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Financial Advisers Willingly Went Along on Madoff’s Ride

Los Angeles Business Journal

By Ryan K. Bakhtiari

Due diligence, fiduciary duty, transparency, risk management, oversight. It’s all part of the sacred bond of trust between financial services firms and the investors who entrust them with their money. Somehow, the lines of that trust became increasingly blurred when it concerned investing with Bernie Madoff and his allegedly corrupt hedge fund scheme.

Long before Madoff’s arrest Dec. 11, rumors and speculation ran rampant on exactly how Madoff could guarantee such high and consistent returns for investors. These weren’t just annual returns; they were monthly. If pressed for an explanation about his money-making performance, Madoff remained silent. At best, the former Nasdaq chairman offered vague responses of investing in blue-chip stocks and hedging them in the options market. Such explanations, no matter how you look at it, are not what one expects from a supposed legitimate money manager who has the best interests of clients at heart, and is therefore committed to providing any and all information about the inner workings of their investments.

A number of hedge fund firms and money managers took the bait, however, and eagerly sent money – investors’ money – to Madoff. In doing so, highly respectable, sophisticated institutions failed their clients miserably. They neglected to perform the basic premise of Investing 101: know who or what you are doing business with.

One such firm is the Brighton Co. of Beverly Hills. In a lawsuit filed Dec. 15 in the U.S. District Court for the Central District of California, Brighton founder Stanley Chais is accused of defrauding investors and using Brighton as an “alleged feeder fund” to channel investors’ monies to Madoff.

According to the complaint, investors were under the impression that Chais had invested their money in currencies, stocks and other securities; Madoff’s name was never mentioned during his tenure as their adviser. Even more troubling: The Securities and Exchange Commission and the California Department of Corporations can find no records of Chais even registering as an investment adviser or as a broker.

Millions of dollars in life savings have now vanished. And, as if to commiserate with those who were allegedly scammed, Chais said his own foundation, the Chais Family Foundation, also suffered in the Madoff scandal. On Dec. 15, the foundation, which gives away about $12 million annually to various Jewish causes, officially closed its doors after losing 100 percent of its money to the disgraced money manager.

The demise of the Chais Family Foundation, while devastating to the causes that benefited from its support, is yet another indicator of ineffective oversight. The foundation of a professional financial adviser’s relationship with his or her clients is built on trust – trust that the person handling your money will perform the necessary legwork to ensure investment decisions are appropriate to meet individual financial goals. By steering investors’ money into Madoff’s funds without thoroughly understanding how such positive returns were generated month after month, many advisers failed to perform adequate due diligence.

Making matters worse, a number of feeder funds raked in hefty fees from investors totaling billions of dollars for their services.

The damage is done. The list of investors who lost some $50 billion because of Madoff’s alleged actions continues to grow by the day. More than just investors, the entire hedge fund industry is now marred – much like what happened in the case of Michael Milken and the junk bond market.

Investor confidence in Wall Street is at an all-time low, with the Madoff affair serving up the final icing on the cake. If money managers and hedge funds ever hope to repair the fractures that have cracked the foundation of trust among themselves and their clients, then it’s time to revisit the concepts of due diligence and fiduciary duty – and fast.

Ryan K. Bakhtiari is a securities lawyer for the L.A.-based firm Aidikoff, Uhl & Bakhtiari.