Madoff's 55-foot fishing boat, “Bull”.
The $17.1 billion that Mr Madoff claimed to have under management earlier this year is all but gone. His alleged confession that the fraud could top $50 billion looks increasingly plausible: clients have admitted to exposures amounting to more than half that. On December 16th the head of the Securities Investor Protection Corporation, which is recovering what it can for investors, said the multiple sets of accounts kept by the 70-year-old were in “complete disarray” and could take six months to sort out. It is hard to imagine a more apt end to Wall Street's worst year in decades.
The known list of victims grows longer and more star-studded by the ...view middle of the document...
He generated returns to match: in the vicinity of 10% a year, through thick and thin.
Charming, but far too smooth
That last attraction should also have served as a warning; the results were suspiciously smooth. Mr Madoff barely ever suffered a down month, even in choppy markets (he was up in November, as the S&P index tumbled 7.5%). He allegedly has now confessed that this was achieved by creating a pyramid scheme in which existing clients' returns were topped up, as needed, with money from new investors.
He claimed to be employing an investment strategy known as “split-strike conversion”. This is a fairly common approach that entails buying and selling different sorts of options to reduce volatility. But those who bothered to look closely had doubts. Aksia, an advisory firm, concluded that the S&P 100 options market that Mr Madoff claimed to trade was far too small to handle a portfolio of his size. It advised its clients not to invest. So did MPI, a quantitative-research firm, after an analysis in 2006 failed to find a legitimate strategy that matched his returns—though they were closely correlated with those of Bayou, a fraudulent hedge fund that had collapsed a year earlier.
This was not the only danger signal. Stock holdings were liquidated every quarter, presumably to avoid reporting big positions. For a godfather of electronic trading, Mr Madoff ran the business along antediluvian lines: clients and feeder-fund managers were denied online access to their accounts. Even more worryingly, he cleared his own trades, with no external custodian. They were audited, of course, but by a tiny firm with three employees, one of whom was a secretary and another an 80-year-old based in Florida.
Perhaps the biggest warning sign was the secrecy with which the investment business was conducted. It was a black box, run by a tiny team at a very long arm's length from the group's much bigger broker-dealer. Clients too were kept in the dark. They seemed not to mind as long as the returns remained strong, accepting that to ask Bernie to reveal his strategy would be as crass as demanding to see Coca-Cola's magic formula. Mr Madoff reinforced the message by occasionally ejecting a client who asked awkward questions.
The trading business was hardly pristine either. It had been probed for front-running (trading for its own account before filling client orders) and separately found guilty of technical violations. Some clients reportedly suspected that Mr Madoff was engaged in wrongdoing, but not the sort that would endanger their money. They thought he might be trading illegally for their benefit on information gleaned by his marketmaking arm.
This failure of due diligence by so many funds of funds will deal the industry a blow. They are paid to screen managers, to pick the best and to diversify clients' holdings—none of which they did...