Madoff- Evidence of an Unregistered Money Management business
-- possibly included Hedge Funds.
By David Scheer and David Glovin
December 15, 2008

Federal investigators working through the weekend to unravel Bernard Madoff’s alleged $50 billion Ponzi scheme found evidence he ran an unregistered money-management business alongside his firm’s brokerage and investment-advisory subsidiaries, two people with knowledge of the inquiry said.

Clients of the undisclosed unit may have included hedge funds, according to the people, who declined to be identified or to name the funds because the probe isn’t public. Investigators from the U.S. Securities and Exchange Commission are looking for signs that others participated in the alleged fraud and are examining why Madoff’s wife’s name appeared on documents linked to transactions under scrutiny, the people said. His wife, Ruth Madoff, has not been accused of any wrongdoing.

Ira “Ike” Sorkin, a lawyer at Dickstein Shapiro LLP in New York representing Madoff, didn’t reply to a phone call and e-mail seeking comment. Calls to residences listed in the Madoffs’ names in Manhattan, Montauk, New York, and Palm Beach, Florida, weren’t answered. John Heine, an SEC spokesman, declined to comment.

Sorkin said on Dec. 13 that the situation was “a tragedy.”

More than a dozen SEC inspectors have been working around the clock examining records at Bernard L. Madoff Investment Securities LLC in New York after his sons told authorities Dec. 10 he’d confessed to orchestrating a Ponzi scheme with more than $50 billion in losses, the biggest in history. People with knowledge of the probe who initially said they suspected the loss estimate was too high now say it may be roughly accurate.

Wilpon, BNP Paribas

The $50 billion figure may reflect the amounts of money clients were told they had in their accounts at the firm, not the amounts they originally invested, two of the people said. Customers who believed they had amassed investment gains over time may have been misled, the people said.

Clients facing losses range from New York Mets owner Fred Wilpon’s Sterling Equities Inc. to hedge funds such as Fairfield Sentry Ltd. The alleged scam has ensnared more than 25 companies around the world, including some of the biggest financial-services firms such as BNP Paribas SA in Paris and Nomura Holdings Inc. in Tokyo, which have said they may lose money because of trading or lending tied to Madoff’s firm. In all, companies, individuals and foundations have disclosed about $24 billion of investments with Madoff, according to data compiled Bloomberg and media reports.

Investigators are still trying to figure out where customers’ money went. Madoff, 70, told his sons last week he had as much as $300 million left, according to an SEC lawsuit filed in federal court in Manhattan. The agency is looking for additional money that may be recovered for victims, two people said. In a regulatory filing in January, Madoff’s firm listed $17 billion in assets under management.

The 17th Floor

Details of the side-business that the SEC is scrutinizing -- including how much client money it held, who besides Madoff may have been involved in it, and how it was kept separate from the firm’s registered investment-advisory unit -- couldn’t be determined.

Madoff kept his firm’s financial statements under lock and key and was “cryptic” about its investment-advisory activities when discussing them with other employees, the SEC said in its complaint. The entire advisory business was a mystery to most staff members, said two firm employees who declined to be identified, citing concern about being drawn into the probe. Madoff’s offices on Third Avenue in midtown Manhattan extended over several floors, with market-making and proprietary trading units on the 19th floor, and back-office functions on the 18th floor, the employees said. Madoff’s advisory business was housed on the 17th floor.

While traffic flowed between the 18th and 19th floors, the 17th floor wasn’t linked to the other floors and there was virtually no interaction between the groups, according to the employees.

In the Dark

Madoff’s sons, who ran the market-making and proprietary units, told employees that their father kept them in the dark about the advisory unit, the employees said. While Madoff seldom appeared on the 18th and 19th floors during the workday, he was known to inspect during the evening for sloppy desks or window shades that weren’t fully drawn, one of the employees said.

The only person the employee recalled seeing Madoff consult with on the 17th floor was an executive known by his first name, Frank.

Reached by phone at home, Madoff official Frank DiPascali referred calls to his lawyer, Marc Mukasey, a former federal prosecutor now at Bracewell & Giuliani in New York. Mukasey declined to comment.

In court documents, U.S. criminal prosecutors and the SEC said Madoff confessed that his advisory business, which catered to rich people and institutional investors as well as hedge funds, was “all just one big lie.” The business had been insolvent for years, according to the SEC’s account of his statement.

SIPC Steps In

He made the admissions to his sons, Mark and Andrew, who turned him in to U.S. authorities, according to Martin Flumenbaum, a lawyer at Paul, Weiss, Rifkind, Wharton & Garrison LLP in New York who represents the brothers.

Madoff was arrested Dec. 11 and charged at federal court in Manhattan with a single count of securities fraud. He was released that day on a $10 million bond guaranteed by his wife and secured by his Manhattan apartment. A day later, a federal court froze the firm’s assets and appointed Lee Richards, an attorney at Richards Kibbe & Orbe LLP in New York, as a receiver.

The fate of Madoff’s brokerage customers also remains undetermined. The Securities Investor Protection Corp., which insures brokerages, plans to take over Madoff’s operation as early as today, three people said. The Washington-based SIPC oversees transfers of client accounts, including securities and cash, when a firm fails.

Brokerage Customers

“We are aware of the situation,” said SIPC President Stephen Harbeck. “Our long-standing policy is not to comment until we do something.”

Investigators haven’t indicated what losses, if any, brokerage customers may have suffered. To prevent losses, securities firms are supposed to keep SIPC-insured accounts isolated from the company’s own accounts. Though the SIPC provides insurance of up to $500,000 per client for lost assets, it doesn’t protect against investment losses.

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