Goldman’s d-e-e-e-e-p look at Madoff

Did due diligence before Tremont sale

Banned Madoff “more than a decade ago”

Investigators looking into Bernard L. Madoff Investment Services LLC should probably drop off a subpoena at 85 Broad. Goldman Sachs — representing MassMutual subsidiary OppenheimerFunds in its 2001 purchase of Tremont Advisers Inc — was part of a due diligence team which, according to a source familiar with the situation, spent three days in Madoff’s offices in mid-2001.

The investment bank was accompanied by representatives of Weil, Gotshal & Manges, OppenheimerFunds’ counsel, and OppenheimerFunds. Then Tremont president and co-chief executive officer Robert Schulman, Tremont’s lead liaison with Madoff, was also present for the review.

The Madoff relationship accounted for roughly 40 per cent of Tremont’s revenues at the time, making it a crucial part of the transaction. Virtually all of Tremont’s $1.5 billion in customer assets were invested in the Rye Select Broad Market fund, a Madoff feeder, and it also had a fee-sharing arrangement with London-based Kingate Global, another leading Madoff feeder. The balance of Tremont’s assets were in institutional alternative investment consulting arrangements that paid no more than 50 bps, and in most cases a lot less.

OppenheimerFunds paid $19 a share for Tremont, valuing the company at around $145 million, in a deal announced Jul. 10 2001. The rich valuation — more than 12-times EBITDA, and 5.5-times asset management fees, at the top end of then current prices in comparable transactions according to the proxy — was largely driven by OppenheimerFunds’ enthusiasm for the perceived strategic benefits of entering the fund of hedge funds market. The sale closed Oct. 1 2001.

(Tremont last week said that clients had $3.1 billion, or 53 per cent of its total $5.8 billion in client assets, in Madoff exposure through its various Broad Market products; Kingate Global reportedly had $2.8 billion with Madoff. Maxam Investment Management, the latest venture of former Tremont chairman and co-chief executive Sandra Manzke, had $280 million with Madoff.)

Apart from verifying Madoff’s performance, the pre-acquisition review probably addressed two other issues: the scalability of Madoff’s purported split-strike investment strategy, and the concern that at least some of Madoff’s purported returns may have came from gaming information culled from his brokerage order flow.

“Even if whatever he was doing was not illegal by the strict letter of the law, there was the chance that the brokers he was paying for order flow might send their business elsewhere, and that would be the end of his information advantage,” the source said.

The fact that the notoriously secretive Madoff even allowed OppenheimerFunds’ advisors on the premises, and that the Tremont transaction subsequently went forward, “lends credence to the theory that strategy was substantially what it was purported to be up until at least 2001. It was another reason why Tremont and Oppenheimer were comfortable with Madoff being a big part of revenues after the deal,” according to the source.

The alternative explanation is that it was just another missed chance to uncover the fraud, especially given that Goldman Sachs’ equity derivatives, prime brokerage and asset management units had severe reservations about Madoff. Among them:

Whistle-blower Harry Markopolos told the SEC that “a managing director at Goldman Sachs prime brokerage operation told me that his firm doubts Bernie Madoff is legitimate so they don’t deal with him.

Markopolos also named Joanne Hill PhD, “vice-president and global head of equity derivatives research” at Goldman Sachs among three equity derivatives professionals who could provide insights into the math behind their belief “that the split-strike conversion strategy that BM runs is an outright fraud and cannot possibly achieve 12% annual returns with only 7 down months during a 14½ year time period.”

It’s unclear from the Markopolos report just when his sources expressed those reservations, but at least some date to well before Goldman Sachs was involved in the Madoff due diligence review. According to The Daily Telegraph, London, yesterday:

More than a decade ago bankers from Goldman Sachs’ asset management division were despatched to Bernard Madoff Investment Securities to discover how the legendary fund manager maintained such consistently good returns...

...One former Goldman partner said: “I remember the guys came back baffled. Madoff refused to let them do any due diligence on the funds and when they asked about the firm’s investment strategy they couldn’t understand it. Goldman not only black-listed Madoff in the asset management division but banned the brokering side from trading with the firm too.”

Forget what they missed, or didn’t miss, at Madoff. Seems like someone forgot to check the restricted lists.