Alternative Accesss - February 2020

... continued from Back

Lessons to Be Learned

4) As the years wore on, the results became ever more improbable.

Fraudulent investments are a challenge to unmask because fundamental lying makes uncovering the truth difficult. In such cases, evidence must be dug out indirectly with scant reliance on input from the principals. Nevertheless, Shinnecock did avoid Madoff despite the overweening temptation. Investors could have known a priori that this investment was too good to be true. What were some of the tip-offs for active due diligencers? To be fair, it would have been harder to avoid this mess in the early days given the shorter track record of heroic returns, but possible. 1) The option strategy was not unique and, deployed on its own, insufficiently robust to avoid declines or more volatile results. 2) Any asset manager unwilling to fulsomely describe what they are doing must be avoided. No one ever saw actual trading records, a critical step. No wonder, there may not have been any. 3) Inadequate service providers. The auditor was a “no-name” two-person firm. Moreover, there was no independent administrator to control cash and undertake independent investor reporting. 4) Family members were in critical control positions, clearly lacking independent objectivity. Later on, when there were significant assets under management, the true picture would have been even clearer upon careful examination. 1) As the asset size grew, it would have been impossible to deploy the strategy in the option markets without severe dislocations. 2) A tiny audit firm could never have successfully examined a fund of such scale, even working 24/7. 3) In general, the Madoff staff was too small to have managed the trading frequency ostensibly required.

The Aftermath

On June 29, 2009, Madoff was sentenced to prison. There were some recoveries,

estimated as approximately half of the capital, circa $31 billion. Funds continued to be distributed to the Madoff Victim Fund as recently as 2017, a long, sad wait for the defrauded investors.

Postscript: Chutzpah — On July 24, 2019, it was reported that Madoff petitioned the Justice Department for clemency from Donald Trump. Madoff remains in jail, serving a 150- year sentence.

Conclusion

After-the-fact analysis of a problem must resist glib conclusions. However, in this case, there were enough troubling facts to keep careful investors away. Always, we welcome additional insights, for we are shameless in our goal of trying to be ever better in this challenging business.

We must offer two mea culpas:

1) Have we avoided all sketchy investments? Alas, not, but once burned, twice shy. Learning from past mistakes is our destiny. With good fortune, we will live long enough to outrun these foibles or, at a minimum, have the courage to share the learning to help others.

2) Years ago, we had the good fortune to invest in Jim Simons’ Renaissance

Technologies, the best performing hedge fund of all time. Did we diligence it? Yes, yet was it possible to understand everything they were doing? No. Unlike Madoff, the experience of the principals involved was noteworthy given their relevant backgrounds, coupled with controls, blue-chip service providers, and no family members in vital positions. Sometimes, Lady Luck smiles on us, but it is unlikely we would make a similar investment now. Our conservatism and age have made us ever more risk-averse and willing to miss a hidden gem in order to protect principal.

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