Saturday, December 13, 2008

America’s own Pak Man Telo to cost investors US$50 billion (RM180 billion)

I was once approached by my office colleague back in early 1990s to invest in scheme in which he promised 10% return per month, or 120% annual return.

I was never convinced. I told him (he was an accounts clerk) that such investment scheme was fraudulent, and will not last more than a year. I explained to him my own understanding of the investment scheme, which turned out to be similar to the pyramid scheme. Monies were collected from new investors to pay the existing investors their dividends. The investors will continue to reap the dividends for so long there are new investors. Without new investors, the scheme will take the monies out of the capital invested, to continue paying the dividends. The scheme will fail when there are no or not enough new investors, and/or when existing investors pull out their invested capital.

Upon my colleague’s insistence, I asked him how long has he been investing (or rather collecting the monies for investment). He mentioned that he has just managed to get his first monthly return. I told the accounts clerk to be careful, and not to invest further. I also told him that in any case, such predetermined dividend scheme was haram (forbidden) and not to use the income to feed his kids. Six months later, the famous story of Pak Man Telo was flashed throughout the mainstream newspapers. Luckily, my colleague “survived” as he partly followed my second advice to him: only reinvest in the part of the capital, and take out the monthly dividend. His “down liners” were not as lucky, and cursed him for that.

In America, the investment scheme is better known as the Ponzi scheme, after a famous swindler called Charles Ponzi back in 1920. Charles Ponzi was not probably the original Pak Man Telo. And yes, the Americans were also susceptible to such fraud.

The Ponzi scheme (or Pak Man Telo) has various disguises. Apart from pure cash investment with promised returns, some swindlers would disguise their scheme under the pretext of saleable websites, internet businesses and others. These schemes will only surface after at least a year of operations, when the later investors would complain of losing their capital. Swisscash scheme, using the internet as a medium, cost Malaysian investors a few hundred million.

Back in 1997, when I first heard of hedge funds, I also thought that they were a variant of Pak Man Telo scheme. Obviously, most of them were not, because they actually made investments via huge leveraging (borrowed a lot of money using the capital that they owned) and excessive speculations (active buying and selling of assets).

It was indeed a shocker to know that former Chairman of NASDAQ, Bernard L. Madoff (sic, what a name too), was actually a grand schemer of a giant Ponzi scheme under the disguise of Bernard L. Madoff Investment Securities LLC.

Madoff has been a Wall Street trading powerbroker and hedge fund manager for years. He allegedly ran the giant Ponzi scheme separately from his other investment businesses. Madoff’s scheme collapsed when his clients asked for US$7 billion to be returned this month. Madoff allegedly confessed to a fraud that may cost his investors a whopping US$50 billion.

The revelation could not have come at the worst time to the American investors, wealthy socialites in Palm Beach and Long Island. With the credit crunch, world financial turmoil and bleak economic outlook, this is something they would not want to hear. Some charities have been investing in Madoff’s scheme too with one of them investing US$8 million.

Madoff’s investment scheme has been making steady above average returns 10% to 11% per annum, with monthly returns of between 0% to 2% per month and never a negative return. These were signs of bogus schemes such as Pak Man Telo. But Madoff’s reputation as person of integrity, and being a former Chairman of NASDAQ may have led to his investors being hoodwinked.

The US$50 billion losses was much bigger than the losses than brought down Bear Stearns, and much bigger than the US$7 billion in hidden losses in Societe Generale’s Jerome Kerviel’s scandals. These banks had thousands of clients. Madoff had less than 300 investors in his scheme.

In Malaysia, some non-Malay investors had alleged that the Amanah Saham Wawasan 2020 is also a Ponzi scheme. In order to discourage the Chinese to invest in ASW2020, they had alleged that the recent RM950 million issues of new units was part of a scheme to sustain the dividend payment to the existing shareholders. These people should have read the audited annual reports of ASW2020 before making such allegations. Unlike Madoff, PNB has been very transparent in issuing their statement of accounts. Investment in shares of public listed companies, as being done by ASW2020 and other PNB's unit trust schemes have values, and not they are not blank papers.

[Updated 17 December 2008:
It was revealed that Madoff investment scheme was audited by a small three-person audit firm. It is amazing that his big spending clients did not question the authenticity of the scheme. Some of the big investors and their potential exposures are as follows:-

HSBC Holdings plc - US$1 billlion
Royal Bank of Scotland - US$590 million
Man Group - US$360 million
Natixis of France - US$620 million
UniCredit SpA Italy - US$100 million
Nomura Holdings Inc - US$300 million
Banco Santander SA Spain - US$3.17 billion
BNP Paribas - US$480 million
Fairfield Greenwich Group - US$7.3 billlion]

US$50b at stake after broker’s arrest over ‘world’s biggest swindle’

NEW YORK, Dec 13 — Some of America’s wealthiest socialites were facing ruin after the arrest of a Wall Street big hitter accused of the largest investor swindle perpetrated by one man.

Shock and panic spread through the country clubs of Palm Beach and Long Island after Bernard Madoff, a trading powerbroker for more than four decades, allegedly confessed to a fraud that will cost his wealthy investors at least US$50 billion (RM180 million) — perhaps the largest swindle in Wall Street history.

Madoff, 70, a former Nasdaq stock chairman, was apparently turned in by his two sons and arrested on Thursday morning at his Manhattan apartment by the FBI. Andrew Calamari, a senior enforcement official at the US Securities and Exchange Commission, described the scheme as “a stunning fraud that appears to be of epic proportions”.

The FBI’s criminal complaint states that when two federal agents arrived at Madoff’s apartment, he told them: “There is no innocent explanation.”

The agents say that he told them “he paid investors with money that wasn’t there”, that he was “broke” and that he expected to go to jail.

Many of his investors came from the enormously wealthy enclaves of Palm Beach, Florida and Long Island, New York, where people had invested billions in Madoff’s firm for decades. He was a fixture on the Palm Beach social scene, and was a member of some of its most exclusive clubs, including the Palm Beach Country Club and Boca Rio Golf Club, where he drummed up much of his business.

The FBI claims that three senior employees of Madoff’s investment firm turned up at his apartment on Wednesday to ask questions about the company’s solvency. Two of them are believed to be his sons, Andrew and Mark, who have worked for their father for two decades.

Madoff told them that he was “finished”, that he had “absolutely nothing”, and that “it’s all just one big lie”. He said the investment arm of his firm was “basically a giant Ponzi scheme”, and that it had been insolvent for years.

A Ponzi scheme, named after the swindler Charles Ponzi, is a fraudulent investment operation that pays abnormally high returns to investors out of money put into the scheme by subsequent investors, rather than from real profits generated by share trading.

The FBI complaint states that Madoff told his sons that he believed the losses from his scheme could exceed US$50 billion. If that is the case, his fraud would be far greater than past Ponzi schemes and easily the greatest swindle blamed on a single individual.

There has been scepticism for years on Wall Street over how Madoff managed to pay such consistently high returns. Ponzi schemes inevitably collapse, and Madoff found himself to be no exception. This month, clients asked for US$7 billion to be returned, the FBI says.

Madoff ran the scheme separately from his main business and his sons had no involvement in it.
Madoff has been charged with a single count of securities fraud. He declined to enter a plea in Manhattan’s US District Court and was released on US$10 million bail. He faces up to 20 years in jail and a US$5 million fine if convicted. His lawyer, Dan Horwitz, said that his client was “a person of integrity. He intends to fight to get through this unfortunate event.”

One investor told The Wall Street Journal: “This is going to kill so many people. It’s absolutely awful.” Ira Roth, from New Jersey, said that his family had US$1 million invested, and that he was in a state of panic. — Times of London

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