Madoff Securities Alleged Ponzi Scheme Exposed: What’s an investor left to do?

In a bull market, investors are happy and tend not ask many questions. But when times get tough, they start wanting answers and Ponzi schemes are inevitably discovered.

The latest, of course, involves Bernard Madoff, a fixture on Wall Street for decades and one of the creators of the NASDAQ exchange. Mr. Madoff is the founder of Bernard L. Madoff Investment Securities. He was arrested by Federal Bureau of Investigation agents and charged with criminal securities fraud by federal prosecutors in Manhattan. The SEC has shown up late to the party once again and filed a civil suit, years after they were alerted of suspicious activity at Madoff Securities’ investment arm. All told, the alleged Ponzi scheme totaled $50 billion, possibly half of which was investor funds.

Naturally, Bernard Madoff’s clients are wondering if there’s anything left, and if so, how they can get their money back. Some investors will have an up-hill road to travel but for others there are legal options they can immediately pursue.

Firstly, to the extent that there are any funds left, claims can be filed against Madoff Securities directly. But it’s unlikely that there will be any money left. “It’s all a lie,” Mr. Madoff told investigators who were there to arrest him.

And it is doubtful there will be any recourse through the Securities Investor Protection Corporation (SIPC) because the money management function at Madoff Securities was held outside of the brokerage unit.

But investors that were placed into the Madoff Funds through other “fund-of-funds” or by another hedge fund manager could have more maneuverability. Indeed, managers of fund-of-funds could have liability for failing to perform a reasonable amount of due diligence on Bernard Madoff’s dealings. They had an obligation to research Mr. Madoff, his firm, and his returns. Managers of fund-of-funds were compensated to do this and likely marketed their due diligence capabilities to their clients.

The red flags were very clear in this case. Perhaps the most compelling was the fact that Mr. Madoff was generating such high returns using a strategy tied to the S&P 500. And this was all happening while the overall market sank in 2008!

The magnitude of Mr. Madoff’s deception is astounding. And the destruction of wealth that has apparently occurred here is shockingly awful. But if there is a silver lining to this at all, it’s that during this economic crisis the unnecessary middle men, fraudsters, hucksters and Wall Street’s ugly underbelly are being exposed and eliminated.

While that is likely of no consolation to Madoff Securities clients and investors, rest assured, they will also have their day in court.

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Keeping Callan and Gregory in the Lehman Tent

It’s standard practice for Wall Street firms to retain executives tied to extensive financial losses and persistent questions about accounting practices, particularly if there is the likelihood of lawsuits. So I note with great interest that that Erin Callan and Joseph Gregory, who today “resigned” respectfully as CFO and COO of Lehman Brothers, will remain at the embattled firm, at least for now. Ms. Callan will rejoin the firm’s investment banking division in an unspecified “senior capacity,” and Mr. Gregory will stay with the company in an “undefined capacity.” Suffice it to say, Callan and Gregory aren’t getting promotions.

It’s doubtful that Lehman is retaining the tarnished executives out of sheer loyalty. More probably, it’s out of concern for the litigation that will no doubt ensue. Company lawyers prefer to have all the major participants responsible for activities leading to litigation in the corporate tent, thereby having some measure of control over the proceedings. Throwing Callan and Gregory to the wolves could put their legal interests at odds with Lehman’s.

The irony of Ms. Callan returning to investment banking must also be noted. During her previous tenure there, Lehman took public both Fortress Capital and Och-Ziff and IPOs that certainly didn’t serve investors well. Since their respective public offerings, Fortress lost 56 percent of its value and Och-Ziff some 25 percent of its value. As I noted earlier, Lehman was also responsible for orchestrating Wachovia’s highly questionable takeover of Golden West.

Perhaps Ms. Callan had no involvement with the aforementioned deals. But given her track record as CFO, Ms. Callan’s return to Lehman’s investment banking group somehow doesn’t inspire further confidence in Lehman’s deal making prowess.

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Legal Reaction to Spitzer