Morning:
8°c
It is tempting to think of the Madoff fraud as one where the victims almost selected themselves, because of their willingness to go into a fund that failed even to have the most basic separation between front and back office, between managing the money and controlling it. Client protections that are seen as basic and fundamental in Europe were missing in the United States.
But the trouble is we will probably all end up paying for this because the Madoff fraud promises to set off one of the biggest chains of legal actions the world has ever seen. The way the law works, had he lost the bulk of his clients' money through bad stock selection and misjudging the markets, no one could have lifted a finger against him or against those who advised clients to choose his funds. A lack of competence - even on the part of those who claim to be competent and charge as if they were - is not the basis for a legal action.
This time, though, it is different. There seems no doubt in the Madoff case that the clients lost their money as a result of his self-confessed fraud. That makes it open season for litigation - and litigation more likely on a scale and to a level that we have not seen before.
One keen-eyed observer of the London insurance scene is convinced that professional indemnity claims will run into tens of billions of dollars - or pounds, for that matter. His thesis is that all the private banks and fund of funds managers have filter systems as part of their due diligence, and these are designed to raise a flag when something is unusual or does not conform to standard practice.
Thus among the things they look for in this safety check are independent auditors of recognised standing, independent fund administrators, a proper understandable investment process which seems repeatable and includes regular meetings with the managers, proper disclosure of performance with attribution so that outsiders can tell where it came from, and so on.
When one of these things is missing, a flag is raised. Two raised flags mean that clients do not get put into the fund because the risk is too great - however inspired the performance appears to be.
This is why the bleats of the intermediaries sound so hollow when they say that they were let down by the regulators.
Whether or not America's Securities and Exchange Commission should have been quicker off the mark is beside the point. These advisers profess to know the fund managers and to have their own system to separate the good, the bad and the ugly. Never, until now, have they said that they simply relied on the regulators to do that for them. Indeed, were that true, what would one be paying the advisers for? They charge (a lot) specifically to pick a way through the minefield.
Thus any adviser looking objectively at the Madoff operation would have seen the warning flags because his omissions would have become obvious during the due diligence. Therefore, if they still put their clients in, they did so only after ignoring the warnings their own systems had generated. And if they did that, they may well find themselves in court, explaining to a sceptical jury why it seemed like a good idea at the time.
There are precedents for this even in the UK. A few years ago, there was a celebrated case between the Unilever Pension Fund and Mercury Asset Management, (which was Merrill Lynch Investment Management by the time the case got to court).
This hinged on whether the fund managers had emp- loyed the process they said they would employ. The performance of the funds under management was specifically not the matter considered by the court. (Merrill Lynch eventually buckled in the face of a torrent of bad publicity as the court case unfolded.)
It may be that clients of the fund of funds managers and private bankers have a case against these intermediaries on the grounds that they contracted to get the benefits of this filtering process, but they did not get it because it was ignored. And on that basis they could legitimately claim to get all their money back.
Thus it is possible that all the billions lost by Madoff will soon the subject to court action, a lot of which will be successful and the cost of which will fall on the insurance industry. Move over Hurricane Katrina and Hurricane Ike, here comes Hurricane Madoff to stake its claim in the record books as one of the biggest single losses ever to hit the London market.
And ultimately this is how we will all end up having to pay. There is already a huge amount of legislation wending its way towards the courts as a result of the alleged mis-selling of structured products based on subprime mortgages. Even if only a small part of that is successful, the claims which have to be paid out will cost the insurance industry billions.
Likewise with Madoff. And that means in a few years' time premiums on almost every other policy - household, motor, travel, none of them remotely connected with finance - will have to go up to pay for it all.
