Kass: Madoff Was Made Up

It is clear that Madoff's fraud paralleled Bayou as both firms fabricated investment returns. In the case of Bayou, that firm was apparently aided by an in-house accountant; in the case of Madoff, it was a very small, unknown account based in Monsey, N.Y. This was red flag No 1.

Similar to Bayou, Madoff's returns were not sensational but they were consistent. My sources indicated that he had only a few monthly losses over an extended period of time, never a down quarter or down year, almost a statistical impossibility. The ability to deliver what appeared to be consistent investment performance attracted a large investor base to Madoff and permitted him to provide little in the way of transparency to investors (individuals and institutions) who should have known better. In a May 2001 MAR/Hedge column, "Madoff Tops Charts; Skeptics Ask How," Madoff said that he believes he deserves "some credibility as a trader for 40 years.... The strategy is the strategy, and the returns are the returns." He went on to say that "those who believe there is something more to it and are seeking an answer beyond that are wasting their time." This was red flag No. 2.

Also similar to Bayou, Madoff's firm did not appear to charge investment management fees; his compensation was commission-based. In the same MAR/Hedge interview, Madoff said, "We're perfectly happy making the commissions." This was red flag No. 3.

In all likelihood, while posting consistent returns, Madoff (again, similar to Bayou) churned his accounts and earned high levels of commissions. At the same time the accounts were being churned and consistent returns were reported, both firms likely lost huge amounts of money in an extremely active trading strategy, with commissions inuring to the firm. I suspect that the losses dramatically increased this year, as his split-strike conversion strategy (similar to a classical buy/write strategy) backfired, providing little downside protection in the bear market of 2008. Madoff also said in the MAR/Hedge interview that this strategy works best in bull markets and that "we've really been in a bull market since '82, so this has been a good period to do this kind of stuff." Years of phony investment performance had the effect of compounding the alleged fraud over several decades.