RBS and Man admit exposure to $50 billion Madoff fraud

The Madoff pyramid scheme fraud continues to claim new counterparty victims

LONDON & NEW YORK - New victims have been revealed in Bernard Madoff's estimated $50 billion hedge fund fraud. Royal Bank of Scotland (RBS), now 58% government owned, and London-based hedge fund Man Group are the latest to admit exposure to Madoff's alleged giant ponzi or pyramid scheme - which duped investors with lucrative interest payments using deposits from new investors.

RBS has announced its potential loss will amount to about £400 million. Man Group has invested around $360 million through its RMF institutional fund business, which equates to 0.5% of the firm's total funds.

Madoff, a former chairman of the New York Nasdaq stock market, was arrested last week and charged with alleged fraud. Madoff's hedge fund allegedly ran up $50 billion of fraudulent losses - making the fraud the largest of its kind.

The list of counterparties already admitting exposure includes French bank BNP Paribas, Japanese bank Nomura and Spanish banks BBVA and Santander group, which owns UK banks Abbey, Alliance & Leicester and Bradford & Bingley. Santander alone said it had invested $3.1 billion through one of its funds in Madoff's pyramid swindle.

Accusations against US regulators of systemic failure have already begun in the relatively unregulated hedge fund industry. It has been revealed US regulator the Securities and Exchange Commission (SEC) had not investigated Madoff's activities since he registered his fund in 2006. The SEC says Madoff has now confessed there is "no innocent explanation" for his behaviour and he had "paid investors with money that wasn't there".

The incident increases the probability of a regulatory backlash as the new Obama administration prepares to take the political reins in Washington, while the hedge fund industry continues to reel from losses incurred over the past 12 months.

The international Hedge Fund Standards Board, which was formed in January 2008 to take forward the work started by the Hedge Fund Working Group to further best practice standards in the industry, was quick to point out the need for the industry to get serious about implementing robust governance standards.

"The Madoff scandal highlights just how important it is to have independence of process in relation to administration of the fund and valuation," says Antonio Borges, chairman of the Hedge Fund Standards Board. "It also highlights the need for robust governance practices and oversight through independent boards, which will challenge management procedures and behaviour. The hedge fund standards are designed to address exactly these issues, to help prevent such events from happening, and to provide investors with the necessary transparency. This is why an increasing number of managers are signing up to the HFSB standards."

While it is too early to quantify the possible legal fallout among affected counterparties, industry practitioners are already saying operational risk managers are increasingly being called in to fight the fires, along with their legal, anti-fraud and audit colleagues.