When a professional investor renowned for his prowess manages to lose around $50 billion, it’s safe to assume his clients were as moneyed as they were naïve. And Bernard Madoff always made sure to court the top tier of investors, here and abroad. Among his trusting institutional victims were Bank Medici of Austria, HSBC, Royal Bank of Scotland, Sterling Equities, Yeshiva University, Mortimer B. Zuckerman Charitable Reminder Trust, and Royal Dutch Shell. Among prominent individuals burned were Larry King, Richard Spring, Steven Spielberg, Kevin Bacon, Henry Kaufman, Norman Braman and Zsa Zsa Gabor. Less known perhaps is that organized labor – a good part of it anyway – got taken to the cleaners, too. Benefit funds of major construction unions in upstate New York, especially in and around Syracuse, suddenly have found their treasuries nearly depleted. The losses, amounting to hundreds of millions of dollars, ought to raise serious doubts about the ability of fiduciaries throughout organized labor to manage assets competently.
The Madoff (pronounced “made-off”) scandal is a dramatic, colorful and tragic story made possible by excessive optimism in an economy leveraged to the hilt. Bernie Madoff, a former NASDAQ chairman, wanted to make a fortune for himself and others. The best way to do this, he thought, was to win the trust of like-minded well-to-do people. Through his firm, Bernard L. Madoff Investment Securities LLC, he and top aides for some two decades practiced a well-honed sales pitch to select audiences. After collecting their money, he invested it, bypassing established brokers in favor of retail brokers taking over-the-counter orders.
The arrangement, which amounted to a complex money-laundering scheme, appeared to work so long as Madoff could find new investors eager for consistently high annual returns and unwilling to ask too many questions. But when the stock market crashed beginning in late 2007, the new investors didn’t materialize and the existing ones became highly worried. The cash-strapped Madoff couldn’t satisfy all those people who now wanted out. His firm imploded in December 2008, leaving a long trail of financial devastation. After his two sons tipped off the FBI to what appeared to be illegal activity, Madoff turned himself in to bureau agents in New York City. His assets – what’s left of them – are now frozen. He’s been under house arrest at his Upper East Side penthouse apartment, and will remain so until his criminal indictment, expected sometime in the middle of this month. Additionally, the Securities & Exchange Commission (SEC) and Securities Investor Protection Corporation (SIPC) each have filed a civil suit against Madoff.
The phrase “Ponzi scheme” has been on everyone’s lips. Indeed, Madoff himself has used that phrase in admitting to what he ran. Embarrassing as it was to be on his list of clients, his victims are coming forth in an effort to get their money back. First, they’ve got to figure out how much they’ve lost. And that will take time, for labor unions as well as the others. Patrick Morin, secretary-treasurer and business manager for Empire State Carpenters Fringe Benefit Funds, admits: “It’s not that easy to unravel.” His organization’s consolidated portfolio as of the end of last June was around $800 million. Almost all of that, say inside sources, was exposed to Madoff’s collapse. Morin has hired a law firm to file a class-action suit in hopes of finding all investment records going back 15 years or more. According to CNBC, the Syracuse area’s Carpenters Local 747 lost most of its $100 million to $150 million in pension funds invested with Madoff through J.P. Jeanneret Associates. The Syracuse-based investment adviser overall is exposed to a whopping $946 million in Madoff-related losses.
The Carpenters wasn’t the only union in central upstate New York to get bamboozled. Plumbers and Steamfitters Local 267, which represents about 1,300 active workers and retirees, may have lost as much as $48 million in Madoff-held health and pension funds invested through Jeanneret. The United Union of Roofers, Waterproofers & Allied Workers Local 195 in Cicero, N.Y. and Plumbers and Steamfitters Local 73 in Oswego, N.Y. each recently sent out letters to members informing them of huge losses. The New York State chapter of the AFL-CIO has reported that fully eight affiliates in the Syracuse area took a bath. Meanwhile, at the western end of the state, Laborers International Union of North America Local 210, formerly in the grip of the Buffalo mob, has achieved notoriety of a different kind: Its pension funds lost as much as $30 million to Madoff’s bad decisions.
Superficially, union beneficiaries are protected. Securities Investor Protection Corporation insures investors against up to $500,000 in losses. But that doesn’t mean everyone, or even close to that, will get their money back. There are several reasons. First, SIPC asset reserves are currently only $1.7 billion, backed up by a $1 billion credit line from the U.S. Treasury and some additional lines from foreign sources. Put simply, the agency isn’t equipped to handle a deluge of claims. Second, SIPC coverage extends only to missing cash or securities due to brokerage collapse or malfeasance, not to losses from price declines. Third, claims may well be treated in the aggregate rather than individually. The Empire State Carpenters benefit funds, for example, comprise 16,000 contributing individual account holders. Yet many investments with Madoff were made through a single adviser, most of all, Jeanneret Associates. SIPC might well determine that each feeder firm constitutes a single investor even if it manages multiple accounts. Fourth, forcing early investors to hand over their gains may be harder than it looks. It’s true that under recent court precedent, such investors may be required to return funds given evidence of a “fraudulent conveyance.” But a fund trustee first has to prove fraud. Fifth, it will take years to identify participants in the Madoff collapse. Common sense as well as evidence suggests his scheme was far too sophisticated to have been a solo job. Already, federal investigators have discovered apparently fraudulent documents in Madoff’s Manhattan offices and are looking into who prepared them. Among those who could be indicted are investment adviser-philanthropist J. Ezra Merkin, Madoff accountant David Friehling, brokerage owner Maurice Cohn, and investment adviser Stanley Chais.
So what does all this say about union benefit fund managers who put beneficiaries in harm’s way? More specifically, why didn’t they check out Madoff and his feeder firms more thoroughly? Union members may be asking themselves the same thing – and not just the ones whose money evaporated with Madoff. The three major U.S. automakers, for example, on January 1, 2010 are set to transfer more than $50 billion in retiree health benefits to United Auto Workers-managed benefit plans. Active and retired workers are hoping there isn’t another version of Bernie Madoff waiting to invest this pot of funds. More than ever, due diligence is a necessity, not a luxury. (Bloomberg News, 12/13/08; New York Times, 12/14/08, 12/15/08; Syracuse Post-Standard, 1/3/09; CNBC, 1/8/09; Buffalo News, 1/25/09; other sources).