Other than Bernie Madoff’s performance all those years, what incentive did the Madoff feeder funds have to place so much money with him? What kind of kickbacks or fee discounts did they get, but then not pass onto their clients?
In a 2000 interview with CNN, Bernie Madoff the market maker was asked about payment for steady order flow:
CNNfn.com: Will payment for order flow ever disappear?
Madoff: No. I think it will get lower and lower as the spreads get lower and lower with decimals. No one tells a firm how they can advertise. If I want to hire salesmen to generate order flow, no one is going to object. I don’t have them. So if I want to use Fidelity’s salesmen and pay part of my trading profits in the form of a rebate, why shouldn’t I be allowed to do it? It was characterised as this bribe and kickback and something sinister, which was very easy to do. But if your girlfriend goes to buy stockings at a supermarket, the racks that display those stockings are usually paid for by the company that manufactured the stockings. Order flow is an issue that attracted a lot of attention but is grossly overrated.
In both the market making business and the Ponzi scheme business, there was obviously enough money to be made that he could give breaks or kickbacks to the folks that brought him business. And we’re not sure if there’s anything wrong with that from his perspective. Where we see an ethical problem is at Fidelity or Tremont — parties that were accepting kickbacks or volume discounts, but were almost certainly not passing those discounts back onto their retail customers.
The conflict of interest is real: Is the money manager going with Madoff because he offers the best service, or because his kickbacks allow the money manager to reap the biggest spread between customer fees and expenses. No doubt many investors would like their money managers to do a little more due diligence, even if that means paying a bit more for maintenance fees.