The Anniversary of the Madoff Fiasco

It was one year ago today, Dec. 10, 2008, that the two sons of Bernard Lawrence Madoff informed authorities that their father had just admitted to them that his asset management operation was "one big lie." He would be arrested the following day. That makes this an anniversary worthy of some reflection.

Those two sons, Mark and Andrew, worked in the trading operation, not asset management, thus they just might have been innocent of any criminal involvement themselves, though I'm sure investigations are continuing, the books are not closed on that.

This distinction between the trading and the asset management side is crucial to the Madoff saga. Madoff's trading operation, formally known as a "market maker," launched in 1960, was legitimate. It was controversial in some respects (especially among those of us who consider the practice of payment-for-order-flow inherently dubious) but it was legal. It also may have been integral to the success of his ponzi scheme, formally known as an investment advisor (IA), although not integral in the way that was so often suspected.

Madoff was often suspected of attaining the unusually consistent results of the IA operation by "front-running," i.e. by making illegal use of information he acquired as a market maker. The SEC would periodically investigate Madoff, only to find that he wasn't front running, so he must be clean! The truth of course is that he wasn't front running because he wasn't really trading through the IA wing of his company at all. It was all a sham, and those surprisingly consistent results were simply invented. So the possibility of front-runing was serving perhaps two purposes. First, as noted it was a false scent that kept the regulators busy. But, secondly, it may have helped attract investors. "Pssst, this guy is likely front-running the info from his market maker side. We should get us a piece of that action."

Or ... maybe not. But it is an intriguing idea: that the victims were in part victimized by their own desire to get on the winning side of a con game. That con game wasn't happening. So they ended up on the losing side of another one.