middle.jpgI’ve never been fond of “middlemen.” I prefer as direct and efficient a chain of connection and distribution as possible.

Each point, person, or entity along the path of commerce is just one more outstretched hand to be filled, one more mouth to be fed. Let’s talk directly, let’s find a way to let the consumer buy straight from the factory floor. Let all those middlemen go find a way to create real value directly. Using this method, Sam Walton achieved much of WalMart’s vaulted everyday low prices by cutting out inefficiencies in the distribution channel and dealing directly with the manufacturer.

A particularly egregious example of outrageously “fat” middlemen is the feeder fees collected by those who raised capital and then “invested” it with Bernie Madoff. While Madoff was certainly running a fraudulent Ponzi scheme, most of those who raised capital on his behalf appear not to have been in on the scheme per se.

Their crime seems more to be monumental incompetence (deliberate blindness?) or more likely failure to do proper and promised due diligence or to disclose how they were investing funds. Some funds appear not to have told their investors they were collecting investment and fund management fees for doing no more than simply turning their investors’ money over to Madoff.

I’m amazed how many inefficiencies exist in our economic system, protected by hidebound custom, archaic statutes, or simple tradition perpetuated by a collective unwillingness to ask hard, penetrating questions, particularly in situations where a social patina has been successfully (and often deliberately) deployed to deflect such needed inquires as unseemly or confrontational.

— Article —

Feeder Fees Topped $790 Million
Madoff Investors Seek Money
The Wall Street Journal
April 11, 2009

Firms that funneled investors’ money to Bernard Madoff likely took in at least $790 million in fees over the years, according to a review of lawsuits and other documents emerging in the wake of Mr. Madoff’s arrest.

Now, investors and authorities are trying to get some of those dollars back, though how successful they will be remains unclear.

Banco Santander SA, one of the biggest of the “feeders” to Mr. Madoff, had some $3 billion with him through its Geneva-based hedge-fund group, Optimal Investment Services SA, according to the firm. Santander earned $52.7 million in 2007 and $43.3 million in 2006 in “investment manager’s fees” from its Madoff-run Strategic U.S. Equity Series, according to a 2007 annual report.

Optimal’s relationship with Mr. Madoff, which dated back more than a decade, was described in a 2008 internal report reviewed by The Wall Street Journal as a “very profitable business for the group.” At the time, the firm collected an average management fee of “above 2%” on money placed with Mr. Madoff. Santander declined to comment.

Mr. Madoff pleaded guilty last month to perpetrating a massive Ponzi scheme. Many of his victims don’t expect to recover anywhere near 100 cents on the dollar and are looking down all avenues for possible relief.

Returning feeder-fund fees could be a “substantial recovery” for defrauded investors, says Stuart Singer, a partner at Boies, Schiller & Flexner, which has sued Fairfield Greenwich Group, the largest Madoff feeder fund. “The biggest challenge ultimately is collecting,” depending on what firms and managers have in assets.

Of course, the suits against feeders might not prevail. And statutes of limitations could limit recovery, lawyers say.

Nearly four months after Mr. Madoff’s arrest, it’s still unknown exactly where all of the money went. Authorities say Mr. Madoff’s scheme totaled $65 billion when fake profits are included, but the amount investors actually gave Mr. Madoff is likely much smaller.

The court-appointed trustee overseeing the recovery effort, Irving Picard, thus far has located $1 billion in assets from Mr. Madoff and his firm. It’s unclear whether the fees taken by feeder funds will be a target.

Already, feeder funds such as Santander have been hit with numerous private lawsuits that in part seek recovery of the fees. In addition, state regulators have zeroed in on feeder-fund profits.

This past week, New York attorney general Andrew Cuomo filed civil fraud charges against J. Ezra Merkin, whose Ascot funds handed money off to Mr. Madoff. The complaint says Mr. Merkin earned more than $169 million in management fees through Ascot for 1995 to 2007. He earned still more in fees off money directed to Mr. Madoff through two other funds, the complaint said. Mr. Cuomo’s suit could result in the disgorgement of fees by Mr. Merkin. Mr. Merkin’s lawyer says he is fighting the charges.

Another feeder-fund operator was Tremont Group Holdings Inc. Through a unit, the Rye Select Broad Market Fund LP charged a 1% management fee and a 0.5% administration fee. According to fund documents, the fund held $2.3 billion on Sept. 30, 2008. At that level of assets, Rye would have collected $34 million in fees a year.

Tremont, which began doing business with Mr. Madoff in the mid-1990s, also offered the Rye Select Broad Market Portfolio Ltd. That fund charged total fees of 1.95% of assets and held $1.2 billion on Sept. 30 of last year, according to fund documents. That level of assets would have brought in annual fees of $23.5 million. Tremont is facing several suits, including one from the town of Fairfield, Conn., which seeks recovery of fees. The firm says it will fight the lawsuits.

The biggest feeder fund was operated by Fairfield Greenwich Group, which first placed money with Mr. Madoff in 1989. On its main Madoff conduit, the Fairfield Sentry fund, the firm for many years took as a management fee 20% of profits earned by investors. In October 2004, it also began collecting a 1% fee on assets under management.

That fee arrangement may have earned Fairfield Greenwich at least $400 million from 2005- 2008, says a suit filed against the company by Massachusetts securities regulators. As part of its complaint, Massachusetts is seeking disgorgement of fees.

A Fairfield spokesman says some of the money collected was in turn paid out to non-Fairfield employees or firms who placed investors in Sentry. The spokesman declined further comment.

Meanwhile, a federal judge on Friday ruled that a group of Mr. Madoff’s burned investors can force him into personal bankruptcy in hopes that will make it harder for him to dispense his assets. The judge said he would lift the injunction barring the customers from filing the involuntary petition against Mr. Madoff.

Federal authorities opposed the effort, saying they could state “unequivocally” that any assets they recovered from Mr. Madoff would be distributed to investors. However, the judge said the bankruptcy court is the best method for recovering the assets.