NEW YORK (Reuters) - Investors scrambled to assess potential losses from an alleged $50 billion fraud by Bernard Madoff, a day after the arrest of the prominent Wall Street trader.
Prosecutors and regulators accused the 70-year-old former chairman of the Nasdaq Stock Market of masterminding a Ponzi scheme of epic proportions through his investment advisory business, which managed at least one hedge fund. Hundreds of people, investing with him through the firm’s clients, entrusted Madoff with billions of dollars, industry experts said.
“Madoff’s investors included captains of industry, corporations — some of which are publicly traded — that used Madoff almost as a high-yielding cash management account, endowments, universities, foundations and, importantly, many high-profile funds of funds,” said Douglas Kass, who heads hedge fund Seabreeze Partners Management.
“It appears that at least $15 billion of wealth, much of which was concentrated in Southern Florida and New York City, has gone to ‘money heaven,’” he said.
A Ponzi scheme is an illegal investment vehicle that pays off old investors with money from new ones, and is dependent on a constant stream of new investment. Because the invested capital is not earning a sufficient return on its own, such schemes eventually collapse under their own weight.
Federal agents arrested Madoff at his apartment on Thursday after prosecutors said he told senior employees that his money management operations were “all just one big lie” and “basically, a giant Ponzi scheme.”
Madoff is the founder of Bernard L. Madoff Investment Securities LLC, a market-making firm he launched in 1960. His separate investment advisory business had $17.1 billion of assets under management.
About a dozen angry investors gathered on Friday in the lobby of the Lipstick Building in midtown Manhattan, where the market-making firm and advisory business are headquartered, demanding to know the fate of their money.
One woman said that when she called the firm’s offices on Thursday she was told it was “business as usual.”
Another investor groused, “Business as usual? Of course it’s business as usual. We’re getting screwed left and right.”
Police later evicted the small group from the building.
Individual investors were feeling the squeeze elsewhere.
“I expect to get back zero,” said Susan Leavitt in Tampa Bay, Florida, who invested through Madoff. “When he tells the Feds, he has $200 million to $300 million left out of billions, what can you expect.
The two most prominent hedge funds that invested with Madoff were the $7.3 billion Fairfield Sentry Ltd, run by Walter Noel’s Fairfield Greenwich Group, and the $2.8 billion Kingate Global Fund Ltd, run by Kingate Management Ltd.
Fairfield Sentry and Kingate Global were among a small group of hedge funds to report positive returns for 2008; the average hedge fund was down 18 percent, according to data from Hedge Fund Research.
“People who came to us for portfolio construction were often already invested with Bernie Madoff, he had hundreds of clients,” said Charles Gradante, who invests in hedge funds as a principal at Hennessee Group LLC. “Now his whole legacy is destroyed. He was God to people.”
Prior to Madoff’s arrest, investors had wondered how he was able to generate annual returns in the low double digits in a variety of market environments. Many questioned how U.S. regulators were able to ignore numerous red flags with regards to Madoff’s operations.
“Many of us questioned how that strategy could generate those kinds of returns so consistently,” said Jon Najarian, an options trader who knows Madoff and is a co-founder of optionmonster.com.
In May 2001, Barron’s reported that option strategists for major investment banks said they could not understand how Madoff managed to generate the returns that he did.
“We weren’t comfortable with Madoff,” said Brad Alford, president at investment adviser Alpha Capital in Atlanta. “We didn’t understand how his strategy could generate the kind of returns it did. We will walk away from things like that.”
U.S. stocks tumbled in early trading on Friday, with some investors citing the Madoff case as well as the failure of talks in Congress on a rescue for the U.S. auto industry. The market later rebounded, with the Dow Jones industrial average rising 64.59 points, or 0.75 percent, to end unofficially at 8,629.68.
Investors overseas were reeling from the alleged fraud.
Benedict Hentsch, a Swiss private bank, said it had 56 million Swiss francs ($47 million) of exposure to Madoff’s investment advisory business. UniCredit SpA’s fund management unit, Pioneer Investments, has exposure through its Primeo Select hedge fund, two people familiar with the matter said.
Bramdean Alternatives Ltd said almost 10 percent of its holdings were exposed to Madoff, sending shares in the UK asset manager crashing.
CNBC Television reported that Sterling Equities, which owns the New York Mets baseball team, had accounts managed by Madoff.
Madoff said “there is no innocent explanation” for his activities, and that he “paid investors with money that wasn’t there,” according to the federal complaint.
Prosecutors also accused Madoff of wanting to distribute as much as $300 million to employees, family members and friends before turning himself in.
Charged with one count of securities fraud, he faces up to 20 years in prison and a $5 million fine. The U.S. Securities and Exchange Commission filed separate civil charges.
A hearing had been scheduled for Friday afternoon in U.S. District Court in Manhattan on the SEC’s request to grant powers to the court-appointed receiver to oversee the entire firm, as well as on the commission’s request for a firmwide asset freeze.
But the hearing was canceled after the matter was resolved, said a deputy for U.S. District Judge Louis Stanton. No other details were immediately available. The receiver, lawyer Lee Richards, had been appointed by the judge on Thursday to oversee assets and accounts of the firm held abroad.
Madoff’s lawyer, Dan Horwitz, said on Thursday, “We will fight to get through this unfortunate set of events.” His client was released on $10 million bond.
Madoff is a member of Nasdaq OMX Group Inc’s nominating committee. His firm has said it is a market-maker for about 350 Nasdaq stocks.
He is also chairman of London-based Madoff Securities International Ltd, whose chief executive, Stephen Raven, said the firm was “not in any way part of” the New York-based market-maker.
All equity trades involving the market-making firm will be processed as usual, the Depository Trust Clearing Corp told Reuters on Friday.
Reporting by Jennifer Ablan, Edith Honan, Aarthi Sivaraman and Leah Schnurr and Dan Wilchins in New York; Svea Herbst-Bayliss in Boston, Steve Slater in London and Lisa Jucca in Zurich; editing by Jeffrey Benkoe, John Wallace, Toni Reinhold