16 December 2008

Madoff Enablers: Everyone Was Getting Paid

As we said the other day in Rogue Nation, schemes like this continue on because everyone is getting paid, directly or indirectly, not to look closely.

Go along to get along with plausible deniability. The 'dumb CEO' and 'overworked civil servant' chasing kittens and alley cats while the lions are on the prowl.

Financial Times
Madoff feeder funds levied high fees
By Henny Sender
December 16 2008

The “feeder” funds that channelled money to Bernard Madoff charged their investors high fees that in some cases exceeded the norms of the hedge fund industry, people familiar with the matter say.

Mr Madoff received much of his funding from feeder funds run by so-called funds of hedge funds. These funds of funds are paid by investors to perform due diligence on hedge funds and allocate money among approved managers.

Typically, funds of hedge funds charge a 1 per cent management fee and take 0-10 per cent of the profits. This would be in addition to the fees charged by the underlying hedge funds – which usually take a 2 per cent management fee plus 20 per cent of the profits, above a certain level, known as the hurdle rate.

Fairfield Greenwich, a feeder fund that invested $7.5bn with Mr Madoff, charged a 1 per cent management fee and took 20 per cent of the profits, according to a person familiar with the matter.

Suzanne Murphy, managing director of Tri-Artisan, a hedge fund consultancy, said she believes other Madoff feeder funds charged fees similar to those at Fairfield Greenwich. At such levels, she claimed, “These organisations were more partners of Mr Madoff than clients.”

In general, generous arrangements such as large performance fees “raise questions about conflicts of interest and caveat emptor,” according to the general counsel of the alternative investment division of one bank. The head of the hedge fund practice at one law firm, added: “At a certain point, if you get outsize compensation, you can argue that you lose the incentive to do due diligence.”

In many cases, the feeder funds that worked with Mr Madoff also did so with few conditions, such as ones requiring that minimum returns be reached before fees would be paid, according to people familiar with the matter.

In some cases, the private wealth arms of banks that channelled money to such feeder funds also received payments from these funds.

Mr Madoff did not charge his investors fees but was paid through commissions on his trades, all of which went through the broker-dealer he controlled. Because he did not charge typical fund performance fees, he earned a reputation among some investors for being a lower-cost manager. (But severely back end loaded. Jesse)