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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

Bernie Madoff

Bailout and Hedge-fund Regulation

outline
Outline
  • Background
  • Bailout?
  • Regulation Moving Forward
  • Conclusion & Ponzi Schemes Moving Forward
outline3
Outline
  • Background
  • Bailout?
  • Regulation Moving Forward
  • Conclusion & Ponzi Schemes Moving Forward
world s largest ponzi scheme
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
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
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 questions8
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
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
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
Exclusive Circle: Club Madoff

Bernie Madoff

Ruth Madoff’s Friends

Exclusive Circle

International Banks;

College Endowments

Feeder Funds

Mutual Funds

outline12
Outline
  • Background
  • Bailout?
  • Regulation Moving Forward
  • Conclusion & Ponzi Schemes Moving Forward
yes bailout
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.
no bailout
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.
outline17
Outline
  • Background
  • Bailout?
  • Regulation Moving Forward
  • Conclusion & Ponzi Schemes Moving Forward
what is a hedge fund
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
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
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
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
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
Other
  • Commodity Exchange Act
  • FINRA
  • ERISA
  • Department of Treasury
  • Fraud
madoff repeated investigations
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
Madoff Skeptics
  • Harry Markopolos
  • Mark Occrant
  • Erin Arvedlund
sec organizational problems
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
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
outline28
Outline
  • Background
  • Bailout?
  • Regulation Moving Forward
  • Conclusion & Ponzi Schemes Moving Forward
in the end
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
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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