared for and managed around.

Daryl Jones
Managing Director
Research Edge LLC