THE BLANCH REPORT

“The Blago Blues”

 

 

Two new stories are developing in the Rod Blagojevich saga. The first is the furor surrounding Blago's politically savvy appointment of former Attorney General Roland Burris to the seat vacated by President-Elect Barack Obama. We'll wait for that story to develop a bit more before analysis.

Right now we're interested in a legal matter: the progress (and lack thereof) in the criminal trial of Blagojevich.

First, cutting through the rhetoric, let's break down the players in the case. On the one side we have the embattled Governor Rod Blagojevich, who stands accused with his Chief of Staff John F. Harris. Harris, but not Blagojevich, has stepped down. On the other side we have an FBI investigative team lead by United States Attorney Patrick Fitzgerald.

Second, what are the charges? The first count is Solicitation of Bribes concerning the vacated senate seat of President-Elect Obama. The second count is Mail Fraud. The third count is Attempted Bribery, in this case of the Chicago Tribune (using state funds). The fourth and final count is Abuse of Power concerning campaign contributions from Children's Memorial Hospital (really Blago!).

What are the maximum sentences for these charges? Solicitation of Bribes is in violation of Federal Title 18, carrying a maximum sentence of 15 years and a $250,000 fine in federal court. It's unclear what jurisdiction Blago will be tried under as the special prosecution powers for corruption are somewhat vague. Halve that total if the Governor faces his charges at a state jurisdictional level.

Mail Fraud is a common criminal charge. According to WestLaw, a legal database, the average sentence is roughly seven years with a $400,000 sentence; the maximum sentence varies dramatically depending on the indictment. For a rough estimate then, on these two counts Blago faces about 18 years in prison and a $650,000 fine.

Bribery averages an 11 year sentence; attempted bribery averages five years and usually carries no fine. Meanwhile, abuse of power at this level averages a four year sentence with a $350,000 fine. All told then, at maximum, Blago faces about 20 years and a million dollars. Cut about half of that off for concurrent sentencing, parole and legal waivers and a pretty realistic maximum sentence emerges: 10 Years / $500,000.

Those are the legal implications and the trial court battle lines. Politically, it's a different matter. Amidst widespread calls to resign, Blagojevich almost certainly will face an impeachment review by the Illinois State House of Representatives. If the House votes to impeach, the State Senate will have the option to convict him, removing Blagojevich from office. The Gubernatorial Election occurs in November, 2010. That's plenty of time, so an impeachment looks likely. Calls to resign will continue to escalate during the process.

Another interesting line concerns the judiciary. The Illinois State Supreme Court is now considering a motion to declare Blagojevich "unfit for office." Such a constitutional holding effectively removes the Governor from office, transferring power to Lieutenant Governor Pat Quinn, a Democrat.

Five Cases, Re: A Brief Legal History of the Ponzi Scheme

 

 

Five cases can tell a long story. These five schemes destroyed a massive amount of wealth – their lesson merits repeating. Always remember: if it sounds too good to be true, it probably is.

William Miller: The First Case

-The Director: William Miller, a Brooklyn Grocer.
-The Cover: Insider High Yield Construction Bonds.
-The Promise: 10% return per week.
-The Damage: $1,000,000 ($25M set to 2007).
-The Discovery: Natural Collapse.
-The Arrest: 1899 –Fraud (Pled Guilty).
-The Sentence: Ten Years. Miller was pardoned during his sentence and led a reformed life as a (mostly) honest shop-keeper.

Charles Ponzi: The Name Case

-The Director: Charles Ponzi, an Italian-American immigrant and con-man. A convicted felon, he got the idea for the scheme from an Italian banker in Montreal.
-The Cover: International Postal Coupon Arbitrage.
-The Promise: 50% return per 45 days.
-The Damage: $10,000,000 ($100M set to 2007).
-The Discovery: Investigative reporters with the Boston Post and Clarence Barron, financial analyst and founder of Barron's.
-The Arrest: August 12, 1920 – Mail Fraud (Pled Guilty).
-The Sentence: Five Years. Ponzi served three-and-a-half and then was re-sentenced to 7-9 additional years on a state charge. After fleeing, he was recaptured and served 8 additional years. (12 Total)

J. David and Company: The Commodity Case

-The Director: J. David Dominelli, a commodity trader.
-The Cover: Commodity Speculation.
-The Promise: A 'virtually guaranteed' annual return of 12-20%.
-The Damage: $80,000,000 ($200M set to 2007).
-The Discovery: Natural Collapse.
-The Arrest: February 1984 – Fraud, Tax Evasion (Pled Guilty).
-The Sentence: Twenty Years. Mr. Dominelli's sentence ended in 2005.

Albania: The Revolution Case

-The Director: Numerous independent operations endorsed by the Albanian Government.
-The Cover: Various.
-The Promise: Various. Roughly 2 in 3 Albanians invested in one scheme or another.
-The Damage: $1,200,000,000 ($1.5B set to 2007).
-The Discovery: Natural Collapse.
-The Arrest: None; General government collapse during the Lottery Uprising of March 1997.
-The Sentence: An extended period of anarchy lasting over two months; a regime change in Albania; nearly 2000 deaths.

Bernard Madoff: The Big Case

-The Director: Bernard Madoff, an investment banker and former NASDAQ Chairman.
-The Cover: Hedge Funds, Private Equity.
-The Promise: An annual return of 12-13%.
-The Damage: $50,000,000,000 ($50B set to 2007).
-The Discovery: Andrew and Mark Madoff, both sons of Bernard Madoff.
-The Arrest: December 11, 2008 – Fraud (No Plea Yet Entered).
-The Sentence: Madoff faces up to twenty years if convicted.

These schemes were massive. The power of a Ponzi scheme lies in its ability to consistently draw reinvestment, allowing it to meet its withdrawal requests. The lower the margin, the longer it takes for the fund to collapse.

And, here is one final chilling thought. Madoff's scheme ran for decades relatively undisturbed. By combining affinity fraud with a low return, he might have gone on for decades more. How many more 'hedge funds' are fraudulent? Only time will tell. That's one advantage of a recession: the market corrects.

ANATOMY OF A PONZI SCHEME

 

Since the Madoff Affair first broke the headlines, we've been hearing a lot about the old-fashioned 'Ponzi Scheme.' What exactly is this devious arrangement?

 

A Ponzi Scheme begins with a director, in this case Madoff, advertising a certain return rate, in this case between 12-13%. The director begins with a small initial deposit; let's say $10,000,0000.

 

Every scheme has a cover. In Madoff's case the alleged cover was Advanced Capital Management. In the modern era, when asset management is so complex, it's easy to come up with something plausible.

 

But it's profit which ultimately convinces. So, how does the director make the promised return? Well, at first its very easy: he just sends each investor an 'asset profile' describing their current holdings - the original deposit plus the promised return. That builds up fund reputation.

 

Sooner or later, though, a depositor asks for his money back - plus the interest. Say he deposited $1,000,000 and he wants it back after a year. True to his word, the director returns $1,200,000. So the scheme itself has lost $200,000. No problem - after all, the scheme has $8,800,000 of operating capital remaining.

 

Now the scheme has proven its value to investors. Everyone who has requested their money has gotten it - on time, and in full - and the returns keep accumulating steadily. Suppose you've got $2,000,000 in the fund. Are you going to remove it? Certainly not! What other investment vehicle can promise a respectable return? If anything, you're inclined to put in more money.

 

Now the game is in full swing. The majority of investors keep 'reinvesting' their profits, often adding new deposits. For every investor who actually withdraws, many are eager to jump in. In fact, a smart director like Madoff regularly denies new depositors, making the fund increasingly desirable.

 

What we have is a positive feed-back loop for confidence. Each new year brings more and more investor confidence, as Madoff posts the required returns, meets each withdrawal without difficulty (usually faster than any other private bank) and turns down most new investors. By skimming a bit out of the general fund, Madoff makes a rich living for decades.

 

(Charles Ponzi, circa 1920's)

But, like all confidence games, the jig unravels when the positive-feedback confidence loop reverses direction. A big depositor withdraws, in Madoff's case the final withdrawal was for $7,000,000,000. Madoff has trouble meeting the request, and word gets out that the fund is becoming illiquid. That begins a process very reminiscent of a bank-run - every new failure creates ten more.

 

Unlike a bank, though, the Ponzi Scheme can't get insurance or FDIC protection - not without opening its books. So the scheme collapses, and everyone loses their money.

 

Because the scam is progressive as opposed to exponential (like a pyramid scheme), it can take decades and decades to come apart. But, in the end, it always does.

 

It all ends up in court, with charges ranging from steep fines to serious imprisonment, depending on the amounts, conduct and defense counsel skill.

Weekend at Bernie’s: Madoff Must Wear Electronic Monitoring Device.

Bernard Madoff has used three properties in New York and Florida as collateral to pay his $10m bail, avoiding jail for the time being, the Wall Street Journal reports. Mr. Madoff could not find the requisite four people to act as co-signers of his bail agreement, since his two sons refused to co-sign the document, but Judge Gabriel Gorenstein allowed him to go home where he is subject to a curfew between the hours of 7pm and 9am daily, and electronic monitoring in the form of an ankle bracelet, after Madoff put up the properties and surrendered his passport.

More scrutiny is also falling on Madoff's 67 year-old wife Ruth Madoff, as investigators are now trying to determine if she kept secret records of her husband's alleged fraudulent operations. Ruth Madoff was also required to surrender her passport this past week. Questions still linger regarding Shana Madoff Swanson, Bernard Madoff's niece and a compliance officer at his investment firm who eventually married Eric Swanson, who worked at the Securities and Exchange Commission for ten years as a senior inspections and examination official and was previously involved in regulating Madoff's firm. The couple has denied any wrong doing, and they have not been charged with any crimes. Some sources have said that Madoff-Swanson is a victim herself and has lost substantially all of her savings in this scandal. Last year, however, Bernard Madoff was overheard during a meeting saying that he had a "very close" relationship with SEC officials, and commenting that, "my niece even married one," according to the New York Post.

In light of the questions many still have regarding Bernard Madoff's closeness with regulatory officials, The Securities and Exchange Commission has ordered its own investigation. SEC Chairman Christopher Cox has admitted that the SEC was aware that issues had been raised regarding the Madoff firm in the past and has now ordered that past handling of the Madoff firm be reviewed, according to the Wall Street Journal. Although Mr. Cox has said that he is "gravely concerned" about the SEC's regulation of the Madoff firm, he also noted on Wednesday that the SEC investigation has "thus far" not discovered any violations of policy or wrongful behavior of personnel, the New York Post reported.

One of the individuals who had in the past repeatedly raised red-flags about the Madoff firm was Harry Markopolous, an investigator who once worked for an investment firm which competed with Madoff's firm. In 2005 he reported in numerous e-mails over a protracted period of time to the SEC that Madoff's operation was "likely a Ponzi scheme," as reported in today's Wall Street Journal cover story. This led the SEC to investigate and to conclude in a report in 2006 that Bernard Madoff had "misled the examination staff about the nature of the strategy" of his funds and "withheld from the examination staff information about certain of these customer's accounts." However, in November of 2007, after Madoff agreed to register his extraneous operations as an investment advisor, it was recommended that the case be closed because, "the staff found no evidence of fraud." In retrospect, may investors now feel that the SEC should have been able to shut down what they now allege was a huge fraud scheme. It appears to some observers that the alleged Ponzi-style operation was so massive and brazen that not even professional regulators who are trained to look for fraudulent activity could see or believe it.

 

Judge Orders Madoff Assets Liquidated. SIPC to return remaining funds.

 

 

Investigators continue to uncover details of the massive fraud allegedly perpetrated by Bernard L. Madoff, as a federal judge ordered the liquidation of the assets and operations of Bernard L. Madoff Investment Securities LLC, according to today's Wall Street Journal. The Securities Investment Protection Corp., or SIPC, requested that the judge appoint a trustee to control any remaining assets, and SIPC will now attempt to redistribute as much money as possible to the investors who have incurred devastating losses this past week due to the Madoff affair.

Details emerged of the options-trading operations conducted by Madoff and how the operation raised funds and attracted investors through exclusive country-club and word-of-mouth style marketing and networking both in the United States and in Europe. Investigators are now trying to determine if other people were involved in the alleged fraud including employees and associates of Mr. Madoff and are now questioning whether or not Mr. Madoff's wife Ruth Madoff had any knowledge or involvement in the alleged scheme, since her name appears on several important documents that are now being examined, according to the New York Post. Investigators are also probing how Madoff was able to allegedly move funds through an unregistered money-management business.

As glaring regulation discrepancies emerge in the investigation, many investors who allege they have been burned by Madoff are asking why the Securities and Exchange Comission did not do more to prevent and stop the alleged fraudulent activity of Madoff in a more timely manner. Some have raised issues of conflict of interest, since Madoff was close with several SEC officials such as former chairman Arthur Levitt, and other regulatory officials as well as a contributor to numerous powerful politicians including Sen. Charles Schumer, Sen. Hillary Clinton, and Rep. Charles Rangel. More disturbing to some investors is the fact that, Madoff employed a compliance staff that had close ties to a former SEC examiner who at one time was responsible for examining the firm's operations, according to CNBC.com. Shana Madoff, Bernard Madoff's niece, was the firm's compliance counsel and is married to former SEC examiner Eric Swanson, who was a member of an SEC team that examined the Madoff firm in 2003. Although the two were not married and claim they had no improper relationship at that time, some investors are troubled by what they perceive to be another possible conflict of interest which the allege may be part of a larger pattern of inappropriate closeness between the Madoff operations and regulators.

The Fairfield Greenwich fund has announced that they will sue Bernard L. Madoff Investment Securities for what they allege is a lack of due diligence and transparency regarding Madoff's investment business. They allege that in their own due diligence, trade confirmations were verified not only by Madoff but by third parties as well, which has led some to believe that there may have been more people involved in perpetrating or facilitating the alleged fraud scheme.

It was also revealed that DreamWorks CEO Jeffrey Katzenberg has been added to the list of investors who have been exposed to the Madoff scandal, through financial advisor Gerald Breslauer who also advises Stephen Spielberg and has had dealings with Madoff since at least 2004, according to the Wall Street Journal. Other investors or entities not previously mentioned in this blog who have been exposed to losses through the Madoff scandal include Access International Advisors, Ascot Partners, Banque Benedict Hentsch, Benbassat & Cie, Fix Asset Management, HSBC, Julian J. Levitt Foundation, Kingate Management, Mirabaud & Cie, Notz, Stucki & Cie, North-Shore Long Island Jewish Health System, Optimal Investment Services, Pioneer Alternative Investments, Robert I Lappin Charitable Foundation, The Town of Fairfield Connecticut, Sterling Equities, Yeshiva University, and others, according to CNBC.com

Madoff Madness: Fraud Scandal Continues to Spread

The impact of the Bernard Madoff financial scandal is being felt around the world as a wide range of investors including international banks, charitable foundations, hedge funds, and wealthy individuals report exposure and losses due to the collapse of the alleged Ponzi-scheme run by Madoff.

The Wall Street Journal and CNBC.com report that investors including Fred Wilpon, the former owner of the New York Mets, J. Ezra Merkin, Chairman of GMAC LLC, and Norman Braman, the former owner of the Philadelphia Eagles have all suffered significant financial losses due to the Madoff affair. Also affected are other notable figures such as Mort Zuckerman, owner of the New York Daily News, US News and World Report, and real-estate company Boston Properties, as well as charitable organizations including the Elie Wiesel Foundation for Humanity, Stephen Spielberg's Wunderkinder Foundation, the Robert I Lappin Charitable Foundation, and the family charity of New Jersey Senator Frank Lautenberg. Other individuals reportedly exposed to the fraud include former Kay Windsor owner Carl Shapiro and Bed Bath and Beyond co-founder Leonard Feinstein.

Several exclusive mutual "funds of funds," which distribute investors' money among several funds, are also reporting exposure, including Fairfield Greenwich Group, Tremont Capital Management, and Maxam Capital Management. Sandra Manzke, owner of Maxam Capital Management in Darien Connecticut, has reported a $280 Million loss and has said she will have to close the fund, according to the Wall Street Journal.

A number of major international banks and financial institutions are also reporting significant losses, according to the Wall Street Journal. They include Man Group PLC and EIM Group, Spain's Groupo Santander SA and Banco Bilbao Vizcaya Argentaria SA, France's BNP Paribas, Societe General, Credit Agricole, and Natixis, The UK's Royal Bank of Scotland, Italy's UniCredit SpA, Japan's Nomura Holdings, and the Swiss banks Reichmuth & Co., Union Bancaire Privee', Neue Privat Bank, and possibly several other international financial institutions. Several banks including Deutsch Bank AG, Dresdner Bank AG and Commerzbank AG of Germany have declined to comment or did not return calls when asked if they were exposed to the Madoff Fraud, as did several major US banks including Bank Of America, Citigroup, PNC Financial, Merrill Lynch & Co., Morgan Stanley, Wells Fargo & Co., Comerica Inc., and US Bankcorp.

As part of the fallout from the scandal, many investors are calling for more vigorous regulation, greater transparency, and asking tough questions about the due-diligence practices of the hedge funds and money managers who invested with Madoff, as well as the regulators who did not prevent the fraud from occurring. Regulators such as SEC Chairman Christopher Cox, Treasury Secretary Henry Paulson, and elected officials including Senator Charles Schumer, Senator Chris Dodd, and Congressman Barney Frank, were mentioned this morning on MSNBC's Morning Joe as being law-makers and regulators who should or likely will be questioned regarding this and other recent financial scandals. Nicola Horlick, a prominent fund manager who heads Bramdean Alternatives based in London was quoted in an interview with the BBC as saying, "I think now it is very difficult for people to invest in things that are meant to be regulated in America, because they have fallen down in the job." Bramdean Alternatives had 9% of its funds invested with Madoff. Horlick added that, "This is the biggest financial scandal, probably, in the history of the markets."

Banco Santander says that it will "undertake the legal actions which may be need to defend the interest of investors," and other investors have already retained legal counsel and are preparing to file claims against Madoff. Brad Friedman, an attorney with Milberg LLP who along with attorneys at Seeger Weiss LLP represents over 30 investors who stand to lose vast sums of money due to Madoff's alleged fraud , has said that the Madoff case has now "swept up some of the most prominent and wealthy Americans, along with many people who thought they were embarking on a comfortable retirement and have now been left destitute."

Attorney Ike Sorkin who represents Mr. Madoff was quoted in the Wall Street Journal as saying that "this is a real tragedy." And that he and his defense team were "going to fight through these events and do what we can to minimize the loss."

Price-Fixing Charges Filed Against Chilean Pharmaceutical Companies:

Charges of price-fixing were filed today by the Chilean Government against SalcoBrand, Ahumada, and Cruz Verde, three pharmaceutical companies whose total sales account for over 90% of the pharmaceutical market in Chile, according to Tomás Dinges of Chile From Within. The Chilean government's complaint alleges that after a bitter price war in 2007, the three companies colluded to set prices at fixed levels in order to stifle competition and ensure high profit margins for each company. By using a coordinated schedule of price increases, pharmaceutical costs rose dramatically throughout the Chilean market in late 2007 and early 2008. In one day alone, prices on the anti-conceptive drug "Marvelon-20" increased by an average of 94% throughout all three pharmaceutical chains.

Price increases were documented on over 200 types of pharmaceuticals, according to the Tribunal de Defensa de Libre Comercio, (Court for the Defense of Free Trade) a branch of the Chilean government which investigates price-fixing and related crimes. The most profound increases came among anti-anemic and diabetic drugs, which rose 88% and 100% on average. Each company is facing up to $12 million dollars in fines for their involvement in the alleged price-fixing.

Bernard Madoff: Investment Manager Arrested for Securities Fraud

Bernard L. Madoff, the 70-year old head of a prominent investment securities firm, was arrested on Thursday, December 11, 2008 for what the SEC describes as a "stunning fraud that appears to be of epic proportions."

Mr. Madoff founded his principal investment firm, Bernard L .Madoff Investment Securities, in 1960 with only $5,000.00. Over the course of 48 years, he turned the company into one of the largest dealers on the NASDAQ stock exchange, of which he is a former chairman. Today's front-page Wall Street Journal article notes that Madoff's company was one of the first to automate the "market making" process, whereby a dealer buys and sells shares of a particular stock on an ongoing basis, acting as a "middleman" between those seeking to purchase and sell securities. For his firm's innovations in this area, Mr. Madoff was widely regarded as a "wall street legend," and "one of the pioneers of modern wall street" according to the New York Post.

CNBC.com reports that the fraud charges he was arraigned on in Manhattan federal court yesterday stem from the operations of an investment advisory and hedge fund business that Mr. Madoff was managing through a separate part of his brokerage office. In a criminal complaint, the FBI alleges that Mr. Madoff had "deceived investors by operating a securities business in which he traded and lost investor money, and then paid certain investors purported returns on investment with the principal received from other, different investors, which resulted in losses of approximately billions of dollars." The operation was basically an elaborate multi-level marketing scheme, also known as a "Pyramid" or "Ponzi" scheme; named for Charles Ponzi who defrauded thousands in the 1920's.

Mr. Madoff was charged by the SEC with one count of civil securities fraud, which can carry a penalty of up to 20 years in jail and fines of up to $5 Million. The FBI complaint cites two senior employees of the Madoff investment firm as saying that Madoff as much as confessed to them that his operation was, "all just one big lie." It is rumored that the two employees in question are in fact Mr. Madoff's two sons, Mark and Andrew Madoff, who serve as the firm's senior managing director/chief compliance officer and director of trading, respectively.

It is believed that the losses from this fraud will exceed $50 billion dollars of capital taken from 11 to 25 clients including hedge funds, banks, and wealthy individual investors, making it larger than the $32 billion dollar collapse of Enron in 2001 and possibly one of the largest frauds in history. The SEC has requested that a federal judge appoint a receiver and seize control of the firm and all of its assets.

Mr. Madoff is being defended by attorney Dan Horwitz, who stated that "Bernard Madoff is a longstanding leader in the financial services industry," and that he would "fight to get through this unfortunate set of events."

Illinois Governor Rod Blagojevich Arrested

There were rumors out that Governor Blagojevich, D-IL, wouldn't survive his term of office (set to end in 2010). But nobody, not even his fiercest critics, expected anything like this.

Today Blagojevich was arrested outright by federal prosecutors, pending charges of fraud, graft, bribery and corruption. In particular, the accusations focus on the Senate seat of President-Elect Barack Obama.

Senator Obama held a senate seat set for re-election in 2010. Since he will assume office as President of the United States in January, Illinois needs a replacement. Under state law, Governor Blagojevich had the authority to make the appointment.

Perhaps it is too much to ask, but one might hope for a sense of humility and respect to come with the role of choosing one of our nation's senators. Instead, Governor Blagojevich called the opportunity "golden" according to recorded conversations.

Prosecutors allege that he planned to do nothing short of selling the seat to the highest bidder. Looking for a high-level appointment and a lot of cash to boot, Blagojevich said he would "just assume office myself" if he didn't get what he wanted.

At least one other Illinois politician would be very, very ashamed.

Suit Against AIG Continues

A $20B breach of fiduciary duty suit against former executives at insurance giant AIG can proceed according to Supreme Court Justice Charles Ramos in a ruling issued today.

AIG was the 18^th-largest company in the world before it faced near-collapse weeks ago. The legal aftermath is still being felt throughout the country.

A fiduciary relationship is a trust held between two parties, like a lawyer-client or trustor-trustee arrangement. The Manhattan case is based on AIG's senior leadership, including former CEO Hank Greenburg, having a fiduciary duty to AIG shareholders.

Simple incompetence is not a legally culpable breach of duty. Knowingly misleading investors surely is; indeed, it can be criminal. The case ruled on today falls somewhere in-between, in the grey zone of 'negligence.'

The legal arguments turn on presumption. If a well-meaning and reasonably competent individual might have made the same mistakes as Greenburg, he is innocent. If, on the other hand, Greenburg expressed a profound neglect for his responsibilities or acted in a manner of wanton unjustifiable incompetence, he could be found liable.

Because of the fuzzy case law, negligence cases often turn heavily on the legal skill brought to the table by both sides.