Madoff Ship of Fools

A recent article called “Ship of Fools” describes the Madoff scandal and its many facets. The article indicates that the scams are avoidable if one asks the following questions.

1. Who is the auditor? Have you ever heard of them? Do they have other reputable clients? Are they independent of the hedge fund?
2. Who is the prime broker? Are they a recognized name in the industry? Are they independent of the hedge fund?

A weak answer on either of these issues should be enough for any smart investor to walk away. Madoff owned his own broker dealer and charged a commission on every trade. He was, in fact, quite open about it. It was how he said he made all his money. He left the management and 20% incentive fees to the feeders, who brought him Investors.

The feeders claimed they had completed their due diligence. One Madoff feeder fund’s website describes its extensive due diligence. It also claims that it completed extensive personal background investigators and explored the “Structural and Operational Risks”.

Many people became involved with the Madoff scam because they incorrectly relied on the assumption that because there were so many other reputable people involved, that one of these other people must have done their research and due diligence. It would be a perfect world if everyone involved in an investment did their own homework, but unfortunately in the real world, investors typically rely on their intermediaries to do the leg work and research on prospective investments. In this instance, and sadly more often than not, intermediaries can fail horribly and have thus given the entire industry a black eye.

Considering the nearly impossibly consistent returns, and some early red flags, it should have been wildly clear that this was a scam from the start. In most investments scams, a manager starts out honestly but then goes awry and at some point decides to lie in an effort to make money back. Madoff obviously was one of these liars, and acted as a cheat from the start, and may have even been desperate to pay someone else off from the start. Desperate people do desperate things.

Lastly and most importantly to the golf community, the author of “Ship of Fools” believes that Mr. Madoff posted false golf score as well! It’s almost always a good idea to count each stroke, successful or not!