Jeremy Warner: Investors should have looked at Madoff's golf scores

Outlook: Ms Horlick and her co-investors were victims, but only of their own stupidity, greed and carelessness
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The Independent Online

When in a mess, blame it on the regulators. Nicola Horlick and others who trusted clients' money to Bernard Madoff's giant "Ponzi" scheme have taken to portraying themselves as hapless "victims" of massive regulatory failure.

Nice try, but unfortunately for their reputations, the failure is entirely their own. If you invest in a hedge fund, you cannot expect anything other than the principle of "caveat emptor" to protect you from rogues and mismanagement. Ms Horlick and her co-investors were victims, but only of their own stupidity, greed and carelessness.

The hedge fund industry, with the active connivance of those who invest in it, has spent years fighting greater oversight, and indeed has long trumpeted the fact that it is largely unregulated as one of its main attractions.

The US Securities & Exchange Commission (SEC) was no doubt at fault in failing to recognise the warning signs, which were legion. Unusually for such an investment manager, Mr Madoff was also his own broker dealer, so tangentially the SEC was responsible for monitoring his activities. His securities operation alone should have set alarm bells ringing.

Yet the hedgies have always operated at the wild frontiers of the capital markets, and though many portray themselves as low risk, you'd be crazy to invest without your eyes wide open. Adequate due diligence is the order of the day for any investment business which isn't fully underwritten by government regulation.

Back in the early 1990s, while on The Independent on Sunday, I was involved in an investigation into the affairs of George Soros, the hedge fund manager then newly made famous as the man who broke the Bank of England. Not much was known about hedge funds in those days. We found it a genuine revelation to discover that the apparently spectacular returns were in large measure down to the application of leverage. More revelatory still was the discovery that Mr Soros and his partners took a substantial share of any profits the funds made on top of their normal management fee, while not being exposed to any of the downside. All this is today old hat, but at the time it was little understood outside the elite of financial markets.

Eventually we were persuaded by our libel lawyers that it wasn't fraudulent to charge a "carry" or to use "leverage", provided investors knew about it, but we were able to conclude that because it encouraged excessive risk-taking it was potentially quite dangerous, both to investors and the financial markets as a whole.

Ms Horlick claims she is the victim of a sexist "witch hunt" in being highlighted for having invested with Madoff when others have lost far more. This may or may not be true, but she has rather set herself up for it by insisting that regulators should have done more to save her. She pretends to be a professional investment manager. Why didn't she save herself?

If Ms Horlick sincerely wants a massive regulatory backlash, she can be pretty sure of getting one now. By the time the politicians, lawyers and regulators have finished with this one, investment managers won't be able so much as to lift their little finger without receiving a red card.

The SEC is not there to protect people like Ms Horlick or the myriad others among the rich and well-advised who placed their money with Mr Madoff. In theory, they should be quite capable of taking care of themselves. The fact that they haven't been able to is their mistake.

As I say, there were enough warning signals, including the fact that Mr Madoff's auditors were a one man and his dog operation housed in a 13ft by 8ft office in Rockland County, New York. In no particular order, the others include the impossibly consistent nature of his performance record. This is matched only by the spooky consistency of Mr Madoff's golf scores at the Palm Beach Country Golf Club, though I don't expect Ms Horlick should have noticed the manipulation that must have gone into them – always in the 80s.

There was also the dead giveaway of amazingly low fees. Nobody on Wall Street charges so little without some kind of scam on the side. Then finally there was the fact that hardly anyone was ever allowed to meet the man, and the few that did always came away completely clueless as to how he made his money. Greed led Mr Madoff's clients to overlook these classic characteristics of the fraudulent operation.

Hedge funds are lightly regulated because they collect their money almost exclusively from the super wealthy and the wholesale money markets. The disciplines of the markets are judged to be sufficient without regulatory interference. In Mr Madoff's case, the money came largely from "feeder funds", some of which would gear up the client's millions by an extra three to four times to achieve even better returns on equity than Mr Madoff was promising. Leverage became overlaid with leverage.

By removing access to this leverage, the credit crunch has severely impaired the returns that hedge funds can make, leading to a mass of redemptions. So serious has the outflow of capital become that many hedge funds have put up barriers to stop investors getting out.

Ironically, this has made some of the better-run funds even morevulnerable to the run of redemptions, since they tend to be the ones where it is still possible for the investor to remove his money.

Mr Madoff's antics will add further impetus to this process, but the real damage will be to the feeder funds, the funds of funds whose only raison d'etre and justification for their fee is to carry out the due diligence and ensure that the hedgies they are invested in are up to scratch.

On this, the likes of Union Bancaire Privée, which has lost about $1bn on Madoff, have plainly failed. If Ms Horlick is looking to blame anyone, it should be the funds of funds, though even here she is hardly on firm ground. The better funds of funds always avoided Mr Madoff like the plague. Even if they are advised, any money manager worthy of the name has to know what on earth it is they are investing in.

As for the bankers – Royal Bank of Scotland and HSBC among them – that lent hundreds of millions of dollars in leverage to funds of funds against the collateral of the Madoff assets, well what do you expect? They are only bankers, after all.

In the scale of the wanton destruction of shareholders' and depositors' money revealed by the unfolding crisis of the past year and a half, this is but a drop in the ocean. It is also, on the other hand, another defining example of the collective stupidity which seems to have overcome them. What could they have been thinking in squandering our money with such abandon?

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