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The Fairfield Greenwich Group's Madoff-invested funds were hemorrhaging cash in 2005 and into 2006. The funds paid out over $1 billion more than they took in during a sixteen-month period and Bernie was laying out a lot of his precious cash with no end in sight.

The bleeding stopped when Bernie increased his rate of return from 7.3% in 2005 to 9.4% in 2006** and the money started rolling in again. Between 2006 and 2007, the funds raked in more than $1 billion. By the end of 2007, the funds had a combined value of $7.4 billion, up from $5.1 billion in 2005.

The folks at Fairfield Greenwich had a lot of money riding on Bernie's profitability in 2006. Were they at all surprised when Bernie pulled a rabbit out of his hat? Or did they think God wanted them to have the money just like he wanted Michael Bienes to have his?

The p.r. reps at Sitrick & Company have done a pretty good job portraying FFG management as amiable bumblers rather than crooks but the FFG execs were sophisticated and smart and by 2006, they had plenty of reasons to be skeptical about Bernie Madoff's 9.4% return.

The Fairfield Greenwich Group had its own issues, too.

In 2005, the Bayou Hedge Fund fraud was exposed and everyone found out that Samuel Israel, the fund manager, had fabricated an entire auditing firm out of thin air. Naturally, FFG's investors were concerned and they began asking questions about FFG's auditors and Bernie's (David Friehling who is on his way to prison).  

In a memorable email exchange between FFG principal, Jeffrey Tucker and CFO, Daniel E. Lipton, Tucker asked Lipton about the size of Friehling & Horowitz at the request of an investor. Lipton told Tucker that F&H was a small-to-medium sized firm that had "hundreds of clients" and was well-respected in in the local community. In Lipton's opinion, the size of an auditing firm didn't really matter and he cited as Enron as an example.

Two days later, the FFG controller told Tucker that Freihling & Horowitz was a one-man band but whether Tucker told the investor is not clear since the meeting with the customer had already taken place. Tucker would have known investors would be up in arms to learn that Bernie was audited by a one-man firm because they were up in arms about one of his funds being audited by a two-man firm.

FFG had two major Madoff-invested funds, Fairfield Sentry, based in the British Virgin Islands and Greenwich Sentry, a U.S. entity. Fairfield Sentry was audited by Pricewaterhousecoopers. Greenwich Sentry, however, was audited by a two-partner firm in Greenwich, Berkow Schecter, up until 2005 when Pricewaterhousecoopers took over.***

FFG probably let Berkow Schecter go in 2005 because customers were concerned that it was too small to be auditing a $167 million hedge fund. They may have been right. A comparison of the 2004 report to the one prepared by Pwc in 2005 shows a different level of disclosure.

Ed Schecter, one of the Berkow Schecter partners, is on the Madoff customer list several times which may have been a conflict of interest.

 Then there's the compliance issue.

In December 2005, the SEC contacted the Fairfield Greenwich Group in connection with the Harry Markopolos complaint. I think the  SEC also took a look at FFG's operations and mandated some changes in the way it operated. 

As disclosed in the 2005 and 2006 financial statements, Greenwich Sentry placed its unqualified investors in a new partnership which ostensibly was a legal move to increase the allowable number of investors in GS. The fund's general partner, Greenwich (Bermuda) Ltd. then registered with the SEC as an investment advisor and, as a result, had to disclose certain information about its operations.   

These changes took place in March 2006, only three months after the SEC made its initial contact with FFG. The wording in the note to the financials makes it appear that the changes were voluntary. But if the changes were made at the behest of the SEC, it raises questions about FFG's much-vaunted compliance department and whether FFG openly flouted SEC rules.

The Fairfield Greenwich Group's seeming indifference to auditors and to the rules cost its customers $7 billion. When does it stop being indifference?

Me, I'd like to know if FFG ever talked to Bernie about where the market was headed.

** Rates of return for 2004, 2003, 2002, 2001 and 2000 were 6.4%, 7.3%, 8.4%, 9.8% and 10.7%, respectively. 

 *** The Fairfield Greenwich Group itself is audited by Rothstein Kass, according to the 10/07 due diligence report. RK specializes in hedge funds.

References:

Fairfield Sentry historic rates of returns for all years here.
Greenwich Sentry financial statements here and here.
Fairfield Sentry financials here, here, here and here.
Fairfield Sentry due dliligence report dated October 2007 here.
Email exchange between Tucker and Lipton here (Exhibit 18).
Chart of Sentry redemptions and subscriptions here (last page). 
Reference to $1 billion net withdrawal over 16 months here (p.11).