Where is the money Bernie

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Inside The Madoff Mysteries
Liz Moyer, 12.16.08, 05:00 PM EST
Where's the money? Does he have it? Did he act alone? Will investors get their money back?

A week after Bernard Madoff confessed to running a $50 billion investor fraud, no one can say for sure what happened, and a lot more remains unknown than known.

Wednesday afternoon, he'll be in court facing a federal magistrate's bail hearing in New York. The hearing may bring some answers. For now, here's a look at the burning questions:

Where's the money?

Good question. Right now, no one knows. A receiver controls Madoff's assets and those of his firm, Bernard Madoff Securities. The investment advisory affiliate of the firm, where the alleged fraud is said to have occurred over untold years, had $17 billion under management at the beginning of the year, according to the Securities and Exchange Commission.

As of last week, Madoff had $200 million to $300 million left that he told senior employees of his firm he was going to distribute to family and friends before turning himself in. So where'd the $50 billion figure come from, apart from what Madoff is alleged to have said to those senior employees the night before his arrest last Thursday?

There are several theories floating about the Internet, and the securities class-action lawsuits are pouring into the courthouse. The key question is how Madoff handled the money he took in from investors. His firm was remarkable for returning consistent gains to investors for years, even in up and down markets, a fact that probably led investors to feel a false sense of security and enticed new investors into the fund. But traders have been saying in recent days that it would have been impossible to carry out Madoff's thinly defined strategy with that size of a portfolio and not have an impact on the markets.

Say instead that Madoff wasn't trading in large-cap stocks and options, as he vaguely described his trading strategy. Say he operated a pure Ponzi scheme, in which new money went to pay returns on existing investors. That $50 billion could be the total amount of money Madoff collected and paid out over the years. But that's just a theory.


He is quoted in court documents telling witnesses he was "finished" and "had absolutely nothing," but the SEC won a court order to freeze his assets and that of the firm. Among other things, that includes an account in Madoff's own name at Bank of New York Mellon (nyse: BK - news - people ), according to exhibits in the case. In the judge's order granting the asset freeze, the judge says, "It appears from the evidence presented that certain ill-gotten gains derived from the defendant's fraudulent conduct have been deposited into the accounts of [the firm] and/or Madoff's personal accounts."

How'd he do it? Did he act alone?


The accused implicated only himself in statements to law enforcement, but many have wondered in recent days how one person could have acted alone in duping so many people. For starters, investors received statements, so that means someone had to draft them, design, print and mail them. The firm would have had an auditor, discovered by some financial blogs to be a two-bit accountant in a tiny office in suburban New York, rather than the major auditing firm you'd typically find poring over books of a firm this size.

Then there are the employees of the Madoff market-making brokerage firm, housed just upstairs from the investment advisory where the alleged scheme took place. Many find it a far stretch to believe employees upstairs never ventured downstairs, or that information about the investment adviser's activities didn't filter up. In court documents, a witness says the adviser's books were kept under lock and key.

Several of Madoff's own family members worked at the firm, another fact that has raised eyebrows. His brother, Peter, is director of trading and chief compliance officer. Peter's daughter, Shana, is a compliance attorney (and it turns out she is married to a former SEC compliance staffer).

Sons Andrew and Mark are directors of proprietary trading and are believed to be the two senior officials to whom Madoff confessed the scheme last week and who turned him in through an attorney.

Will investors get their money back?

They're certainly going to try. The receiver, and ultimately the bankruptcy trustee (assuming the firm seeks bankruptcy, which lawyers say it will), has authority to claw back money from investors who successfully redeemed their investments before the alleged scheme unraveled. And there were many who were successful. Madoff's undoing was a $7 billion tsunami of redemptions.

Investors will no doubt also sue the firms that invested in Madoff on their behalf, but the precedent is trickier. A 2006 lawsuit against Hennessee Group by investors in the failed hedge fund Bayou Management was tossed out after the judge ruled Hennessee, which claims to perform due diligence for hedge fund investors, was just as duped as the SEC and everyone else to Bayou's deceptions. Bayou collapsed in 2005 and was eventually revealed to be a Ponzi scheme.

The Hennessee ruling is being appealed, with arguments set for January.

How did Wall Street's watchdogs miss this one?

In a statement late Friday, the SEC said its enforcement team probed the firm in 2007 and recommended no action. Many have said in recent days they saw clear warning signs at the firm--its extraordinarily even returns, the secretiveness with which Madoff managed the money, the fact that others could not replicate the firm's stated investment strategy--but no one stopped it until it was too late.