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Bernie Madoff. Bailout and Hedge-fund Regulation. Outline. Background Bailout? Regulation Moving Forward Conclusion & Ponzi Schemes Moving Forward. Outline. Background Bailout? Regulation Moving Forward Conclusion & Ponzi Schemes Moving Forward. Gravity.

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Bernie Madoff

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Bernie Madoff

Bailout and Hedge-fund Regulation


Outline

  • Background

  • Bailout?

  • Regulation Moving Forward

  • Conclusion & Ponzi Schemes Moving Forward


Outline

  • Background

  • Bailout?

  • Regulation Moving Forward

  • Conclusion & Ponzi Schemes Moving Forward


Gravity


World’s Largest Ponzi Scheme

The bankruptcy court released a 162-page list naming thousands of Madoff victims, including:

◊◊Aozora Bank (Japan)

◊◊Nordea Bank (Sweden)

◊◊ Bank Medici (Austria)

◊ New York University ◊ ◊ HSBC

◊ John Malkovich ◊

◊ Steven Spielberg ◊ Fairfield Greenwich

◊ Kevin Bacon ◊


Begs the questions

1) How could this scheme go on for so long?

2) How could so many sophisticated individuals be taken in by a fund that provided no info on how it was able to achieve consistent returns of 8-13% for many years, during both good and bad times?


20+ Years of trickery

  • SEC did a bad job regulating. They too were caught up with the hype surrounding investors.

  • Split-Strike Strategy – complex with many moving parts.


Begs the questions

1) How could this scheme go on for so long?

2) How could so many sophisticated individuals be taken in by a fund that provided no info on how it was able to achieve consistent returns of 8-13% for many years, during both good and bad times?


Information Cascades

  • Each successive investor assumed that the previous investor did their due diligence

  • “Information cascades” – kind of like playing telephone.

  • Perhaps “sophisticated” financial institutions are NOT immune from hypes


Bernard L. Madoff

  • Professional Accomplishments:

    • Founder of Bernard L .Madoff Investment Securities (BMIS)

    • Chairman of the Board of NASDAQ

    • Founding Member of the International Securities Clearing Corporation in London

    • Board of Governors of National Association of Securities Dealers


Exclusive Circle: Club Madoff

Bernie Madoff

Ruth Madoff’s Friends

Exclusive Circle

International Banks;

College Endowments

Feeder Funds

Mutual Funds


Outline

  • Background

  • Bailout?

  • Regulation Moving Forward

  • Conclusion & Ponzi Schemes Moving Forward


Yes Bailout . . . .

  • Millions were affected

    • Not only wealthy white-collar individuals, but also blue-collar individuals with retirement funds managed by one of the feeder funds.

  • Hedge Fund Bailout

    • It’s been done before with success, i.e. LTCM.


LTCM v. Madoff


LTCM v. Madoff


No Bailout

  • Legal Remedy Available

    • People are already bringing lawsuits against Madoff and feeder funds.

  • Bailout will encourage Ponzi Schemes

    • If government bails out Ponzi scheme participants, then taxpayers stand to lose more money than Ponzi players. This incentivizes a rational person to partake in the next Ponzi game rather than avoid it.


Outline

  • Background

  • Bailout?

  • Regulation Moving Forward

  • Conclusion & Ponzi Schemes Moving Forward


What is a Hedge Fund?

  • Unregistered, privately-managed pools of capital

    • Equity investments

    • Leverage and short selling

    • Absolute return

  • Why regulate?

    • Long-term incentive alignment

    • Retailization

    • Systemic risk


Securities Act of 1933

  • Section 4. Exempted Transactions

  • Regulation D, Rule 501

    • “Accredited Investor”

    • Calculating purchasers

  • Regulation D, Rule 506

    • No more than 35 purchasers

    • Sophisticated purchasers


Securities Exchange Act of 1934

  • “Dealer” vs. “Trader”

    • In the business of buying and selling securities

    • Registration under 15(b)

  • Section 12. Registration Requirements for Securities

    • More than 500 holders of record, and

    • Assets in excess of $10M


Investment Companies Act of 1940

  • Section 3(c). Further exemptions

    • 3(c)(1) –type hedge fund

      • Up to 100 investors

      • No public offerings

    • 3(c)(7) – type hedge fund

      • Up to 500 qualified purchasers

      • No public offerings

  • “Qualified Purchaser”


Investment Advisors Act of 1940

Section 203(b). Registration of Investment Advisors

  • Fewer than 15 clients in past 12 months, and

  • Doesn’t hold self out as an investment advisor


Other

  • Commodity Exchange Act

  • FINRA

  • ERISA

  • Department of Treasury

  • Fraud


Madoff: Repeated Investigations

  • 1999: SEC send examiners to review trading practices

  • 2000: SEC sends examiners to review trading practices

  • 2004: SEC investigates front running allegations

  • 2005: NASD reviews Madoff

  • 2005: SEC investigates front running allegations

  • 2006: SEC investigates Ponzi Scheme allegations


Madoff Skeptics

  • Harry Markopolos

  • Mark Occrant

  • Erin Arvedlund


SEC: Organizational Problems

  • Understaffed

  • Lawyers not financial experts

  • Political influences

  • Little deterrent effect

    • GAO study – 92% of hedge funds in study were not in compliance.


Any Lessons Learned from LTCM?

  • “Unique characteristics and unlikely events”

  • Amount of leverage is rarely seen today

  • Private parties were willing to buy LTCM

  • Counterparties could have absorbed losses from a default


Outline

  • Background

  • Bailout?

  • Regulation Moving Forward

  • Conclusion & Ponzi Schemes Moving Forward


In the end…

  • No Bailout for Madoff victims

  • Regulation laws seem fine. The problem is the people running the organization.


How to Succeed in a Ponzi Scheme

  • Don’t expand too fast.

  • Show bad numbers once in a while.

  • Run while you’re ahead.


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