January 29th, 2009

Was Madoff’s operation a hedge fund?

Starting with this comment in a previous thread about Madoff, a discussion ensued about whether the operation he ran that turned out to be a Ponzi scheme could be called a hedge fund.

Here are some definitions of “hedge fund.” It seems to me to be a fairly loose term, and that Madoff’s scheme (at least as presented to investors) would qualify.

Of course, in reality it seems to have been no sort of fund at all, but rather a pure Ponzi scheme—or, as this writer states, a virtual reality game—with some very nasty consequences in the real world.

4 Responses to “Was Madoff’s operation a hedge fund?”

  1. csimon Says:

    neo– after further detailed research, and because of the rather loose definition of a “hedge fund,” you are right in that Madoff’s investment fund could qualify as a hedge fund. Other than the means by which the manager of a fund derives his compensation, and a few client qualifications — which apply only to a small no. of clients, there is very little that specifically identifies a fund as a hedge fund.

    I do know that as “hedge funds” have proliferated in the last 3 – 4 years, this has been the subject of much controversy, specifically because of the small degree of regulation on hedge funds other than management must be registered with the SEC.

    I also know that “Madoff’s scheme” was NOT presented to investors as a hedge fund, as you assert. I know this because, as I have written here before, I was an investor — and am one of the victims.

    There are many sites with differing definitions of hedge fund, but quite a detailed one is available on Wikipedia.

    http://en.wikipedia.org/wiki/Hedge_fund

    It is significant to note how a hedge fund is, in general, defined; that is, the common use of hedging to hedge — or protect itself — from large and risky bets in the market such as shorting stocks (borrowing shares of stock, betting on those shares to go down in price, then buying shares at the lower price to replacing the borrowed shares, and pocketing the difference. (They have to replace the no. of shares of the stock they borrowed; not the dollar value of the shares when borrowed).

    Such was not the way Madoff described his operation of the fund to investors. While certainly an objective of Madoff’s fund was to grow an investor’s principle by earning money, it was presented to investors as a very stable and consistent method of investment restricted to the purchase and sale of blue chip companies, and providing for fluctuations due to economic eventualities by selling and buying calls or puts.

    These are rights to sell or buy stock at a specified price in the future, and have a specified life. If the stock hasn’t moved in the direction projected by the buyer/seller of the puts or calls, the amount paid for this option is pocketed without having to sell owned stock or purchase stock. These involve much smaller amounts of money than operations such as shorting. Among the controversies surrounding Madoff’s operation, is that many writers commenting on the affair, have, in hindsight, drawn information from past statements and reconstructed the transactions by extrapolating the volume of calls or puts listed on one (or more) statement(s), and based on the estimated amount of money under Madoff’s management at the time. Then they have looked up the volume of puts and call transactions at the time specified in statements and supposedly found that Madoff’s purported actions exceeded actual volume. Obviously, none of this has been verified by authorities.

    Significant to this, for those who deride Madoff investors as stupid and failed in due diligence is the fact that this was done in RETROSPECT, after Madoff admitted to his Ponzi scheme, and after certain investors made available their statements for such purposes, and all this was still, based on extrapolated numbers which were, in turn, based on estimates of Madoff’s management at the given time of reconstruction — something they could not know without access to internal records.

    Also, critics ascribe as greed the objective of Madoff investors. If looking to obtain the best returns on your accumulated money on a steady and reliable basis is defined as greed, then I suppose one might call Madoff investors greedy. Generally, that is what most people do with the money they have accumulated. I, of course, do not regard knowledge and use of what seems to be good opportunity based on a long history of steady results, concrete comfirmation of said results along with highly regarded reputation and complete absence of malfeasance, with greed..T

  2. Holmes Says:

    I think what this practically means is that not only should our actualy investment assets be diversified, but we should also diversify our investment advisors. Trust is the basis of our economy and that is being eroded at every level.

  3. Wolla Dalbo Says:

    It seems to me that they key fact here is that “Bernie” used to be the chairman of NASDAQ, and could hardly be better connected. Once he had these credentials, he was practically “bulletproof,” as is illustrated by the fact the SEC itself had installed him and his sons on several of it’s panels considering regulatory matters. You don’t check the head of the Boy Scouts to see if he is sleeping with the boys, do you?

  4. LondonTrader Says:

    My understanding is that he wasn’t running a fund but rather had a series of managed accounts. The difference that is in a fund investors buy shares or a limited partner interest in a single entity, the fund, whereas a managed account is an account held in the name of the investor with a power of attorney given to the manager. In legitimate enterprises the difference is significant.

    The accounts in this case were maintained at his own broker/dealer run by his sons. There were feeder funds such as Fairfield that were hedge funds but these in turn held managed accounts with Madoff.

    This is based on newspaper articles and a general knowledge of the industry. csimon would know better the exact set up as an investor.

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Previously a lifelong Democrat, born in New York and living in New England, surrounded by liberals on all sides, I've found myself slowly but surely leaving the fold and becoming that dread thing: a neocon.
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