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GREG N . GREGORIOU "I know Bernie. I can get you in. " he decided to pay out existing investors with
is a professor of finance at money coming in fi"om new ones. Things grew
the State University of New —A former friend
worse as redemptions increased and new
York in Plattsburgh, NY. he man had an impeccable reputa- investor money dried up.
gregorg@plattsburgh.edu
FRANCOIS-SERGE
LHABITANT
is a professor of finance
at the HEC University
T tion on Wall Street. He was on the
shorthst of guests to every family
birthday, anniversary, bar mitzvah,
wedding, and graduation. His firm was ranked
as one of the top market makers in Nasdaq
While his story seems eerily recollective
of the spectacular fall of the U.S. $450 million
Bayou Funds in August 2005, the size of the
potential loss is likely to be massively different:
up to U.S. $50 billion, according to Madoff
of Lausanne and at the traded stocks. His solid and consistent track himself The U.S. SEC investigations have just
EDHEC Business School
in Nice, France.
record generated a mixture of amazement, fas- started and are likely to last several years, given
f@lhabitant.net cination, and curiosity. Investing with him was the complexity of the case. The abuity to invest
exclusive—a clear sign that one had made it with Madoff was officially not open to all, but
socially. Bernard MadofFwas truly a legend in the list of potential victims has already unrav-
the fmancial industry. Admired by most, ven- elled in the media spotlight and seems to grow
erated by some, his success was such that very with the strength and swiftness of a typhoon.
few dared criticizing him without risking their It includes not only charitable organizations,
careers. His house of cards nevertheless crum- pension funds, and well-to-do individuals and
bled on December 11, 2008, when news broke celebrities, but also numerous investment pro-
that the F.B.I, had arrested Madoff and charged fessionals, reputable banks, hedge funds, and
him and his brokerage firm Bernard L. Madoff fund of hedge funds. As of January 6, 2009,
Investment Securities LLC (BMIS) with secu- more than 8,000 claim forms had been mailed
rities fraud. According to the SEC's complaint, to Madoff customers seeking protection under
Madoff himself informed two of his senior the Securities Investor Protection Act.
employees that his investment advisory busi- All Madoff investors should in retrospect
ness was "just one big lie" and "basically, a kick themselves for not asking more questions
giant Ponzi scheme." prior to investing. As many of them have
Hedge fund failures usually generate a learned to their regret, there is no substitute
great deal of press coverage. The Madoff case for due diligence. Indeed, as discussed in this
was no exception. According to the Wall Street article, there were a number of red Oags in
Journal, the troubles started when Madoff suf- Madoff's investment advisory business that
fered from reversals. Rather than admit losses.
EXHIBIT 1
Unbundling the Split-Strike Conversion Portfolio
Terminal
payoff
Participation
S&P Index'
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Year
1990 2.8% 2.8%
1991 3.1% 1.5% 0.6% 1.4% 1.9% 0.4% 2.0% 1.1% 0.8% 2.8% 0.1% 1.6% 18.6%
1992 0.5% 2.8% 1.0% 2.9% -0.2% 1.3% 0.0% 0.9% 0.4% 1.4% 1.4% 1.4% 14.7%
1993 0.0% 1.9% 1.9% 0.1% 1.7% 0.9% 0.1% 1.8% 0.4% 1.8% 0.3% 0.5% 11.7%
1994 2.2% -0.4% 1.5% 1.8% 0.5% 0.3% 1.8% 0.4% 0.8% 9% -0.6% 0.7% 11.5%
1995 0.9% 0.8% 0.8% 1.7% 1.7% 0.5% 1.1% -0.2% 1.7% .6% 0.5% 1.1% 13.0%
1996 1.5% 0.7% 1.2% 0.6% 1.4% 0.2% 1.9% 0.3% 1.2% .1% 1.6% 0.5% 13.0%
1997 2.5% 0.7% 0.9% 1.2% 0.6% 1.3% 0.8% 0.4% 2.4% (J.6% 1.6% 0.4% 14.0%
1998 0.9% 1.3% 1.8% 0.4% 1.8% 1.3% 0.8% 0.3% 1.0% .9% 0.8% 0.3% 13.4%
1999 2.1% 0.2% 2.3% 0.4% 1.5% 1.8% 0.4% 0.9% 0.7% .1% 1.6% 0.4% 14.2%
2U00 2.2% 0.2% 1.8% 0.3% 1.4% 0.8% 0.7% 1.3% 0.3% 0.9% 0.7% 0.4% 11.6%
2001 2.2% 0.1% 1.1% l.i% 0.3% 0.2% 0.4% 1.0% 0.7% 1.3% 1.2% 0.2% 10.7%
2002 0.0% 0.6% 0.5% 1.2% 2.1% 0.3% 3.4% -0.1% 0.1% 0.7% 0.2% 0.1% 9.3%
2003 -0.3% 0.0% 2.0% 0.1% 1.0% 1.0% 1.4% 0.2% 0.9% 1.3% -0.1% 0.3% 8.2%
2004 0.9% 0.5% o.r/o 0.4% 0.7% 1.3% 0.1% 1.3% 0.5% 0.0% 0.8% 0.2% 7.1%
200S 0.5% 0.4% 0.9% 0.1% 0.6% 0.5% 0.1% 0.2% 0.9% 1.6% 0.8% 0.5% 7.3%
2006 0.7% 0.2% 1.3% 0.9% 0.7% 0.5% 1.1% 0.8% 0.7% 0.4% 0.9% 0.9% 9.4%
2007 0.3% -0.1% 1.6% 1.0% 0.8% 0.2% 0.2% 0.3% 0.2% 0.5% 1.0% 0.2% 6.4%
2008 0.6% 0.1% 0.2% 0.9% 0.8% -0.1% 0.7% 0.7% 0.5% -0.1% 4.5%
EXHIBIT 3
Fairfield Sentry Ltd versus the S&P 100 (OEX)
800n
0
Nov-90 Nov-93 Nov-96 Nov-99 Nov-02 Nov-05