TheImportance
of Being Diligent
Trust, but Verify Webinar
N.1: Made-off Japan
“The truth is rarely pure and never simple.”
Oscar Wilde, The Importance of Being Earnest
Can you tell the similarity in
the following two charts?
0%
50%
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500%
Nov
-90
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-91
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-92
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g-9
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94
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-96
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r-9
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r-0
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Nov
-11
Fairfield Greenwich Sentry
(A feeder fund for Bernie Madoff) AIM Millennium Fund
(A flagship fund of AIJ)
Excellent Track Record
Far Better Than Madoff
-20%
0%
20%
40%
60%
80%
100%
120%
140%
160%
180%
200%
May-0
2
Aug-0
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AIJ: 16.91% p.a.
Madoff: 7.20% p.a.
Successful Business
(1,500)
(1,000)
(500)
-
500
1,000
1,500
2,000
2,500
Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11
AUM
In Reality…
(1,500)
(1,000)
(500)
-
500
1,000
1,500
2,000
2,500
Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11
AUM
Cumulative Losses
Confirmed Assets
Fraud Ranking…
Case Name Portfolio Manager(s) Estimated Size
Madoff Bernie Madoff $60,000,000,000
Stanford Alan Stanford $8,000,000,000
Petters Thomas Petters, et al $3,650,000,000
AIJ Kazuhiko Asakawa, et al $2,400,000,000
Absolute Capital Florian Homm, et al $2,100,000,000
WG Trading Steven Walsh & Paul Greenwood $1,300,000,000
Millennium Michael Balboa $844,000,000
Weavering Magnus Peterson $639,000,000
K1 Helmut Kiener $597,000,000
Manhattan Michael Berger $575,000,000
Bayou Sam Israel $450,000,000
Lake Shore Philip Baker $312,000,000
Beacon Hill John Barry $300,000,000
Scoop Arthur Nadel $300,000,000
PAAMCo Paul Eustace $278,000,000
Westgate James Nicholson $220,000,000
Top16 Total $81,965,000,000
Made-off Japan…
• Background
• Japan’s Structural Problem
• How did they hide losses?
• There were Many Red Flags
• Q + A
Made-off Japan
Background
• Founded in 2000 by Kazuhiko Asakawa, a
legendary salesman at Nomura Securities.
• Marketed as an option-related strategy with
low volatility and low correlation to the
markets.
• AIJ had operated a $2.4 billion Ponzi scheme
for more than ten years until February 24,
2012. Most of investors are Japan’s small and
medium corporate pension funds.
Japan’s Structural Issues
Pension Problem
• Under pressure to find higher return
opportunities with limited resources… they only
generated a 2.97% p.a. from 1996 to 2010, far
short of the original target of 5.50% p.a.
0%
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Average Pension Fund
Target
Start of the zero % interest rate policy
Pension Problem (cont’ed)
• There are 1,395 corporate pension funds in
Japan (2011) and almost 1,000 funds (75%) are
managing assets less than $300 million.
• Only 12% of those pension funds hire a
consultant because they cannot afford to.
• Some pension funds invested almost 50% of their
assets in AIJ.
How did they Hide Losses?
Contractual Relationship
ITM Securities
AIJ Investment
Advisors
Japanese Trust Bank
Discretionary
investment
contract
Trust agreement
Discretionary investment
contract
Application for
subscription
Application for
subscription
Investment Instruction
Customer
(pension fund)
AIJ Funds
Cayman Islands
Money Flow
ITM Securities
Japanese Trust Bank
Customer
(pension fund)
AIJ Funds
Cayman Islands
Fund trustee bank
(HSBC?)
Financial broker
Overseas Fund
Derivative transactions on
Market (Nikkei
futures/options, JGB
futures/options)
Venture Investment Alpha &
Venture Investment Alpha II
Paper Chase
Investment Manager
(AIJ)
Administrator (AIA)
Trust Bank
Investors
Brokers
Investment Manager
(AIJ)
Placement Agent (ITM)
Trust Bank
Investors
Independent Auditor
Brokers
Monthly Statements Annual Financials
100%
Own
Fabricated NAV
Fabricated Financials
80% Own
(indirect)
Hidden Facts
• ITM Securities, Global Fund’s placement agent
in Japan, was 80% owned by AIJ, directly and
indirectly.
• AIA was established, owned and controlled by
AIJ.
There were Many Red Flags
Criminal History?
• Shimpei Matsuki, a former head of Nomura’s
powerful equity department and Asakawa’s
long-term friend, was a principal of AIJ.
• Matsuki’s criminal record shows that he was
arressted in 1997 while he was at Nomura and
sentenced 8 years (with suspension of 3 years)
for his involvement with an infamous payoff
scandal.
Compliance Violation?
• AIJ began its operation in 2002 as a non-
discretionary investment advisor and was not
allowed to manage a fund by itself.
• Without permission, AIJ launched a Cayman-
based fund in 2002 and lent a name of
Cigna, which had a discretionary advisory
license, to serve as an investment advisor of the
fund, until their merger in 2004.
• This is potentially a violation of the securities
law in Japan.
Suspiciously Little Revenue?
• In 2010, AIJ purportedly managed ¥390 billion.
• However, the firm earned only ¥423 million
(approx. $5 million) as revenue, including
management fees. This is only 11bps (0.11%) of
the firm’s AUM.
Option Arbitrage?
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Ma
y-0
2
Oct
-02
Ma
r-0
3
Au
g-0
3
Ja
n-0
4
Ju
n-0
4
No
v-0
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Ap
r-0
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Se
p-0
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Fe
b-0
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Ju
l-0
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De
c-0
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Ma
y-0
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Oct
-07
Ma
r-0
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Au
g-0
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Ja
n-0
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Ju
n-0
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No
v-0
9
Ap
r-10
Se
p-1
0
Fe
b-1
1
Ju
l-11
AIM Millennium Fund
Nikkei 225
• AIJ claimed it generated returns through “writing put options on
TOPIX’… then, why could they make steady returns when TOPIX
continued falling in 2002 and 2007-2009?
No Prime Broker?
• In 2010, AIJ executed over ¥57 trillion (over
$700 billion) transactions through derivatives.
• The portfolio turnover was 146x a year.
• However, there was no evidence that AIJ had
ever engaged with any prime broker.
Equity
futures
Bond
futures
Equity
option
Bond
optionTotal
Transaction volume
(trillion yen)227 18 2 36 57
Turnover
(multiple of AUM)>1x 47x 5x 93x 146x
A Little-Known Admin?
• It is unusual for a $2.3 billion fund to use AIA, a
little-known administrator.
Source: “2013 Survey Results – Hedge Fund Operational Due Diligence”, Bill Bogle, NEPC, LLC
A Little-Known Admin?
• Offshore administrators must be recognized by
local authorities to provide administrative
services.
• AIA was established in the BVI, but was not
recognized by the BVI Financial Services
Commission as a “Sub Cat. B – Admin of
Investment Mutual Funds.”
www.bvifsc.vg/en-gb/regulatedentities.aspx
Summary
• Obtain financials directly from an auditor
• Check legitimacy of an administrator
• Check reputation among broker society
• Investigate a history of an investment manager
• Check employee’s past record
• Check affiliation of a placement agent
Trust, but Verify!
Q + A
See you next month!
Trust, but Verify Webinar Series (No. 2)
From Minnesota with Lies: Petters Case