Maxwell echo that should have alerted Madoff’s fans

Chris Blackhurst
5 Jan 2009

When Robert Maxwell died and his frauds were exposed, I remember vividly the shock of some of those who worked closely with him. I recall one woman executive telling another of his senior employees how she wanted to go home, have a bath and wash all trace of the crook off her body, she felt so angry and ashamed to have been in his pay.

Something similar is occurring with Bernard Madoff. Those who ran the funds he fleeced are professing rage and total ignorance of his deeds. Yet we've been here before — with Maxwell, in fact.

Wherever City folk have gathered over the holiday the conversation has turned to Madoff. How could he? And, more to the point, how could they? How could some of the supposedly finest minds the investment community has to offer fall for his story?

Some blame the Securities and Exchange Commission for not doing its job properly. But all are agreed: his choice of auditors should have flashed a giant warning signal.

Friehling & Horowitz was based in a suburban shopping precinct in upstate New York, its glass door next to that of a doctor's surgery. Inside, the firm of just three employees apparently supervised Madoff's $50 billion empire and one of those was 80-year-old Jerome Horowitz, who left the firm in 1997 and now lives in Florida.

“What if General Motors had a three-person accounting firm doing its audits?” said Jim Vos, chief of the hedge fund consulting firm Aksia LLC in New York. What indeed. As Vos's colleague Jake Walthour said: “Most hedge funds, even when they are small, use one of four or five big-name firms. And this wasn't one of them.”

Those investment managers who entrusted Madoff with their clients' cash wouldn't be seen dead using an obscure auditor, yet they were happy to let Madoff do so. This is the sin of those who have lost so heavily. Friehling & Horowitz simply did not have the manpower that comes with one of the large firms to scrutinise Madoff's affairs. And they should have known so.

It's not as if Madoff's trick was new. In 1973, the Department of Trade and Industry published a damning report into Maxwell's management of his Pergamon Press company. Pergamon issued totally misleading financial information and the DTI inspectors knew who, apart from the fat crook, was at fault — the small, obscure firm of accountants he employed called Chalmers Impey. “We are driven to the conclusion that Chalmers Impey should not have been satisfied by Mr Maxwell's ever-ready explanations and that they failed to rumble him,” said the DTI.

After Chalmers Impey was replaced by the then Price Waterhouse, it complained the new, bigger auditor was “looking at the accounts from a different direction for a different purpose”.

They were different all right: Price Waterhouse came up with a 50% cut in Pergamon's originally published profit figure and a 33% reduction in net assets.

Vos's company looked into Madoff last year and warned investors off, finding several “red flags”. One was the hedge-fund king's auditor. A private investigator reported to Aksia that there seemed to be only one person working at Friehling & Horowitz. phone calls were not returned until someone finally answered and said the firm was not open for business.

Those who claimed to have done their due diligence on Madoff have no excuse. Accountants are “the handmaidens of the wealthy”, someone once said. Who was that someone? Robert Maxwell.

Save Woolies tears for the real disaster

It started with the death of Princess Diana and now, God forbid, shows signs of spilling over into commerce.

We didn't quite get the giant floral tribute with Woolworths but we weren't far off. To read and listen to the comments on the store chain's passing you would honestly have thought we had lost something uniquely dear and precious, not a desperately ill-managed brand that had long been abandoned by most people and had become a national joke.

The credit crunch was the final nail for Woolworths, as it was for MFI, the other high-profile casualty. They were on borrowed time anyway, something that seems to be forgotten during the hand-wringing and wailing. Their demise was the result of a long-overdue restructuring, not the downturn per se.

So far, we haven't seen the genuine surprise, the high-profile, spectacular crash that causes us to pause. That, to my mind, will be when the recession truly hits. That is also the moment for which we should reserve our real dismay.

Creditors left out in the cold with these too-cosy pre-packs

The first buzz phrase of 2009 is with us: pre-pack. The large accountancy firms are said to have 15 large pre-packs ready for January, most of them in retailing.

So that means 15 sets of creditors will wake up to be told the assets of a company that owes them money have been sold before the company is formally declared insolvent.

We've seen it occur with USC, the designer clothing chain backed by Sir Tom Hunter. The 58-store group appointed accountants PKF to handle the administration and no sooner was that move made than Hunter's West Coast Capital immediately bought 43 of the shops.

The justification is that 43 stores continue trading and 1127 staff keep their jobs. Whittard and The Officers Club are other early pre-packs in this recession. We are going to see far more.
But they stick in the craw: suppliers to the 15 USC branches that have gone and the landlords, for example, receive nothing. In essence, Hunter's operation carries on as before but without 15 dud shops and their debts.

Pre-packs are a tried and tested insolvency device. That doesn't necessarily make them right, however.

What's particularly worrying is where the assets are instantly resold back to the former management, as they were with USC.

The auditors are under a duty to secure the best outcome for the creditors of the whole group.
Yet the process lacks transparency. If any marketing is done, it takes place incredibly discreetly.

Usually, the first time the bulk of the creditors are aware of a serious problem is when they are told that bits have been disposed of and the company is going under. They're not able to influence the outcome. They've got no idea if the best price was raised or if breaking up the operation in this way was the best solution.

While the accountants can argue their work is regulated by statute and their professional code of conduct, there is, surely, a case for a wholly independent observer, like a High Court judge, to cast their eye over the pre-pack. Without any objective analysis, the whole thing, frankly, is far too cosy for comfort.

Party's over but parties are more fun

Hedge funds in retreat, rocked by the collapse of Madoff and now having to do a lot of explaining of their own. Private equity in crisis, unable to flog the businesses they had bought to make a quick buck and unable to attract new funding.

Investment bankers having to weigh up whether to keep the holiday chalet in Courchevel or the villa in Provence. Oligarchs kissing goodbye to billions and their entourages wearing glum faces. The emerging markets bores having to bite their lips.

Economists and know-alls being made to look stupid. Graduates wanting to become engineers rather than bankers. Those who made it look too easy coming a cropper. Nobody talking about bonuses but instead justifying their jobs. No one coming up to you with a business proposition and suggesting if you can get some leverage you can join them. Not a whiff of derivatives and securitisation. Suddenly, parties are enjoyable again.