WHY A MADOFF SCANDAL COULDN'T HAPPEN IN ISLAMIC FINANCE

The Madoff scandal reveals a major weakness in the hedge fund business, resulting in the fraudulent activity that is the fuel behind speculative bubbles and the “magic” behind all financial scams. No-one in recent times has exploited this as blatantly as Wall Street major player Bernard Madoff, a former NASDAQ chairman arrested for allegedly running the biggest dollar Ponzi scheme of all time.

His victims include wealthy friends and family as well as banks and numerous financial institutions such as HSBC Bank, BNP Paribas Bank, Fortis Bank, Bank Medici, Fairfield Greenwich, Nicola “Supermum” Horlick’s Bramdean Alternatives and many more, valued in total at more than $50bn. This figure raises questions. How could such a large shortfall have arisen, given that Bernard Madoff Investment Securities had assets of only $17bn under management at the start of the year? The funds run by Madoff were not advertised as being leveraged, although derivatives were supposedly used to reduce volatility. But who now knows? Nothing about his “black box” investment process can now be believed.

The supposition is that it was a giant Ponzi scheme, with returns funded by new investors. But if that is the case, Mr Madoff must have been raising hundreds of millions of dollars a month to achieve his alleged returns of about 10% a year. In these markets, however, raising that kind of money is tricky and his downfall came when some investors actually asked for their money back, as investors will now do from a host of other funds.

The biggest question is how a scam of this size can remain a secret for so long? This is especially pertinent considering that there had been suspicions about Mr Madoff’s consistent record for some time. Even if he was working alone, sophisticated investors as well as the SEC are accountable for negligence in their failure to perform risk assessment or report on unusual performance which could be the result of fraud on a large scale. Risk assessment in the conventional system needs to be re-examined.