Bernie Madoff's One-Way Social Contract

A 2001 profile on Bernie Madoff in Barron's magazine carried the telling title Don't Ask, Don't Tell, a reference to how impossible it was to get any real information from Madoff. No one understood how his firm was managing its funds, and returning such stellar profits for Madoff's clients.

The article's subtitle was Bernie Madoff is so secretive, he even asks his investors to keep mum. Secrecy was Madoff's hallmark. When the reporter for Barron's pressed him for details, Madoff simply replied "It's a proprietary strategy. I can't go into it..."

We know now the principle reason why Madoff was so passionate about keeping his methods secret. The questions in my mind, though, are these:

Why was Madoff's firm allowed to keep its methods proprietary, in the first place?

Why do we have a system that permits billion dollar companies -- whether financial firms or otherwise -- to keep their major activities and strategies a secret?

No one who has gotten burned by Madoff would be likely to argue that they benefitted by his penchant for secrecy? Even those who took their profits before Madoff's mega-Ponzi scheme collapsed didn't necessarily benefit, as they are recipients of stolen goods, and, when all is said and done, may not be allowed to keep their 'profits'.

Society at large certainly doesn't benefit. No one is looking forward to the years of trials, lawsuits, counter-suits, insurance claims, and everything else that follows in the chaotic wake of Madoff's multi-billion dollar collapse.

Even had Madoff's enterprise been a legitimate one, the question still stands: What is the benefit, to anyone other than Madoff, of allowing his firm's key activities to stand as corporate secrets?

There simply are no external benefits. None at all. And if Madoff is the only one benefitting by legally permissible secrecy, then there is something drastically askew. No contract should be a one-way street. All parties involved in a contract should gain proportionate benefits. That's just a fundamental principle of how society is supposed to operate.

But when it comes to corporate secrecy, the social contract is totally one-sided. It's time it was rewritten.

Friehling & Horowitz, CPA's

It wasn't easy, but I obtained a copy of the auditor's report for Bernard L. Madoff Investment Securities (see the December 20th post about SEC form X-17A-5). The form was filed just about a year ago by Friehling and Horowitz, Madoff's accounting firm in New York. Its 16-pages makes for a dense but interesting read.


I'm particularly fond of the section that says:

An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statement...

I wonder what tests Friehling and Horowitz actually performed. What evidence was collected? Hopefully, they aren't secret.

If anyone wants a full copy of the document, just drop me a note.

The Culture of Secrecy

AIG is a huge insurance company (too big to fail, by some reckonings).

It's not a household name, or at least, it wasn't until two things happened. First, it received an enormous bailout from the federal government, even after other big financial firms like Lehman Brothers were allowed to go belly-up. And second, it sent some of its corporate executives to a lavish, all-expenses-paid meeting at a luxurious resort, a week after getting its taxpayer-financed $85 billion bailout. Talk about embarrassing!

So what lesson did AIG take away from the scathing press on this story. I can tell you what lessons they didn't learn. They didn't learn not to spend lavishly on executive retreats that look way more like vacations than business meetings. Nor did they learn to stand up and defend the meetings as a necessary part of doing business, appearances notwithstanding.

No, I'm afraid the lesson that AIG took away was this: Let's keep meeting, but let's not tell anyone. That's right... they learned that the best approach is to keep their meetings secret. Or at least, to try to. Hotel employees at the resort where AIG met were instructed to not even utter the letters, A.I.G.

The attempt at holding secret junkets begs the question: How could AIG management make such an idiotic decision? The answer, I'm afraid, is that there is such a deeply-ingrained culture of corporate secrecy throughout the world of business, that the thought of not keeping the meeting secret probably never crossed their minds.

Don't believe me? Consider GM's response when their executives got raked over the coals at Congressional hearings for flying their private corporate jets to Washington DC to plead for bailout money.

The company's response? Delist their jets in FAA's database, so that the GM jets' flight paths are now secret.

In a way, AIG's and GM's insistence on secrecy is a good thing. As these companies continue to make decisions that erode the small amount of public trust that still remains, they hasten the day when the deep-rooted culture of corporate secrecy is no longer deemed an acceptable way of doing business.

It can't come soon enough.

What's Nike Up To?

Hope everyone had a great holiday! I got a sweatshirt made by Nike. The sweatshirt includes a few tags containing a few tidbits of information which, as far as I know, are required by law.

One tag discloses materials: 80% cotton, 20% polyester. That tells me something useful. I like cotton.

Another tag tells me where the sweatshirt was manufactured, with a simple statement: Made in China/Fabrique en Chine.

This is a bit useful to know, but my curiousity is piqued: where, exactly, in China was my sweatshirt made? Was it sewn together by an underaged, underpaid school girl? Is the factory a horror show of worker safety and environmental abuse?

Or is it a good place? One that adheres to Nike's codes of conduct for their suppliers? Nike is aiming to improve the world, "one factory at a time". There are almost a million workers in hundreds of factories around the world piecing together goods for Nike. Is the factory that made my sweatshirt one of those that has raised the bar? Or is it one that needs some raising?

Nike, of course, wouldn't tell where the sweatshirt was made (I haven't asked them, but trust me, they wouldn't tell). But why not? Why keep the place of manufacture a secret?

Think about it. If the information was public, there would then be a veritable army of citizens, workers, journalists, NGOs, and just plain folk who could make the connection between a piece of clothing on their back, and the actual factory where that item of clothing was made. An army of people who could assist Nike in overseeing their important code of conduct, and in making sure the code is much more than just words on paper.

But if Nike continues to keep the factory information a secret, than we have little choice but to take their word that they are doing good deeds. And when sweatshop conditions come to light at a Nike factory (as they inevitably do from time to time), we are asked, again, to take them at their word when they say that it's simply an aberration rather than the way things are being done at Nike suppliers around the world.

But of course, their list of suppliers is top secret. So who's to really know?

I imagine Nike will see this post at one point or another. They are, of course, more than welcome to respond.

A Few Assorted Quotes

I'm not the only one who thinks corporate secrecy is out of hand. Here are a few tidbits from around the web.

"It's something any bank would demand to know before handing out a loan: Where's the money going? But after receiving billions in aid from U.S. taxpayers, the nation's largest banks say they can't track exactly how they're spending the money or they simply refuse to discuss it."
Matt Apuzzo, Associated Press

"We've lent some of it. We've not lent some of it. We've not given any accounting of, 'Here's how we're doing it'... We have not disclosed that to the public. We're declining to."
JPMorgan Chase, which received $25 billion in emergency bailout money.

"We're choosing not to disclose that...I just would prefer if you wouldn't say that we're not going to discuss those details."
Spokesman for Bank of New York Mellon, which received about $3 billion

"We are going to decline to comment..."
Morgan Stanley

"We're not sharing any other details. We're just not..."
Comerica Inc. in Dallas, which received $2.25 billion

"If the appropriate restrictions were put on the money to begin with, if the appropriate transparency was in place, then we wouldn't be in a position where you're trying to call every recipient and get the basic information that should already be in public documents..."
Elizabeth Warren, TARP watchdog

"...no one knows how it happened, least of all the federal regulators charged with policing [Madoff] and protecting the public....But have we yet learned anything? Incredibly enough, as we careen into 2009, the very government operation tasked with repairing the damage caused by Wall Street’s black boxes is itself a black box of secrecy and impenetrability."
Frank Rich, columnist, NY Times

"...without transparency and accountability in Washington’s black box, as well as Wall Street’s, there will continue to be no trust in the system, no matter how many cops the S.E.C. puts on the beat."
Frank Rich, columnist, NY Times

“...the standard agreement between Treasury and the participating institutions does not require that these institutions track or report how they plan to use, or do use, their capital investments.”
US General Accounting Office

sources:
http://news.yahoo.com/s/ap/20081222/ap_on_bi_ge/meltdown_secrets_3
Where'd the bailout money go? Shhhh, it's a secret

http://www.nytimes.com/2008/12/21/opinion/21rich.html
Who Wants to Kick a Millionaire?

http://www.gao.gov/new.items/d09161.pdf
TROUBLED ASSET RELIEF PROGRAM: Additional Actions Needed to Better Ensure Integrity, Accountability, and Transparency

Mr. Madoff's Secrets

From all appearances, Bernard Madoff is an out-and-out crook, the mastermind of one of history's largest thefts, and likely, one of it's most destructive as well.

What did investors know about Mr. M? I decided to look at EDGAR, the usually-frustrating, but sometimes-wonderful database at the SEC that houses all their publicly filed reports.

What EDGAR reveals about Madoff's firm, Bernard L. Madoff Investment Securities, LLC, is...not much. The public would be hard pressed to know anything of significance about BMIS from the electronic reports in EDGAR. Apparently, so would the SEC.

Start with Madoff's FOCUS report. This is an annual financial report required under the Securities laws. Here is how the SEC site somewhat unhelpfully describes it:

"Focus Report (Form X-17A-5) Every broker or dealer registered pursuant to Section 15 of the Exchange Act must file annually, on a calendar or fiscal year basis, a report audited by an independent public accountant."

Whatever it is, it sounds intriguing. As a possible investor (or regulator), I suppose I'd like to have a look. Let's pull it up, shall we.

Ooops. Every FOCUS report has a [Paper] tag, meaning, it's not available electronically. Why would that be? Could Madoff not afford a computer or two needed for electronic filing? Do I really want to make a trip to the SEC Documents Room in the hopes I might be able to see it?

Actually, almost all FOCUS reports, from all firms, seem to be reported on paper, rather than electronically. I'm not sure why this is, but it certainly bears some looking into.

But no matter, there are also the 13F-HR quarterly reports of Madoff's holdings, and happily, they are available online.

Let's see what they tell us.

Oddly enough, the form details holdings with a combined value of about $275 million. Where is the $17 billion, or $25 billion, or $50 billion that Madoff allegedly manhandled? In some other fund? Unreported? Locked away on the 17th Floor? These are open questions. They money is certainly not detailed in EDGAR.

Here's a look at BMIS' top ten holdings:

=============================================

NOV 2008 HOLDINGS ........Value($000) .....SHARES

ISHARES RUSSELL 2000 IDX.......12,172 .......179,000
TRIAN ACQUISITION I CORP .......4,720 .......533,300
HICKS ACQUISTION CO 1 INC ......4,489 .......501,600
UNITED REFINING ENERGY CORP ....4,470 .......495,000
ANHEUSER BUSCH COS INC .........4,412 ........68,000
LIBERTY ACQUISITION HLDGS CORP .4,316 .......496,100
SAPPHIRE INDUSTRIALS CORP ......4,180 .......465,000
GREY WOLF NC ...................3,819 .......490,846
UST INC ........................3,726 ........55,992
WRIGLEY WM JR CO ...............3,709 ........46,710

=============================================

Anyone can claim to be holding $4.4 million of Anheuser Busch stock. But there's just no way to really check now, is there?

If I called Anheuser Busch, or any of the hundeds of other firms on Madoff's list, to ask if BMIS really is one of their shareholders, they'll just tell me...

Sorry. It's a secret.

Information is power

Information is power, and power belongs in the hands of citizens. Not companies. Citizens.

We allow companies to withhold information -- keep secrets -- out of some sort of notion that it's somehow a good thing, that secrets help companies make more money, help the economy operate more efficiently, or are simply a fundamental right that corporations have.

None of this is true.


Imagine how the world would be different if large, billion-dollar-plus companies were subject to a few simple rules like:

• Senior management meetings should be open to the public, via webcast


• A company's financial books are public documents, that anyone may examine
  
• Companies reveal who their major suppliers are.


• All large companies provide annual reports that include a plain-English explanation of where their money comes from, where it goes, and where their funds are at risk.

What would Enron's "plain English" explanation of their income stream would have sounded like? What would Citi's boardroom discussions on the risks of collaterized debt obligations have sounded like if those discussions were publicly broadcast? If Bernie Madoff's books were, well, an open book, would we all be $50 billion deeper in the hole? If Wal-Mart, Nike and the Gap revealed their suppliers, would there be fewer sweatshops in the world?

If large, billion-dollar companies were obliged to be less secretive, we all would be much better off.