Lots of Bernie Madoff’s investors, including institutional investors and banks, thought Madoff Securities was running a scam–they just didn’t realise he was scamming them.
The scam everyone thought he was running was basically having his hedge fund operation front-run the trades from his electronic market making operation. As the saying goes, you can’t cheat an honest man…but cheating those who are dishonest is all too easy.
The Financial Times today describes how one Swiss bank thought Madoff had an “edge” because of his market making business:
A Swiss bank that helped channel funds to Bernard Madoff says the New York money manager had a “perceived edge” in the financial markets because he handled so many trades through his broker-dealer arm.
Union Bancaire Privée, which advised 11 hedge funds that placed money with Mr Madoff, included the characterisation in a letter that it sent to clients on December 17 to explain why it felt comfortable with Mr Madoff.
Mr Madoff’s clients believed that he employed a “split-strike options strategy” that would make money in both up and down markets through trades in stocks and options.
“We were assured that he had some visibility as to the momentum of the markets…due to his significant volume size as a broker/dealer,” the UBP letter said.
“The perceived edge was Madoff’s ability to gather and process market-order flow information and use this information to time the implementation of the split-strike options strategy.”