Santander’s Optimal Strategy with Madoff – plain dumb or crooked?

“So we lost your $3.6bn in a fraud. Sorry guys, but we are also victims here – we’ve lost $17m” – that’s pretty much Santander’s line so far to investors in Optimal Strategic US, its feeder fund into Madoff. Does the “innocent victim” line stand up to scrutiny?

Optimal Investment Services (redesigned post-Madoff) website still boasts that they have “more than 18 years of experience in the alternative investment field. Talented and highly-qualified research team drawn from investment banking, trading and investment management and holding numerous MBA, CFA and MFin designations”. This does not sound like a group of innocent schoolgirls. To get a CFA you have to understand options and equity markets enough to know Madoff’s strategy would require trading more than the entire volume on US equity options markets. To get an MBA you need to know enough about accounting and operational risk to spot that a one-man, one-client accounting firm does not count as an independent and reliable audit. With 18 years of experience in the field you would have to question the bizzare structure that Madoff proposed. You cannot plead ignorance.

An investor in Optimal Strategic US would have read (on the old website), that “once a fund has been earmarked as a potential investment our analyst teams thoroughly research, analyze and evaluate it. In addition to rigorous scrutiny of the hedge fund’s investment process we conduct a thorough operational review”. Given the calibre and experience of the “talented and highly-qualified research team”, they should have spotted a Ponzi scheme with implausible returns and nothing but Madoff’s word to back it up. The problem was – it was not in their interest to look too closely.

In fact, Optimal Strategic was a best-seller for the group. Given the low volatility and consistent returns it practically sold itself. Even people who might have otherwise been suspicious, swallowed the story as it was dressed up in Santander’s respectability and backed by “rigorous scrutiny”. It was a knock-out combination that required no work, risked “other people’s money” and brought in $77m in annual fees (2.15% on 3.6bn by 2008). Why kill the golden goose?

The people working for Optimal had a huge incentive not to probe too deeply, as they were being paid for increasing assets under management. And there was no better way to do it than by having the world’s most consistent returns packaged in a “safe” product offered by the world’s 9th biggest bank. Even if Santander refunds its clients, the Optimal team gets to keep the bonuses it was paid over the last 8 years or so. It was in their interest, just like Madoff, to keep the scheme going and growing as long as possible without rocking the boat. Madoff is going to prison and having all his toys taken away, while they will (maybe) lose their jobs or take a pay-cut. In fact, they have done better out of the scam than anyone else.  As for the $17m that Santander lost, it only represents a part of the year’s fees and certainly not a conscious and convincing investment by the bank.

In a sense, Santander as an institution is also a victim. Optimal is only a small part of the bank’s empire. While the cash was rolling in, nobody from higher up would want to interfere with its operations. However, after having to pay out for repackaged Lehman products, following its bankruptcy in September, top management must have decided to have a closer look at its subsidiaries. According to a recent  article (in Spanish) on Cotizalia.com, Santander’s chairman Emilio Botin sent his right hand man Rodrigo Echenique and a team directly to Madoff in November 2008. Unsurprisingly, they did not like what they saw and Santander demanded all the money back. This may well have contributed to the collapse of the scheme a few weeks later – the rest is history. However, by giving its Optimal subsidiary its backing and respectability for a decade, while failing to monitor its activities, Santander has commited itself. The sudden concern was right but far too late.

Under international law, assisting money laundering is a serious crime, even if you don’t know you are doing it. As a financial professional you are obliged to spot and report red flags – even if you pretend not to notice, you go to jail. Your employer gets fined for not training and controlling its employees. Assisting a fraud must be treated the same way. If Optimal’s investors are not compensated, the door is wide open for many more Madoffs.

It will probably be impossible to prove that Optimal’s whiz-kids willingly looked away and were complicit in the fraud. They will play dumb, act shocked and find another job. The big failure has to be with Santander’s organisation which incentivised such behaviour and promoted it without any control. The bank must now pay for this failure, otherwise it will have also benefitted from the fraud ($500m in fees over 10 years?), without learning any lessons. It needs to change its structures to ensure there is no repeat. Playing dumb is not an option for an institution that spans the globe and runs a balance sheet of over E900bn.

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