The Emperor's New Securities

Last December we noted that a Connecticut bank had been drawn into the Madoff scandal. Now the holders of more than two dozen retirement accounts are suing Westport National Bank, which served as custodian of the $60 million in their accounts. Except, of course, there was no $60 million – everything was invested with Madoff.

Madoff's operation is still a puzzlement. Both fund-of-fund managers and direct investors seemed to think of it as a hedge fund. Yet hedge-fund investors own partnership interests or shares or something. Madoff investors owned nothing; they merely opened brokerage accounts with him.

The New York Times succinctly describes the problem of custodianship that resulted:

[Westport National's custodian] agreement … indicates that the bank would take custody of whatever investments Mr. Madoff made on the customers’ behalf. For example, the agreement specifically requires the bank to adequately document the customers’ ownership of investments made with the Madoff firm “and held by the bank as custodian.”

In fact, there was nothing for the bank to hold since Mr. Madoff never bought any securities for his investors, according to the bankruptcy trustee ….

You can read the entire custodian agreement here.