Friday, December 12, 2008
(Cont'd from above)...

Jim (cont'd):   

When the full size of this thing is revealed, some people are saying that it could be $50 billion in losses. Again, if this is all true, you got to give this guy some credit... he was thinking big...

This is way beyond the garden variety manipulation that we've gotten used to on a daily basis... the nonsense that we see all the time at the hedge funds using turbocharged ETF's... to push the market around in the last hour of trading...

If all of the allegations are true... that Madoff was able to con even the savviest of big-money guys for billions... and if there is one sure take away of this episode, it is that you cannot... absolutely cannot... trust or rely on Chris Cox's SEC, which has become, alas, a joke of a watchdog.

The SEC was all over Madoff's firm... because it was a broker/dealer... they had to look into it as an investment advisor... and they found nothing... I think that the SEC was looking for all the wrong things, and more concerned with form than substance... they were probably placated by the fact that Madoff's money management operation was on a separate floor from the rest of his organization. That's the stuff they care about, but they couldn't bother to notice the alleged Ponzi scheme that was right under their nose?... who cares if investors are being robbed and defrauded as long as everything is up to code...

Now we can say definitely that whatever Cox believes that the SEC exists to do, one thing that it doesn't seem to have in mind is protecting you... and protecting investors... If it can happen to them, then it can happen to you.

So, tonight, I'm going to take you inside the world of hedge funds... that's where I used to work... to teach you everything you need to know to avoid being the victim of this kind of hustling...

I want to show you how not to get Maddoff'D...

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If you had money with Madoff, you could have seen this coming from a mile away if you had done some due diligence... You could have gotten out before the whole house of cards collapsed... you just need to know the warning signs... the red flags...

So how do you know when you're getting him... what should set off the alarm bells?...

First, if you can't make heads or tails of your monthly brokerage statements... if you can't understand how the money manager is generating his returns... then you need to get out.

Second, if the returns looked too good to be true, let me tell you something... then they probably are too good to be true... Madoff's managed funds didn't claim to produce spectacular returns, but the allegedly made up numbers were way too consistent to be legitimate like this... no ripples... Apparently, Madoff's fund never had a down quarter or a down this?... what were your positions?... If he didn't show you, leave... if he showed you and you didn't understand it, leave... Esoteric methods of making money ceased to work at least a year and a half ago, for heaven's sake... he would have spotted it...

Here's the third way to avoid getting Madoff'D...

Pay attention to the accountants... Bayou use its own in-house accountant... that was a big scandal. Madoff... much, much bigger, even though he's running $17 billion... used an accountant based in Muncie, New York... Muncie?... Exactly...

I always had the accountant that was on my fund report to the investors, not to me... That's right, not to me... He saw my daily portfolio runs. And, if someone had a question about my performance or what I was up to, I directed it to him, not me, because they paid, okay... they paid for him... that's the way I set it up... It is a great demand to have in place... I want your accountant to be separate from you, and I want the accountant to have all of the papers of what you do. I think that you should demand that level of accountability, if you are in a hedge fund or being managed by a private money manager...

And since Madoff would not provide account transparency, he was freed to fiddle with the numbers however he liked... When investors questioned his methodology, Madoff apparently threatened to give their money back...

I bet a lot of people wish they had taken him up on that offer now...

Never allow someone who refuses to be transparent about his methods to come within a mile of your money...

How else do you know that something is rotten in the state of Denmark?...

When the fee structure is wrong... Madoff didn't charge investment management fees, and that's how hedge funds usually make their money. They typically take 2% of the assets that they manage, and 20% of the profits... Madoff's firm didn't do that... his compensation was based on commissions... That meant that Madoff had every incentive to do a lot of trading in the accounts that he managed, because that's how he got paid. So, even if this was all above board, I think that he still would've made a bad money manager, since he was compensated for buying and selling securities, not making his clients money... Ever heard of "churning"...

Madoff's investment advisory business, the allegedly fraudulent side of things, was part of a larger company that was mainly a market maker... a broker/dealer... and that allowed Madoff to do what is known as "self clear"... meaning he was his own broker. Boy, that makes it much easier to hide any kind of fraud, even if, by itself, it doesn't say that anything is necessarily wrong, I like those two separate... On top of everything else, though, it's a big neon sign screaming, "Get out!"... a separate brokerage, please, from clearing...

Bottom line...

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The Bottom Line!:     Protect yourself from money managers... know how to spot a fraud. Impenetrable account statements, results that are too consistent to be true, and a lack of transparency... they all spell trouble. And, if your money manager is his own broker/dealer, be extra careful if you see any of the other warning signs. That way, you won't get Madoff'd... And remember the tenet that this show is built upon... No one cares more about your money than you do... no one. Trust yourself. The worst that happens... you do it to yourself. And, by the way, if you scam yourself, let's just say... There's no way that Mad Money can help you.

Read Jim's next Segment here