Frank DiPascali Jr.'s Secret Fee Arrangments - Don't Ask Don't Tell

Frank DiPascali Jr. is scheduled to plead guilty today. Mr. DiPascali was reportedly Madoff’s top aide who sometimes referred to himself as the Chief Financial Officer of Madoff’s firm. While the specific charges to which he will be pleading guilty to are unclear (although it is likely to include multiple counts of fraud) it is suspected that his sentence will be lessened by the fact that he is reportedly cooperating with investigators. This cooperation is also supposed to assist investigators in strengthening their case against certain feeder firms. These supposed deals guaranteed certain feeder funds (and perhaps even funds of hedge funds) with higher rates of return, albeit fraudulent ones, than other Madoff clients were receiving.


I find these supposed deals quite interesting. While pre-Madoff it may have been unheard of to think that investors with the same terms might all be generally receiving the same performance returns for investment in the same hedge funds it is now becoming more apparent that all investors are not competing on a level playing field. Please note I said above, investors with the same terms. That’s just the problem, not everyone has the same terms for each hedge fund investment. While, today many hedge funds seem to be resisting the temptations they may have succumbed to a few years ago to enter into side letters with investors spelling out a myriad of different nuances such as capacity agreements, most favored nations clauses and the like, such agreements are still prevalent, if not only for legacy reasons.

Here is a video from Fox Business News about the planned guilty plea:


During the course of the operational due diligence process, it is often useful to inquire about not only the so-called standard fund terms listed in the fund’s offering documents and marketing materials but about what “special deals” other investors may have bartered. Sometimes a hedge fund may clam up and simply state they don’t disclose the details of other investors. This curt response should be viewed as a stumbling block, not a brick wall. When faced with such a dilemma, the role of the operational due diligence analyst should be to try to utilize their red flag social network, to locate other investors and gather some general market intelligence. This may not yield any results, but at least it’s worth asking. Additionally, if the same request is sent to the hedge fund for this information several times they may eventually crack. Uncovering such information is no guarantee that a hedge fund manager may give you the same preferential terms as it may have given to a day one or extremely large investor, but it will give you the peace of mind to know that you are making an informed decision.

In Mr. DiPascali’s case, any unwillingness to talk, even generally, about such deals should have certainly been a red flag. Bloomberg even reported that Madoff didn’t want any notes taken during meetings, no less discussing such sensitive issues about fee arrangements. Now it looks like those investors which were swindled by Madoff will have to learn about them via court documents rather than during the due diligence process.

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