Madoff's scandal seen as ill omen-Other firms wave red flags, data show

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Madoff's scandal seen as ill omen
Other firms wave red flags, data show
By Eamon Javers

Posted: 01/12/2009 12:01:00 AM CST


Bernard Madoff, December 17, 2008. (Daniel Acker/Bloomberg News)Barack Obama's economic team, already reeling from the financial meltdown, certainly doesn't need any more headaches. But investigators and Washington officials say that they're almost certainly going to face one unexpected problem in 2009: More Bernard Madoff-style corruption scandals.

The ranking member on the House Financial Services Committee, Rep. Spencer Bachus, R-Ala., says he's confident there's more bad news on the way.

"History teaches us that if there is a gap in regulatory enforcement, there will not only be one offender that will be devious enough to slip through," Bachus said. "Unfortunately, when the tide goes out, you find out who's swimming naked, and I suspect that Madoff was not the only one."

Veteran fraud investigators, too, say they're almost certain other financial frauds are waiting to be discovered. "There are probably a lot of shocks out there still to come," said Michael Varnum, a former chief of the FBI's public corruption and economic crimes programs who's now a senior vice president at the private investigative firm Corporate Risk International.

"There is probably another Bernie Madoff out there," Varnum said.

The question, then, is how to find the questionable firms?

One way to search for them is to look for companies that exhibit the same red flags investors say indicated Madoff was running a scam.

The main red flag in Madoff's case was that he never reported a down quarter. With the natural ups and downs of market trading, investigators say it's nearly impossible to have continuous success.
Are there other firms out there with unblemished quarterly records? Yes.

According to research done by Morningstar Inc., there are 1,684 hedge funds that have disclosed their results for the past 20 consecutive quarters. Of those, Morningstar found 34 that have never reported a down quarter in the past five years. And of those 34, at least seven funds, or their parent firms, are in some way connected to the Madoff scandal as investors in Madoff's operation. That leaves 27 firms that have a five-year track record of gains and no known connection to Madoff.

Varnum says that's suspicious on its face. "It's a red flag for me as a potential investor," he said. "I'd look at that and say, 'How could there not have been any down quarters?' "

Indeed, one of the funds is run by an executive who has faced a series of lawsuits.

To be sure, the time frame captured by the Morningstar data — the fourth quarter of 2003 to the third quarter of 2008 — was generally a good time to make money in the stock market — though it got much tougher in 2008. And many of the firms may be exactly what they purport to be: excellent, and perfectly


Among funds of funds, or hedge funds that invest their money in other funds, such results are much more rare. Morningstar found that of 1,227 funds of funds that have reported 20 consecutive quarters of results, only four have failed to report a single down quarter in that time frame. And none of the four seems to be publicly connected to the Madoff scandal.