US Department of Labor Sues Investment Managers and Advisors Over Madoff Investments

New York-based Ivy Asset Management, Beacon Associates Management, J.P. Jeanneret Associates, Andover Associates Management and their principals have been sued by the Department of Labor for allegedly failing to examine swindler Bernard Madoff’s business practices and consequently losing millions in pension money.

(October 22) — The US Department of Labor (DoL) has sued four investment firms for allegedly failing to look into fraudster Bernard Madoff’s business dealings before entrusting him with hundreds of millions of dollars in pension fund money.

In a complaint filed Thursday in US District Court in Manhattan, Ivy Asset Management, Beacon Associates Management, JP Jeanneret Associates, Andover Associates Management and their principals are accused of violating the Employee Retirement Income Security Act (ERISA) by recommending, making, and maintaining investments with Madoff, which resulted in the loss of hundreds of millions of dollars of ERISA-covered pension plan assets. Also named in the lawsuit, brought under ERISA on behalf of union-sponsored and single-employer benefit plans, are Joel Danziger and Harris Markhoff of Beacon and Andover, Lawrence Simon and Howard Wohl of Ivy, and John Jeanneret and Paul Perry of JP Jeanneret. According to the DoL, the defendants provided advice and investment services to the plans. As relief, the suit seeks to require the defendants to restore all losses suffered by the plans, return any fees and profits improperly received as a result of plan investments with Madoff, and permanently bar them from serving in a fiduciary capacity to any plan governed by ERISA in the future.

“These defendants chose their own financial interests over those of the plans whose assets they were duty bound to manage prudently. Their actions put the future benefits of thousands of workers in jeopardy,” said Secretary of Labor Hilda L. Solis in a statement. “The defendant fiduciaries caused the plans to invest with Madoff over many years, and imprudently failed to cause the plans to divest their Madoff investments, even though the defendant fiduciaries had strong indications, suspicions and red flags of Madoff’s conduct,” the lawsuit said.

The suit claims that the defendants were irresponsible in investigating and monitoring Madoff and his purported trading, failing to examine suspected “red flags” in Madoff’s business practices. Furthermore, the suit alleges that while the defendants collected tens of millions of dollars in fees for themselves as a result of the Madoff investments, they failed to guard the plans’ interests.

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Madoff, who was arrested in December 2008, is currently serving a 150-year prison sentence after he admitted to heading the largest Ponzi scheme in history. The government has auctioned or sold his multi-million-dollar homes and possessions to repay investors.

Separately, former Florida hedge fund manager Arthur Nadel, dubbed the “mini-Madoff,” was sentenced to 14 years in prison in Manhattan federal court Thursday for his Ponzi scheme that persuaded 390 investors to give him more than $330 million. Similarly to Madoff, Nadel told investors that he had consistent-double-digit returns when in reality, his trading lost money. According to Reuters, the Sarasota-based fund manager deceived investors across the United States in managing six different funds, stealing about $168 million between January 1999 and January 2009. Losses to investors were approximately $168 million.

To contact the <em>aiCIO</em> editor of this story: Paula Vasan at <a href='mailto:pvasan@assetinternational.com'>pvasan@assetinternational.com</a>; 646-308-2742

Flash Crash Report Points Finger at Wrong Source of Big Trade That Went Bad

The trade and algorithm blamed for sparking the Flash Crash in the report by the SEC and CFTC was not executed by “mutual fund complex” Waddell & Reed but their executing broker, Barclay's Capital. The report's contention that the algorithm was simplistic and did not take price changes into full account may also be untrue. aiCIO's Joe Flood reports.

The joint Securities Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) report on the Flash Crash that was published three weeks ago laid out a controversial but fairly clear narrative of what went wrong on May 6th, when the Dow plunged hundreds of points in the blink of an eye, then (mostly) recovered just as quickly. According to the report, an unnamed “mutual fund complex” known to be Kansas-based Waddell & Reed executed a trade to sell 75,000 E-Mini contracts, a kind of future for the S&P 500. Unfortunately, Waddell’s algorithm was too simplistic, piling more and more sales orders onto an already saturated market, and kicking off an ugly chain of rapid price changes and liquidity evaporation that drove that market into a tailspin.

Some elements of this story have already been challenged by market research firm Nanex, which has been deeply involved in investigating the crash and received raw data from the trade itself. But now sources are confirming a major hole in the report’s underlying story. First, Waddell & Reed can’t directly trade E-Minis. E-Minis are a product of the Chicago Mercantile Exchange and can only be traded on that exchange, and Waddell & Reed is not a member. Like most mutual funds, they rely on a “clearing member” of the exchange to route their trades.

More importantly, in the case of the fateful trade it was not actually Waddell’s own algorithm that executed the trade, as implied by the SEC-CFTC report, but that of its broker, Barclay’s Capital. Further complicating matters, researchers and people close to the trade are disagreeing with the report’s characterization of the algorithm that executed the trade, pointing out that it has been many times for much larger trades with no similar fallout.

“Based on our data, this was actually a very good algorithm,” says Nanex founder Eric Hunsader, who has analyzed the trade data. “It’s portrayed [in the report] as a very simple algorithm, but you can clearly see that it did take into account things like price—if it hadn’t, you could have really seen a market collapse…What really caused the collapse was firms re-selling these contracts incredibly quickly and just drying up all the liquidity.”

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The SEC-CFTC report makes no mention of any executing broker or other source of the algorithm, pinning the blame for the trade squarely on the “mutual fund complex” known to be Waddell & Reed. But in a statement from a CFTC spokesman, the commission acknowledged that there was an executing broker responsible for handling the trade. The spokesman went on to say that the CFTC “interviewed both the large trader and the executing broker about the algorithm and is confident of the description in the joint report.”

When asked if investigators interviewed the Barclay’s engineers responsible for handling the executing algorithm before concluding the investigation and filing the report, the CFTC declined further comment.

The SEC and Barclay’s both declined immediate comment, and Waddell & Reed released the following statement: “Following the recent release of the regulatory report on the “flash crash,” many market observers have noted that the events of May 6 involve multiple issues that transcend the actions of any single market participant. We agree with those observations.”

Stay tuned for more developments.

<p>To contact the aiCIO editor of this story: Joe Flood at <a href="mailto:joe.flood@gmail.com">joe.flood@gmail.com</a></p>