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?

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Fairfield Greenwich Sentry

(A feeder fund for Bernie Madoff) AIM Millennium Fund

(A flagship fund of AIJ)

Excellent Track Record

Far Better Than Madoff

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AIJ: 16.91% p.a.

Madoff: 7.20% p.a.

Successful Business

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In Reality…

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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.

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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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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