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Bernie Madoff

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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  1. Bernie Madoff Bailout and Hedge-fund Regulation

  2. Outline • Background • Bailout? • Regulation Moving Forward • Conclusion & Ponzi Schemes Moving Forward

  3. Outline • Background • Bailout? • Regulation Moving Forward • Conclusion & Ponzi Schemes Moving Forward

  4. Gravity

  5. 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 ◊

  6. 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?

  7. 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.

  8. 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?

  9. 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

  10. 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

  11. Exclusive Circle: Club Madoff Bernie Madoff Ruth Madoff’s Friends Exclusive Circle International Banks; College Endowments Feeder Funds Mutual Funds

  12. Outline • Background • Bailout? • Regulation Moving Forward • Conclusion & Ponzi Schemes Moving Forward

  13. 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.

  14. LTCM v. Madoff

  15. LTCM v. Madoff

  16. 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.

  17. Outline • Background • Bailout? • Regulation Moving Forward • Conclusion & Ponzi Schemes Moving Forward

  18. 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

  19. 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

  20. 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

  21. 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”

  22. 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

  23. Other • Commodity Exchange Act • FINRA • ERISA • Department of Treasury • Fraud

  24. 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

  25. Madoff Skeptics • Harry Markopolos • Mark Occrant • Erin Arvedlund

  26. 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.

  27. 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

  28. Outline • Background • Bailout? • Regulation Moving Forward • Conclusion & Ponzi Schemes Moving Forward

  29. In the end… • No Bailout for Madoff victims • Regulation laws seem fine. The problem is the people running the organization.

  30. 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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