"It was all fake" - Madoff's Frank DiPascali Jr.'s Begins Talking...

Frank DiPascali Jr., Bernard Madoff’s former “chief lieutenant” and chief financial officer formally entered his guilty plea yesterday. Mr. DiPascali pled guilty to 10 felony counts of conspiracy, fraud, money laundering and perjury. DiPascali was hired by Madoff straight from Archbishop Molloy High School. He went onto work for Madoff for 33 years. Some notable quotes from Mr. DiPascali’s appearance include:


-"I ended up being loyal to a terrible, terrible fault."

-"I apologize to every victim of this catastrophe, and to my family and to the government. I'm very, very sorry."

-“It was all fake”

-“It was all fictitious. I knew no trades were happening.”

-“I knew I was participating in a fraudulent scheme, I knew everything I did was wrong, and it was criminal, and I did it knowingly and willfully. I accept complete responsibility."

Despite these statements and both the prosecution and defense arguing for bail, U.S. District Judge Richard Sullivan denied his $2.5 million bail.

In making this decision the Judge Sullivan cited a presumption that a convict should be denied bail in the absence of "clear and convincing" evidence that he isn't a flight risk.

Here is a video discussing Mr. DiPascali's appearance:


With Mr. DiPascali remaining behind bars perhaps it will continue his continued cooperation and the additional parties who participated in the Madoff fraud he is expected to name.

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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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Another day, another fraud - Mr. Pippin's search for Ponzi fulfillment

Stuart J. Pippin of Kerrville, Texas, USA today was to be sentenced today for defrauding 35 investors of over $2 million dollars. Mr. Pippin, who is 60 years old and in a twist of irony, is named after a famous Broadway musical in which, “The Leading Player invites the audience to join them in a story about a boy prince searching for fulfillment.” Perhaps that’s what Mr. Pippin’s investors were looking for when they wrote checks without apparently performing any due diligence whatsoever.


Mr. supposedly told investors he would be running a commodity trading pool. The problem was that no trading actually occurred. Even worse, Mr. Pippin never even had bothered to set up a trading account for his CTA, Pippin Investments. In classic Ponzi fashion, Mr. Pippin even went so far as to manufacture false account statements and pay false dividends to some investors with other people’s money.

As if it was any consolation, at least the good Mr. Pippin wasn’t discriminating in selecting his victims which including his brother Fred, his former dentist brother-in-law Randall Voigt and other friends and relatives.

The CFTC caught on and sued Mr. Pippin who in 2006 was forced to pay $1.68 million in restitution and $106,500 fine. More recently the FBI came in and pursued a criminal indictment for wire fraud which is the crime he was being sentenced for today.

While this amount of money lost in this case may seem paltry when compared to the large scale sums of hundreds of millions of dollars in play in fraud cases such as Madoff, these cases highlight an important point. Often times it is the ultra-high net worth individual rather than the large institution that needs to be overly cautious in the hedge fund due diligence process.

This is particularly true for operational due diligence when an investor may have little to no concept of the additional types of operational risk they are signing up for when investing in a hedge fund manager. Perhaps a new good rule of thumb for hedge fund investing harkens back to an old classic: if a manager cannot explain, either operationally or from an investment perspective, what they are doing and it seems too good to be true – don’t invest. There are plenty of other people who will provide transparency in an effort to secure your investment.

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Has Rigor Mortis Set In On Your Due Diligence?

Corgentum Consulting has released a new piece entitled, "Has Rigor Mortis Set In On Your Due Diligence? - The dangers of inflexible operational risk methodologies."
This paper outlines the benefits of adding an element of flexibility to operational due diligence approaches and cautions against overly rigid operational risk methodologies.
The piece can be found in the Research section of the www.corgentum.com website or via direct link here.
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Preparing for the operational due diligence visit: A hedge fund's guide

As a result of the current economic environment and frauds such as the Madoff scandal, hedge fund investors have placed an increased importance on performing detailed operational due diligence reviews.

Corgentum has recently released a paper which outlines a few key steps a hedge fund can take to ensure that they are adequately prepared for an operational due diligence review. The paper can found in the Research section of the www.corgentum.com website, or via direct link here.

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The Depth Of The Dive: Gauging The Scope And Scale Of Due Diligence

Corgentum Managing Partner, Jason Scharfman, has written an article as a guest contributor for FINalternatives. The article, The Depth Of The Dive: Gauging The Scope And Scale Of Due Diligence .
The piece states in part, "in the post-Madoff environment it is no longer acceptable for a fund of hedge funds or any institution, which allocates to hedge funds, to simply claim that they have comprehensive investment and operational due diligence practices. These firms must be able to consistently demonstrate the depth and breadth of their due diligence." The full article can be read on the FINalternatives website here.
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Analyzing Operational Due Diligence Frameworks In Fund of Hedge Funds

Corgentum consulting released a study today entitled Analyzing Operational Due Diligence Frameworks In Fund of Hedge Funds.

This study seeks to develop a transparent benchmark against which operational due diligence frameworks may be compared. Key study findings include:
• Only 27% of fund of hedge funds have a full time person on staff or team dedicated to fraud detection

• There are less resources are dedicated to operational due diligence in the US as compared to the rest of the world(Asia and Europe)

• There is lack of consistency in fund of hedge funds operational due diligence approaches

• Smaller fund of hedge funds (under USD $1 billion) use a wide variety of operational due diligence frameworks with less dedicated resources

The full study can be read on here.

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A Due Diligence Quagmire: Merkin's Day in Court

APRIL 6, 2009

Andrew Cuomo (New York's attorney general) and son of Mario Cuomo (former NY governor who is now on the Willkie Farr & Gallagher payroll) filed a complaint today charging J. Ezra Merkin (a Harvard Law School graduate) and his Gabriel Capital Corporation (the Ascot, Gabriel and Ariel funds) with civil fraud charges alleging, in part, that:

1) Merkin concealed his links to Madoff
2) Lied about where investor's money was actually going
3) Used company's funds for personal purchases (including approximately $91 million of artwork for his apartment at the famous 740 Park Avenue, New York, NY)
4) Collected more than $470 million in management and incentive fees
5) Was responsible for investor losses of approximately $2.4 billion



The statement from Cuomo's office can be read here and the full complaint can be read here.

The complaint's more interesting quote highlights include:

1) "J. Ezra Merkin betrayed hundreds of investors who entrusted him with their savings by recklessly feeding their funds into the largest Ponzi scheme in history,..."
2) "Merkin was just a 'glorified mailbox.'"
3) “Merkin admitted that his 'monitoring' of Ascot consisted of, at best, general conversations with Madoff approximately once per month"
4) “Merkin was 'at best a charlatan.'"

Mr. Merkin's lawyer (Dechert's Andrew Levander) claims that the suit is "hasty" and "without merit." Mr. Levander further elaborated that:
1) clients knew that money was going to Madoff
2) some of them even met with Madoff personally
3) Merkin analyzed Madoff's strategy before investing
4) “Contrary to Mr. Zuckerman’s allegations, Mr. Merkin performed extensive due diligence on Madoff and his trading strategy,” Levander said. “Unfortunately, Mr. Merkin’s due diligence, just like the detailed investigations performed by countless others, including regulators, was thwarted by the intricate, fraudulent scheme perpetrated by Madoff.”

Schulte Roth & Zabel represents the Ascot Partners fund.

Merkin reportedly lost millions of his own money in the Madoff fraud.

Adding to Mr. Merkin's woes was another suit filed by Mort Zukerman. Mr. Zukerman is the chairman of chairman of Boston Properties Inc. and publisher of the New York Daily News.



According to Bloomberg the case is CRT Investments Ltd. v. J. Ezra Merkin, 601052/2009, filed in New York State Supreme Court (Manhattan).

The Cuomo complaint raises a number of operational due diligence red flags:

1) Misstatements regarding the roles of Madoff:

Merkin misstated Madoff's role in offering memorandum for the Ascot funds. The offering memorandum suggested that Madoff was one of many prime brokers utilized when quite the opposite was in place.

In 2006, for example, approximately 98% of Ascot’s transactions were both effected and cleared by Madoff, and Madoff had custody of over 99% of Ascot’s purported securities holdings.

The role, diversity and independent oversight of third-parties is an essential element to proper operational due diligence. All of which were apparently missing in this case.

2) Lack of reporting transparency:
Ascot’s quarterly statements to investors disclosed only the value of each investor’s account and the purported appreciation during the prior quarter.

3) A smoke screen was created regarding the roles of traders:

If investors asked who carried out Ascot’s trading activity, Merkin would sometimes deceive them by explicitly indicating that he and his employees at the 450 Park Avenue office did so.

Merkin's traders however, were involved only in managing Ariel’s and Gabriel’s assets, not Ascot’s, and Ascot’s trading was almost entirely carried out by Madoff.

4) Unclear investment strategy:

Merkin at times concealed the fact that Ascot engaged in the “split strike conversion” strategy by misrepresenting Ascot’s investment strategy as well as its management.

5) Counterparty risk:
Merkin made false and misleading statements to investors to foster the impression that Ascot’s funds were held with a sound, creditworthy broker (Morgan Stanley) when in fact the majority of assets were held with Madoff.

6) Misstatements about the role of BDO (the Ascot fund's auditor):
The complaint alleges that Merkin told an investor that he required Ascot’s auditor, BDO Seidman LP, to visit Madoff’s offices two or three times a year to perform standard operational due diligence. This representation was false. BDO did not perform standard operational due diligence, or any other kind of examination, on Madoff’s operation, and Merkin had no reason to believe otherwise.

Interestingly, the complaint also claims that Mr. Merkin himself "failed to conduct adequate due diligence in the face of clear warning signals for fraud."

• I am curious how many investors picked up the phone and called Morgan Stanley, BDO or anyone else to check on the nature of Merkin's claims?

• Or a better question could be what kind of due diligence was being conducted by the financial advisors of the hundred of investors who most likely funneled their client's money to Merkin?

• With all of these red flags seemingly overlooked, how did so many get it so wrong?

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e Managed Funds Associations Practice's Sound?

APRIL 1, 2009

Ahead of the now ongoing G20 London summit and eventual US regulation, the traditionally clandestine hedge fund industry has seemingly raised its own public profile via the actions of leading industry associations in the past few weeks. It seems the goal of this public profile raising is two-fold:
1) To show the world that the hedge fund industry is serious about self-regulating itself and it doesn't really need strict regulatory oversight

2) The hedge fund industry welcomes regulation BUT, (to plead in the alternative) if the hedge fund industry should be regulated then:

a) it wants a hand in designing that regulation

b) it wants just enough regulation to quell the current ire of the masses who have lost millions in Ponzi schemes and irresponsible risk taking, but not too much to actually make a difference

One of the most vocal voices in this campaign has been the Managed Funds Association which has released:
1) Sound Practices for Hedge Fund Managers 2009
2) A due diligence questionnaire

Each of these items should be addressed individually:

1) Sound Practices for Hedge Fund Managers 2009-
In what is essentially a regurgitation of the Presidents Working Group's Report of the Asset Managers' Committee, this 277 page document provides a series of platitude like generalist statements which are supposed to guilt hedge fund managers into building stronger operations. The most interesting thing to me about this document is that it contains approximately 1 page of "guidance" to hedge fund managers regarding what it terms to be operational risk. This as much an oxymoron as is a jumbo shrimp.

Operational risk is the very same series of risks that caused Ponzi schemes such as Madoff. Yet, apparently it's not sound practice to focus on such risks, rather things like Anti-Money Laundering (which received an entire chapter in the report) are apparently more important. To be fair the report does cover other operational areas such as valuation, trading and compliance in more detail without using the term "operational risk."

Specifically the report states, "A Hedge Fund Manager should have a strong operational infrastructure that is commensurate with the complexity of its business..." If anyone can explain to me what exactly this means I'd love to know. For example, is an infrastructure with no in-house accounting staff commensurate with a $50 million long/short manager? What about a $50 million distressed fund? Would one on-staff accountant be commensurate with the needs of a $500 million distressed fund? What if a hedge fund outsources the entire accounting process to a top-tier administrator? Is that commensurate enough? Of course the answer is it depends - to which the sound practices offer both hedge fund managers and investors no real guidance in developing an answer to these question.

2) A due diligence questionnaire-
This questionnaire, which in light of the massive Sound Practices document, is a ridiculously short 15 pages begins with an introduction from the MFA stating, " We believe that Hedge Funds are valuable to our capital markets and provide investors with valuable portfolio diversification and risk management." Translation, just give this questionnaire to your manager (or make any small changes you want), have them complete it, check the box and move on.

There is a general movement in the operational due diligence industry away from utilizing due diligence questionnaires. In certain instances, due diligence questionnaires are useful tools but the key is that they be detailed and probing. Operational due diligence is a detailed oriented and resource intensive process - the responsibility for which hedge fund investors cannot outsource to a questionnaire.

A Modest Proposal:
Far be it from me to offer criticism without offering my own solution.

Sound practice documents and due diligence questionnaires (along with the regulation of the hedge fund industry) are a good thing. However, such guidelines and questionnaires become very dangerous to hedge fund investors when they come with a wink and a nod that "the hedge fund industry accepts regulation, is self-regulating and if you don't believe it here's a guide to perform your own cursory due diligence." To me this is equivalent to giving investors a loaded gun with a hairpin trigger. The same types of investors that lost money with recent frauds, are exactly the same types that will look towards the MFA's due diligence questionnaire for guidance. Unfortunately, it is unbelievably short on real world specifics. Yes, the due diligence and the Sound Practices are meant to be only a starting point but my questions is - why set the bar so low?

A better approach would be to require hedge fund managers to provide an increased global uniform level of transparency and disclosure in relation to both financial and operational data. This would be the first step
towards leveling the playing field for hedge fund investors and stamping out fraud. But unfortunately in the hedge fund industry disclosure is dirty word, so for now we are left with the 2009 model of the old status quo.

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Fairfield Greenwich Charged With Fraud in Madoff Case

APRIL 1, 2009

An administrative complaint was filed today by Massachusetts Secretary of the Commonwealth William F. Galvin.

In the complaint it is alleged that a "profound disparity between the due diligence that Fairfield represented to its investors that it would conduct with respect to Bernard L. Madoff Investment Securities and the due diligence it actually conducted."

Here are the links to the complaint as filed:

1) Fairfield Complain (part 1 of 2)

2) Fairfield Complaint (part 2 of 2)

The exhibits are located here.

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Hedge Fund Regulation Doesn't Matter: An Artificial Operational Due Diligence Floor

MARCH 27, 2009

The new proposed hedge fund regulations suffer from a number of missed opportunities to raise operational due diligence standards for both "professional" hedge fund allocators such as fund of hedge funds and consultants as well as for individual investors.

Corgentum Consulting has released a new paper entitled, "Hedge Fund Regulation Doesn't Matter: An Artificial Operational Due Diligence Floor." This paper provides an overview of some of the primary shortcomings and pitfalls of the proposed legislation.

It is available here and was recently referenced at Conde Nast Portfolio.

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The effect of the Madoff guilty plea on hedge fund operational due diligence

MARCH 10, 2009

Bernard Madoff is expected to enter a guilty plea tomorrow and faces up to 150 years in jail. In light of this Corgentum Consulting has released a new white paper which discuss the effects of the Madoff scandal on hedge fund operational due diligence from both the investor’s and hedge fund’s perspective. The paper is entitled, “The Madoff Identity: A New Operational Due Diligence Paradigm in a Post-Madoff World.” and is available here.

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