Madoff wasn't a hedge fund

Further to my post yesterday, and despite my own desire to use the Madoff case to have a pop at hedge funds (!), I think we need to be clear that this isn't primarily a hedge fund issue. I'm nicking the text below, which sets out the facts pretty fairly, from an email I got this morning:

The New York Times, for example, has written "Mr. Madoff was not running an actual hedge fund, but instead managing accounts for investors inside his own securities firm. The difference, though seemingly minor, is crucial. Hedge funds typically hold their portfolios at banks and brokerage firms like JPMorgan Chase and Goldman Sachs. Outside auditors can check with those banks and brokerage firms to make sure the funds exist." For his part, Bernard Madoff had consistently stated that he did not run a hedge fund, and that his primary business was market-making. In a 2001 interview, Madoff compared his firm's role to a privately managed account at a broker/dealer, with the broker/dealer providing investment ideas or strategies, executing the trades, and charging commissions on each trade.... [A]ll incentive fees generated by the trades, all the administration and marketing, and all the investor relations were received or conducted at the third-party feeder fund level - in sharp contrast to the standard hedge fund model.

So 'better' or 'tougher' or whatever else-er regulation of hedge funds is not the obvious problem/answer here. Having said that, those who argue that this has no bearing on hedge funds at all are also wrong in my opinion, because hedge funds themselves did invest in Madoff. There are questions about exactly how they decide what is and isn't a good investment.

The scale of this fraud - if it was it has been reported to be - is mind-bogglingly large. And it is first and foremost a fraud - something that we can't regulate out of existence, even if we can get better at stopping them happening. But the second story here is one of colossal ineptitude on the part of supposedly professional investors. The fact that major investors were taken in is almost as worrying as the fraud itself.