The recent arrests of several major investment managers such as R. Allen Stanford, Arthur Nadel, partners Paul Greenwood and Stephen Walsh, and the conviction and sentencing of Bernard Madoff have proved unsettling. In the Bernie Madoff scandal, even presumably astute and wealthy investors can be victims of fraud on a massive scale. One is left with the impression that shady and unscrupulous characters are lurking around nearly every business plan, retirement investment or contest opportunity.
The act of being taken in by con artists is as old as civilized man. In today's world, the techniques have become more sophisticated in several ways. Still, there are often red flags that could easily alert the public that something is amiss and proper due diligence could unearth questionable practices and ties suggesting there are potential problems beneath the surface.
In the Madoff case, there were countless warnings that should have cautioned potential investors and prompted further scrutiny. These red flags included too-good-to-be-true rates of return on investments during both buoyant and down economic times. A small, 3-person audit firm that included only one actual certified public accountant that audited Bernard L. Madoff Investment Securities should have been a show-stopper. Another cause for concern was that Madoff performed all three major investment roles. He was the broker-dealer, investment advisor and asset custodian. Lastly, Madoff did arouse the suspicions of some in the industry. For nearly a decade, another fund manager tried unsuccessfully to convince the Securities and Exchange Commission to investigate Madoff.
"Unfortunately, investors sometimes have to dig really deep to find those connections that might cause them to reconsider writing a check," cautions Frank Bragg of Centurion Intelligence Partners. Bragg runs a due diligence firm that scours the one-off partnerships and the less-than-arms-length relationships that had been overlooked in years past. "Today, it's an absolute necessity to turn over every single rock," he warns.
Bragg's warning has merit. Another firm that has fallen under a cloud of suspicion is one whose owners have both impeccable family pedigree and the best of political connections. A federal judge recently froze the assets of hedge fund Ponta Negra Fund I, LLC after hearing claims from the SEC that the firm committed a multi-million dollar fraud by forging documents, falsifying returns and misrepresenting assets under management.
The SEC's action against Ponta Negra is not the newsworthy event. It is the fund's curious relationship with Paradigm Global Advisors, LLC. A fund of hedge funds, Paradigm is owned and managed by James and Hunter Biden, brother and son of Vice President Joe Biden.
The SEC has not alleged any wrongdoing by Paradigm, but as a fund of hedge funds, the firm's forte is purportedly to be the wizards of due diligence. On this task, they have seemingly come up short. Ponta Negra and Paradigm occupied the same floor in a Manhattan office building, used the same marketing agent, and shared the same telephone number. Paradigm officials have explained that this curious set of coincidences was a result of Ponta Negra having leased office space and facilities from Paradigm.
Fair enough. But the shared marketing agent, Jeffry Schneider, had a sketchy past and was previously the subject of numerous complaints and litigation. The SEC's action against Ponta Negra was filed in U.S. District Court in Austin, Texas, where Schneider was previously employed suggesting the SEC investigation likely began with him. Questions have been raised regarding Schneider's past employment and the circumstances regarding his departures from previous investment firms.
Ponta Negra wasn't the Bidens' only brush with dodgy characters during their nearly three-year ownership of the fund. In mid-2007, Paradigm formed the Paradigm Stanford Capital Management Core Alternative Fund with Stanford Financial Group. Stanford Financial was led by the same R. Allen Stanford who stands accused of running a multi-billion dollar Ponzi scheme. The Paradigm-Stanford relationship was ended after the SEC filed civil charges against Allen Stanford earlier this year.
There is more unpleasant history at Paradigm for the Vice President's family. In early 2007, a lawsuit and a counter-suit were filed between the Bidens and one-time partner Anthony Lotito, Jr., over business arrangements, professional credentials, and fees regarding the Bidens' 2006 purchase of Paradigm. According to a court filing, a goal of Paradigm under the ownership of Lotito and the Bidens was to "expand its network of investors, particularly among public employee pension funds." The trio settled the case out-of-court late last year.
As part of the proceedings, James Biden filed an interesting affidavit in which he alleged Paradigm "had only between two and three hundred million dollars under management" and not the more than $1.5 billion he and his nephew previously believed. He also claimed Paradigm's returns "were not as represented to us." The Bidens eventually purchased a controlling interest in Paradigm without original partner Lotito.
One might expect the investing public would tread a bit more cautiously in the post-Madoff era after it became known Ponzi schemes can be run out of a Manhattan office building just as easily as from an industrial park storage facility. Yet, this does not appear to be the case. The sloppiness and inattention to detail exhibited by some of those in the investment business suggest proper due diligence lessons may not have been well-learned.