Madoff Begs Questions, Promises Litigation
By Bill McIntosh
How will the alleged fraud carried out by Bernard Madoff affect hedge funds? A conclusive answer may be premature, but several clear observations are already apparent.
For investors, the big issue is how funds of funds portfolio managers missed such a big diversion. FoFs, afterall, get paid a 1% fee to carry out basic diligence, among other things. Many, it seems, were happy to take the money without carrying out their duties. Investors have every right to be livid.
The fiasco comes at an extremely sensitive time for the industry. It is like the crest of a tsunami whipped up by the perfect storm, hitting land without warning.
“The number of people affected and afflicted is just staggering,” says Jeremy Walton, a Cayman-based partner in Appleby’s litigation practice group and the head of the global law firm’s fund disputes team. “This is exacerbating the already massive liquidity problems. There will be more suspensions of redemptions and liquidations of funds.”
He fears that the main planks in the hedge fund sector’s defence – justifiably blaming banks for the crisis; few cases of fund fraud; and the sufficiency of light regulation – now look wobbly. “Those are the three main planks of the industry’s defence,” Walton says. “All are now impaired by the Madoff saga. The timing couldn’t be worse.”
Normally, the year end is a very busy time in the hedge fund sector. Investments are reviewed, allocations and redemptions are finalised and performance fees are billed. This year, however, solicitors are busy with litigation focused on lowered gates, fund suspensions and liquidations.
Walton predicts that the rebuilding process the industry will be going through will feature big battles over who should have spotted Madoff. And who among regulators, auditors, and the funds themselves, is the principle culprit.
“What due diligence was done?” he asks. “Why weren’t (the irregularities at Madoff) picked up? If best practices were followed, why did they fail?”
“There is a very interesting consequence to this. People Investors who put funds with Madoff, who now have nothing, will have massive claims,” Walton says. “Service providers – the investment managers and advisers, auditors and administrators - these are all the types of people who can be targeted and held accountable to make a contribution to the losses. “But who is going to pay for the cost of pursuing these claims? Who will pay for the liquidators? The one area that is going to grow is those group of funds which go to insolvent funds, to finance the activities of liquidators trying to recover value for investors.”
The Bear Stearns Structured Credit Fund did just that, getting outside financing to pursue the substantial claims that investors had against the fund’s service providers. “There aren’t many people out there who are willing and able to finance that kind of activity,” Walton says. “Can you sue service providers? The advisors to the investment? The auditors? These are all the types of people who can be targeted and held accountable to make a contribution to the losses.”
His remarks came as GMAC said it had begun legal action against Ezra Merkin and his firm Ascot Partners. It is believed that Merkin allocated an entire $1.6 billion fund of funds to Madoff but didn’t disclose who was managing the money.
For investors, the big issue is how funds of funds portfolio managers missed such a big diversion. FoFs, afterall, get paid a 1% fee to carry out basic diligence, among other things. Many, it seems, were happy to take the money without carrying out their duties. Investors have every right to be livid.
The fiasco comes at an extremely sensitive time for the industry. It is like the crest of a tsunami whipped up by the perfect storm, hitting land without warning.
“The number of people affected and afflicted is just staggering,” says Jeremy Walton, a Cayman-based partner in Appleby’s litigation practice group and the head of the global law firm’s fund disputes team. “This is exacerbating the already massive liquidity problems. There will be more suspensions of redemptions and liquidations of funds.”
He fears that the main planks in the hedge fund sector’s defence – justifiably blaming banks for the crisis; few cases of fund fraud; and the sufficiency of light regulation – now look wobbly. “Those are the three main planks of the industry’s defence,” Walton says. “All are now impaired by the Madoff saga. The timing couldn’t be worse.”
Normally, the year end is a very busy time in the hedge fund sector. Investments are reviewed, allocations and redemptions are finalised and performance fees are billed. This year, however, solicitors are busy with litigation focused on lowered gates, fund suspensions and liquidations.
Walton predicts that the rebuilding process the industry will be going through will feature big battles over who should have spotted Madoff. And who among regulators, auditors, and the funds themselves, is the principle culprit.
“What due diligence was done?” he asks. “Why weren’t (the irregularities at Madoff) picked up? If best practices were followed, why did they fail?”
“There is a very interesting consequence to this. People Investors who put funds with Madoff, who now have nothing, will have massive claims,” Walton says. “Service providers – the investment managers and advisers, auditors and administrators - these are all the types of people who can be targeted and held accountable to make a contribution to the losses. “But who is going to pay for the cost of pursuing these claims? Who will pay for the liquidators? The one area that is going to grow is those group of funds which go to insolvent funds, to finance the activities of liquidators trying to recover value for investors.”
The Bear Stearns Structured Credit Fund did just that, getting outside financing to pursue the substantial claims that investors had against the fund’s service providers. “There aren’t many people out there who are willing and able to finance that kind of activity,” Walton says. “Can you sue service providers? The advisors to the investment? The auditors? These are all the types of people who can be targeted and held accountable to make a contribution to the losses.”
His remarks came as GMAC said it had begun legal action against Ezra Merkin and his firm Ascot Partners. It is believed that Merkin allocated an entire $1.6 billion fund of funds to Madoff but didn’t disclose who was managing the money.
