Madoff ‘Big Lie’ Hits Fairfield Sentry, Kingate Funds

Date: Friday, December 12, 2008
Author: Bradley Keoun, Josh Fineman and Katherine Burton, Bloomberg

Hedge funds, already heading for their worst year on record, may lose at least $10 billion from investing with a New York firm that founder Bernard L. Madoff called “a giant Ponzi scheme.”

The biggest loser may be Walter Noel’s Fairfield Greenwich Group, whose $7.3 billion Fairfield Sentry Ltd. invested with Madoff’s eponymous firm, three people familiar with the matter said. Another client was Kingate Management Ltd., whose $2.8 billion Kingate Global Fund Ltd. invested with Madoff, they said.

Investors, ranging from hedge funds that depend on outside managers to wealthy individuals, entrusted their money with the 70-year-old Madoff, who told employees before his arrest yesterday that his firm was “one big lie” and may have cost clients as much as $50 billion. His confession comes with hedge- fund assets poised to fall as low as $1.1 trillion by Jan. 1 from $1.9 trillion in June, reflecting market losses and customer redemptions, analysts at Morgan Stanley estimate.

“If the losses were $50 billion or even half that amount, it would be the biggest Ponzi scheme in history,” said Mark Schonfeld, the former head of the U.S. Securities and Exchange Commission’s New York office, who is now a partner at Gibson Dunn & Crutcher LLP.

Fairfield spokesman Andrew Ludwig declined to comment. A call to the Bermuda-based office of Kingate wasn’t returned. Madoff, whose New York-based firm was the 23rd largest market maker on Nasdaq in October, faces as much as 20 years in prison and a $5 million fine if convicted.

‘Black Eye’

“Bernard Madoff is a longstanding leader in the financial services industry,” said defense lawyer Dan Horwitz. “We will fight to get through this unfortunate set of events. He’s a person of integrity.”

The fraud is “a black eye to an industry that doesn’t need one,” said Bill Grayson, president of San Francisco-based investment firm Falcon Point Capital LLC.

Fairfield Sentry has a record of more than 15 years with an annual return of 4 to 6 percentage points above benchmark interest rates, according to a marketing document dated this month that was prepared by Zurich-based NPB New Private Bank Ltd. On an absolute basis, returns exceeded 10 percent every year from 1991 through 2000. Since then, they ranged from 6.4 percent to 9.8 percent.

The strategy is a “split-strike conversion,” where the investment manager buys shares of large U.S. companies and enters into options contracts to limit the risk, the document says.

‘Ripple Effect’

“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 said in a Bloomberg Radio interview today. “I doubt that investors will get pennies back as a result.”

Another client was Fix Asset Management, which had an account worth at least $400 million with Madoff Investments. The firm said it’s checking with lawyers about the holdings.

“We are very shocked,” John Fix, the son of founder Charles Fix, said by phone from Greece. “We put in redemptions in the past few months and got our money back no problem. We are just so surprised about all this.”

Madoff, who founded his firm in 1960, won an assignment to manage a $450,000 stock offering for A.L.S. Steel Corp. of Corona, New York, two years later, according to an SEC news digest.

‘Lock and Key’

He ran his investment advisory business from a separate floor of his firm’s office, keeping financial statements “under lock and key,” prosecutors said. Early in December, he told one employee that clients wanted to redeem about $7 billion and that he was struggling to free up the funds, the government said.

Not every potential Madoff investor was fooled. Jim Vos, who runs due diligence firm Aksia LLC, said he spent several months probing Madoff’s firm on behalf of clients, only to recommend against investing in it. Vos said eight “feeder funds” invested about $15 billion with Madoff. Vos declined to name the clients.

Among the red flags, Vos said: Madoff’s auditor, Friehling & Horowitz, operated from a 13-by-18-foot office in Rockland County, New York. Vos had an investigator stake out the office. A call to the New City, New York, office of Friehling & Horowitz after business hours wasn’t returned.

‘Blind Eye’

“I’m shocked by how investors turned a blind eye to returns that were too good to be true, constant steady small positive monthly returns,” Vos said. “When something is too good to be true, it probably is.”

Individual investors are also worried. A 68-year-old New York woman, who declined to be identified, said she and her 73- year-old husband invested about $12 million with Madoff. Her husband’s former law partner had met him at a country club on Long Island, she said.

Madoff bought and sold stocks frequently, she said, as reflected in trading-account statements running over six pages. Although she said she has four residences, including one on Manhattan’s Upper East Side, she fears the couple’s entire savings are gone except for $60,000 in a bank account.

Since 2000, Madoff has donated at least $100,000 to the Democratic Senatorial Campaign Committee and more than $23,000 to the party’s candidates, including New York Senator Charles Schumer and New Jersey Senator Frank Lautenberg, according to the Center for Responsive Politics.

Money ‘Flowing In’

When markets are rising, schemes like this can be hard to detect “because the money’s flowing in,” said Schonfeld. “But when the market declines, people want their money back, and the whole thing collapses.”

Joyce Z. Greenberg, a retired financial adviser in Houston, said her late husband, entrepreneur Jacob Greenberg, first invested with Madoff in 1987. While declining to disclose the size of the account, she said it increased 10-fold in 21 years, according to Madoff’s monthly statements, and never had a losing year.

“He had trading authority,” she said. “I never questioned anything he did because I felt he was doing a good job. I figured everything was on the up-and-up.”

Greenberg said she felt “disbelief” upon reading news reports about Madoff.

“This feels like a nightmare,” she said. “I’m just grateful that I didn’t have all my eggs in one basket.”

To contact the reporters on this story: Bradley Keoun in New York at bkeoun@bloomberg.net; Katherine Burton in New York at kburton@bloomberg.net; Josh Fineman in New York at jfineman@bloomberg.net.