Madoff: Still Messin' With My Head

The legitimate part of the Madoff operation may not have been.

This story has been evolving over roughly five financial quarters now. One constant has been the distinction between the trading (market making) side and the asset management (or investment advisory or just IA) side of Bernie Madoff's operations, a distinction always described as crucial. Madoff's trading operation, which had been quite innovative when launched in 1960, was controversial in some respects (especially among those of us who consider the practice of payment-for-order-flow inherently dubious), but it was legal.

Madoff was often suspected of attaining the unusually consistent results of the account management operation by "front-running," i.e. by making illegal use of information he acquired as a market maker. The SEC would periodically investigate Madoff, only to find that he wasn't front running, so he must be clean! The truth of course is that he wasn't front running because he wasn't really trading through the IA wing of his company at all. It was all a sham, and those surprisingly consistent results were simply invented. So the possibility of front-running was serving perhaps two purposes. First, as noted it was a false scent that kept the regulators harmlessly occupied. But, secondly, it may have helped attract investors. "Pssst, this guy is likely front-running the info from his market maker side. We should get us a piece of that action."

Again, the above two paragraphs state the conventional wisdom. But the new arrest indicates there was still more to the story. Daniel Bonventre, the Madoff associate now under fire, was for thirty years the director of operations of the market-making part of the operation. Here's the criminal complaint against him.

Authorities allege that the income from the ponzi scheme was used to support the market-making operation at least from 1997 onward, and that the necessary transfers were accounted for on the books in such a way as to conceal their true source. Most reports indicate that they caught on to Bonventre because Frank DiPascali has been squealing like a stuck pig of late.

I hereby point out, as is only right, that Bonventre through his attorney has denied doing anything wrong and that he is innocent until proven guilty.

Still, if the investigators are on to something, this changes a good deal. Other potential defendants arise once the supposed wall between the legitimate and illegitimate sides of the supposedly bifurcated operations turns out to have been porous.