Risk Professional: Mad about Madoff

It's difficult to keep Nicola Horlick out of the news and her Bramdean Investment Managers firm's admission that about 10% of its funds under management were with Bernard Madoff's funds has brought out cries that US regulators were not paying attention.

True: they were not. But that is no surprise: US regulators don't pay attention to very much. In short, US regulators are pretty rubbish. They have failed to spot failings in investment funds, investment banks, retail banks, ratings "agencies" (which are not agencies in any accepted sense of the word) and the entire mortgage sector. Whilst not entirely to blame for the current financial crisis, they have certainly played a central part.

It it, perhaps only to the English, a wonderful irony that Americans use the term "oversight" when they mean "supervision." Lesson in English - "oversight" means you have missed something. Like the fact that your entire financial system is built on a flaw the size of the San Adreas Fault - but more predictable as to when and how it would go wrong.

But it is not only US regulators who are at fault: investing in funds at the Madoff level comes with a wealth warning. Only invest what you can afford to lose. In the US, so called "hedge funds" (they are actually no such thing) are clearly defined: only "sophisticated" investors and then only those that don't need advice from the fund and who can demonstrate they can afford to lose their investment are allowed to invest - and then they have to find out about the fund by a sort of osmosis because the funds are not allowed (more accurately, not supposed) to advertise.

So funds are marketed by nods, whispers and in restaurants, bars and places of worship and related gatherings.

But some funds can be openly marketed: these are "funds of funds" where the money comes from other funds which are themselves the type of funds described above.

Madoff's funds were a mix of institutional investor, funds of funds and some "sophisticated investors."

Spectacularly, the very funds that placed money with him appear to have done so, and to have left it with him, with very little due diligence.

The Madoff scandal proves two things above all else:

- It's easy for "hedge funds" to be a vehicle for fraud because everyone operates by word of mouth and there is very little intervention - and the result of this is inadequate due diligence and monitoring by investors including institutional investors.

- regulators have fundamentally missed the risks of funds going rogue, or just being badly managed. And it happens more in the USA than anywhere else precisely because US regulators are hopeless whilst telling the rest of the world what a great job they are doing and that other countries should buck up.

Not for the first time, that has been proved entirely false.

Annoyingly, it won't be the last.