This may be the biggest Ponzi scheme already, but the impact disclosed so far may be the tip of the iceberg.
It seems that outside of Mr. Madoff’s specific firm, a large number of other managers, much like remoras on sharks, attached both their client’s fortunes and their personal livelihood to this fraud.
Because of another aspect of so-called hedge funds that hasn’t been getting much media time, the fraud seems to be mushrooming. The practice is known as Fund of Funds, which is one hedge fund investing in another with each taking their asset based fee. This deferring of actual investment decision making to another entity not only acts as a multiplier of commission fees but also absolves most supposed advisers of possessing any actual knowledge about investing.
I’ll lay out a simple example:
- John Q. Public invests $100,000 through his BFF( best friend forever), Tom Sawyer, an educated, licensed financial advisor with a reputable Wall St. Firm, “Goldman Lynch” (GL).
- Tom Sawyer directs these funds, along will other clients funds to GL’s internal asset management department, deducting his annual commission.
- GL’s asset management department further delegates investment decision to hedge fund “Lynch Capital Management” (LCM), minus a commision fee of course
- LCM then takes these funds and entrusts them to the CEO’s college roommate, who now runs his own hedge fund of hedge funds, “Diversified Genius Fund (DGF)” for further investment, minus its fee of course.
- The investment manager of DGF finds the hedge funds with the most consistent returns and delegates decision making further by picking the ten best hedge funds, just grabbing DGF’s fee of course
From 2005 to 2006 it seems that each of these ten funds either invested in home mortgages because of it’s seemingly perpetual and steady returns, or worse to men such as Mr. Madoff and his agents for completely fictitious perpetual steady returns.
Remember that in our example, the original investor, John Q. Public is only told about the fee from GL; all other fees are hidden in the return figures and not disclose as fees. The investment holdings are also hidden because Mr. Madoff’s fund, similar to most hedge funds, was both unregulated and not required to disclose investment to its clients, and consequently undisclosed to the client’s clients.
While the fees coursed through the financial system, silent and unseen, the bad decisions and frauds will continue to reverberate throughout the financial system both loud and in plain sight.