Dermot Butler, chairman, Custom House Global Fund Services

Learning the lessons of the Madoff scandal

By Dermot Butler - It is ironic, but nonetheless a good thing, that many professional and institutional investors, led by the best of the Private Banks in Switzerland, gave an ultimatum, early in 2009, to many US hedge fund managers that they would no longer invest in their self-administered funds, unless they appointed an independent fund administrator, by the end of that year. I think it is fair to say that almost everywhere else in the world the self-administered fund was as rare as it was commonplace in the United States.

I said it was ironic, because this investor pressure was a direct reaction to the Madoff scandal and fraud, which reverberated around the banking halls of Geneva with devastating effect. The irony is the fact that most of these losses occurred within funds that used Madoff as a manager and each of those funds were administered by a leading hedge fund administrator.
 
It has become apparent that the failure with Madoff was not a lack of independent administration, but rather a criminal lack of due diligence by almost everyone involved, including investors and service providers.
 
A further irony connected with the market's reaction to Madoff was the surge in demand for managed accounts, which were deemed attractive because of their transparency and liquidity. They were touted around the market place as the new 'miracle cure', despite the fact that they have been around as long as I have in these markets and that is over 40 years. In fact, in my experience, most of the multi-billion dollar CTAs started with a handful of managed accounts. That is not to say they should be denigrated, but they shouldn't be promoted as the 'miracle cure' either.
 
It is of course ironic that most of what have been described as "feeder funds"(a misnomer, in my opinion) into Madoff were in fact invested - if that is not too strong a word) in managed accounts with Madoff and which he "managed " in his own unique way.
 
So what has the hedge fund community actually learned from its Madoff experience? 
 
Firstly: the importance of due diligence and the fact that it is essential both before making an investment and on-going whilst holding that investment;

Secondly: although Managed accounts offer transparency and liquidity and the ability to oversee  the manager's activity, that is worthless  unless the investor can and does monitor the account on a daily basis; and

Thirdly: an independent administrator is appointed to give the security that investors need to know that not only has the fund been valued accurately, but that the assets purported to be held by the fund actually exist.
 
But of all these the most important is the original and continual due diligence - don't forget that overseeing your managed account and appointing and overseeing the fund's independent administrator is all part of that on-going due diligence.

Dermot Butler is the chairman of Custom House Global Fund Services Ltd and Custom House Group

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