Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 407

Revealed: Madoff so close to embezzling Australian investors

  •   Anon
  •   12 May 2021
  • 4
  •      
  •   

Editor's note: Firstlinks has never published an article anonymously before, but while we cannot reveal the source of this piece, it is known to us and we consider it impeccable.

In debating whether to publish, we felt encouraged by the decision by Peter Singer and colleagues as reported in The Conversation:

"Philosophers Peter SingerJeff McMahan, and Francesca Minerva have announced a new academic outlet, the Journal of Controversial Ideas, as an “open access, peer-reviewed, interdisciplinary journal specifically created to promote free inquiry on controversial topics,” it will give authors the option to publish their work under a pseudonym “in order to protect themselves from threats to their careers or physical safety.”"

In the same spirit, confident in the source, we are publishing this informative piece without implicating anyone.

***

In 2007 Bernie Madoff’s fraudulent hedge fund came perilously close to being distributed by a major Australian wealth manager. Sensible minds (just) prevailed and the distribution deal was aborted. A year later the largest hedge fund fraud of all time, a US$65 billion Ponzi scheme, was exposed.

This article, which for obvious reasons must remain anonymous, is a reminder that financial institutions, just like retail investors, are vulnerable to fraud. Financial institutions have their own set of agency issues and behavioural biases which need to be managed.

Distribution of the funds of external managers

In the finance industry, distribution is king. The logic is that it doesn’t matter how good your product is, if it doesn’t sell, it's not worth having. Even if you argue that money will eventually find its way to quality investment products, there is a shorter-term imperative that demands businesses maximise their short-term return on equity.

Look at the CEOs of most wealth managers. Many come from a distribution rather than a specialist background such as investments. This is not a bad outcome by any measure: an all-round suite of skills is required for a CEO to succeed and a successful grounding in distribution provides many of those skills.

It is common for wealth managers to distribute externally managed funds. This practice has existed for decades and can take many forms. A simple contractual arrangement is known as a third-party distribution arrangement while a more integrated relationship could be described as a partnership model. Another model is the white label approach, commonly used for global sectors, whereby a wealth manager outsources the asset management of their own branded product to an external manager.

Third-party distribution decisions bring different payoff profiles to wealth managers compared with the outcomes realised by retail or institutional investors. Performance will impact the asset-raising prospects for the wealth manager while directly impacting performance outcomes for end investors. Non-success of a third-party distribution arrangement represents an opportunity cost more than any significant financial cost.

Fiduciary responsibility and fraud ... enter Madoff

It is only in the case of a fraud that both wealth managers and investors experience extreme pain. For wealth managers, their brand may be irreparably damaged and there is an issue of compensation. For investors, there is a performance write-off and reputational damage if the investor is an institution, such as a super fund.

There are many agency issues and behavioural biases which exist in wealth management. The agency issue centres on the degree to which staff view themselves as fiduciaries or renters of the company’s brand and scale. Some of the behavioural biases include confirmation bias (tendency to ignore contrary information to their view), herd mentality (blindly follow and copy others), and a framing bias (where the narrative may distract from the facts).

So how does Bernie Madoff come into this story?

One of many tactics used by Madoff was to allow other firms to distribute his hedge fund through select third-party relationships. This added further credibility to his name: investors take comfort from the assumed due diligence undertaken by the distributor.

A major Australian wealth manager came perilously close to entering a distribution arrangement with a respected US-based third-party distributor. The major attraction: access to Madoff’s hedge fund which had enviable performance, a legendary reputation and limited capacity, some of which this distributor had exclusively reserved.

What a coup to be able to partner with this group! It could really make someone’s career.

The business case was straightforward: exclusive access to a legendary hedge fund and an attractive distribution fee.

How to garner business case support?

Here's where big institution politics came into play. At the time there was an unofficial ideological power struggle between distribution and investments. The business case was selectively shared with ‘friendlies’ before being distributed to the broad executive group. There was significant momentum behind the business case by the time key questions were asked regarding the investment integrity of the underlying investment managers.

One investment executive engaged an independent consultant to provide an initial investment opinion on the suite of funds offered by the US third party distributor, including Madoff’s.

Madoff never cooperated with the due diligence processes of any investor but he had many established strategies to attract clients, including:

  • access to exclusive IP (intellectual property) which couldn’t be shared
  • his previous career successes, where Madoff had been heavily involved in broking and software
  • connections and implicit endorsement from the sheer weight of investors and capital invested in the fund, and
  • exclusive distribution rights, as others were ready to take your spot.

The consultant report raised concerns that something didn’t feel right, but without full due diligence access it would have been near impossible to claim that such a large and famous hedge fund manager was a fraud.

A fine balance tilted the right way

The decision was finely balanced, but it was decided to not proceed. I’ll never know to what degree the decision was political or objective. All I can say is that I am forever glad the right decision was made and that Madoff’s Ponzi scheme never managed to defraud Australian investors.

What’s fascinating is that no one did anything wrong. It is healthy for employees to propose new business ideas. The processes worked, and the agency issues and behavioural biases were managed.

Just.

 

This article is published anonymously but from an exemplary source as a warning that even when dealing with the biggest names in the industry for what looks like a sure profit, great care and due diligence are required. 

 

4 Comments
Graham Hand
May 12, 2021

Please note that some comments are coming in speculating who was behind this, and since they are guesses with some indiscriminate and unrelated remarks, we are not publishing them.

Patrick Bennett
May 12, 2021

Not a happy ending for those who lost money with Madoff, but an amusing read none the less.
Institutions managing other people's money should decide whether they are primarily investment businesses or distribution businesses. In my experience, not much good ever came out of allowing the marketing people to have a say in what investments should be offered to clients. Too little understanding of risk and too much lure of bonuses based on sales. Memories of Challenger High Yield, Basis Capital, BT's TMT Fund, various agri-schemes, Macquarie's Geared REIT fund, CDOs, etc. leap to mind. All had big red flags and all were sold with great enthusiasm by naive distribution teams. When senior management is stacked towards distribution, as is usually the case because they are perceived as being the revenue generators, risk is down played and that is when things do not end well.

Sulieman Ravell
May 15, 2021

I seem to recall that one of the fund of hedge funds distributed in Australia already had exposure to Madoff but was only 1-2% of the overall exposure

 

Leave a Comment:

RELATED ARTICLES

No easy way to make money

banner

Most viewed in recent weeks

Are LICs licked?

LICs are continuing to struggle with large discounts and frustrated investors are wondering whether it’s worth holding onto them. This explains why the next 6-12 months will be make or break for many LICs.

Retirement income expectations hit new highs

Younger Australians think they’ll need $100k a year in retirement - nearly double what current retirees spend. Expectations are rising fast, but are they realistic or just another case of lifestyle inflation?

Welcome to Firstlinks Edition 627 with weekend update

This week, I got the news that my mother has dementia. It came shortly after my father received the same diagnosis. This is a meditation on getting old and my regrets in not getting my parents’ affairs in order sooner.

  • 4 September 2025

5 charts every retiree must see…

Retirement can be daunting for Australians facing financial uncertainty. Understand your goals, longevity challenges, inflation impacts, market risks, and components of retirement income with these crucial charts.

Why super returns may be heading lower

Five mega trends point to risks of a more inflation prone and lower growth environment. This, along with rich market valuations, should constrain medium term superannuation returns to around 5% per annum.

The hidden property empire of Australia’s politicians

With rising home prices and falling affordability, political leaders preach reform. But asset disclosures show many are heavily invested in property - raising doubts about whose interests housing policy really protects.

Latest Updates

Shares

Four best-ever charts for every adviser and investor

In any year since 1875, if you'd invested in the ASX, turned away and come back eight years later, your average return would be 120% with no negative periods. It's just one of the must-have stats that all investors should know.

Our experts on Jim Chalmers' super tax backdown

Labor has caved to pressure on key parts of the Division 296 tax, though also added some important nuances. Here are six experts’ views on the changes and what they mean for you.        

Superannuation

When you can withdraw your super

You can’t freely withdraw your super before 65. You need to meet certain legal conditions tied to your age, whether you’ve retired, or if you're using a transition to retirement option. 

Retirement

A national guide to concession entitlements

Navigating retirement concessions is unnecessarily complex. This outlines a new project to help older Australians find what they’re entitled to - quickly, clearly, and with less stress. 

Property

The psychology of REIT investing

Market shocks and rallies test every investor’s resolve. This explores practical strategies to stay grounded - resisting panic in downturns and FOMO in booms - while focusing on long-term returns. 

Fixed interest

Bonds are copping a bad rap

Bonds have had a tough few years and many investors are turning to other assets to diversify their portfolios. However, bonds can still play a valuable role as a source of income and risk mitigation.

Strategy

Is it time to fire the consultants?

The NSW government is cutting the use of consultants. Universities have also been criticized for relying on consultants as cover for restructuring plans. But are consultants really the problem they're made out to be?

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.