Toomre Capital Markets LLC

Real-Time Capital Markets -- Analytics, Visualization, Event Processing, and Intelligence

Madoff Source of Investor Funds in 1992 Refund?

Over the past couple of days, Toomre Capital Markets LLC ("TCM") has spent some time focusing on the Bernie Madoff fraud scandal and particularly on how he could have perpetuated the fraud in such a great amount on so many investors over such a great period of time. Some of the resulting TCM posts have included:

TCM has been particularly interested in what lessons might be learned from this scandal, particularly regarding the areas of Enterprise Risk Management and due diligence. Let's summarize TCM's understanding to date about Bernie Madoff's early days:

Apparently Bernie Madoff started out in 1960 with $5,000 in funds that he had "saved" from a lifeguard and home sprinkler installation jobs. He was married to his high school sweetheart, Ruth Alpern Madoff. He may have worked earlier for his future father-in-law at the Manhattan accounting firm Alpern & Heller where Frank Avellino and Michael Bienes also then worked. His first investor was the philanthropist was Carl Shapiro. Apparently, though, Bernie Madoff never made a single trade for his investment business customers.

Starting in 1962, Frank Avellino and Michael Bienes solicited monies that were then "invested" with Bernie Madoff that generated steady returns for investors in the range of 13.5 per cent to twenty per cent. Their investment solicitation business was so successful that by 1984 Avellino and Bienes gave up their accounting business. By 1992, Avellino and Bienes had amassed more than 3,200 investors and approximately $450 million in investment principal.

Then, in late 1992 based upon a tip from an anonymous source about a possible Ponzi scheme, the SEC investigated Avellino & Bienes ("A&B"). The SEC was surprised to learn that the funds were invested with the then current Chairman of the NASDAQ, a certain Bernie Madoff. The books apparently were in order and according to reports at the time, "all of the money was there." Hence, the SEC only sanctioned Avellino and Bienes for running an unregistered investment advisor and ordered that the firm close after returning all of the funds to its investors. Apparently, Madoff, Avellino and Bienes also returned "every cent" to those early investors.

At that point in 1992, given that:

  1. Bernie Madoff had been running his fraud for about twenty years,
  2. Bernie Madoff apparently had been "generating" returns of at least 13.5% per year (or at least that is what he reported to A&B), and
  3. Bernie Madoff also apparently never did a trade (and hence never had any market exposure)

One question suddenly screams out: What were the sources of the funds that Madoff used to return both the interest earned and investment principal A&B's investors in 1992? In short, if Madoff was running a Ponzi scheme for A&B (as alleged in 1992), what other sources of funds were available to Madoff? Did he have as much other "invested" monies at that point? Or did he have some "rabbi" (like Carl Shapiro thought he was being in November 2008) from whom Bernie Madoff borrowed money?

(Apparently, subsequent to the SEC settlement, many of the A&B unregistered note investors rolled over their investments into accounts directly with Bernie Madoff's securities firm. One has to wonder though why none of these investors inquired about and/or confirmed whether that firm was indeed registered as an investment advisor.)