Ross Asset Management Cash Flow 2000 to 2012

“It was not the financial elite, [it] was ordinary New Zealanders who are working hard and have saved money,” he said.

I am pleased to read that there are rumblings of net winners having money clawed back from the Ross Asset Management scheme.

In the recovery of assets in the Madoff scheme, Irving Picard has pursued “net winners” who received more from the scheme than they put in. He has achieved several substantial settlements, notably the estate of Jeffry Picower and the NY Met owners who used Madoff like a checking account.

The comment by investor Bruce Tichbon that his group of investors want to limit the fees charged by receivers and liquidators is entertaining.

The cost of recovering funds from fraud is high due to the need for forensic accounting experts and civil suits against “net winners”. Many of the transactions over the past few years could qualify as voidable preference, meaning the liquidator can claw them back.

The process will also take years to wind down. There are no quick resolutions to situations like this. You can’t just get a court order one month and have the “net losers” bank cheques the next.

We are yet to hear back from the Serious Fraud Office on whether charges will be laid against David Ross.

But by representing the cash flows identified by PWC in its report to the High Court graphically, we can see how these schemes work:

The net difference over the 12 year period, which excludes activity before 2000, is -$15,774,673.59. But over $303 million was contributed to the scheme and almost $290 million withdrawn. Management fees accounted for almost $30 million dollars.

The onset of the global financial crisis seems to have set the unwinding of David Ross into motion. A substantial increase in withdrawals along with a major reduction in contributions rapidly altered the mathematics here.

It’s clear that although management fees of $30 million were a factor in the collapse of the scheme, they are dwarfed by the mathematics. It’s simply not possible to keep adding substantial investors to finance the withdrawals of other investors in a global financial crisis where people are cautious about investing outside of lower risk assets.

I am extremely concerned that anti-money laundering rules didn’t pick up on really odd cash flow patterns like this. I hope the FMA will use this occasion to instruct the commercial banks to identify high cash cash flow patterns like we saw above.

The “unusually large” number of brokerage accounts held by RAM and its associated entities are also major red flags. If you have hundreds of millions of dollars under management, maintaining accurate performing reporting over a handful of accounts is difficult enough – dozens of accounts would require a substantial back office operation.

With respect to overseas asset recovery, if a substantial portion of the management fees has been transferred offshore best of luck to PWC in getting any of that back.

This is going to be one of the most interesting cases to come out of the global financial crisis in New Zealand. The fact that nobody has done serious due diligence does not bode well for any notion that investors are capable of managing their own money without enormous investment in education and financial literacy.

Red Flags And Ross Asset Management

The report by High Court appointed receivers PWC regarding Ross Asset Management makes for sober reading. In the wake of several ponzi schemes being uncovered as the global financial crisis led to more withdrawals than contributions, we have to think carefully about the enormous red flags that presented themselves when it came to Ross Asset Management.

Brian Gaynor wrote in the Herald:

Investors deposited funds with RAM, assets were purchased and sold on their behalf and held by RAM. The investment performance of these funds was reported by RAM without any independent verification or audit. RAM clients had their own individual portfolio and, as a consequence, could have widely differing investment returns.

As he notes, this was exactly the same structure employed by Bernie Madoff. The cash flowed into a single account and back out again when withdrawals were requested. The PWC receivers have identified just $10.2 million out of a supposed $449.6 million in assets under management. The cash flow analysis in the PWC report makes for sobering reading.

When you think about due diligence on potential investments, the Ross Asset Management proposition sets off multiple sirens. The lack of independent verification of returns, the use of an accountant who shared the same address as the firm, the absence of an independent custodian and maintenance of client records in a single Access database are just the tip of the iceberg.

There was quite a disturbing interview on Radio New Zealand where the poor lady involved had all of her savings with David Ross. It is clear that Ross Asset Management was operating on the down low, relying on referrals and word of mouth.

With the high average account balance of around $500,000 many investors would have been wholesale investors / accredited investors. That means lower disclosure is required and filing prospectuses with the FMA isn’t necessary.

It’s clear that having $500,000 to invest is not sufficient evidence of an ability to manage your own wealth. An enormous amount of reading and careful thinking needs to be done before writing a cheque to anyone – let alone to an asset management firm that operated completely outside standard practice.

Since the collapse of MF Global it has been clear that you are an unsecured creditor to any investment firm you have an account with. Every single dollar of your wealth is at risk – your term deposit, your bonds, your shares, your derivatives trades – they all require ongoing monitoring and tough questions being asked of the people you’re dealing with.

When the most clued up fund managers in the world regularly clear different types of trades through different prime brokers to reduce the counter-party risk involved, that’s a clear signal to ordinary investors that breaking up where you put your money is the bare minimum of risk reduction you can do.

I am surprised that accountants performing the foreign investment fund tax calculations for investors in Ross Asset Management didn’t double check shareholdings via the registry. How could you file accurate tax returns reporting foreign capital gains and dividends without double checking the relevant share registries?

I will follow the development of this case with interest. Because Mr Ross was an “Authorised Financial Advisor”, it will be interesting to see whether more background investigation will be conducted to see if other AFAs are running investment funds of this magnitude on the side and outside the regulatory framework the FMA oversees.


Book Review : Too Good To Be True By Erin Arvedlund

“What do you mean he’s been arrested?” she screamed. “But that’s where all our money is!” – Ellen Jaffe, wife of Madoff agent Robert Jaffe.

The central theme of the Bernard Madoff affair is that you can only trust yourself with your money. You cannot rely on personal relationships, cultural ties, regulation, due diligence, the historical relationship of your family with the asset manager or any other reason. You simply must conduct ongoing due diligence of every asset class you are exposed to and the “professionals” that you deal with.

A track record of solid performance doesn’t mean that your investments are safe or even being managed properly. There is always a risk of fraud or misappropriation if the correct procedures aren’t being followed with your money. Arvedlund describes in detail how all of the investments in Mr Madoff’s fund went to one JP Morgan Chase checking account. Billions of dollars flowed in and out, with nothing ever being done about it.

In Too Good To Be True Erin Arvedlund presents a detailed story of how Bernard Madoff exploited cultural ties and the need to feel special in order to run a ponzi scheme that could have started as early as the 1987 stockmarket crash. A successful market maker on Wall Street and well known in regulatory circles, Madoff cynically leveraged his ties to regulators and several failed SEC investigations as “proof positive” that his “split-strike options strategy” was legitimate.

The fraud also played on Jewish ties – country clubs with predominantly Jewish members, Jewish social circles, Jewish foundations and university endowments. Working class Jews were also targeted through lower level agents and referrals from Madoff employees themselves. Holocaust survivors like Elie Wiesel lost money. Absolutely sociopathic abuse of cultural ties on the part of Madoff.

 “Recessions catch what the auditors miss” – John Kenneth Galbraith

In 2008 the global financial crisis begun. Because of Madoff’s reputation for quickly returning customer money, he was flooded with almost $7 billion in redemptions towards the end of 2008. He didn’t have enough cash on hand and couldn’t raise any more money from the feeder funds who raised money for him.

Through telling his sons and pleading guilty, he avoided a trial. He also avoided a lot of the arcane but interesting details being brought to light. Arvedlund expounds on the network of feeder funds and how they worked. In exchange for a management fee and performance fee, these funds trawled the charity ball circuit and wealthy social circles for new investors. They then wired their money to Bernard Madoff. The people who earned commissions from Madoff lived lavish lives of luxury and didn’t ask too many questions – they simply couldn’t go back to the way they lived before the Madoff kickbacks.

Investors received regular but not excessive returns. It is clear that some investors had “returns to order” produced where they could invent losses in their Madoff accounts to offset their tax bills. When people asked questions Madoff always had an answer at hand. When Madoff investors were confronted by other people in the financial industry about the impossibility of Madoff’s consistent returns they ignored the suggestion that they remove money from their Madoff investments. It simply was “too good to be true”.

There is a sort of schadenfreude about the Madoff affair. The trustee Irving Picard is analogous to Breeden in the Conrad Black case. He is making millions of dollars managing the recovery of assets for investors. Some investors stand to receive more back than they initially invested in Madoff because their other investments have performed dismally during the global financial crisis. Ignoring opportunity costs and taxes paid on fictitious returns, it is estimated that at least half of Madoff’s investors will lose no capital.

Bernard Madoff played on our need to feel special, like we are one of the elite. By making it hard to invest in his fund he created an air of exclusivity that made otherwise sophisticated investors act like teenagers not invited to a house party. The need to perform extreme levels of due diligence before investing in anything is another central theme running through the book.

We will never know the true story of the Bernard Madoff affair. We will never know with certainty that all of the assets have been recovered and investors made whole. But some extremely arrogant people had their wings clipped by the collapse of Madoff. This is a good thing in the long-run and why arguments about taxing inherited wealth don’t make sense.

If investors in Madoff had stuck to the rules and not thought that they were better than the great unwashed with their special investment relationship with “Bernie” they wouldn’t have needed to sell their apartments and Palm Beach winter homes. They could have kept their NetJets fractional shares and American Express bills in the six figures.

The investors I feel slightly sorry for are the usual dupes – the “mum and dad” types who invested on the recommendation of friends and family. They never win in the financial markets because they are like people going to the sales without being able to tell a horses rear from its ears. As I’ve written before, they shouldn’t try and invest at all because it always ends in tears.

Relying purely on regulators as a risk reduction strategy as a success rate approaching 0% as evidenced by:

  • finance companies and the Securities Commission
  • the NZX, auditors and the Feltex IPO
  • Bernard Madoff and the SEC
  • Ratings agencies and mortgage backed securities being rated AAA

The book doesn’t touch on the reality that any investment fund can experience a run at any point in time. If all the investors want to withdraw their money, the fund won’t necessarily have liquid assets to cover the redemptions. It’s like a run on a bank, only investment fund’s will quickly sell off their assets to meet redemption requests. This will depress the value of the investor’s accounts even further.

I have followed the Bernard Madoff story closely. So far, billions of dollars has been recovered and due to the “net winners and net losers” calculation, many investors will actually get all of their money back. For sure, this is without interest and with considerable stress. But I’d wager it’s a better return than they would have got investing in some other asset classes since 2008.

If you like reading about the human side of how these schemes work, I’d definitely recommend checking this book out. It’s yet another cautionary tale about taking everything you read or hear with a grain of salt and pursuing a skeptical line of inquiry into the reality of the situation.