Madoff, Tremont and More: "I Suppose You Could Program a Computer to Violate A Regulation, But We Haven't Gotten There Yet"

Reed Kathrein — Sat, 07 Mar 2009 00:37:00 GMT

As we proceed to work our way through the Madoff litigation, we focus on cases where we believe there is a source of recovery for our clients. To date, that is largely the Tremont Rye Funds, controlled by Oppenheimer and Massachusetts Mutual, audited by the Big Four accounting firms and supposedly a custodial bank, Bank of New York Mellon.

We have also focused on the feeder funds to the Tremont Rye Funds, such as Spectrum, Future Select, Austin and Meridian. Other funds continue to crop up every day. Nevertheless, these stories are rather dry and our minds still wrestle with how Madoff pulled this off.

A video of Bernie Madoff discussing his business has surfaced online. When I watched this video of Bernie Madoff and his algorithm guru, Josh Stampfli, participating in a round table discussion on the future of the stock market, I expected to find a hint of irrationality or slick behavior. Instead, we hear a very rational human being, thoughtfully discussing fraud, human behavior and profits. We also see tremendous irony in Bernie's statements.

I highly recommend anyone impacted by this scandal to watch, especially around the 43-minute mark, and I've included an index to Bernie's more ironic statements below:

At minute 26, Bernie Madoff states:
"Now, no one is going to run a benefit for Wall Street, so whenever I go down to Washington and meet with the SEC and complain to them that the industry is either over-regulated or the burdens are too great, they all start to roll their eyes, just like all of our children do whenever we talk about the good old days."
At minute 28, Bernie Madoff states:
"Today, basically the big money on Wall Street is made by taking risks. Firms were driven into that business, including us, because you couldn't make money charging commissions, primarily because the rates were lowered and because of the regulatory infrastructure you had to have dealing with clients."
At minute 30, Bernie says:
"There are so-called Chinese Walls that are required to be established at every brokerage firm. They're called Information Barriers - a term most people would understand - to sort of wall off a brokerage firm from taking advantage of information that he has as to what clients are basically going to trade or not going to trade. There are separate divisions within the firms and it is very carefully enforced and surveillanced. It doesn't mean there are not abuses, for sure, but largely in today's regulatory environment, it's virtually impossible to violate rules. This is something that the public really doesn't understand. If you read things in the newspaper and you see somebody violate a rule, you say well, they're always doing this. But it's impossible for a violation to go undetected, certainly not for a considerable period of time. And when you consider the volumes of trading, the trillions of dollars of trading that go on today in Wall Street-I mean, our firm, for example, we trade an excess of $1 trillion dollars a year and that's one firm-and you look at what we would consider to be the infractions, they're relatively small, primarily because of all the regulation. Most firms do try to comply with that."
At minute 43, Bernie states:
"So we determined that the best thing for us to do was basically to take the human being out of the equation. That had two advantages in our industry. Number one, when you take the human being out of the equation, you solve your regulatory problems because the nature of any human being, certainly anyone on Wall Street, is the better deal you give the customer, the worse deal it is for you. You're on the other side of the transaction. It's like going into any store-the store sells you a television at a higher price, they're going to make more money. They sell you the lower price, their profit goes down accordingly. As honest as you try and get people to be, there's this normal, natural pole that you have to deal with. By taking the human being out of the equation to a great extent and turning it over to a computer to make your decision-I guess you could also program the computer to violate the regulations, but we haven't gotten there yet."
At minute 69, Bernie states:
"The future is silence. I don't see a lot changing in the marketplaces. It's hard to of course say that because everything always changes, but I cannot imagine what else we'd do, from an automation standpoint..."
At minute 71, Bernie states:
"You know, this is a psychoanalytical group, I guess, right? I'm sort of curious-maybe because no one got a chance to ask any questions about it yet-what are human beings contributing to the marketplace? Is there any change in their actions?
At minute 111: Bernie states:
"This is the SEC's concern today because they call us all the time and ask us: should we be concerned about the fact that certain firms have left certain areas of the industry and are not serving the public, or not serving even other parts of the industry itself? The answer is it's too late, because you've done it. So there's always this friction that goes on between the regulation side of the industry and the practitioners that say okay, where do you draw the line? I'm very close with the regulators so I'm not trying to say that what they do is bad. As a matter of fact, my niece just married one.
(Speaker: My condolences) (Speaker: Did the SEC approve?)
Madoff: He's an attorney.
(Speaker: Okay.)
Madoff: The issue is, the way they tend to look at the industry if you're making a profit there's something wrong, even though intellectually they know that shouldn't be.
At minute 118, Bernie states:
"You know, my theory-and I've always said this even though we were one of the ones that started all this automated algorithmic trading-was that I never wanted to get into a cockpit of a plane and see there wasn't a pilot sitting there...
But more importantly, in our firm-and I don't know that we're unique, but I know there are other firms that do not operate this way-we have a group of traders that are watching the systems work and the results of the systems to make sure that from their sense of trading things look right. With all due respect to Josh and a lot of other people that we have with similar backgrounds, programmers-not that he's a programmer-but people of his ilk can tend to believe too much in the math and in the model. They fall in love with it sometimes. Not so much Josh, which is why he's with us, but we have a lot of people like Josh that we employ and deal with. They're different. The thing that separates somebody that is a good algorithmic trader from somebody that is dangerous is somebody that just always believes the machine is right. There are people like that. It goes back to what Bob said about the joke of the dog. It's supposed to make sure that nobody touches the machine. You always want to have the human factor involved in the process because that makes it better. At least that's been our experience.
In addition, most disturbing at minute 125:
"Audience: My question is a little basic. It's open for the whole audience. How do you feel that the baby-boomers retiring, starting this year, will affect the future of the stock market, considering there are probably about 60 million people who are going to retire in the next ten years?
Madoff: Good luck."

The take away from this is hard to find. Here we have a man who created the NASDAQ, removed the human element out of trading, and clearly likes to spend time with people. Maybe he was bored and needed the human touch. By playing the ‘big man on campus,' and spreading largess, he became the center of attention.

As he states in minute 69...."The reason why is it's quiet. When you went up to our firm you said, "Well, I'm surprised at how quiet it is." I find it difficult to get used to that because I'm used to a lot of noise and screaming."

Clearly, the worst punishment for Bernie Madoff is the silence.

Oppenheimer Champion Income Fund – If it walks like a duck…

Reed Kathrein — Wed, 25 Feb 2009 00:20:00 GMT

Earlier today, we filed a class-action suit on behalf of investors in the Oppenheimer Champion Income Fund (OPCHX). We are claiming that the fund managers misled investors; we contend they painted the fund as a conservative, high-income fund with a risk profile at par with other funds in its class. Instead, we believe Oppenheimer actually morphed the fund into a much riskier, volatile fund, investing in highly speculative derivates.

You know the old saying, if it walks like a duck...

From what we see here and what we've heard from investors, this fund has more in common with a hedge fund than a high-income fund.

The issue is that when Oppenheimer touted these funds to investors, we believe they hid the ugly parts of the duck - the risk - and touted the benefits.

We are learning from clients and through our own investigations that until 2006, the fund was chugging along - dare I say waddling - delivering reasonable returns as a bond fund, but during that year, the fund managers started altering the fund's strategy, likely in hopes of goosing the returns upward. It appears that the fund managers began purchasing complex derivative instruments, along with mortgage-backed securities without informing investors of these monumental changes to the fund's risk profile.

It also appears that Oppenheimer took investor money and purchased Credit-Default Swaps (CDSs), essentially insurance-like products that protect other investors against defaults. In this approach, the fund backed the risks of others' investments in things as diverse as office-building leases. This appears to be a horrible choice. By September, it appears that the losses tied to CDSs alone cost the fund $47 million.

Investors purchased fund shares through major brokerages like Citigroup, Smith Barney, UBS and Merrill Lynch to name a few, thinking they found an investment that would provide a reasonable return for its risk class. Instead, investors lost about 80 percent in 2008, with November delivering a whopping 55 percent loss in that month alone.

Also interesting, is that Oppenheimer didn't discriminate to whom they marketed the fund. It appears about 10 percent of the fund was held by other Oppenheimer funds.

We anticipate that Oppenheimer will try to defend its actions, saying they were acting in the interests of the fund investors. They will probably point to a $150 million injection of capital to increase the fund's liquidity. They will also point to other internal changes, but we also suggest this may be in response to these issues.

For the time being, we have a lot of upset investors, who lost a lot of money and most upsetting is that it could have been avoided. We believe fund managers pushed too hard when they increased the percentage of investments in mortgage-backed investments, violating the funds policies and did so without warning the funds owners, the investors.

We're certainly hearing a lot of ‘quacking.' If you've suffered losses with the Champion Fund we'd like to hear from you - feel free to contact us at oppenheimer@hbsslaw.com.

Meaningful Disclosure : Oppenheimer

Madoff, Tremont and More: "I Suppose You Could Program a Computer to Violate A Regulation, But We Haven't Gotten There Yet"

Oppenheimer Champion Income Fund – If it walks like a duck…