By Najib Aminy and Cindy Liu
In light of the current economic crisis, which has served as the catalyst for many drastic changes, it becomes almost painfully obvious who has been practicing good financial habits. This environment forced financier Bernard Madoff to expose his 40-year operation. Thousands of investors have lost millions of dollars with Madoff through his alleged Ponzi scheme. The Stony Brook University Foundation-a privately governed non-profit organization created for the benefit of the University-is no exception.
Like many other charities and university endowment funds, the Stony Brook Foundation became a victim to one of the world’s largest pyramid schemes, losing $5.4 million of its $120 million endowment.
The Stony Brook Foundation manages donations for the benefit of the University, Medical Center and Veterans Home, and is responsible for distributing scholarships and improving student life. Donations go into the endowment fund where the money is invested in hopes of creating a larger return and giving more back to the University.
Yet there won’t be as much of a return as prior years. According to Dr. Robert J. Frey, Co-Chair of the Investment Committee, the foundation lost 4.5 percent of its total endowment fund to Madoff and is 15 percent down from the end of last November. While the total amount invested is unknown, Frey is certain that it was a significantly large number.
The foundation’s direct investment with Madoff dates back to 1994. “What happened with Madoff, quantitatively, he had a very low risk measure and had steady returns,” Frey said. “They weren’t quite unbelievable, but they were really good.” However, qualitatively, the foundation noticed some risks, specifically with the lack of transparency. That detection ultimately led to a reduction in its investment from 15 percent down to 5 over the period of a few years.
Frey said he doesn’t believe Madoff started off his business in 1960 with the intention to run a Ponzi scheme. Simply put, a Ponzi scheme requires an exponentially increasing number of investors in order to continually sustain itself. Eventually, it collapses under its own weight. According to Frey, it was the recently declining economic climate that facilitated this incident. Investors who normally would not ask for returns suddenly found themselves in dire need of them. “It was probably not a planned fraud, but once it got away from him he just embraced it,” Frey said.
One potential warning sign that may have tipped people to Madoff’s scandal was that he was not using a custodial bank. However, not everybody does. A custodial bank is a third party in which the investment manager would direct the bank manager to put a certain amount of money into specific funds and so on. The bank serves as an administrator and manages the books and records of the investment company.
“Madoff formed his own custodial shell around his assets, which is not uncommon, but one of the things that allowed him to perpetrate this fraud.”
At the same time, Frey says the foundation ranks in the top 10 percent in the nation in terms of college endowment funds.
The Stony Brook Foundation was the only endowment fund involved linked to a state university. However, it did not suffer as badly as other schools. Compared to the $20 million lost by Tufts University, $24 million lost by New York University, and the $110 million lost by Yeshiva University, Stony Brook University remains in good shape. “There is the absolute sense in which you hate to lose money at all, but there is the comparative sense in which we were losing half as much as everybody else,” Frey said.
Many investors were connected through feeder funds, also known as fund-of-funds, which conducts its investors through managing other funds. In this way, people who were indirectly linked unaware of their connection lost millions of dollars. The Stony Brook Foundation was directly invested with Madoff.
One reason that The Stony Brook Foundation’s loss was minimized is because of the approach that it takes towards investments. “Rather than hit a return target, we actually have a risk target,” said Frey, who is also a professor in Applied Mathematics and Statsics at Stony Brook. Frey said that a lot of other people focus on getting a high return regardless of the level of risk, which is not always a good approach. Rather than investing everything with one investor, the foundation holds funds in approximately 25 separate investments.
Taking these numbers into account, the impact of the loss was minimal. “Times are bad, but they’re not that bad,” Frey said.
The Stony Brook Foundation offices could not be reached for comment in time for the publication of this issue.