As the Bernard Madoff scandal continues to implode, it’s becoming clear that he had help from all corners of the financial and regulatory worlds, intended or otherwise. An expert in the financial markets with extensive connections, Madoff was masterful in his fraud. Though it’s way too early to assess the full consequences of this mess and assess blame solely on the “Lone Ranger,” the ideology known as the “free market” will surely be a major determinant in this disaster.
As is becoming clear, many friends, associates, business partners, customers and regulators were eager to embrace this scion of the financial industry and ignore the suspiciously consistent returns he delivered. It appears that other investment professionals chose to ignore warning signs that Bernie’s deals were too good to be true.
Exotic funds of funds, specialized loans from banks designed to amplify the gains of the Madoff investments and other sophisticated strategies were deployed while ignoring underlying risks associated with a virtually unvarying investment return over many years. Like investors in other sophisticated investment vehicles, these individuals and institutions failed to wipe the steam off the shower door and see the naked guy in the shower.
Compounding this familiar scenario were regulators who apparently failed to hold this good old boy to any rigorous standard. It would appear that due diligence of the sort required for Madoff’s investment funds was reserved for suckers and those without connections.
As a registered investment advisor myself, I have been subject to periodic audits by SEC personnel. While I think that the field auditors are professionals, I am also acutely aware that political pressures above their pay grade drive them in certain circumstances.
About 3 years ago, SEC auditors dispatched from the Philadelphia field office audited my firm. I was informed that, in this instance, they wanted to conduct a proxy voting audit. Given that my work as an investment advisor was to provide proxy voting services to institutional investors, it made sense.
Upon their arrival, they began an inquiry about how I voted my proxies, focusing on how I made my voting decisions and whether I was influenced by recommendations from the AFL-CIO. I found this rather unusual but not totally unexpected, as there was pressure from the U.S. Chamber of Commerce on the SEC at the time to look at the Unions’ influence in advocating for pro-investor votes. I raised questions about their motives in conducting the audit but received no response from them. The SEC agents conducted themselves professionally and the audit was completed in a matter of days. From that experience, I took away a gnawing feeling that politics trumped the mission of the SEC. The Madoff scandal cleared up my suspicions.
What strikes me about the current disaster involving Bernie Madoff is the fact that the SEC is a politicized agency. From my experience, it was clear that politics, not its mission, drove the decision making with respect to regulatory compliance. While the circumstances surrounding my experience were minor, those surrounding Bernie Madoff’s operations had a far more profound impact as we are witnessing. The free market, deregulation mantra that remains the rage in the Bush Administration and in the Republican Party (aka non-regulation), sowed the seeds of this disaster.
How this situation unfolds in the coming weeks and months is anyone’s guess. However, what is certain is that unless meaningful steps are taken to apply reasoned regulation to the markets and the players, along with real enforcement, we will quickly repeat the colossal mess we are suffering through today.
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