Wednesday, August 12, 2009

DiPascali Pleads Guilty

Bernard Madoff's efforts to portray himself as a "lone gunman" have been to no avail.

One of his key co-conspirators, perhaps the key co-conspirator, has now pleaded guilty. That would be Frank DiPascali, who was Madoff's director of options trading for a decade, from 1986 to 1996.

That title is a crucial fact in understanding the case against DiPascali, even more crucial than the title "Chief Financial Officer" that he assumed in 1996. Because the strategy that Madoff claimed to be pursuing, the investing thesis that supposedly laid all these golden eggs he kept reporting to investors, was what is known as a "split strike options" strategy.

The idea is that Madoff would buy a portfolio consisting of about 35 of the bluest of blue chip stocks, stocks included within the S&P Index. He would then sell call options and buy put options at different strike prices, on the S&P index itself, creating a cushion on both sides of the purchase price of those stocks. The options positions would cost him money if the price of the underlying stocks rose rapidly (but that would be okay, since he owned the stocks and benefitted from that rise), and they would earn him money if the index fell rapidly (which would cushion the effect of that fall).

The claim has been purely fictitious for a long time now -- but the key fact is -- if the claim had been truthful, the director of options trading would be a very busy and strategically crucial person in the overall operation. How could that director not know that he wasn't doing what Madoff kept telling clients he was doing? this was the crucial point that drew attention to DiPascali. He must have been the Mayor of a Potemkin Village.

Concomitant with the guilty plea on the criminal charges, DiPascali also entered into a partial settlement with the SEC on its civil complaint. This complaint lays out the mechanics of the Madoff fraud more thoroughly than any document yet made public. See for yourself.

This could be very bad news for othr co-conspirators, and there clearly are others. DiPascali is not as stoic as his former boss about accepting more than one hundred years behind bars as a sentence. He'll talk. Indeed, he said yesterday: "I know my apology means almost nothing. I hope my actions going forward with the government will mean something."

Yes, but watch out when you do take up residence in prison, Frank. The new neighbors don't have a high opinion of squealers.

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