In the wake of Tufts’ announcement on Friday that it had lost $20 million of its endowment in Wall Street mogul Bernard Madoff’s alleged $50 billion Ponzi scheme, the university has maintained that its investment met due diligence standards.
When the Board of Trustees’ Investment Committee approved an investment in Ascot Partners in 2005, the body was aware that the hedge fund was linked to Madoff, Director of Public Relations Kim Thurler told the Daily yesterday.
Thurler maintains that university officials followed appropriate guidelines, despite widespread outcry from the financial community in recent days that Madoff’s methods had raised a number of red flags and that his returns were simply too good to be true.
“Before making this investment, the university followed all of its usual due diligence procedures, including a full legal review and full review of the fund’s investment strategy, and an analysis of the risks and strengths of the investment, including audited returns,” Thurler said in an e-mail. “In light of this analysis, this investment seemed to be a prudent one.”
But after Madoff’s arrest on Dec. 11 for securities fraud and his own admission of deceiving investors, University President Lawrence Bacow announced in an e-mail to the community that Tufts, too, had fallen victim to the former Nasdaq chairman’s scheme.
The school has written off the total amount of the $20 million investment, which represented nearly 2 percent of Tufts’ endowment, and its disappearance will not significantly impact operations, Bacow said. He added that the university will participate in investigations of the fraud and will attempt to recover its losses.
Meanwhile, Ascot Partners and its manager Jacob Ezra Merkin are the first in what is likely to be a series of firms and individuals to be sued by investors looking to recoup funds. Tufts is currently evaluating available legal avenues, according to Thurler.
“At this time, we can’t predict if we will be able to recover any portion of the loss, but we are exploring all our options, including legal action,” she said.
For Tufts and other misled investors, any results will likely take time to come to fruition. “This will go on for years,” Economics Lecturer Christopher McHugh said. “Everybody will go after everybody else … I don’t think there’s any simple legal device.”
The casualty list
While Madoff’s alleged fraud may have pulled $50 billion out of the economy and left victims scattered across the globe, college endowments have emerged relatively unscathed.
James Hedges IV of LJH Global Investments, a firm that specializes in investing in hedge funds and private equity for wealthy families, told Fortune Magazine that the absence of universities from the casualty list likely stems from their adherence to a more traditional investment playbook.
“[With Madoff], when you get to page two of your 30-page due diligence questionnaire, you’ve already tripped eight alarms and said, ‘I’m out of here,'” he said.
Aside from Tufts, Yeshiva University and New York Law School have also reported losses. All three institutions shared a common thread: their connection to Merkin.
New York Law School has filed a lawsuit against Ascot Partners and a firm that audited the hedge fund to recover $3 million in investments. Yeshiva was hit harder, according to school officials, who say they lost $110 million.
Other schools have also suffered indirectly. The failure of the Picower Foundation, a Palm Beach-based charity that was active in the Boston area, is expected to leave a significant dent in research efforts at Harvard and the Massachusetts Institute of Technology, for example.
While most colleges appeared to have stayed away from Madoff, Thurler said that his investments seemed strategically appealing.
“The investment was to provide a stable, low-volatility return and represented a very small percentage of our endowment,” she said.
So far, Tufts economists have hesitated to criticize the trustees’ Investment Committee for the $20 million in losses, but they have pointed to lingering questions.
“I’m somewhat surprised, I must admit, that the whole $20 million was put into one place. I would normally expect that they would diversify to some extent,” Economics Professor George Norman said. “[But] I don’t want to second-guess the Investment Committee of the university, because the Investment Committee has done a very good job over the years.”
McHugh, who works at the Boston hedge fund New Generation Advisors, placed most of the blame with Ascot Partners. He said that the fund’s managers should have pressed Madoff for more details on his investment strategies and insisted on seeing more documentation.
Investors who did actually grill Madoff, he said, generally avoided entrusting their money to him. “With Madoff … they weren’t getting anything really except for some cursory statements,” McHugh said. “I don’t think that Ascot Partners [was] doing their job right.”
Still, the university also could have been more cautious, McHugh added. “I do think that perhaps they weren’t as suspicious as they should have been,” he said.
Beating the market
According to most financial experts, what many saw as the most enticing attraction of investments with Madoff – the regular 10 to 17 percent returns – should also have been the biggest red flag.
While higher returns generally come with added risk, Madoff’s strategy appeared to be entirely safe. Instead of questioning the logic of the system, McHugh said, most investors naively clung to the belief that Madoff was merely smarter than the market.
“In this business, a lot of people are cocky,” he said. “We have a tendency to believe that the market is easy to beat.”
According to McHugh, this philosophy flies in the face of the concept of the efficient market. He called Madoff’s unfailingly high returns “absurd.”
“Anybody who believes in the efficient market would pick that up,” he said.
Norman, too, registered surprise that so many investors implicitly trusted Madoff. He cited the example of the European bank Société Générale, which internally blacklisted Madoff after noticing a surprising number of warning signs.
“They refused to put money into Madoff’s accounts because when they went over and talked to him, they were suspicious,” Norman said. “It’s surprising that other financial bodies weren’t equally suspicious.”
The blind faith investors often put in Madoff represents a larger dependence in recent years on hedge funds that aim to significantly outperform the market, McHugh said.
“There are a lot of people out there who want to think that there are these market-beating investors who can pull it off,” he said. “There was the perception that they would do better and that they would not have the downside risk – that they were nimble [and] could move around quickly.”
Colleges have been particularly drawn to hedge funds in recent years, McHugh said. “For a while, it worked out great,” he said. “Everybody loved hedge funds until this year.”
A ‘sophisticated’ crowd
Even if red flags truly did abound, the very ability of Madoff to draw the rich and powerful from around the world into his web of deceit is telling, sources said. Madoff, 70, formerly chaired the Nasdaq and was a pioneer in electronic trading.
“Let’s be frank: Madoff managed to attract a lot of very, very sophisticated people,” Norman said. “You’re looking at major financial institutions, major banks, all of whom have done their due diligence and decided to invest in Madoff. So it’s very difficult to work out where the blame should lie here.”
Tufts does indeed join a star-studded crowd of victims, one that contains the likes of Britain’s Royal Bank of Scotland; Spain’s largest bank, Santander; the Elie Wiesel Foundation for Humanity; a U.S. senator; and a co-founder of the retail store Bed Bath & Beyond.
“We, along with many knowledgeable investors, were deceived by dishonest individuals,” Thurler said. “Outright fraud can be difficult to detect through even the most sophisticated systems.”
As a result, Tufts administrators and federal officials alike have promised to look into institutional reforms.
“[We] are reviewing our processes and procedures to see if there are any ways to strengthen them or other lessons to be learned,” Thurler said, echoing comments made by Bacow in his Friday e-mail.
On the national level, the Securities and Exchange Commission (SEC) has been a popular target for criticism, with detractors saying that the body ignored the warning signs that emerged over the years. In fact, it recently came to light that a Massachusetts investor repeatedly warned the SEC over the past nine years about the possibility that Madoff was running a giant Ponzi scheme, but the commission did not take any substantial action.
“I think the SEC has got so much egg on its face that it’s really got to go and revisit its [policies],” Norman said. “There’s a sense that the SEC has been pro-deregulation; perhaps they’re going to have to revise their stance on that.”
But McHugh argued that additional regulation is not the answer. Instead, he encouraged increased responsibility among individual investors. “The more [we] regulate, the more people say it’s not their problem,” he said.
Expected impacts on the Hill
The Madoff scandal comes at a difficult time for the university on the financial front. In light of an increasingly dire economic outlook, the administration has projected a 25 percent decrease in the value of the school’s endowment this year. In addition, it is planning for an expected $36 million in budget cuts for next year.
In his e-mail to the community, Bacow acknowledged the administration’s financial stewardship obligations and pledged to seal any potential loopholes.
“We deeply appreciate the trust and confidence that each donor places in the university,” he said. “We also have an obligation to our students and faculty to manage these resources wisely for their benefit.”
Director of Advancement Communications and Donor Relations Christine Sanni said that while she expects contributors to share the university’s outrage, she does not anticipate a decline in their willingness to give in the wake of the Madoff scandal.
“We don’t think this news will affect our efforts to raise funds for our students and faculty,” she said in an e-mail. “Tufts is fortunate in having many alumni and friends who remain as committed to Tufts as ever and a dedicated advancement team that is able to steward those relationships.”
University officials have emphasized that they do not foresee any cuts in services stemming from the losses.
“The payout from our endowment for next year is determined by combining the value of all investments – not a single investment – and establishing a percentage payout for all programs,” Thurler said.
The Madoff scandal, as well as the expected decline in the value of the university’s endowment due to bleak economic conditions, comes in the midst of Beyond Boundaries, a capital campaign aiming to raise $1.2 billion by 2011.
While the campaign’s public phase kicked off in late 2006, its quiet stage began in 2002 – three years before Tufts made its investment with Ascot Partners. Sanni was unable to say if any of the lost money came from donations made through the campaign.
“Once a gift is made to the university, it’s treated as a pooled resource. In other words, the endowment as a whole is invested – not any one gift or fund,” she said. “Though there may have been Beyond Boundaries dollars within [the lost funds], it would have been a small portion of what’s been raised to date.”