Toomre Capital Markets LLC

Real-Time Capital Markets -- Analytics, Visualization, Event Processing, and Intelligence

Lars Toomre's blog

More on Timothy Geithner's Tax "Fraud"

Earlier today and this week, Toomre Capital Markets LLC ("TCM") wrote about the possible willful failure of Treasury Secretary-nominee Timothy Geithner to pay his social security taxes during the 2001-2004 period when he was employed at the International Monetary Fund. Those posts were WSJ: IMF Informed Geithner on Taxes and Timothy Geithner Has Some Past Tax Problems.

Reading further about this failure to pay taxes when due, TCM has concluded that this possible willful failure to pay taxes is much worse than originally portrayed. According to The New York Times, "“Look, is this an embarrassment for him? Yes. He said so himself,” Mr. Obama said, referring to Mr. Geithner’s remarks in a private meeting with the Senate Finance Committee the day before. But Mr. Obama said Mr. Geithner had made a common mistake and corrected it."

Apparently, Timothy Geithner accepted payment from the IMF on an annual basis as restitution or a "true up" for social security taxes he was required to have, but had not, in fact, paid. Further, according to Byron York of National Review, the IMF supposedly

took great care to explain to those employees, in detail and frequently, what their tax responsibilities were. First, each employee was given the IMF Employee Tax Manual. Then, employees were given quarterly wage statements for the specific purpose of calculating taxes. Then, they were given year-end wage statements. And then, each IMF employee was required to file what was known as an Annual Tax Allowance Request. Geithner received all those documents.

The tax allowance has turned out to be a key part of the Geithner situation. This is how it worked. IMF employees were expected to pay their taxes out of their own money. But the IMF then gave them an extra allowance, known as a “gross-up,” to cover those tax payments. This was done in the Annual Tax Allowance Request, in which the employee filled out some basic information — marital status, dependent children, etc. — and the IMF then estimated the amount of taxes the employee would owe and gave the employee a corresponding allowance.

At the end of the tax allowance form were the words, “I hereby certify that all the information contained herein is true to the best of my knowledge and belief and that I will pay the taxes for which I have received tax allowance payments from the Fund.” Geithner signed the form. He accepted the allowance payment. He didn’t pay the tax. For several years in a row.

According to an analysis released by the Senate Finance Committee, Geithner “wrote contemporaneous checks to the IRS and the State of Maryland for estimated [income] tax payments” that jibed exactly with his IMF statements. But he didn’t write checks for the self-employment tax allowance. Then, according to the committee analysis, “he filled out, signed and submitted an annual tax allowance request worksheet with the IMF that states, ‘I wish to apply for tax allowance of U.S. Federal and State income taxes and the difference between the “self-employed” and “employed” obligation of the U.S. Social Security tax which I will pay on my Fund income.”

In a conversation today with sources on Capitol Hill who are familiar with the situation, I asked, “Was Geithner made whole for tax payments that he didn’t make?”

“Yes,” one source answered. “He was getting the money. He was being paid a tax allowance to pay him for tax payments that he should have made but had not.”

If this reporting turns out to be fact, there is no way Timothy Geithner, no matter how much he otherwise is qualified, should be confirmed as Treasury Secretary of the United States. One simply cannot have a tax fraud overseeing the Internal Revenue Service. What is even more troubling though is reporting that President-elect Barack Obama and his transition team have been aware of Geithner's tax issue since early November 2008. Yet, despite what clearly was not an "common mistake", President-elect Obama went forward with this nomination and continues to support Timothy Geithner's confirmation.

What does this say about the judgment and morality of the United States' in-coming President? Henceforth, will it be permissible for other "tax frauds" to be confirmed for leading governmental positions? The events of the coming week will say much about what is permissible for the country's leadership and whether the American electorate even cares whether their leaders lie, cheat and potentially defraud.

Toomre Capital Markets LLC strongly hopes that some of our leaders will draw a line in the sand and hence prevent the successful confirmation of this nominee. A tax cheat simply cannot be allowed to oversee the IRS in our society of voluntary compliance. Leadership means holding oneself up for others to follow and aspire to. Do Americans really want to follow the leadership of a tax cheat???

Frank Avellino, Michael Bienes and Bernie Madoff

<br />
Michael Bienes with wife Dianne. Back in 1992, the United States Securities and Exchange Commission ("SEC") reached a settlement with Avellino & Bienes ("A&B"), a tiny New York accounting firm that was run by Frank Avellino and Michael Bienes. According to legal documents from that case, these two started raising money from clients, friends and relatives in the early 1960s and handed over that cash over to Bernie Madoff to invest. (This was about the same time that Bob Jaffe's future father-in-law, Boston philanthropist Carl Shapiro, gave Bernie Madoff his first funds with which were used to start his investment business.) By 1984, apparently Avellino and Bienes had ceased their accounting practice to focus exclusively on finding additional investors for Madoff.

In 1989, two other accountants Steven Mendelow and Edward Glantz and later Glantz's son Richard also began raising funds for Bernie Madoff. By the time that the S.E.C. ordered these three firms to return all funds to their investors for selling unregistered shares, some $454 million had been raised from more than thirty-two hundred investors. Apparently, the S.E.C investigation had been sparked by a confidential tip that one of the money managers was promising annual returns of up to twenty percent.

The regulators subsequently examined Madoff's books and it appears that they were satisfied when every penny was returned to the former accountant's investors. Bernie Madoff and his investment operation never were sued by the regulator and consequently never was subject to any operational restrictions. The former accountants were collectively ordered to pay $875,000 and to cease from further violations of securities laws.

Rather interestingly, Avellino & Barnes were then represented by Ira "Ike" Sorkin, the lawyer who currently represents Bernie Madoff in his criminal proceedings. In another connection between Avellino and Madoff, Lee Richards, who has been appointed by the SEC as the receiver of all Bernard Madoff Investment Securities assets, also served as the court-appointed trustee over Avellino & Bienes during its legal dispute with the federal agency, according to Bloomberg News.

What originally caught the attention of Toomre Capital Markets LLC ("TCM") about Frank Avellino and Michael Bienes was their relationship to Bernie Madoff's eventual father-in-law, Saul Alpern. Mr. Alpern was the lead partner of a Manhattan accounting firm back in the 1950's and 1960's then called Alpern & Heller. His colleague was Sherman Heller. Two of the junior accountants at the firm were named Frank Avellino and Michael Bienes. Mr Heller apparently died in the mid-1960's at the age of 46 and then in the 1970's Avellino and Bienes took over that accounting business renaming it Avellino & Bienes. According to the blog mehtafiscal in their post The End of a Sure Things: Madoff's Long Bet, one early investor with A&B and Madoff claimed that "Madoff had worked at Alpern & Heller in the late 1950s, with Avellino and Bienes, and was friendly with them [this last statement could not be independently verified]."

TCM was previously unaware that Bernie Madoff had worked at an accounting firm. (Perhaps it was this accounting firm was the source of the original connection between Carl Shapiro and Bernie Madoff?) Carl Shapiro was Madoff's original investor and also one of his last when he supposedly contributed $250mm to Madoff in November 2008. Carl Shapiro also likely was the link that connected his son-in-law, Robert Jaffe, with Bernie Madoff and eventual employment at Cohmad Securities Corp.

Various charity filings with the SEC subsequent to 1992 suggest that both Frank Avellino and Michael Bienes continued to have at least some funds invested with Bernie Madoff. Whether they played a larger role after 1992 in Madoff's investment business remains to be disclosed. However, given that their personal relationships with Madoff that apparently were far deeper than the SEC disclosed back in 1992, one is left to wonder.

Two interesting pieces of news this month contribute to this state of wonder. On Monday January 12th, Mr. Bienes, "the fabulously wealthy Fort Lauderdale benefactor", abruptly resigned from the board of the prestigious Broward Center for the Performing Arts via a short one sentence letter of resignation. Why did he suddenly resign at this time? One might also wonder just how this formerly junior accountant became so wealthy. Did he really make his millions because "he got lucky on Wall Street"? Or perhaps some of his "wealth" came from his old buddy Bernie Madoff?

The other piece of intriguing news concerns his partner Frank Avellino. Mr. Avellino too has progressed far from his younger days as an accountant at Alpern & Heller. Today he apparently owns a $4 million home in Palm Beach, a residence in New York City and another $10 million summer residence on Nantucket. Also apparently, Mr. Avellino just recently put his Nantucket residence on the market. The timing of that move too is interesting and perhaps quite innocent, particularly in these difficult economic times.

However, when one learns that Mr. Avellino also has recently been accused of bilking his house-cleaner out of $124,000 life savings, one really begins to wonder. This article in Nantucket's Inquirer and Mirror has more details of the suit filed by one Nevena Ivanova against Mr. Avellino. Apparently a few years ago, Mr. Avellino accepted some funds from Ms. Ivanova for investment. Then recently he announced that all of her money had been lost. It is unclear how exactly Mr. Avellino was supposed to invest the householder's money. Perhaps he invested it with his good buddy Bernie? If so, how then did Mr. Avellino allegedly announce on December 1st that all of her funds had been lost? Did perhaps Mr. Avellino know something about Bernie Madoff's fraud some ten days before his arrest?

Inquiring minds really would like to know more about the recent relationships between Bernie Madoff, Frank Avellino and Michael Bienes. Hopefully, more information will be forthcoming shortly.

WSJ: IMF Informed Geithner on Taxes

 Timothy Geithner, Federal Reserve Bank of New York President On Thursday January 15th 2009, The Wall Street Journal published an article entitled IMF Informed Geithner on Taxes. According to the article's lead, "Timothy Geithner, whose nomination as Treasury secretary has been delayed by his past failure to pay taxes, was repeatedly advised in writing by the International Monetary Fund that he would be responsible for any Social Security and Medicare taxes he owed on income he earned at the IMF between 2001 and 2004."

Toomre Capital Markets LLC ("TCM") wrote about this issue two days ago in the post Timothy Geithner Has Some Past Tax Problems. If the information is indeed correct, sadly while admiring Mr. Geithner's work in general, Toomre Capital Markets LLC strongly believes that the willful decision to avoid paying social security taxes, particularly being audited and being required to pay back taxes for the 2003 and 2004 tax years, disqualifies Timothy Geithner from being confirmed as Treasury Secretary in the Obama administration. TCM strongly believes that a tax evader is unqualified to oversee the Internal Revenue Service.

While we wish that Timothy Geithner had paid his taxes when due, his personal decision smacks of tax avoidance when he chose not pay social security taxes for the years 2001 and 2002 (after the 2006 IRS audit) until the business day before his nomination. TCM does not accept the defense offered by the transition officials earlier this week: Mr. Geithner made a mistake common to people who work for international institutions. Mr. Geithner is a pretty sharp individual and he should have at a minimum known that he had made a mistake after the 2006 audit.

If Mr. Geithner did not know that those past taxes were due (after the audit), he surely is not qualified to lead economic policy in the new administration. If he did know that they were due and still did not pay them until recently, the incident speaks volumes to his personal ethics and should likewise disqualify him from overseeing the IRS. As Senator George V. Voinovich (R., Ohio) said, "He may be a smart guy, but the average person on the street sees that he hadn't paid his taxes." In this period of change, Toomre Capital Markets LLC hence hopes that either President-elect Obama will rescind this nomination or the United States Senate will refuse to confirm this nominee.

In short, if one willfully cheats on one's taxes, one definitely is not qualified to oversee the IRS and the United States tax system, not matter how qualified one otherwise is. Will the Senate and President-elect Obama demonstrate that they understand and live true to a world of high ethics? Or will this be yet another example of cutting an ethical corner? Reader comments and thoughts are welcome.

Bob Jaffe, Bernie Madoff's Man To See, Ducks Subpoena

Robert Jaffe in his vintage MG from the Palm Beach Daily News annual selection of stylish Palm Beachers. Toomre Capital Markets LLC ("TCM") has been rather amazed by both the number of and the sophistication of the various individuals, institutions and charities that have been victims of the Bernie Madoff fraud. (Yes, under American law, one is presumed innocent until one either pleads guilty or is convicted by a jury of one's peers. However, given that Bernie Madoff apparently confessed to his brother Peter Madoff, his two sons, Andy and Mark Madoff and the FBI agents on the morning of his arrest, TCM is this particular scandal will henceforth forgo using the term "alleged".) Like many in the finance industry, TCM has been surprised that a fraud of this magnitude could have been perpetuated against so many investors for so long by a firm that flew relatively below the radar.

As TCM has written about previously in the post Update on Bernie Madoff Scandal and Feeder Funds, one of the keys to Bernie Madoff's fraud were the various "feeder funds" that in essence bundled investment monies from multiple investors and then deposited much, if not all, of those funds with Bernie Madoff. Apparently the five largest of these "feeder funds" were Fairfield Greenwich, Tremont Capital, Banco Santander, Bank Medici and Ascot Partners. Other "gate keepers" who apparently funneled funds to Bernie Madoff included Jerry Breslauer, Richard Spring, Bramdean Alternatives, Prospect Capital, Stanley Chais, Cohmad Securities Corp. , and Robert M. Jaffee (pictured to right in picture by Greer Gattuso/Palm Beach Daily News).

According to a December 21st 2008 article in The Boston Globe entitled Bernie Madoff's Man To See, Robert M. Jaffe, 64, of both Weston, Massachusetts and Palm Beach, Florida cut quite the figure, even in the rarefied world of high society in Palm Beach. "With his impeccably coiffed hair, a golf game to envy, and a $17 million waterfront mansion, he was a man to be seen. He was also the man to see, if you wanted in on a sure thing - Bernard L. Madoff's investment." Apparently Mr. Jaffe "relished his access to wealthy friends and investors at country clubs and charity galas" and hence attracted "an A-list of the powerful and famous, as well as his closest friends, family - and himself" to Bernie Madoff's fraud.

Mr. Jaffe served as a Vice President of Cohmad Securities Corp., a broker/dealer that apparently was set up primarily to bring in investment management clients for Bernie Madoff. In Palm Beach and Boston, Mr. Jaffe offered coveted access to the now infamous New York investment firm and apparently this MBA dropout functioned more as a symbol of the extraordinary wealth and status Madoff clients could achieve. Driving "a green 1954 MG TF British convertible, [Jaffe] seemed to find more success doing business on the golf course than in the boardroom. And it showed in his game: Jaffe was the club champion earlier this year at Palm Beach Country Club."

The article continued, "Massachusetts investigators are looking into questions such as whether Jaffe or his firm failed to protect investors they steered to Madoff. In an interview, Massachusetts Secretary of State William F. Galvin said he had subpoenaed Jaffe to better understand Madoff's operations. 'Maybe Mr. Jaffe didn't know' about the alleged fraud, Galvin said, 'but he certainly was a key player in getting people to invest.'"

HSBC, UBS May Be Liable for Madoff Losses As European Retail Custodians

On Wednesday January 14th 2009, Bloomberg News reports that HSBC Holding Plc and UBS AG may be held liable for as much as $3.2 billion of the losses linked to Bernie Madoff fraud scandal. Apparently there is quite the dispute over the duties of European financial custodians at funds in Luxembourg and Ireland. According to the article, "At stake is the image of the European fund industry, French Finance Minister Christine Lagarde wrote in a Jan. 12 letter to the European Commission and Luxembourg Prime Minister Jean- Claude Juncker. European funds’ assets grew 59 percent to 6.8 trillion euros ($9 trillion) over the past six years, partly because rules protecting investors made them attractive.

"'If they aren’t required to pay the money, then investor protection doesn’t mean anything and people might as well just invest in offshore funds,' said Isabelle Wekstein-Steg, a lawyer at Wan Avocats in Paris who is representing 10 French retail investors and two institutions that face Madoff-related losses at Luxembourg funds. 'UBS didn’t do its job of knowing at all times where the assets were, and the same with HSBC.'

"Custodians are charged with oversight of funds and they manage cash inflows and payments to investors. Those looking to recoup money would have to prove the banks failed to fulfill their duties, according to nine lawyers surveyed by Bloomberg News. HSBC has said it isn’t liable and UBS declined to comment on the issue."

Later, the article further explains, "Funds sold in the European Union to retail customers must follow rules on how money can be invested, called the Undertaking for Collective Investment in Transferable Securities, or UCITS. The rules also set out the responsibilities of custodian banks. Liability is determined under national laws in each member state. The EU said yesterday that it’s reviewing how rules that require EU-regulated mutual funds to safeguard clients’ assets are enforced around the 27-country bloc."

Toomre Capital Markets LLC ("TCM") suspects that HSBC and UBS will be held to be at least partially responsible for not fulfilling their custodial duties. Somewhat ironically then investors in following funds may have some additional deep pockets to recover their losses from: the $1.4 billion LuxAlpha Sicav-American Selection fund in Luxembourg (for which UBS is custodian), the $419 million Luxembourg Investment Fund-U.S. Equity Plus (for which UBS also is custodian), the $226 million Herald LUX-US Absolute Return Fund (for which HSBC is custodian) and Dublin-based $1.1 billion Thema International Fund Plc (HSBC custodian). The Thema and Herald funds were managed by Bank Medici AG, the Austrain bank founded by Sonja Kohn, whose clients invested approximately $3.2 billion in the Madoff fraud scandal.

Timothy Geithner Has Some Past Tax Problems

On the afternoon of Tuesday January 13th 2009, news emerged that Treasury Secretary-nominee Timothy Geithner has a few tax problems in his recent history. As a result, his confirmation hearing scheduled for that date was postponed. Instead, behind closed doors, members of the Senate Finance Committee huddled with the nominee to discuss the specifics of his particular case. Similar tax issues in the past have derailed other candidates for high office.

Rather predictably Democratic senators emerged from the meeting reiterating their support for President-elect Obama's nominee. According to The Wall Street Journal, "Obama aides said they didn't think these issues would present a problem, given what they characterized as the minor nature of the infractions and the gravity of the role Mr. Geithner has been nominated to take. Mr. Geithner's 'service should not be tarnished by honest mistakes, which, upon learning of them, he quickly addressed,' Obama press secretary Robert Gibbs said in a statement."

Sen. Charles E. Grassley of Iowa, the committee's senior Republican, did not give Mr. Geithner a pass. "It's serious, and whether or not it's disqualifying is to be determined," Mr. Grassley said after the meeting. A new hearing, which promises to be contentious, has been scheduled for Friday January 16th.

Raoul Weil from UBS Declared A Fugitive

Toomre Capital Markets LLC ("TCM") has previously written of the bubbling scandal regarding the Swiss banking giant UBS and its activities in helping American citizens participate in various tax-avoidance schemes. Such posts included Former UBS Private Banker To Plead Guilty, Wealthy Americans Under Scrutiny in UBS Case, UBS Global Wealth Chairman Raoul Weil Indicted, and UBS Poised To Name US Tax Dodgers.

On January 13th 2009, this story is back in the news. U.S. District Judge James Cohn declared that Raoul Weil, 49, the former chairman of the global wealth management division at UBS, was a fugitive from American justice. Apparently, Mr. Weil, the head of the division in which UBS private banker Bradley Birkenfeld once worked, did not surrender to United States judicial officials on charges of conspiring to help wealthy Americans hide assets from U.S. tax authorities. In the indictment unsealed in November 2008, Mr. Weil and other unidentified bankers conspired to help approximately 20,000 Americans hide as much as twenty billion of assets in Swiss bank accounts without declaring them to U.S. tax authorities and hence paying any income taxes generated from them.

This scandal stems from the December 2007 case in which Orange County, California billionaire Igor Olenicoff pled guilty to a charge of filing a false tax return and agreed to pay $52 million in back taxes, penalties and interest. An American based in Switzerland, Bradley Birkenfeld, worked for Raoul Weil (who then oversaw UBS cross-border private banking services, including those offered to wealthy American citizens) and was the private banker for Mr. Olenicoff. Mr. Birkenfeld himself then pled guilty to conspiring to tax avoidance charges and is rumored to be cooperating with American authorities.

Mr. Weil was based in Switzerland and was a member of UBS' executive board until he stepped down after the indictment was made public. Apparently, Switzerland does not consider tax-avoidance charges serious enough to merit the extradition of its citizens. Hence, there always has been some doubt about whether Mr. Weil might ever appear before United States judicial authorities. Mr. Weil's failure to appear, though, likely will increase the pressure on his now former employer UBS to release the complete list of American citizens who had cross-border private banking accounts in Switzerland before UBS unilaterally made the decision to close them last summer.

Fairfield Greenwich Sued Again Over Madoff Losses

Bernard Madoff allegedly defrauded many investors over many years. One of the key reasons why his alleged fraud was able to continue for so many years was that Madoff was able to claim that he only had a few investors, most of which were so-called "feeder funds". As Toomre Capital Markets LLC ("TCM") noted in the post Update on Bernie Madoff Scandal and Feeder Funds, the five largest admitted feed funds were Fairfield Greenwich, Tremont Capital, Banco Santander, Bank Medici and Ascot Partners. Two days ago, TCM wrote more about the legal travails of Ezra Merkin and his Ascot Partners and Gabriel Capital hedge funds in the post Ezra Merkin and Madoff Feeder Funds Face More Lawsuits.

The largest of the Madoff "feeder funds" was Fairfield Sentry Fund run by Walter Noel's hedge-fund firm Fairfield Greenwich Group. All told that firm had approximately $7.5 billion invested with the alleged fraudster Bernie Madoff. On Monday January 12th 2009, the latest (and at least the third) civil complaint was filed against this "feeder fund" manager. This suit was filed on behalf of investors by noted lawyer David Boies, who also represents "Hank" Greenberg (formerly the CEO of AIG) and who previously argued before the U.S. Supreme Court on behalf of presidential candidate Al Gore in the 2000 election litigation regarding the State of Florida re-count fiasco. Mr. Boies is now representing two trusts and a holding company based in the Cayman Islands as well as Carlos Gauch of Mexico.

The complaint states “Most, if not all, of the assets of the plaintiff class had invested with defendants were stolen through the Madoff Ponzi scheme.” Boies further wrote “These losses could have been avoided if defendants had fulfilled their duties” and “if they had adequately investigated and monitored Madoff. ” Through the complaint, the plaintiffs are seeking the return of their investments and fees as well as damages.

The defendants are the firm's founder Walter Noel, Andres Piedrahita and Jeffrey Tucker. They are accused of breach of fiduciary duty, negligence and unjust enrichment, among other counts. Other defendants apparently include the Dublin branch of Netherlands-based Citco Bank Nederland NV, which maintains Fairfield Sentry’s escrow account, according to the complaint. The inclusion of Citco (primarily known as a fund administrator for a great percentage of the largest hedge funds) is noteworthy because it suggests that Mr. Boies is attempting to go after other "deep pockets" that might be able to contribute to the funds available to aggrieved investors. This suit is referenced as Inter-American Trust v. Fairfield Greenwich Group, 09-cv-301, U.S. District Court, Southern District of New York (Manhattan).

Ezra Merkin and Madoff Feeder Funds Face More Lawsuits

At high noon on Monday January 12th 2009, a Federal magistrate will announce his decision about whether fraudster Bernie Madoff will remain free on bail confined to his penthouse apartment on Manhattan's Upper East Side. The magistrate might instead agree with Federal prosecutors who have argued in briefs filed last week that Bernie Madoff is a "danger to society" and hence he should be remanded until his trial where he almost assuredly will be convicted of at least one criminal act and then probably imprisoned for the remainder of his life.

Remand is an unusual order in most white-criminal cases. However, a fraud of approximately $50 billion and the mailing of "sentimental heirlooms" (in some cases worth more than a million dollars in a single mailing) in violation of court order are also highly unusual. Toomre Capital Markets LLC ("TCM") suspects that public pressure to see "crook" Madoff imprisoned and Madoff's reported decision to cease cooperating with investigators and prosecutors will lead the magistrate to order Bernie Madoff off to jail.

As Bernie Madoff contemplates his possible last few hours of freedom, one of his enablers (and feed fund managers), Ezra Merkin, apparently faces fresh lawsuits seeking as much as $100 million that investors claim he squandered (certainly without their knowledge nor possibly their consent) on Madoff's $50 billion Ponzi scheme. According to The Guardian in the article Hedge Fund Billionaire Sued For Investing in Madoff Scheme written by James Doran, Mr. Merkin, 55, was forced to close his $1.5 billion Gabriel Capital hedge fund in December 2008 after disclosing massive losses from investing in Madoff's business.

As TCM wrote in the post Update on Bernie Madoff Scandal and Feeder Funds last week, Mr. Merkin has already been sued by both New York Law School and New York University ("NYU"). NYU claims its investment was placed with Madoff without permission. "Until 12 December 2008, we had no knowledge that NYU's funds were instead being managed by Bernard Madoff," said an affidavit from NYU filed in New York state supreme court.

Madoff Victims Selling Illiquid Assets And Life Insurance Policies

The Sunday January 11th 2008 edition of The New York Post included an article entitled Antique & Gem Dealers Get Hock Of A Deal. This article has some details about how the victims of the Bernard Madoff Ponzi scandal are selling off their antiques, fine art and jewels in order to raise cash from their high-end collections. "You've got these people who lost all of their investments, but have Rembrandt, Matisse, Van Gogh and Picasso on their walls," said a source close to several victims. Kofski Antiques, a shop in Palm Beach, Fla., has received items from several Madoff victims, said owner Chris Hill, including a 75-year-old who told him, "I was worth in excess of $100 million, and, son, I don't think I could buy you lunch today."

Apparently Mr. Hill also recently put an advertisement in a local paper asking, "Have you been affected by Bernard Madoff, a downturn in the economy, a reversal of income? You may want to contact Kofski." Another ad also openly asks "Madoff victims" if they want to sell their life insurance.

This last line of the article caught the attention of Toomre Capital Markets LLC ("TCM"). In the year plus since it was first posted, the TCM post Appeal of Insurance-Linked Securities and Life Settlements has been quite popular with those looking for further information on this relatively novel sector of the collateralized debt markets. Some have been interested in how these type of investments have had limited correlation with other types of debt and collateralized structured products. Others have been interested in how they might realize more than surrender value from the disposal of an often forgotten asset such as a whole life insurance policy.

Robert Rubin Packs It In At Citigroup

Friday January 9th 2009, former Goldman Sachs CEO and former Treasury Secretary Robert Rubin announced his resignation effectively immediately from Citigroup. After arriving in 1999 with great fanfare as one of the world's savviest and highly respected financial executives, he collected more than $115 million in pay while acting as a Citigroup director and senior counselor. Now some 70 years old, Mr. Rubin is leaving on a low note. In his resignation letter, he wrote that his "great regret is that I and so many of us who have been involved in this industry for so long did not recognize the serious possibility of the extreme circumstances that the financial system faces today."

Many have questioned just what Robert Rubin did that resulted in his being paid about fifteen million dollars per year. Mr. Rubin himself has continually emphasized that he had no operating role at Citigroup and hence should bear little of the blame for the firm's horrendous financial results that partly resulted from his strategic advice. Nonetheless, he has come under considerable fire in the last eighteen months for his strong role in pushing Citigroup back in 2003 through 2006 to increase its risk-taking as the housing and derivatives bubbles expanded.

The net result of that increased risk taking without proper risk management controls has been devastating. During the past eighteen humiliating months, Citigroup has witnessed the ouster of former CEO Sandy Weill's successor Charles Prince, taken $83 billion in write-downs, raised $36 billion in investor cash, take $40 billion in preference shares from taxpayers and gotten the federal government to backstop more than $250 billion in risky and illiquid assets on its balance sheet.

During the past decade there also has been considerable personnel tumult at Citigroup. His tenure began with the tainted-research scandal that entwined analyst Jack Grubman and Sandy Weill. Then came the missteps that led to Citi's shutting down part of its Japanese banking unit in 2004. Ousted or reassigned executives during his career included such high-profile names as Prince, Weill, Michael Carpenter, Michael Klein, Sallie Krawcheck, Todd Thomson and Tom Maheras.

The constant throughout all this tumult was Robert Rubin. He had a very prominent role in picking several top managers at Citigroup, particularly two recent CEOs including Vikram Pandit. One really has to wonder just what Robert Rubin did each year as a rainmaker that justified his considerable compensation over the past decade.

Toomre Capital Markets LLC ("TCM") is not sorry to see the Robert Rubin period of "nightmare" at Citigroup come to an end. Every time shareholders look at their portfolio statements, they are reminded of the bank's dismal record and its 90% decline in stock price. Thank you Mr. Rubin for your "service"!! Of course, you were just a bystander to this disaster and worth every cent paid to you. We really do understand and appreciate!!

Update on Bernie Madoff Scandal and Feeder Funds

Four weeks ago, the alternative investment world was shocked by the arrest of Bernie Madoff after he allegedly confessed to running an investment Ponzi scheme that according to his own admission swindled investors out of close to $50 billion. In the days since, there has been daily news of this or that individual, family, foundation, organization or charity having suffered devastating losses because of Madoff's fraudulent behavior. In recent days, the receiver appointed by the courts to try to recover investor funds has sent out potential claim forms to more than 8,000 entities that had invested funds through Madoff in the last twelve months.

Before news of this scandal broke, Toomre Capital Markets LLC ("TCM") had tangentially heard of Bernard Madoff Investment Securities, primarily in connection with its market making in small illiquid NASDAQ common stocks and its early adoption of technology to support electronic trading. We had no sense, though, that Bernie Madoff was running an investment advisory business nor that he potentially had so many funds under management from such a wide and diverse group of entities.

Apparently, his annual registration statement filed in 2007 for the investment management subsidiary indicated that he had $17 plus billion under management from less than two dozen investors. While one never can be sure of what is truth with regard to what Bernie Madoff said or did, based on information that has come out since, both of these numbers appear to be wrong. TCM suspects that Madoff purposely understated both the amount of assets supposedly under management and the number of investors so as to reduce the chance of inspection from the SEC and FINRA.

The real numbers for his annual registration statement apparently should have been somewhere around $35 billion and (depending upon how one defines the term "customer") more than 5,000 investors. Had such numbers been reported to regulators on his investment advisor registration form, there is no doubt that Madoff's investment operation itself would have been subjected to a rigorous regulatory review, especially since there previously had been no review conducted and it only registered for the first time in 2006.

One of the curious items about the Madoff scandal is how there could be such a difference what he reported as customers and what the press has reported as victims of the Madoff fraud. The key lies in the various feeder funds that in essence bundled funds from multiple investors and then deposited most, if not all, of those funds with Bernie Madoff. These feeder organizations included Fairfield Greenwich, Tremont Capital, Banco Santander, Bank Medici and Ascot Partners. Most of these feeder funds have now been sued by one or more of their investors.

Citadel Investment Group's Main Hedge Funds for 2008: Negative 53%!!

According to Dow Jones, the preliminary 2008 results for Citadel Investment Group’s main hedge funds are out and the numbers are not pretty. The $10 billion Kensington and Wellington hedge funds lost approximately 53% for 2008 and were down about 9% during the first 24 days of December. Chicago-based Citadel last month barred investors from withdrawing money from these two hedge funds until at least March 2009. With such “wonderful” performance, one has to wonder how much of the funds’ investors have queued up to leave once it is again possible to do so.

Toomre Capital Markets LLC (“TCM”) previously has written about Citadel in the post Citadel Investment Group To Try To Raise $500 Million. With this type of performance, though, TCM is now wondering whether Citadel Investment Group will survive the on-going credit crunch. In order to get back to their “high water” mark (at which point they can again start to earn performance fees), Citadel will need more than a 100% gain from their 2008 year-end balances. Citadel earned more than thirty percent in 2007. It will need approximately three years of such “lights out” performance before it will pass the former “high water” mark. Can they really successfully run the hedge fund company just on management fees? Time will tell. Reader comments and thoughts are welcome.

December 2008 Developments and Scandals

During the past few weeks, Toomre Capital Markets LLC ("TCM") has been busy working on client engagements and hence has had limited time to comment upon important sentiment and capital market developments. Since the start of December 2008, there have been a number of significant developments. Several of these deserve further detailed commentary that hopeful will be forthcoming before the end of the year.

First, the United States Department Labor reported a very sharp decline of some 533,000 jobs for the November period as well as significant adjustments to the prior reports for the September and October periods. In total, some 830,000 more jobs were reported lost over the most recent three-month period for a total of 1,156,000. Ouch! On a percentage basis of the workforce, this is the worst report since the recession period at the start of the Reagan presidency in the 1980s. Other economic reports have subsequently confirmed that economic activity sharply dropped around the time of the Lehman Brothers bankruptcy on September 15th and continued through November.

The sharp drop-off in both business investment and consumer demand since the Lehman Brothers bankruptcy has led many businesses to reevaluate their staffing needs. On Wall Street, there have been a considerable number of "redundancy" decisions leading to layoffs of more than ten percent of staffs. Many speculate that there will be further layoffs after the start of the 2009 if underwriting volumes continue at such non-existent levels. After all, what good is an investment banker if there are no deals to complete or capital to raise? Equally as well, what good are large staffs of salesmen and traders if there is no capital to commit or investors/hedge funds with whom to buy and/or sell?

On Main Street, the relatively sudden and very steep contraction in demand is leading to mass layoffs and even questions about whether the American automobile industry might survive. Clearly, the job losses witnessed in the last few months will continue and the fourth-quarter GDP will be sharply negative. Many macabre discussion wonders whether the 4th quarter GDP decline will be five, six or even eight percent on an annualized basis. Not many are willing to definitively speculate about what the first quarter of 2009 might be.

The Federal Reserve has responded in a very proactive manner to the down-turn in economic activity. The Federal Reserve lowered the effective Fed Funds target to a range of zero to 0.25 percent and announced further expansions in its alphabet soup of various special lending programs. Its decision to start to purchase GNMA, FNMA and FHLM mortgage pass-through securities, Agency debentures and highly-rated ABS backed by consumer debt has started a contraction in credit spreads relative to Treasuries. With many portions of the Treasury yield curve now yielding around two percent or less, the Federal Reserve clearly is encouraging investors to take on more risk premium than simply buying Treasuries and hunkering down in a bunker-like mentality seeking safety and no worries.

In the past month, three significant scandals have become public. In late November, Democratic Illinois Governor Rod Blagojevich was arrested by federal authorities who alleged that he was engaged in a "political corruption crime spree" that included recorded conversations about he might personally profit from the "sale of US Senate seat" to replace President-elect Barack Obama. While many not from Illinois might dismiss such charges as part and parcel of Chicago-area machine politics, the crassness of the conversations disclosed in the criminal complaint suggests that "pay to play" was very much a part of that Governor's mode of operation. No doubt with the Governor's subsequent pledge to "fight, fight, fight" the public will be exposed to more details about this repugnant public official.

The second scandal that recently emerged concerned the fraudulent activities of one Marc S. Dreier, the sole equity partner of a major law firm called Dreier LLP. He was first arrested in Toronto where he apparently was impersonating a lawyer at a Canadian pension fund in an effort to sell fake promissory notes to a unit of Fortress Investment Group. After spending several days in Canadian jail, he was released and then arrested again by American authorities upon his return to the United States where he was charged with defrauding several other hedge funds by selling or attempting to sell fake promissory notes based upon commercial real estate. Subsequently, the scope of his fraud was alleged to have totaled approximately $380 million. Surely more details about this fraud too will emerge in the coming days as this Harvard-educated lawyer languishes in the "comfort" of federal government custody.

The third scandal concerns the fraudulent activities of one Bernie Madoff. This former chairman of NASDAQ apparently ran an "investment" division within his well-known market-making firm. Some investors had invested with him for more than thirty years and were rewarded with steady returns in the range of ten to twelve percent each year. On December 11th, he was arrested after he confessed to his two sons who held senior executive positions in the market-making side of the family firm that the whole investment side of the business was one large Ponzi scheme. By his own admission, Bernie Madoff apparently defrauded investors world-wide of approximately $50 billion. He since has been released to supervised home confinement as various investigators search through his firm and the various fund of hedge funds firms that fed monies to his fraudulent operations. This Madoff scandal is going to continue to be in the news for many weeks to come and Toomre Capital Markets LLC will expand its posts on this scandal shortly.

Combined the dismal economic statistics, the large number of layoffs (that also apparently have continued in December) and the three above scandals have led many investors to pull back even further from making significant investment decisions. Liquidity continues to be quite poor in the capital markets and is likely to remains so through the early months of 2009. There is considerable speculation that the hedge fund redemptions will continue at a high rate as a result of the Madoff scandal as many investors flee the opaqueness of these investment pools and their relatively poor absolute performance during 2008.

There also is considerable uncertainty about what the earnings potential of large companies might be during 2009. The net result is that at least through the first quarter of 2009, Toomre Capital Markets LLC expects business activity to continue to decline and returns from investment activity to be relatively flat if not negative. It appears that few seem willing to make significant investment decisions until the depth and breadth of the economic downturn that accelerated in September 2008 becomes more fully known. Hence, it probably remains a prudent decision to keep one's powder relatively dry and to continue to deleverage wherever possible. In the meantime, the above scandals (and others that are likely to emerge with proverbial receding of the economic tide) will dominate many of the coming news cycles. Reader comments and thoughts are welcome.

Pay Option ARMs Continue To Worsen

Back in January 2008, Toomre Capital Markets LLC ("TCM") penned the post Option ARMs Spur New Worries. That post highlighted a number of other ticking credit bombs that were going to be effecting the Capital Markets in the coming months. Its chief focus was on the most toxic mortgage credit "bomb" of all: the Pay Option ARMs.

On Saturday December 6th 2008, The Los Angles Times and its writer E. Scott Reckard yet again return to this toxic subject in the article entitled Record 10% of U.S. Homeowners In Arrears Or Foreclosure. The subtitle of the article is "California, with 19% of new foreclosures in the third quarter, is a big contributor to the worsening picture." The prime culprit of this rise in the combined delinquency foreclosure rate are those Pay Option ARMs, given primarily to what were known as Prime borrowers and to a lesser extent to Sub-prime borrowers.

One might remember from the earlier TCM post: "Typically, these Pay Option ARMs present the mortgage borrowers with a choice every month during the first five years of the loan: pay the interest due and some of the principal; pay interest only, leaving the loan balance untouched; or pay less than the interest due, making the loan balance rise. Then, at the end of the five year option period, the loan is reset to fully pay-off with a fully indexed adjustable interest rate. Since many of the mortgage borrowers elect to pay less than the amount that will fully amortize the mortgage and the effect of fully indexing the interest rate from the typical more "teaser" initial rate, when Pay Option ARMs are reset, they almost always require a higher principal and interest ("P&I") payment than initially was required. Sometimes these reset P&I payments are as much as two or even three times what the borrower was originally paying on the mortgage each month. If the borrower elects only to pay interest only during the initial months and the balance rises above a set percentage of the original loan amount, the reset process can occur earlier as soon as three years."

Remember too Pay Option ARM loans often were granted on the basis of stated income, not proof of a borrower's income, giving rise to their nickname, "liar's loans." It has been said that "This is not a sub-prime crisis. This is a stated income crisis." In short, where Pay Options ARMs were most issued (Florida and California), evidence is accumulating that a significant portion of the spectacular rise in residential housing prices earlier this decade was driven by people who stated that they more financial income and assets than was truly the case.

From the above article, according to Jay Brinkmann, chief economist for the Mortgage Bankers Association, "California represents 13% of the loans in the country, but is recording 19% of all new foreclosures." One why might wonder why California is having so many more problems than other parts of the country. It is visible in the so-called "roll rate, which is defined as when one compares the number of newly delinquent loans in one quarter with the number of loans entering the foreclosure process in the subsequent quarter.

As Brinkman explained, That foreclosure "roll rate" was about 10% to 12% nationally in the 1990s and ran from 12% to 15% for most of this decade. The percentage is now 30% nationally but has reached 79% in California and 65% in Florida. "This is nothing like anything we've ever seen before," Brinkmann said. "We were shocked when we saw the California roll rates."