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So I actually visited Bernie Madoff's firm in 1997, and they pitched me on what I think was the very hedge fund that appears to have been a multi-billion dollar Ponzi scheme. Sadly, I don't remember many details. I remember it being very intriguing but also kind of irregular in several ways. Ironically, their purported strategy sounded a bit unethical to me, which is funny given that they weren't actually doing it at all.
I don't think it was nearly as big back then as it became later. It seemed like an adjunct to Madoff's main business as a market maker in NYSE stocks.* If I recall correctly, the story was that in his position as market maker for such an enormous amount of money, he was uniquely situated to exploit the price effects of the ebb and flow of trading in S&P 100 stocks. Basically all he needed to do was to use index options to hedge the positions that a market maker has to take as part of making markets, and bam, instant nearly risk-free profit. What sounded unethical to me was the complete lack of distinction between his broker-dealer business and his asset management business. Of course, it turns out that what he was actually doing was a lot lower down the ethics scale than just some conflicts of interest.
I can certainly see how people fell for it. His returns were moderate, but with exceptionally low volatility. The strategy sounded sensible on the surface, and he had enough of a reputation that you would feel like you had gotten in on a good thing while only the cool people knew about it.
I'm pretty sure we didn't put any of our clients into it while I was there, but I wouldn't be surprised to hear that my ex-boss had fallen for it after he got rid of me. He had exactly the sort of personality that would be susceptible to their pitch -- unreasonably concerned with prestige, pathologically self-important, a need to believe he was special. He probably would have overlooked a lot of warning signs if someone were feeding those needs.
I'm going to be interested to hear how his partners and employees explain how they never figured out that it was all lies. It's hard to imagine how they could have missed it, but it's hard for me to imagine how people believe that someone on TV is in love with them.
*For those of you who know something about the stock market, that probably sounded wrong, because you expect NYSE stocks to be traded with specialists on the exchange, not over the counter through market makers. The thing Madoff did was what's called "payment for order flow". If a broker placed an order with him, Madoff rebated one cent per share, whereas NYSE specialists charge two cents per share. This made his operation fairly popular for very large heavily traded stocks, such that his firm's volume could be something like 10-15% of the entire NYSE volume.
I don't think it was nearly as big back then as it became later. It seemed like an adjunct to Madoff's main business as a market maker in NYSE stocks.* If I recall correctly, the story was that in his position as market maker for such an enormous amount of money, he was uniquely situated to exploit the price effects of the ebb and flow of trading in S&P 100 stocks. Basically all he needed to do was to use index options to hedge the positions that a market maker has to take as part of making markets, and bam, instant nearly risk-free profit. What sounded unethical to me was the complete lack of distinction between his broker-dealer business and his asset management business. Of course, it turns out that what he was actually doing was a lot lower down the ethics scale than just some conflicts of interest.
I can certainly see how people fell for it. His returns were moderate, but with exceptionally low volatility. The strategy sounded sensible on the surface, and he had enough of a reputation that you would feel like you had gotten in on a good thing while only the cool people knew about it.
I'm pretty sure we didn't put any of our clients into it while I was there, but I wouldn't be surprised to hear that my ex-boss had fallen for it after he got rid of me. He had exactly the sort of personality that would be susceptible to their pitch -- unreasonably concerned with prestige, pathologically self-important, a need to believe he was special. He probably would have overlooked a lot of warning signs if someone were feeding those needs.
I'm going to be interested to hear how his partners and employees explain how they never figured out that it was all lies. It's hard to imagine how they could have missed it, but it's hard for me to imagine how people believe that someone on TV is in love with them.
*For those of you who know something about the stock market, that probably sounded wrong, because you expect NYSE stocks to be traded with specialists on the exchange, not over the counter through market makers. The thing Madoff did was what's called "payment for order flow". If a broker placed an order with him, Madoff rebated one cent per share, whereas NYSE specialists charge two cents per share. This made his operation fairly popular for very large heavily traded stocks, such that his firm's volume could be something like 10-15% of the entire NYSE volume.
