Madoff Charged In $50 Billion Ponzi Scheme

Dec 12 2008 | 4:19pm ET

New York hedge fund manager and Wall Street legend Bernard Madoff has been charged with what could be the largest Ponzi scheme in history, and hedge funds are among his most prominent alleged victims.

Bernard MadoffBernard MadoffMadoff, who was arrested and charged yesterday, allegedly stole as much as $50 billion from clients of his Bernard L. Madoff Investment Securities’ advisory business, at least half of which are hedge funds.

 Madoff, whose firm is also one of the largest market-makers for Nasdaq securities, confessed to two senior employees at his Manhattan home on Wednesday, and then to a Federal Bureau of Investigation agent yesterday, according to federal prosecutors.

“It’s all just one big lie,” he reportedly told the employees, who had asked for a meeting after noticing that Madoff had been under a “great deal of stress.” He said his firm, which had about $17 billion in assets under management last month, was “a giant Ponzi scheme” with losses totaling $50 billion. He allegedly told the FBI agent that there was “no innocent explanation” for the missing money, and that he had “paid investors with money that wasn’t there.”

Hedge funds could bear the brunt of the losses, with industry players facing at least $10 billion in write downs. Among those reportedly caught up in Ponzi scheme are the Fairfield Greenwich Group’s $7.3 billion Fairfield Sentry fund, Kingate Management’s $2.8 billion Kingate Global Fund, “Superwoman” Nicola Horlick’s Bramdean Alternatives and Pioneer Alternative Investments’ $280 million Primeo Select Fund. Bramdean said it had roughly 9% of its assets invested with Madoff, while Pioneer said “substantially all” of Primeo Select’s assets were invested with the indicted money manager.

Fairfield called the indictment “a shocking development,” and said it is taking steps “to protect our investors and our firm.” Surprise seemed to be the reigning sentiment on Wall Street and among Madoff’s clients when the news broke.

“We are very shocked,” Fix Asset Management’s Jon Fix told Bloomberg News. “We put in redemptions in the past few months and got our money back no problem.”

Madoff was released on $10 million bond after a hearing in New York yesterday. The 70-year-old has been charged with securities fraud, and faces as much as 20 years in prison and a $5 million fine if convicted. He has also been sued by the Securities and Exchange Commission, which is seeking an asset freeze against Madoff Investment Securities and to have a receiver appointed.

“Bernard Madoff is a longstanding leader in the financial services industry,” Madoff’s lawyer, Dan Horwitz, said. Madoff, an early supporter of electronic trading, has served in senior roles at the National Association of Securities Dealers, the Nasdaq Stock Market and the Securities Industry Association.

“We will fight to get through this unfortunate set of events,” Horwitz said. “He’s a person of integrity.”

The federal cases against Madoff tell a different story. According to prosecutors, the scheme began to unravel earlier this month, when Madoff told an employee that clients had sought about $7 billion in redemptions and that he was having trouble cobbling together the money. He also told another that he planned to pay out bonuses before the end of the year, two months early, leading the two employees to seek the meeting Wednesday.

In addition to the alleged confession, prosecutors say Madoff told the employees that he was “finished,” that the firm had only $200 million to $300 million left, and that he planned to give that money to employees, family and friends before turning himself in next week.

There may be almost no money left for hedge funds and Madoff’s other clients to recoup in the wake of the charges.

“We are going to see a ripple effect of substantial amounts of money going to individuals and philanthropies that just went up in smoke,” former SEC Chairman Arthur Levitt told Bloomberg Radio. “I doubt that investors will get pennies back as a result.”

“Some investors in Madoff’s funds face 100% write-downs on the money they invested, they will suddenly be nursing full write-downs in December,” Christopher Miller of the London hedge fund ratings agency Allenbridge Hedgeinfo told The Wall Street Journal. “When people realize the magnitude of this it will be fizzing around the stratosphere.”

The huge losses could have a wide-ranging impact on the hedge fund industry, Miller said.

“Some of the world’s biggest hedge funds have been hit by this,” he told the Journal. “There will be a monumental impact for the hedge fund industry; it could be larger than Enron.”

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