Article by the Forensic and Investigation Services Department

If it sounds too good to be true it probably is. This is the old maxim that investors and regulators seem to have failed to appreciate with the $50 billion Madoff fund, the largest Ponzi scheme in history, a scheme that by its nature could only survive by paying returns out of new investors' monies. Madoff's guilty plea in the criminal proceedings seems to confirm this.

Madoff's fund gained a reputation for generating above average returns on a consistent basis year on year whether the markets overall were showing gains or losses. Apparently this was done by investing in US equities and using cap and collar arrangements. However, these arrangements normally only limit the upside and downside of an investment portfolio, not transform losses into consistently high profits. Remarkably Madoff had achieved only 7 small losses in a 14 year period. Hedge funds worldwide were tempted into investing with Madoff and received 20% of any profits apparently achieved. Not an incentive to move funds elsewhere. However, there are now rumours that Madoff never actually invested in anything at all.

We have seen and investigated these sort of schemes before. Typically they are conducted in low regulatory environments but, in this case, events unfolded under the nose of the SEC and were perpetrated by the former chairman of NASDAQ, one of the key US investment markets. This raises (again) major issues regarding the effectiveness of the regulators in the US and by association in Europe. Another important characteristic of such schemes which we have observed before is the lack of independent involvement in the investment structure, particularly by custodians, administrators and investment managers. Other warning signs include the use of professional advisers who have inadequate experience in this field, the payment to introducers of high commissions for introducing new investors and getting existing investors to put in more funds, and the appointment as auditor of relatively small audit firms.

In the US there are a number of class actions against Madoff's companies, various hedge funds, fund managers, auditors, custodians and one against the SEC. It also appears that there may be similar actions in the UK on foot.

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